On Monday Oct. 29 the Supreme Court heard oral arguments in a case involving Klein & Co. Futures Inc. and the New York Board of Trade stemming from a scandal that culminated in the downfall of the Klein clearing firm in May of 2000.
The question before the Supreme Court is whether a futures commission merchant (FCM) may sue a U.S. futures exchange for bad faith misconduct. This summer the Supreme Court agreed to hear Klein’s appeal on whether it had standing to sue the New York Board of Trade. Klein’s case was dismissed on those grounds by the trial court and later dismissed by the New York Second Circuit Court of Appeals.
The Commodity Futures trading Commission (CFTC) found in a 2001 order that the New York Futures Exchange (Nyfe, a subsidiary of Nybot) violated the Commodity Exchange Act by not following its own market oversight rules, which allowed for the gross manipulation of option settlements in the Pacific Stock Exchange Technology Index (P-Tech, which was traded at Nyfe) by Norman Eisler, a Klein customer and chairman of Nyfe and the P-Tech settlement committee at the time.
Klein is being supported by the Futures Industry Association (FIA), which filed an amicus brief with the court and the CFTC according to Mark Young, attorney at Kirkland & Ellis LLP, the law firm representing the FIA.
Young says, “If an exchange acts in bad faith and if they fail to enforce rules and if that damages a clearing firm, we think that firm should be able to seek [redress under] the CEA.”
The FIA takes no position in the underlying case but has argued vigorously that FCMs should have a right of action against an exchange. But while the facts of the case may have faded into the background and the issue at hand is whether or not an FCM may sue an exchange, if the Supreme Court rules that the appeals court erred in upholding the dismissal and the facts of the case are brought out in the open it could prove an embarrassment to the CFTC, all while the regulator’s reauthorization is still pending.
Despite noting in its decision that the manipulation of settlement prices occurred for at least nine months and inflated the value of Eisler’s account by an average of $2 million each day, the CFTC fined Nyfe a relatively paltry $75,000 and issued a report on lessons learned. In May of 2000 when the option settlements were corrected, Eisler’s account value was negative $4.9 million despite being seemingly liquid a few days prior.
Nybot, its clearinghouse and Eisler also faced lawsuits from a group of P-Tech locals and hedge fund manager Jim Moore. Both suits were eventually dismissed. Moore blamed a lack of cooperation from the CFTC with the trial court in contributing to his case not moving forward. The actual facts of the case have never been before a judge.
