R&W Technical Services Ltd. v. Commodity Futures Trading Commission

REVISED MARCH 1, 2000

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

______________

No. 99-60182
______________

R & W TECHNICAL SERVICES LTD.; GREGORY M. REAGAN,
Petitioners

versus

COMMODITY FUTURES TRADING COMMISSION,
Respondent

______________

Petition for Review of an Order of the Commodity Futures Trading
Commission
______________

February 24, 2000
Before HIGGINBOTHAM and SMITH, Circuit Judges, and FALLON*,
District Judge.

PATRICK E. HIGGINBOTHAM, Circuit Judge:

Petitioners petition for review of a final order of the

Commodity Futures Trading Commission affirming violations of the

Commodities and Exchange Act and assessing a civil monetary penalty

of $2.375 million. We AFFIRM the finding of liability, but find

that the civil monetary penalty imposed was not reasonable in light

of the violations at issue and that in assessing the penalty,

mitigating evidence was improperly excluded from consideration. We

REVERSE the order imposing a civil penalty and REMAND for a new

assessment consistent with this opinion.

*
District Judge of the Eastern District of Louisiana, sitting by designation.
 I.

From April 1993 to March 1996, the petitioners, R&W Technical

Services, Ltd., sold computer software to individuals interested in

trading commodity futures contracts. This software required users

to provide a source of real-time financial data which the software

analyzed each day. Based on preset formulas and the real-time

data, the software made buy and sell recommendations that the user

was advised to act upon at the open of trading the next day. In

order to help sell the software, the petitioners’ advertisements

included claims of enormous profits made during their seven years

of trading with this system.

The advertisements characterized these results as “certified.”

The advertisements claimed that one reason R&W was selling this

proprietary software was to generate more capital which they could

invest with their system. Some advertisements stated that the

software was only available in “limited quantities” and encouraged

buyers to act quickly. The petitioners sold upwards of 1,000

copies of their software for prices of approximately $2,500 per

copy. The advertisements offered to refund the purchase price plus

10 percent if the user did not show a profit after a year of using

the system; apparently, only 11 customers ever requested a refund.

What the petitioners neglected to mention in their

advertisements is that they never tested their system by making any

trades in actual markets with real money. Instead, all of their

performance data came from “paper” trades. In other words, the

petitioners ran their system on real-time data but only pretended

2
to perform the trades which their program recommended. The

petitioners kept track of these virtual gains and losses and then

presented the results as having been obtained with real cash.

On March 19, 1996, the Commodity Futures Trading Commission

filed a four-count administrative complaint against the petitioners

and its constituents, Gregory M. Reagan and Marshall L. Worsham

individually, alleging violations of the Commodity and Exchange Act

(CEA).1 Count I alleged fraud in the solicitation of customers in

violation of CEA § 4b(a)(i) and (iii). Count II alleged that the

sellers were acting as Commodity Trading Advisors (CTAs) without

being registered, in violation of CEA § 4m(1). Count III alleged

fraudulent sales practices and fraudulent advertising as CTAs in

violation of CEA § 4o(1) and Commission Rule 4.41(a). Count IV

charged the petitioners with failure to produce required records

and books. Reagan and Worsham also were charged as aiders and

abettors and controlling persons for R&W’s violations. On December

1, 1997, an Administrative Law Judge found R&W and Reagan2 liable

on all counts and imposed a civil penalty of $7.125 million.

On May 16, 1998, the petitioners timely moved to reopen the

hearing for evidence of customer satisfaction which might mitigate

the penalty. On March 16, 1999, after de novo review, the

Commission affirmed in part and reversed in part the ALJ decision.

The Commission affirmed violations under Count I (fraudulent

solicitation) and Count III (fraudulent advertising). The

1
See 7 U.S.C. §§1 et seq.
2
Worsham died in 1996.

3
Commission declined to reach Count II (failure to register as a

CTA) or Count IV (record keeping). The Commission denied the

request to reopen the hearing for mitigating evidence, ordered the

sellers to cease and desist from their violations, and imposed a

penalty, jointly and severally, of $2.375 million. The sellers

then petitioned for review of the Commission’s final order.

II.

A.

The petitioners contend that there is insufficient evidence to

support a finding of materiality, an element of fraudulent

solicitation under CEA § 4b(a)(i) and (iii).3 Whether a

misrepresentation is material is “a mixed question of law and

fact,” involving the “application of a legal standard to a

particular set of facts.”4 A deferential standard applies to

questions of law encompassed by the agency’s expertise so long as

the agency’s conclusion is reasonable.5 However, “‘[w]hen the

question is of the sort that courts commonly encounter, de novo

review is proper.’”6 Because materiality in allegedly fraudulent

transactions is a question that courts often encounter, de novo

review is proper at least insofar as the application of the law to

the Commission’s findings of facts, which are conclusive “if

supported by the weight of evidence.”7

3
See, e.g., Herman v. T&S Commodities, Inc., 592 F. Supp. 1406, 1416 (S.D.N.Y.
1984).
4
TSC Indus. v. Northway, Inc., 426 U.S. 438, 450 (1976).
5
See Ryan v.CFTC, 145 F.3d 910, 916 (7th Cir. 1998).
6
See id. (quoting Monieson v. CFTC, 996 F.2d 852, 858 (7th Cir. 1993)).
7
CEA § 6(c).

4
 In this case, the petitioners misrepresented hypothetical

trading results as real trading results. They sold software

proclaiming that high profits had been obtained through actual

trading over a period of years. These results supposedly had been

“certified.” In fact, however, no actual trades were ever made

with their system. Instead, all results were simulated, and the

petitioners risked no money in testing their system.

A statement or omitted fact is “material” if there is a

substantial likelihood that a reasonable investor would consider

the information important in making a decision to invest.8 We have

little hesitation in saying that a reasonable investor would regard

as material the fact that the petitioners’ trading system “had

never been tested through actual trading.”9 Specifically,

according to the Commission’s expert, “hypothetical trading results

have many inherent limitations.” For example, such results assume

a customer can execute his trade at the opening price. They also

ignore the ability of a customer to steadfastly adhere to a

particular trading scheme even when confronted with an initial

series of losses.

The petitioners attempt to characterize their method as not

hypothetical or unreliable because their results were based on

real-time data and not based on the benefit of hindsight. In the

end, however, the problem with reporting hypothetical trading

results as real is that it allows an unscrupulous seller to test an

8
See TSC Indus., 426 U.S. at 449.
9
Levine v. Refco, Inc., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH),
¶ 24,488, at 36,115 (CFTC July 11, 1989).

5
arbitrarily large number of potential investment systems at little

cost and then merely market the ones that happen to do best. Even

if each system tested used real-time rather than historical data,

the choice of which system to market introduces a hindsight bias.

If real money is used in testing, a seller cannot afford to

indulge in such cherry-picking, which means investors can have more

confidence in the seller’s claims. There is no allegation that R&W

tested multiple systems and only marketed the best, but this

rationale nevertheless explains why any reasonable investor would

be skeptical when hypothetical results are portrayed as real.10

The petitioners’ advertisements proclaimed that the money made

through their software sales was plowed back into real trades using

their system. This also was a misrepresentation. The Commission

found that the use of a trading system by its developers is a sign

of authenticity, which reasonably increases consumer confidence in

buying and using the system. The petitioners contend that these

representations were of no additional benefit to consumer

confidence, given that the petitioners already offered a money-back

guarantee and had placed their corporate logo on the product.

Actual futures trading, however, creates exposure to

substantial risk. A claim that one trades pursuant to the system

one sells clearly expresses a higher level of confidence than

merely putting a corporate logo on the product and offering a full

refund. The petitioners also misrepresented the risks of futures

10
See also In re Armstrong, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH)
¶ 26,332, at 42,612 (CFTC Mar. 10, 1995), aff’d, 77 F.3d 461 (3d Cir. 1993)
(rejecting an argument identical to the petitioners’).

6
trading by making bold predictions of high profits. Such claims

“amount[] to the type of guarantee of profit prohibited under

Section 4b of the Act.”11 The petitioners respond that their

guarantee of profits was backed only by a refund policy, which

clearly established the only risks they insured against. However,

the existence of a limited refund policy coupled with extravagant

claims of false profits only confirms that the petitioners

misrepresented the existence of the substantial risks inherent in

futures trading.12

The petitioners argue that the Commission presented little

evidence that actual trading would have been very different from

real trading. However, even accepting the petitioners’

characterization of the evidence as true does not change the fact

that their statements were fraudulent and would have made a

difference to a reasonable investor, even if the difference in

practice did not produce catastrophic losses. As the Commission

reasoned, a claim of “actual trading can convey to a customer that

‘these results have been achieved,’ [whereas] the petitioners’

method can only convey that ‘these results might have been

possible.’”13

Because simulated results inherently overstate the reliability

and validity of an investment system, and because extravagant

11
Levine, ¶ 24,488, at 36,115.
12
Rule 4.41(b) requires that certain disclosures about risk be made when
presenting the performance of hypothetical commodity accounts. The petitioners
protest that they were not charged with violating Rule 4.41(b). This is true,
but we also do not find any violation of Rule 4.41(b) was improperly used to
buttress any fraudulent solicitation violation.
13
In re R&W Technical Services, Ltd., No. 96-3, 1999 WL 152619, at *20, Comm.
Fut. L. Rep. (CCH) ¶ 27,582 (CFTC Mar. 16, 1999).

7
claims understate the inherent risks in commodities trading, a

reasonable investor would find the petitioners’ fraudulent

misrepresentations to be material.14

B.

CEA § 4b(a) prohibits any person from defrauding another

person “in or in connection with” a commodity futures contract.

The Commission interprets “in connection with” to reach the

petitioners’ conduct, while the petitioners dispute that any

alleged misrepresentations were made “in connection with” any

commodity futures contracts. To resolve this dispute, we first

must determine the proper standard of review.

1.

To the extent that a legal question involves the

interpretation of the CEA, the Commission should normally be

accorded a high level of deference,15 since the Commission is

entrusted with administering the CEA through rules and

regulations.16 Moreover, the Commission administers the CEA not

only through its rulemaking authority, but also through its

adjudicative power.17 As this court has stated, “[e]ven the

14
See CFTC v. AVCO Financial Corp., 28 F. Supp. 2d 104 (S.D.N.Y. 1998) (finding
similar misrepresentations to be material), appeal pending sub nom. Vartuli v.
CFTC, No. 98-6280 (2d Cir.); cf. CFTC v. Skorupskas, 605 F. Supp. 923, 933 (E.D.
Mich. 1985) (finding similar misrepresentations to violate CEA § 4b(a)).
15
See Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S.
837, 843-44 (1984).
16
See, e.g., 7 U.S.C. § 4a(j).
17
See, e.g., 7 U.S.C. §§ 9, 13.

8
adjudicative interpretations of policy-making agencies are entitled

to Chevron deference.”18

In the present case, however, Congress has given adjudicative

authority not only to the Commission, but also to the federal

district and appellate courts, both in terms of reviewing

Commission orders and decisions and in terms of original

jurisdiction over certain types of actions.19 However, the

Commission remains the only governmental body entrusted with

rulemaking authority in this area of law, and thus still remains

the primary authority for interpretive policy decisions.20

Although the federal appellate courts have the power to review

Commission orders and decisions, and although the district courts

have been granted original jurisdiction in certain cases under the

CEA, nothing in the CEA purports to lower the standard of review of

Commission orders and decisions with respect to questions of

statutory interpretation. Thus, because the phrase “in connection

with” is a term of ambiguous scope, and because the Commission is

the primary policy maker in this area, we find no reason to depart

from regular Chevron deference, despite the fact that federal

courts at some times may be called upon in an original action to

interpret the CEA regarding a provision whose meaning has not yet

been interpreted by the Commission in a rule or adjudication.

However, if there is no prior interpretation by the

18
Microcomputer Technology Institute v. Riley, 139 F.3d 1044, 1047 (5th Cir.
1998).
19
See 7 U.S.C. §§ 9, 13a-1, 13a-2.
20
Cf. Salleh v. Christopher, 85 F.3d 689 (D.C. Cir. 1996) (declining to
determine relative primacy when two governmental entities asserted truly
conflicting claims of interpretive authority).

9
Commission, any question of Chevron deference becomes moot.

Instead, interpretations advanced by the Commission during the

litigation may be construed as offered for the purpose of

“provid[ing] a convenient litigating position”; if so, the

Commission’s interpretation would not be entitled to deference.21

If a federal court answers a question of statutory

interpretation before the Commission, then that court’s

interpretation may later conflict with an interpretation adopted by

the Commission in a later rule or case. The resolution of such a

conflict, however, is not before us, since the federal cases which

have interpreted “in connection with” have not constricted the

phrase any narrower than the Commission has interpreted it in its

decisions. Thus, we must defer to the Commission’s interpretation

unless it is unreasonable.22

2.

In order for a fraudulent statement to be “in connection with”

a commodities future contract as required by § 4b(a), the statement

must first misrepresent the fundamental risk associated with such

investments.23 Misrepresentations regarding the tax status of a

commodities account are not actionable,24 nor are misrepresentations

21
See, e.g., United States v. Food, 2,988 Cases, 64 F.3d 984, 987 n.5 (5th Cir.
1995) (citing Irving Indep. Sch. Dist. v. Packard Properties, 970 F.2d 58, 64
(5th Cir. 1992)).
22
See Chevron, 467 U.S. at 843-44.
23
See, e.g., Kearney v. Prudential-Bache Securities, Inc., 701 F. Supp. 416,
424-26 (S.D.N.Y. 1988).
24
See id.

10
regarding commissions.25 The plain language of § 4b(a) requires the

misrepresentation to have some connection with the trading of

commodity futures contracts. At issue is how tenuous that

connection can be.

While it is clear that the petitioners’ advertising claims

misrepresented the fundamental risk associated with commodity

futures investments and trading systems, the unusual aspect of this

case is that the petitioners executed no trades for customers.

They only sold software. In essence, the petitioners provided

investment recommendations, but did not have any additional

discretion to make trades on behalf of their customers. The

petitioners generally profited only from the sale of software and

not from the trading of their customers.26

In Saxe v. E.F. Hutton & Co.,27 another fraud case under the

CEA, a broker solicited the opening of a discretionary account by

misrepresenting the experience and skills of another broker who was

to trade for the account.28 In the instant case, the petitioners’

misrepresentations regarding the reliability of their system are

analogous to the broker in Saxe misrepresenting another broker’s

track record. Unlike the broker in Saxe, however, the petitioners’

25
See Williamsport Firemen Pension v. E.F. Hutton & Co., 567 F. Supp. 140 (M.D.
Pa. 1983).
26
In point of fact, however, one of the first sales R&W made was to a
commodities broker who financed the purchase by paying R&W a portion of each
commission he charged his customers whenever he made a trade based on R&W’s
system. Clearly, any misrepresentations in that particular sale would have been
in connection with commodity futures contracts because R&W sold the system with
the intent of being paid from commissions made using the recommendations of the
software. However, this apparently was an atypical sale and not the basis for
the Commission’s general complaint.
27
789 F.2d 105 (2d Cir. 1986).
28
Id. at 110.

11
customers only purchased recommendations from the petitioners. The

petitioners had no authority to execute any trades on their

customer’s behalf, whether at the customer’s request or at the

petitioners’ discretion. In one sense, then, the “connection”

between the fraud and trades in Saxe is two levels closer than in

the current case. The broker in Saxe had both the customer’s money

and the customer’s permission to execute trades.

In Clayton Brokerage v. CFTC,29 however, the Eleventh Circuit

found misrepresentations to be “in connection with” commodity

trading regardless of whether the account was discretionary or

traded only at the request of the customer. Clayton Brokerage is

thus only one level removed from our case, in which the petitioners

made recommendations but did not have any direct stake in the

trading.

Moreover, although the petitioners did not profit from

customer trading by receiving commissions, the petitioners did not

give their advice away and necessarily expected their customers to

make trades. This expensive software had no purpose except as a

device for choosing which trades to make. In the end, then, the

question is whether the phrase “in connection with” can reasonably

be read to reach the petitioners’ fraud.

Under the Commission’s interpretation, fraud in the sale of

investment advice will be “in connection with” the sale of a

commodities future contract if the fraud relates to the risk of the

29
794 F.2d 573, 582 (11th Cir. 1986).

12
trading and the primary purpose of purchasing the advice is to

execute trades. Under this interpretation, the fraud here can be

understood as more similar to the fraud in Clayton Brokerage and

Saxe than first appears. The only purpose for depositing money in

a commodity account is to subsequently make trades, either on one’s

own initiative or at the recommendation or discretion of the

broker. Similarly, no one spends several thousand dollars on a

sophisticated software package without seriously intending to

execute trades.

These scenarios contrast markedly with other sales of

investment advice. For example, magazine and newspaper articles

often dispense investment advice on a variety of topics. A person

may buy a newspaper or magazine to read such articles with no

intention to follow through on any of the recommendations. Such

sources are invariably used not only for educational and research

purposes, but also entertainment or leisure purposes. The same,

however, cannot be said about petitioners’ software. As the

Commission noted below:

unlike the cases that have found the connection between
the fraud and trade lacking, the misrepresentations in
this case are neither incidental nor secondary to the
futures trading but are directly related to that trading.
In fact, the gravamen of the claim is that the
respondents misled potential purchases of their system
concerning trading profits and trading risks in order to
induce customers to trade, and there is ample evidence to
show that they did trade.30

There are additional reasons to construe § 4b(a) broadly

30
In re R&W Technical Services, Ltd., No. 96-3, 1999 WL 152619, at *23, Comm.
Fut. L. Rep. (CCH) ¶ 27,582 (CFTC Mar. 16, 1999).

13
rather than narrowly. Originally, § 4b(a) only applied to members

of a contract market. In 1968 it was extended to reach “any

person.”31 In fact, “[t]he legislative history [of § 4b(a)]

indicates a progressive trend toward broader application of the

CEA.”32 In 1974, Congress gave the Commission even greater

enforcement powers, in part because of the fear that unscrupulous

individuals were encouraging amateurs to trade in the commodities

markets through fraudulent advertising.33 Remedial statutes are to

be construed liberally,34 and in an era of increasing individual

participation in commodities markets, the need for such protection

has not lessened.

The Commission’s position in its earlier adjudication of this

case is consistent with CFTC v. AVCO Financial Corp.35 and does not

conflict with any earlier interpretations by the federal courts.

The petitioners defrauded customers regarding the reliability of a

system whose only intended use was as a means of selecting

commodity futures contracts. To say that such fraud is “in

connection with” commodity futures contracts is not unreasonable.

Given the standard of review, we must affirm the Commission’s

findings of liability under § 4b(a).

31
See Pub. L. 90-258, 82 Stat. 27 (1968).
32
Saxe, 789 F.2d at 111; see also Hirk v. Agri-Research Council, Inc., 561 F.2d
96, 103-04 (“The plain meaning of such broad language [as ‘in connection with’]
cannot be ignored.”).
33
See Saxe, 789 F.2d at 111.
34
See Monieson v. CFTC, 996 F.2d 852, 859 (7th Cir. 1993).
35
28 F. Supp. 2d 104 (S.D.N.Y. 1998), appeal pending sub nom. Vartuli v. CFTC,
No. 98-6280 (2d Cir.) (finding nearly identical misrepresentations in
the sale of software to be “in connection with” futures contracts).
14
 III.

The petitioners were also charged with violating CEA § 4o and

Commission Rule 4.41(a), which prohibit Commodity Trading Advisors

(“CTAs”) from defrauding clients and prospective clients through

various schemes including false advertising. At issue is whether

the petitioners were functioning as CTAs.

A.

A CTA is defined as any person who “for compensation or

profit, engages in the business of advising others, either directly

or through publications, writings, or electronic media, as to the

value of or the advisability of trading in [futures contracts].”36

Excluded from this definition is any “publisher or producer of any

print or electronic data of general and regular dissemination,

including its employees.”37 However, the publisher exception only

applies if the CTA’s “furnishing of such services . . . is solely

incidental to the conduct of their business.”38 The Commission

argues that “such services” refers to “any advisory services,”

while the petitioners argue that it refers only to “personalized

advisory services.”

The plain language of the statute, however, shows that the

phrase refers to “any advisory services.” Section § 1a(5)(A)(i)

defines a CTA as any person who “engages in the business of

advising others, either directly or through publications, writings,

36
7 U.S.C. § 1a(5)(A).
37
7 U.S.C. § 1a(5)(B).
38
7 U.S.C. § 1a(5)(C).

15
or electronic media.” Absent any other distinctions, the later

reference to “such services” can only refer to both the direct and

indirect provision of advisory services. This might appear to

vitiate the entire publisher exception, since the publishing of

such advice may often be the primary business of a publisher.

However, the exclusion still protects incidental publishers of such

advice, such as general magazines and newspapers, even if it does

not exclude publishers who specifically concentrate on commodities

and futures advice. To accept the petitioners’ interpretation,

however, would allow any large publishing company to offer highly

personalized trading advice on the side – such as a 1-800 number

trading hotline – without having to conform to the rules regulating

commodity trading advisors, so long as the service was “incidental”

to their regular impersonalized publishing activities. For these

reasons, the Commission’s interpretation is the correct one.39

Alternatively, we note that the petitioners’ software

publishing was neither “generally” nor “regularly” disseminated, as

required in order to meet the publishing exception.40 In Lowe v.

SEC,41 the Supreme Court dealt with an even broader publisher

39
Even if we accepted that the statutory definition of CTA was ambiguous, we
would defer to the Commission’s interpretation under Chevron since it is not
unreasonable. Similarly, the fact that Congress included “selling subscriptions”
within the listed activities of CTAs, and referred to a CTA’s “subscribers”
supports the notion that Congress intended to regulate impersonal publishers,
since the selling of subscriptions necessarily involves the publishing of
impersonal advice. Legislative history of the CEA also supports the idea that
Congress intended to protect the commodities markets from the improper influences
of impersonal advisors. See H.R. Rep No. 93-963, at 37 (1974) (describing CTAs
as “individuals who are involved either directly or indirectly in influencing or
advising the investment of customers’ funds in commodities” (emphasis added));
id. at 54-55, 68 (expressing concern for potential market manipulations occurring
when advisors make impersonalized, identical recommendations to their customers).
40
See 7 U.S.C. § 1a(5)(B)(iv).
41
472 U.S. 181 (1985).

16
exception within the Investment Advisers Act of 1940. The Court

defined regular dissemination to require that “there is no

indication that [dissemination] ha[s] been timed to specific market

activity.”42 In this case, the petitioners’ recommendations were

provided by software that was programmed to “speak” only when

certain market conditions were met. Thus, the petitioners’

recommendations were timed to particular market activity and not

“regularly” disseminated. Moreover, a publication is only of

“general” dissemination when it is circulated for sale to the

general public at large in an open market.43 The record here

indicates that the petitioners advertised that the software would

only be sold in limited numbers. While that may have been a

selling tactic, such claims cut against their argument that their

software was “generally” disseminated.

The petitioners contend, however, that under Lowe,

“impersonal” publishers of investment advice cannot be CTAs. In

Lowe, the Court found that publishers of impersonal advice were not

investment advisors under the Investment Advisers Act of 1940

(IAA),44 which defined investment advisor to include persons who

advised others indirectly through publications.45 The Court found

that the legislative intent behind the IAA was to regulate only the

business of dispensing personalized advice and not to regulate

impersonalized publishing activities; therefore, impersonal

42
Id. at 209.
43
See id. at 210.
44
See id.
45
See 15 U.S.C. § 80b-2(a)(ii).

17
publishers were not included in the definition of “investment

adviser.”46

The petitioners in this case were impersonal publishers. The

software they offered provided impersonal recommendations as to the

buying and selling of commodities. Such recommendations were not

based on any knowledge regarding the user’s personal financial

situation. Admittedly, this is a more sophisticated form of

publishing than a weekly newsletter, but in substance it is the

same as if the petitioners operated their proprietary software at

home and faxed reports to their subscribers on a daily basis.

Just because Lowe found that the IAA excluded such publishers,

however, does not entail that the CEA must. The statutes are

different, and Lowe read the statute to avoid constitutional

concerns. Had impersonal advisors been included in the definition

of an investment advisor, there would have been an unconstitutional

prior restraint in regulating them, since the publication of

impersonal advice about specific investments is fully protected

speech under the First Amendment.47

The Commission does not contest that such regulations would be

a prior restraint, but instead argues that we need not consider

that constitutional question because the validity of the CEA’s

registration requirements is not before us. The petitioners are no

longer charged with registration violations, and even if the

registration requirements are unconstitutional, the rest of the CEA

46
Lowe, 472 U.S. at 204, 207-08, 210.
47
See id. at 210 n.58.

18
would remain intact under a severability clause.48

Instead, the Commission argues that the CEA can define

impersonal publishers as CTAs, even if the CEA cannot impose

registration requirements upon them. Then, once the CEA has

defined such advisors as CTAs, the CEA can impose liability on them

for violations of the CEA’s antifraud provisions, since liability

for fraud would not run afoul of the First Amendment.49

In general, statutes should be construed so as to avoid

constitutional questions.50 However, the constitutional question

in this case has already been avoided because the registration

requirements are not before us. We find, then, that the

petitioners fall within the plain meaning of the definition of CTA

and thus are subject to the CEA’s antifraud provisions which apply

to CTAs. However, we do note that lower courts have split on this

issue.51

B.

In order to apply § 4o and Commission Rule 4.41 to the

petitioners, their advertising scheme must have been used to

defraud potential “clients.”52 The petitioners argue that their

48
See 7 U.S.C. § 17; cf. Taucher v. Born, 53 F. Supp. 2d 464 (D.D.C. 1999)
(finding that the CEA’s registration provisions are unconstitutional).
49
See Lowe, 472 U.S. at 225 (White, J., concurring) (citing Zauderer v. Office
of Disciplinary Counsel, 471 U.S. 626, 651 (1985); Village of Schaumberg v.
Citizens for a Better Env’t, 444 U.S. 620, 637-38 (1980); Schneider v. State, 308
U.S. 147, 164 (1939)).
50
CFTC v. Schor, 478 U.S. 833, 841 (1986).
51
Compare Commodity Trend Serv., Inc. v. CFTC, 1999 WL 965962 (N.D. Ill. Sept.
29, 1999) (including impersonal publishers within the definition of CTA), on
remand from 149 F.3d 679 (7th Cir. 1998), with Ginsburg v. Agora, Inc., 915 F.
Supp. 733 (D. Md. 1995) (excluding such publishers from the definition of CTA).
52
See CEA § 4o(1); Commission Rule 4.41(a), (c).

19
customers were not clients because no personal relationship existed

between the petitioners and their customers. While the CEA does

not define “client,” the petitioners urge that the common meaning

of the term requires a personalized relationship.

In terms of Commission Rule 4.1, the Commission has previously

interpreted it to apply to advertisements directed to mere

subscribers of investment advice.53 The Commission’s interpretation

of its own rule would, of course, be “controlling . . . unless it

is plainly erroneous or inconsistent with the regulation.”54

The petitioners’ argument regarding § 4o, however, finds

superficial support in cases such as Lowe, which distinguished

between the impersonal publisher-subscriber relationship and “the

investment adviser-client” relationship.55 Lowe’s distinction was

made based on the IAA Act and not the CEA. However, even the CEA

makes a distinction between clients and subscribers. For example,

§ 4o and Rule 4.41(c) apply only to clients, while Rule 4.33(a)

specifically applies to clients and subscribers.

The petitioners, however, failed to raise their argument

regarding the definition of “client” before the Commission and

instead simply argued that § 4o did not apply to them because they

were not CTAs. We have held that “[a]s a general rule, in

considering a petition for review from a final agency order, the

courts will not consider questions of law which were neither

53
See, e.g., In re Armstrong, [1994-1996 Transfer Binder] Comm. Fut. L. Rep.
(CCH) ¶ 26,332, at 42,612 (CFTC Mar. 10, 1995), aff’d, 77 F.3d 461 (3d Cir.
1996).
54
Bowles v. Seminole Rock Co., 325 U.S. 410, 414 (1945).
55
Lowe, 472 U.S. at 210.

20
presented to nor passed on by the agency.”56 Because we find no

compelling reason to address this question of interpretation for

the first time on appeal, we do not decide the issue.

IV.

An agency’s refusal to reopen the record is a procedural

matter which is reviewable for an abuse of discretion.57 In the

present case, the Commission refused to hear testimony that

demonstrated widespread customer satisfaction with the petitioners’

product.

The reason the petitioners did not give such evidence at the

ALJ hearing was because both the ALJ and enforcement counsel had

indicated that whether the software worked as advertised was not at

issue. The ALJ even excluded the Division’s customer witness

testimony as irrelevant. Yet after the hearing, the ALJ made

findings of fact based on an assumption that no trading scheme

could work as the petitioners advertised.58 When the Commission

then refused to hear evidence of customer satisfaction, the

Commission stated that exculpatory evidence, including evidence of

customer satisfaction, was not material because the Commission

agreed that the efficacy of the system was not at issue.

However, evidence of the efficacy of the petitioners’ system

56
Myron v. Martin, 670 F.2d 49, 51 (5th Cir. 1982).
57
See Alaska Steamship Co. v. Federal Maritime Comm., 356 F.2d 59, 62-63 (9th
Cir. 1966).
58
See In re R&W Technical Services, Ltd., Comm. Fut. L. Rep. (CCH) ¶ 27,193, at
45,727 n.75 (CFTC ALJ Dec. 1, 1997).

21
was relevant in assessing sanctions.59 The Commission now portrays

the petitioners’ failure to adduce evidence at the ALJ hearing as

a tactical decision.60 Such a characterization is hard to square

with the fact that the ALJ and Division stated that the efficacy of

the system was not at issue. Further, we see no tactical advantage

the petitioners might have gained by holding back evidence that

their customers were satisfied and had made rather than lost money.

When the Commission conducted its review, its review was de

novo. Thus, there was no need to exclude the defendant’s

mitigating evidence based on deference to prior factual findings.

Because of the relevance of this mitigating evidence, and because

the ALJ appears to have misled the petitioners as to the

admissibility of this evidence, the Commission abused its

discretion in refusing to reopen the record to hear this evidence,

especially given that the ALJ originally imposed over a $ 7 million

penalty based on a finding that no such trading system could

provide a “trader with any significant market advantage.”61

V.

Sanctions are reviewed under the abuse of discretion

standard.62 The standard is that the sanction must be rationally

59
See In re Grossfeld, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶
26,931, at 44,468 & n.30 (CFTC Dec. 10, 1996) (in assessing civil money
penalties, the loss suffered by customers is one pertinent factor), aff’d in part
and appeal dismissed in part, 137 F.3d 1300 (11th Cir. 1998).
60
See In re Interstate Secs. Corp., [1990-1992 Transfer Binder] Comm. Fut. L.
Rep. (CCH) ¶ 25,373, at 39,261 (CFTC Aug. 27, 1992).
61
R&W Technical Services,¶ 27,193, at 45,727 n.75.
62
See Ryan v.CFTC, 145 F.3d 910, 916 (7th Cir. 1998).

22
related to the offense.63 Given that the Commission should have

considered evidence of the efficacy of the system and customer

satisfaction, the penalty must be reassessed in light of such

mitigating evidence. The improper exclusion of evidence aside, the

original penalty was unreasonably excessive.

The penalty may be determined by focusing on the “relative

gravity of . . . misconduct” in light of factors such as:

(1) the relationship of the violation at issue to the
regulatory purposes of the Act; (2) respondent’s state of
mind; (3) the consequences flowing from the violative
conduct; and (4) respondent’s post-violation conduct.64

Furthermore, “[t]he level of sanctions should reflect ‘the

particular mitigating or aggravating circumstances presented by the

unique facts of the individual conduct at issue.’”65 On occasion,

penalties in similar cases have been “a guide to the appropriate

level of a civil monetary penalty.”66 However, an undue focus on

past penalties fails to account for changes in policy or inflation,

and thus may undermine deterrence.67 Federal courts have also

rejected the notion that uniform sanctions must be imposed by an

administrative agency for similar violations.68

Even if sanctions need not be precisely uniform, they must be

rational, and neither inflation nor expressed policy changes can

explain the magnitude of the penalty in this case. At oral

63
See Monieson v. CFTC, 996 F.2d 852 (7th Cir. 1993).
64
Grossfeld,¶ 26,921, at 44,467-68.
65
Id. (quoting In re Premex, [1987-1990 Transfer Binder] Comm. Fut. L. Rep.
(CCH) ¶ 24,165 (CFTC Feb. 17, 1988)).
66
Id.
67
See id.
68
See Butz v. Glover Livestock Comm. Co., 411 U.S. 182, 187 (1973); Monieson,
996 F.2d at 864.

23
argument, counsel for the Commission was unable to say that there

had ever been a fine greater than $100,000 in a case in which there

had been no demonstration of harm to others. One case allowed a

civil penalty of $1.8 million, but only after a defendant committed

extensive solicitation fraud, his customers suffered losses of more

than $2 million, and the defendant violated a cease and desist

order.69

In calculating a civil penalty, “the financial benefit that

accrued to the respondent and/or the loss suffered by customers as

a result of the wrongdoing are especially pertinent factors.”70 In

this case, the Commission had no evidence of customer losses and

thus focused exclusively on the gain to the petitioners when

approving a $2.735 million sanction based on estimated gross

revenues. When a penalty is designed for deterrence and not

restitution, however, the proper measure of gain to the defendant

is net profits, not gross revenues.71

Thus, the lack of demonstrated harm in this case suggests that

the petitioners’ violations, while actionable, were not so

egregious as to warrant a $2.375 million penalty. Presumably, the

petitioners’ system worked better than the one at issue in CFTC v.

AVCO Financial Corp.72 In both AVCO and the present case, sellers

portrayed hypothetical results as real results.73 The evidence of

69
See Grossfeld, ¶ 26,921.
70
See id. ¶ 44,468 & n.34.
71
See CFTC v. AVCO Financial Corp., No. 97 CIV. 3119, 1998 WL 524901, at *1
(S.D.N.Y. Aug 21, 1998) (reducing $4.15 million penalty based on gross revenues
to $700,000 penalty based on net profits).
72
28 F. Supp. 2d 104 (S.D.N.Y. 1998), appeal pending sub nom. Vartuli v. CFTC,
No. 98-6280 (2d Cir.).
73
See id. at 115-17.

24
actual losses suffered by AVCO’s customers shows why such

misrepresentations would be material to reasonable investors.74 The

lack of any demonstrated losses in this case makes plain that a

$2.375 million penalty is capricious and indefensible. Even the

Commission’s witness, whose testimony demonstrated that the system

did not perform as well in practice as in theory, earned a $60,000

profit in one year using the system and stated that no other system

worked better.

The Commission has never imposed a penalty this large on any

individual and has never imposed a penalty of even the same order

of magnitude absent demonstrated harm to others. Thus, on remand

a new assessment of the penalty should begin with the petitioner’s

net profits, which then should be adjusted lower based upon any

mitigating evidence the petitioners present with regard to customer

satisfaction.

AFFIRMED in part, REVERSED in part, and REMANDED.

74
See id. at 112-13.

25