Disgruntled Investor Unsuccessful in Seeking to Hold Regulator Liable for Broker’s Conduct

A disgruntled investor sued the organization that regulates registrations for certain securities brokers after he lost his investment. The investor argued that the securities broker had a history of misconduct dating back more than 30 years and should have had his membership revoked under the organization’s bylaws. The investor claimed that because the organization violated its own bylaws, it was liable for the actions of the securities broker. The district court determined that the organization did not violate the bylaws because the conduct of the broker had not led to the expulsion of an associated organization, only a voluntary withdrawal. The appellate panel agreed and affirmed the decision of the district court.

The Commodities Futures Trading Commission promotes the integrity of the U.S. derivatives markets through regulation via the Commodity Exchange Act. Congress authorized the CFTC to establish futures associations with authority to regulate the practices of its Members. Since 1981, there has been a single CFTC-approved registered futures association under the CEA, the National Futures Association. The NFA is charged with processing registrations for futures commission merchants, swap dealers, commodity pool operators, commodity trading advisors, introducing brokers, retail foreign exchange dealers, and relevant associated persons.

One requirement enforced by the NFA is Bylaw 301(a)(ii)(D), which prohibits a person from becoming or remaining a member if they were, by their conduct while associated with another member, a cause of any suspension, expulsion, or order. Between 1983 and 2015, Thomas Heneghan was an associated person of fourteen different NFA-Member firms. Dennis Troyer, an investor in financial products since the 1990s, invested hundreds of thousands of dollars in financial derivatives through NFA Members and their associates.

Although Troyer chronicled history of misconduct by Heneghan, dating as far back as 1985, the first interaction between Troyer and Heneghan was not until October 2008 when Troyer invested more than $160,000 between October 2008 and March 2011 under Heneghan’s advisement. In 2009, Heneghan came under the scrutiny of the NFA. This scrutiny continued for several years as Heneghan changed affiliation across several NFA member firms. Heneghan was eventually barred from NFA membership, associate membership, and from acting as the principal of an NFA member in 2016.

In the wake of this action, Troyer attempted to withdraw his entire investment from Heneghan and was unsuccessful. Troyer filed a four-count complaint in the Northern District of Indiana seeking accountability for Heneghan’s allegedly fraudulent solicitation of funds from Troyer for the purpose of purchasing commodities futures. After amending his complaint, only the NFA remained as a defendant, and the district court granted summary judgment to the NFA. Troyer then appealed.

On appeal, Troyer argued that the NFA violated the CEA through its failure to enforce its own bylaws, specifically NFA Bylaw 301(a)(ii)(D). Troyer argued that Heneghan should have been disqualified from continued registration as an NFA associate member and as an associated person of any NFA-member firm. The appellate panel began by stating that the bylaw bars persons from becoming or remaining NFA members or associated members if their conduct was the cause of an NFA expulsion. The panel then continued, noting that Troyer alleged that Heneghan was a cause of the expulsion of one of his NFA firms, Statewide, in 2011. Troyer further alleged that after this expulsion occurred, the NFA was obligated to immediately terminate Heneghan’s membership.

The panel noted that Statewide voluntarily withdrew from NFA membership after the NFA’s investigation and that in order to prevail, Troyer was required to show that the bylaw included voluntary withdrawal under a settlement within the definition of “expulsion.” The panel found that the NFA did not fail to enforce Bylaw 301(a)(ii)(D) because the NFA did not expel Statewide. Citing Peterson v. National Futures Association, the panel stated that the CFTC firmly established that an “agreement not to reapply” is not an “expulsion.” Because Bylaw 301(a)(ii)(D) is triggered only by a suspension, expulsion, or order, the panel reasoned, Troyer’s argument that the association failed to enforce its bylaw was not persuasive. The panel, therefore, affirmed the decision of the district court.

You can view the entire decision here.

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