Secure Leverage Group, Inc. v. Bodenstein (In re Peregrine Financial Group, Inc.)

Citations: 510 B.R. 190; 2014 WL 1806790; 2014 Bankr. LEXIS 2076Docket: Bankruptcy No. 12 B 27488; Adversary No. 12 A 01572

Court: United States Bankruptcy Court, N.D. Illinois; May 7, 2014; Us Bankruptcy; United States Bankruptcy Court

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The plaintiffs, former customers of Peregrine Financial Group, Inc., are pursuing a legal claim for the return of funds deposited with Peregrine, alleging these funds qualify as 'customer property' under the Bankruptcy Code. Specifically, in Count IV, they seek a declaration that their transactions involving foreign currency and over-the-counter metals are classified as 'commodity contracts' under 11 U.S.C. § 761(4). The trustee has moved for summary judgment, arguing that these transactions do not meet the definition of 'commodity contracts,' and therefore the deposited funds are not 'customer property' entitled to priority under the Bankruptcy Code.

The plaintiffs assert that their transactions are 'similar to' those explicitly defined in the statute. However, the court disagrees, determining that the plaintiffs’ foreign exchange and metals activities do not fit within the specified definitions nor are they 'similar' for the purposes of § 761(4)(F)(i). Consequently, the court rules that the funds deposited with Peregrine are not 'customer property,' granting judgment to the trustee on Count IV.

The background reveals that this proceeding stems from Peregrine's Chapter 7 liquidation following the discovery of customer fund theft. The plaintiffs had opened accounts for trading retail foreign currency and OTC metals under a standard customer agreement that encompassed various forms of trading, not limited to forex and metals. After Peregrine's bankruptcy filing in July 2012, the trustee sought to distribute 'customer property' but excluded retail forex and OTC metals customers, prompting the plaintiffs to contest this exclusion through a series of motions, ultimately leading to the current adversary proceeding.

The Commodities Futures Trading Commission (CFTC) has intervened in a case where the trustee determined that plaintiffs are not entitled to interim distributions, arguing that their retail forex and metals transactions do not qualify as 'commodity contracts.' Count IV of the plaintiffs' complaint asserts that these transactions are indeed 'similar to' those described in § 761(4)(F)(i), which includes transactions akin to specified types defined in the Bankruptcy Code. The plaintiffs seek a declaration that their funds should be treated as 'customer property' and distributed with priority similar to other customers. The trustee has filed for summary judgment, contending that there are no material facts in dispute and that the court can rule as a matter of law that the plaintiffs' transactions do not meet the definition of 'commodity contract' under § 761(4). The CFTC supports the trustee's position. Summary judgment is governed by Federal Rule of Civil Procedure 56, which allows for judgment when no genuine issue of material fact exists. The definition of 'commodity contracts' is crucial to this dispute, as outlined in § 761(4), which specifies various types of contracts and includes a 'similar to' clause for transactions akin to those listed. The plaintiffs argue their retail forex and OTC metals transactions align with the definitions in subparagraphs (A)-(E), which cover different types of futures and options transactions.

The case centers on whether retail forex and OTC metals transactions are classified as futures contracts under § 761(4). The trustee argues that the precedent set in In re Zelener, 373 F.3d 861 (7th Cir. 2004), dictates that these transactions are not similar to futures. In Zelener, the Seventh Circuit ruled that retail forex transactions do not qualify as futures under the Commodity Futures Trading Commission (CFTC) jurisdiction, as defined by § 2(a)(1)(A) of the Commodity Exchange Act (CEA). The court highlighted that "future delivery" has a specific technical meaning that distinguishes futures contracts from forward or spot contracts. Futures involve standardized contracts traded in organized markets, eliminating counterparty risk, whereas spot and forward contracts involve direct commodity sales with unique delivery terms. Other circuits have aligned with this interpretation, affirming that forex trading does not meet the criteria for futures. In Zelener, AlaronFX, the defendant, facilitated retail forex transactions where customers rarely took delivery, often rolling over contracts instead. This arrangement allowed customers to maintain open positions without engaging in actual delivery, further distinguishing their transactions from futures contracts.

A customer experiences a loss when a currency position is closed by selling back to AlaronFX, with the profit or loss determined by the price difference between the initial transaction and the closing transaction. The court in Zelener differentiated retail forex transactions from futures contracts, noting that customers purchase foreign currency immediately without standardized terms, leading to unique, non-fungible transactions that cannot be traded on an exchange. Forex trades were classified as spot sales for delivery within 48 hours. Similar principles apply to retail forex trading at Peregrine, where plaintiffs acknowledged that their trades involved direct currency transactions rather than contracts. The Peregrine Customer Account Agreement reflects this, stating that forex transactions occur on the interbank system and that Peregrine acts as the principal counterparty. Prices are determined by Peregrine, and they have discretion to manage currency positions without timely customer instructions. Each transaction is treated separately, though Peregrine can net opposite transactions at its discretion. The essential facts of this case mirror those in Zelener, with both involving spot transactions rather than futures. Plaintiffs argue against the applicability of Zelener, claiming it is outdated due to a 2008 statutory amendment to the Commodity Exchange Act (CEA), but this claim is refuted. The amendment, known as 'the Zelener fix,' expanded the CFTC’s anti-fraud jurisdiction without negating the original Zelener ruling regarding the nature of retail forex transactions.

Congress did not overturn the Zelener ruling, which classified retail forex transactions as spot contracts rather than futures contracts. Despite being aware of the Zelener and Erskine decisions, Congress did not include retail forex in the definition of 'commodity contract' during the 2005 and 2010 amendments, nor did it include forex under the CFTC’s anti-fraud jurisdiction in 2008. The Zelener decision remains authoritative within this circuit, affirming that retail forex transactions are not considered futures contracts.

The plaintiffs contend that their transactions fall within an exception noted in Zelener, which allows for off-exchange transactions to be classified as futures if the seller promises to provide an offsetting contract. However, the court found no such promise in the AlaronFX customer agreement, which permitted AlaronFX to act at its discretion without guaranteeing an offsetting trade. 

The plaintiffs also claim that Peregrine made a sufficient promise to provide an offsetting position. They reference a provision from the Agreement stating that PFGBEST would set prices and valuations for Currency Forex, arguing that this constitutes an unambiguous promise for netting upon customer demand. However, the court did not interpret this provision as fulfilling the requirement for a promise to create an offsetting position.

Peregrine holds exclusive authority to set trading prices, determine customer position values, and establish margin requirements, indicating that interbank prices do not dictate these aspects. The provision does not grant customers an unconditional right to purchase offsetting contracts from Peregrine upon request. Plaintiffs claim a National Futures Association (NFA) rule mandates forex dealers to provide offsetting transactions at customer demand; however, the relevant rule states that dealers must offset matching positions on a first-in, first-out basis, without imposing an obligation for every open position. A 2010 CFTC regulation reinforces that a setoff occurs only when an opposing transaction already exists in the customer account. Neither the NFA rule nor CFTC regulation aligns Peregrine's forex transactions with the exceptions noted in Zelener.

The plaintiffs argue that the court cannot resolve the nature of their retail forex transactions at the summary judgment stage due to factual disputes surrounding the Agreement and trading practices at Peregrine. They suggest the need for parole evidence to clarify ambiguities in the contract regarding settlement or rollover instructions, but the court finds that the essential features of the transactions are undisputed and sufficient for legal analysis. The plaintiffs also assert that the lack of foreign bank information precludes settlement by delivery, but the court cites Zelener, stating that the intent regarding delivery does not influence whether a transaction is categorized as futures, spot, or forward. Lastly, the plaintiffs raise concerns about potential misclassification of customer funds without providing evidence of such misclassification. Consequently, the court concludes that there are no significant factual disputes, allowing it to legally classify the plaintiffs’ retail forex trades as spot contracts rather than futures, based on established precedent from Zelener.

The inquiry does not conclude with this classification, as a transaction may still be a "commodity contract" under § 761(4) if it fits specified types or is deemed "similar to" such transactions. The trustee contends that Zelener's precedent confirms retail forex transactions are not "similar to" futures for the same reasons they are not classified as futures.

Congress intentionally excluded retail forex customers from the definition of commodity contracts in the Bankruptcy Code and the Commodity Exchange Act (CEA). The court concurs with this interpretation, referencing the Zelener case, which, while not addressing the similarity clause directly, indicates that retail forex transactions are not 'similar to' futures contracts. The ordinary meaning of 'similar' suggests that the two types of transactions lack essential similarities. Futures contracts are traded on regulated exchanges with standardized terms and involve a clearinghouse that mitigates counterparty risk. In contrast, retail forex transactions are private, unique trades without a clearinghouse and were largely unregulated until 2000. Although both futures and retail forex serve speculative purposes, this shared characteristic is deemed insignificant compared to their fundamental differences.

Furthermore, the historical context of commodities regulation supports this conclusion. The CEA, enacted in 1936, was designed to address manipulation and speculation in futures trading, explicitly excluding 'spot' and 'cash forward' transactions from its purview. The CEA regulates only those transactions that involve future delivery of commodities, while transactions intended for immediate delivery do not fall under its regulatory framework. This distinction highlights the regulatory intent to differentiate between futures (regulated) and cash forwards (not regulated). Since its inception, the CEA has mandated that futures trading occur on regulated exchanges through Futures Commission Merchants (FCMs), who are required to maintain customer funds in segregated accounts, reinforcing the regulatory divide.

The emergence of off-exchange markets for retail customers and subsequent congressional actions expanded the Commodity Exchange Act (CEA) and the Commodity Futures Trading Commission's (CFTC) jurisdiction. In 2000, Congress enacted limitations on firms engaging in retail forex transactions, followed by further legislation in 2008 that extended the CFTC’s anti-fraud authority to retail forex, despite acknowledging prior court rulings that classified such transactions outside the definition of 'commodity contract.' In 2010, Congress broadened CFTC authority over off-exchange retail transactions in all commodities, including those categorized as spot or forward contracts, while again omitting uncleared transactions, like retail forex, from the 'commodity contract' definition. This omission implies that retail forex is excluded from protections under the Bankruptcy Code regarding 'customer property.'

The CFTC, established in 1974, regulates commodity futures and has developed regulations for commodity broker bankruptcies, particularly through the Part 190 regulations. These regulations align the definitions of 'commodity contract' and 'customer property' in the Bankruptcy Code with the CEA's segregation requirements, which mandate that customer funds be treated as distinct from the firm's assets. Consequently, customer property enjoys the highest priority in bankruptcy distribution, except for certain administrative expenses, reflecting their status as customer property under the CEA and CFTC regulations.

In 1978, Congress granted the Commodity Futures Trading Commission (CFTC) the authority to determine which assets are classified as 'customer property' under the provisions governing commodity broker bankruptcies, irrespective of the Bankruptcy Code. This has led to a contention between the CFTC and trustees regarding whether the CFTC can redefine 'customer property' and 'commodity contract' as outlined in the Bankruptcy Code. The CFTC has established regulations prioritizing certain classes of 'customer property' in bankruptcy but explicitly excludes retail forex and OTC metals due to the lack of required segregation of customer funds in these markets. According to Regulation 190.08, 'customer property' is distributed among defined account classes, which include futures accounts and cleared swap accounts, all of which mandate segregation of funds under the Commodity Exchange Act (CEA) and CFTC rules. Conversely, no such requirement exists for retail forex or OTC metals, leading the CFTC to omit these from the 'customer property' classification. Furthermore, the CFTC mandates that retail forex dealers inform customers that funds deposited do not have regulatory protections, and in bankruptcy, these funds may be treated as unsecured claims. Consequently, under the CFTC’s regulations and interpretation, customer funds from retail forex trading are not considered 'customer property' and lack special bankruptcy protections, reinforcing that retail forex does not meet the definition of 'commodity contract' in the Bankruptcy Code.

Plaintiffs contend that retail forex falls under the similarity clause of § 761(4) based on a 'common denominator' approach, arguing that since all transactions listed in this section are regulated by the CFTC, retail forex should also be included due to its CFTC regulation. They fail to support this argument with statutory language or legislative history, noting that Congress defined 'commodity contract' specifically rather than broadly encompassing all CFTC-regulated transactions.

Additionally, plaintiffs reference the legislative history associated with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), asserting that the similarity clause was intended to allow flexibility in defining financial agreements as market conditions evolve. However, they misinterpret the House Judiciary Committee report, which does not suggest that retail forex fits within the definition of 'commodity contract.' Instead, the BAPCPA amendments aimed to enhance protections for financial contracts in bankruptcy, not to include distinctly different transactions like retail forex under the established definitions in § 761(4). The report indicates that Congress intended to account for similar transactions that evolve over time, not to broaden the definition to include transactions known to Congress at the time of the amendment.

Congress did not intend for retail forex transactions to be classified as commodity contracts under the similarity clause, supporting the court's conclusion. The plaintiffs argue against the CFTC's view that “customer property” protections under the Bankruptcy Code align with the segregation requirements of the CEA and CFTC regulations. They assert that “trade options” are included in the definition of commodity contracts but fail to define them or clarify their relation to options in 761(4)(E). The CFTC counters that “trade options” are distinct and do not fall under that subparagraph. The court finds it unnecessary to reconcile these definitions, affirming that the CFTC's regulations create consistency between segregation requirements and the Bankruptcy Code's treatment of “customer property.” 

The plaintiffs claim that segregation requirements for retail forex customer funds are similar to those for forex dealers, which the court refutes. Regulations mandate forex dealers to maintain assets equal to their obligations but do not mandate holding customer funds in trust or preventing commingling with dealer assets, thus not equating to true segregation. 

Regarding OTC metals, most plaintiff arguments focus on retail forex, acknowledging that OTC metals transactions are spot contracts and not retail trades, only available to Eligible Contract Participants (ECPs) who are high-net-worth investors. Only one plaintiff, Treasure Island Coins (TIC), engaged in OTC metals trading, which was unregulated under the CEA due to a statutory exemption prior to the bankruptcy filing. The plaintiffs fail to demonstrate that TIC’s OTC metals trading aligns with any specified commodity contracts in 761(4), and their broader argument does not encompass OTC metals transactions as these were not regulated by the CFTC until after the bankruptcy petition. Consequently, the court concludes that there are no material facts in dispute, granting judgment to the trustee on Count IV of the complaint.

Plaintiffs' retail forex and OTC metals transactions do not qualify as commodity contracts under § 761(4) of the Bankruptcy Code. The court will not consider subparagraphs (G) through (J) as no party argues their relevance to retail forex or OTC metals. As a futures commission merchant (FCM), only subparagraph (A) applies to transactions through Peregrine, while subparagraphs (B) through (E) do not, as they pertain to other entities. The plaintiffs assert that Peregrine was an FCM.

A futures contract involves a purchase or sale of a commodity for a future date, while a spot contract is for immediate delivery or within 48 hours, and a forward contract allows for delivery beyond 48 hours. The trustee posits that the forex transactions are spot contracts, a contention the plaintiffs do not directly dispute. Instead, they claim that rollover provisions make this classification irrelevant, although they acknowledge that retail forex contracts typically settle within 48 hours, aligning with spot contracts.

The trustee's statement, supported by documentation and depositions, asserts that the plaintiffs' retail forex transactions were indeed spot transactions. Plaintiffs' attempt to contest this is ineffective as they provide limited evidence that does not refute the trustee's claims. The CFTC's stance on regulating retail forex is deemed irrelevant to this case, as established by the precedent set in Zelener. 

A CFTC regulation mandates that forex dealers inform customers of the limitations of closing transactions. The CFTC's prior positions do not impact the current case, and the plaintiffs' expert affidavit, which offers legal opinions, is inadmissible and does not create a genuine issue of material fact.