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CFTC order levies major fine on hedge fund trader

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Summary:

The CFTC ordered a hedge fund manager who operated four commodity pools to pay more than $279 mm in restitution to prior hedge fund investors as well a $20 mm civil penalty for his fraud. The manager concealed huge losses from investors by issuing false account statements which reflected consistently profitable trades. The hedge fund manager also misappropriated some of the investor’s assets.

Press Release:

Release: 5531-08
For Release: August 19, 2008

Hedge Fund Trader Paul Eustace and Philadelphia Alternative Asset Management Co. Ordered to Pay More Than $279 Million to Defrauded Customers and More than $20 Million in Civil Monetary Penalties in CFTC Action

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that Paul Eustace of Ontario, Canada, was ordered to pay more than $279 million in restitution and a $12 million civil penalty, based on an order that resolves a CFTC enforcement action against him for defrauding commodity pool participants in four pools that he managed.

The court also entered an order of default judgment against the commodity pool operator that Eustace controlled, the Philadelphia Alternative Asset Management Co. (PAAM), imposing permanent trading and registration bans, requiring payment of restitution of approximately $276 million, subject to offset by prior disbursements and payments by Eustace, and imposing an $8.8 million civil monetary penalty.

The supplemental consent order, entered by the Hon. Michael M. Baylson of the U.S. District Court for the Eastern District of Pennsylvania on August 13, 2008, follows a July 13, 2007 consent order of permanent injunction against Eustace that enjoins Eustace from further violations, and imposes permanent trading and registration bans.

“This concludes a successful effort by our Division of Enforcement to stop fraud in its tracks, return as much money as possible to defrauded investors, and to bring wrongdoers to justice,” said CFTC Acting Chairman Walter Lukken.

The orders arise out of a CFTC complaint filed on June 21, 2005, and later amended, against Eustace and PAAM. (See CFTC Press Release 5091-05, June 29, 2005.)

At the outset of the litigation, the CFTC’s action froze all the assets under the control of PAAM and Eustace and preserved more than $70 million for return to pool participants. The CFTC also obtained the appointment of a receiver to recover and distribute funds to defrauded participants. Through related receivership litigation, an additional $96 million has been obtained to date for the benefit of defrauded pool participants. Defendants’ restitution obligation shall be offset by any funds distributed through the receivership.

As alleged in the amended complaint, and as the 2007 consent order found, from at least the spring of 2001 through June 2005, Eustace fraudulently operated four commodity pools: the Option Capital Fund LP (Option Capital Fund); and, through PAAM, the Philadelphia Alternative Asset Fund, L.P. (LP Fund); the Philadelphia Alternative Feeder Fund LLC; and the Philadelphia Alternative Asset Fund, Ltd., an offshore fund with over $250 million in assets. During this time, Eustace incurred losses of approximately $200 million trading commodity futures and options either in accounts held in the name of the funds or in his name. Eustace concealed those losses by issuing or causing to be issued, false account statements reflecting highly and consistently profitable trading results. Eustace also misappropriated assets of the Option Capital and LP Funds and received incentive and management fees through his fraudulent operation of the pools. Eustace was also charged with fraudulent solicitation and registration violations.

The CFTC Division of Enforcement appreciates the assistance of the Ontario Securities Commission and the National Futures Association in this matter.

In December 2007, the CFTC issued a related order filing and settling failure to supervise and recordkeeping charges against MF Global, Inc. (MFG), a registered futures commission merchant, and Thomas Gilmartin, a former associated person of MFG relating to their mishandling of certain trading accounts managed by Eustace and PAAM that sustained losses of approximately $133 million. MFG and Gilmartin paid collectively $2.25 million in civil monetary penalties and Gilmartin agreed never to seek registration with the Commission. (See CFTC Press Release 5427-07, December 26, 2007.)

The following CFTC Division of Enforcement staff members are responsible for this case: Gretchen L. Lowe, Michael J. Otten, Kara Mucha, Glenn I. Chernigoff, Richard B. Wagner, and Vincent McGonagle.

How to register as a CPO or a CTA

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Many hedge fund managers choose to utilize futures and/or commodities in their trading purposes. Generally such managers will need to register as commodity pool operators (“CPO”) and as commodity trading advisors (“CTA”). The hedge fund itself will be deemed to be a commodity pool. For purposes of the Commodities Exchange Act (“CEA”), a future and commodity are functionally equal as it relates to hedge fund manager registration. Registration as a CPO or a CTA is an often overlooked part of the hedge fund formation process. Your attorney should discuss the requirements for registration and whether any exemptions from registration are available.

In addition to hedge fund managers, retail foreign exchange (“Forex”) managers may very soon be required to register because of the recently passed “Farm Bill.” The retail Forex markets have been very loosely regulated and the CFTC and NFA have been clamoring for authority to regulate this are of the markets. Accordingly, this article will give you the basics on how to register as a CPO and/or a CTA.

A very general outline of the CPO registration process is as follows:

Prerequisite – the Series 3 exam

Each CPO or CTA firm will need to have at least one Associated Person (AP). Generally an AP will be anyone in the firm who has contact with clients in something more than a purely administrative or clerical role. All managers and non-clerical employees will be APs. All APs must have passed the Series 3 exam. Information on the Series 3 exam:

  • Series 3 (National Commodity Futures Examination)
  • Cost: $95
  • Number of Questions: 120 True/False and Multiple Choice
  • Subject Matter: (part 1) Market knowledge and (part 2) U.S. regulations
  • Time: 2 hours 30 minutes
  • Passing Score: 70% for each part

Like the Series 65 exam, I highly recommend you spend plenty of time studying for the exam. If you would like some suggestions on various study guides, please let me know.

Filing the application forms with the NFA

During this process your compliance professional will: gain access to the NFA’s registration system on your behalf, input certain basic information on the Form 7-R (for your CPO/CTA firm) and Form 8-R (for the initial AP) – generally you will provide this information to your compliance professional prior to completing these forms, and submit the 7-R and 8-R on your firms behalf.

After the Form 7-R and 8-R have been submitted you will need to pay for registration ($200 registration fee for the CPO or CTA; $85 for each associated person or principal; $750 for NFA membership (this is an annual fee)). After payment has been submitted, the NFA will review your application. Typically registration should be complete within about 3-5 weeks. The next step will be to have your disclosure document approved by the NFA – your compliance professional can help you with this process.

You will be able to check on your registration through the NFA’s BASIC system.

Definitions

According to the CFTC website, the definition of CPO and CTA are as follows:

Commodity Pool Operator (CPO): A person engaged in a business similar to an investment trust or a syndicate and who solicits or accepts funds, securities, or property for the purpose of trading commodity futures contracts or commodity options. The commodity pool operator either itself makes trading decisions on behalf of the pool or engages a commodity trading advisor to do so.

Commodity Trading Advisor (CTA): A person who, for pay, regularly engages in the business of advising others as to the value of commodity futures or options or the advisability of trading in commodity futures or options, or issues analyses or reports concerning commodity futures or options.

Associated Person (AP): An individual who solicits or accepts (other than in a clerical capacity) orders, discretionary accounts, or participation in a commodity pool, or supervises any individual so engaged, on behalf of a futures commission merchant, an introducing broker, a commodity trading advisor, a commodity pool operator, or an agricultural trade option merchant.

CFTC Announces Formation of Retail Foreign Currency Fraud Enforcement Task Force

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Washington, DC— The Commodity Futures Trading Commission (CFTC) has formed a special task force charged with investigating and litigating fraud in the off-exchange retail foreign currency (forex) market.

The creation of the task force within the Division of Enforcement comes in the wake of Congress’ passage in June 2008 of “The Food, Conservation, and Energy Act of 2008” that clarified and strengthened the CFTC’s jurisdiction over this market. The task force will focus on fraud in the retail forex market and will work cooperatively with other federal and state regulatory and criminal authorities.

“The formation of the CFTC’s new Forex Enforcement Task Force reaffirms our agency’s commitment to stopping unscrupulous individuals working in this space. Not only do forex fraudsters prey upon unsuspecting citizens, but their illegal activities taint the reputations of those working honestly in the futures industry,” said CFTC Commissioner Michael Dunn, head of the agency’s Forex Education and Outreach Task Force. “This announcement sends a clear signal that the CFTC is on the beat, and that our continued and increased cooperation with law enforcement authorities will help put these forex dealers where they belong – in jail.”

“Forex fraud impacts investors of all stripes,” CFTC Acting Director of Enforcement Stephen J. Obie said. “With the creation of the retail forex task force, the CFTC has committed the resources necessary to expand its efforts to identify and prosecute those who commit fraud in the retail forex market.”

Since enactment of the Commodity Futures Modernization Act in 2000, the CFTC has filed nearly 100 enforcement actions against firms and individuals selling illegal forex futures and option contracts. To date, the CFTC has obtained judgments in these enforcement actions for civil monetary penalties of approximately $560 million and restitution of investor losses totaling $450 million.

CFTC Release 5527-08

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Release: 5527-08
For Release: July 31, 2008

Tampa Resident Edward J. Evors Ordered to Pay $904,000 in Restitution and Civil Monetary Penalties in CFTC Action Evors Permanently Prohibited from Engaging in Commodity Trading-Related Activities

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) announced today that it obtained $452,000 in restitution and a $452,000 civil monetary penalty in a consent order against Edward J. Evors of Tampa, Florida. The order also permanently prohibits Evors, who has never been registered with the CFTC in any capacity, from engaging in any commodity trading-related activities.

The court also entered default judgment orders against two Nevada companies controlled by Evors, Bally Lines, Ltd. (Bally Lines) and GPS Fund, Ltd. (GPS), requiring them to disgorge funds received from Evors’ customers.

The orders were entered by the Honorable Richard A. Lazzara of the U.S. District Court for the Middle District of Florida. The consent order as to Evors resolves CFTC charges that he misappropriated customer funds that he solicited and received for the purpose of trading commodity futures contracts with Coyt E. Murray and Murray’s trading firm, Tech Traders, Inc. of North Carolina. Instead of investing customer funds with Tech Traders, Evors misappropriated the funds and concealed his theft by sending customers false account statements misrepresenting their investment. (See CFTC Press Release 5385-07, September 20, 2007.)

According to the CFTC’s September 2007 complaint, Evors instructed customers to send their funds to Bally Lines and GPS for placement with Tech Traders, but these firms actually provided no services and had no legitimate claim to any customer funds. As such, the complaint named Bally Lines and GPS as relief defendants and sought disgorgement from them.

Murray and Tech Traders were defendants in a previous CFTC enforcement action in which they and other defendants were ordered by the U.S. District Court of New Jersey to pay more than $30 million in sanctions (see CFTC Press Release 5357-07, July 23, 2007).

The following CFTC Division of Enforcement staff members are responsible for this matter: Elizabeth M. Streit, David A. Terrell, Joy H. McCormack, Scott R. Williamson, Rosemary Hollinger, and Richard Wagner.

CFTC Release 5525-08

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Release: 5525-08

For Release: July 30, 2008

California Resident Gilbert Philip Castillo, Jr. to Pay More Than $272,000 to Resolve CFTC Anti-Fraud Action

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) announced today that Philip Castillo, Jr. of Walnut Creek, California, will pay $92,474.60 in restitution and a $180,000 civil monetary penalty to resolve CFTC charges that he committed fraud in connection with the trading of S&P 500 commodity futures and option contracts through three Internet websites.

The consent order, entered by the Honorable Thelton E. Henderson, U.S. District Court Judge for the Northern District of California, also permanently prohibits Castillo from engaging in any business activities related to commodity futures trading.

The order arises from a 2006 CFTC complaint against Castillo (see CFTC Press Release 5212-06). The complaint charged that Castillo and his company, Castle Enterprise Corporation (Castle) d/b/a WallStreetWar.com, CastilloResearch.com and Never-Lose.com (collectively, the Wall Street War websites), operated Internet websites from February 1999 through mid-2005 that made fraudulent representations to the general public regarding Castillo’s trading successes and the accuracy, profitability, and track record of Castle’s various commodity advisory services. During this time, Castle was purportedly acting as a Commodity Trading Advisor (CTA) without being registered with the CFTC, as required.

The order finds that Castillo violated the anti-fraud provisions of the Commodity Exchange Act by making false material representations through the Wall Street War websites. These representations included touting that the Wall Street War Advisory Service is “[p]roven to be the most accurate and profitable advisory available!”, and claiming that the system had a track record of 90 to 96 percent profitability, with “tremendous returns in different market conditions for six years!” that ranged “from 302% to 447%.” In fact, many of the advisory services offered to the public by Castillo and Castle never operated and clients were abandoned after purchasing trading systems or courses.

The order also finds Castillo liable as a controlling person of Castle and for being an unregistered Associated Person (AP) of Castle, which was operating as an unregistered CTA.

Previously, on February 5, 2007, the court entered a final default judgment against Castle, ordering it to pay $814,858.89 in disgorgement to be used for restitution to victims of its fraud and a $480,000 civil monetary penalty (see CFTC Press Release 5291-07).

The following CFTC Division of Enforcement staff members are responsible for this case: Timothy J. Mulreany, David Reed, Michael Amakor, Paul Hayeck, and Joan Manley.