On Appeal from the United States District Court for the District of New Jersey D.C. Civil Action No. 1-04-cv-01512 (Honorable Robert B. Kugler).
The opinion of the court was delivered by: Scirica, Chief Judge.
Before: SCIRICA, Chief Judge, SLOVITER and HARDIMAN, Circuit Judges.
This case involves a civil enforcement action under the Commodity Exchange Act, 7 U.S.C. § 1 et seq., and related regulations. Defendants were charged with fraud under 7 U.S.C. §§ 6b and 6o and failing to register with the Commodity Futures Trading Commission, as required by 7 U.S.C. §§ 6m and 6k, among other counts. In a bench trial, the District Court concluded Equity Financial Group was regulated as a commodity pool operator, and it found defendants liable for fraudulent conduct, failing to register, and other violations. The principal issue on appeal is whether Equity Financial is a commodity pool operator under 7 U.S.C. § 1a(5), even though it operated a feeder fund-a fund that did not itself execute commodity futures transactions but invested in another fund for that purpose. We will affirm.
Defendants are Equity Financial; Vincent Firth, Equity Financial's president and sole shareholder; and Robert Shimer, its lawyer. They created Shasta Capital Associates, an investment vehicle that raised funds from investors through the sale of member shares. Equity Financial and Shasta Capital were distinct legal entities, but Equity Financial was the manager of Shasta Capital, controlling the Shasta Capital funds. Defendants solicited more than $15 million into Shasta Capital to trade futures contracts. Equity Financial did not execute commodity futures transactions on behalf of Shasta Capital but it invested the Shasta Capital assets in another fund, Tech Traders,*fn1 which pooled the Shasta Capital investment with other funds' investments, and executed transactions on behalf of the pool of funds. In this arrangement, Shasta Capital was a "feeder fund," and Tech Traders a "master pool" or "super fund."
Tech Traders and Coyt Murray, its president and chief executive officer, defrauded investors by misappropriating funds and falsely reporting Tech Traders's performance.*fn2 Defendants, Equity Financial, Firth, and Shimer, participated in the fraudulent conduct. They solicited and retained Shasta Capital investors by misrepresenting their qualifications and the performance of Shasta Capital's investments, and they took a portion of the invested funds for personal use through an arrangement with Murray that was not disclosed to investors.
Defendants made several false statements to investors, primarily in monthly and quarterly reports to investors and in Internet postings. They represented that Shasta Capital was earning profits every month between June 2001 and February 2004, including double-digit rates of return in twenty-three of those thirty-three months.*fn3 But during this period, the Shasta Capital fund, which had invested solely in Tech Traders, was sustaining losses. Defendants' reports were based on information received from Tech Traders about Tech Traders's performance, but Firth and Shimer knew at least some of the Tech Traders reports were false or probably false.*fn4 Additionally, Shimer created a verification procedure that concealed the falsity of Tech Traders's reports. At Shimer's insistence, Tech Traders hired an accountant, J. Vernon Abernathy, who calculated and forwarded Tech Traders's false rate-of-return numbers to another accountant, Elaine Teague, hired by Shasta Capital. Teague relied on Abernathy's numbers in her own reports to defendants and in communications with Shasta Capital investors. But Shimer played a more direct role in the creation of Tech Traders's false reports. He invented the method Abernathy used to calculate Tech Traders's returns-a method that did not employ standard accounting practices and was misleading-and he helped Abernathy prepare many of the reports. Shimer also knew Abernathy lacked access to the records needed to calculate a proper rate of return. Apparently Teague was not aware of Shimer's involvement in the creation of the reports, the use of a nonstandard accounting procedure, or Abernathy's lack of access to necessary records. Teague accordingly provided a front to investors and potential investors, to verify the false reports.
Moreover, Firth and Shimer benefitted from an undisclosed arrangement with Murray and Tech Traders. Murray and Shimer had been involved in a prior business venture in which two other persons absconded with funds Shimer raised. Murray agreed to help Shimer repay the earlier investors if Shimer would solicit funds for Tech Traders. Under this agreement, Tech Traders would divert a portion of its "profits" back to Shimer through a trust called Shadetree in Nevis, West Indies.*fn5 Neither Firth nor Shimer disclosed the Shadetree agreement to Shasta Capital investors in statements or in Shasta Capital's detailed Private Placement Memoranda.*fn6
Tech Traders paid $1,314,930 under the Shadetree agreement into accounts controlled by Shimer. Some of this money went to pay the earlier investors, some to pay a mortgage for Firth, and some to pay a referral fee to a former associate of Shimer.
The District Court concluded that Equity Financial was a commodity pool operator under 7 U.S.C. § 1a(5), and Firth and Shimer were statutorily defined associated persons of Equity Financial under 7 U.S.C. § 6k. It found Equity Financial liable under 7 U.S.C. § 6m for failing to register with the CFTC as a commodity pool operator, and Firth and Shimer liable under 7 U.S.C. § 6k for failing to register themselves as associated persons. The court concluded all three defendants had committed fraud under 7 U.S.C. §§ 6b and 6o.*fn7 Equity Financial, it held, was liable under 7 U.S.C. § 2(a)(1)(B) for Firth and Shimer's violations, and Firth and Shimer liable under 7 U.S.C. § 13c(b), as controlling persons of Equity Financial, for Equity Financial's violations, including its failure to register. Finally, the District Court concluded, Shimer is liable under 7 U.S.C. § 13c(a) for aiding and ...