Court Upholds $26 Million Judgment In Salomon Versus Tauber Decision

The U.S. Court of Appeals for the Fourth Circuit which sits in Virginia upheld a June 1992 decision in favor of Salomon Forex, Inc. in the case brought against Dr. Laszlo Tauber. The October 18 opinion issued by a panel of three judges has significant implications for the market, sources say.

First and foremost, they say, it removes a degree of uncertainty surrounding the possibility that the Commodity Futures Trading Commission (CFTC) could have regulatory jurisdiction over the interbank FX markets.

However, the decision failed to distinguish between a forward and a futures contract, and so raises the question about the CFTC's regulatory powers over the exchanges, according to market participants.

Over the course of two and one-half years, Tauber (who owns foreign currency trading company, Westwood Options, Inc. and holds a seat on the Philadelphia Stock Exchange) entered into 2,702 transactions with Salomon and related entities, each involving the sale of foreign currency futures and options. Tauber also engaged in deals with more than a dozen other companies during the period in question, in which he exchanged billions of dollars worth of currency, the court said.

In March 1991, when Tauber's investments declined sharply in value, he allegedly failed to cover his open positions as demanded by Salomon, the court said. Salomon subsequently ceased trading with him, and Tauber soon owed $25 million under 68 futures contracts. At the time, Tauber had a total outstanding balance of $30 million. After applying $4 million in collateral that was holding in his balance, Salomon billed Tauber for almost $26 million.

Tauber's principal defense, according to the court, rests on the ground that his transactions with Salomon are unenforceable because they violate the Commodities Exchange Act (CEA) which establishes a comprehensive system for regulating futures and options contracts.

Tauber claims that the CEA requires that foreign currency futures be traded exclusively on exchanges designated by the CFTC and that options be traded either on such exchanges or on securities exchanges designated by the Securities Exchange Commission, said the court.

The central issue of the case, according to the courts, was whether Congress intended transactions such as those between Salomon and Tauber to be regulated by the CEA. With the legality of the trades in question, the case sparked the interest of the futures exchanges, the regulatory authorities and the U.S. Foreign Exchange Committee (FX Week, Aug. 31, 1992).

The basis for Tauber's appeal, argued May 6, lay in the argument whether professional traders may individually negotiate sales of foreign currency futures and options off organized exchanges without violating the CEA.

The CFTC has regulatory oversight of commodity trading on the exchanges under the CEA. A Treasury amendment to the CEA was implemented to exempt foreign currency transactions from the act, however, this does not extend to futures trading in foreign currencies off organized exchanges, according to the amendment. Tauber's argument contended that his transactions with Salomon were off-exchange futures, thus rendering the transactions illegal under the CEA.

Salomon, meanwhile, refers to the transactions in question as forwards rather than futures. The district court declined to resolve the contracts' nature, noting that summary judgment is appropriate whether the contracts are futures or forwards, says the judges' opinion.

Tauber's interpretation of the amendment was thus again rejected by the courts. The judges came to the conclusion that, under the appropriate interpretation of the Treasury amendment, all off-exchange transactions in foreign currency, including futures and options, are exempted from regulation by the CEA.

"There has been a controversy over whether the Treasury amendment validly covered all foreign exchange contracts, says Lewis Teel, president of the Foreign Exchange Committee and executive vice president at Bank of America. "What the court is saying is, yes it does--which removes that uncertainty. So the CFTC does not have regulatory oversight of currency contracts, and that is a wonderful thing."

Another argument presented by Tauber questioned his status as a sophisticated investor. In a letter by the General Counsel of the Department of the Treasury, regarding amendments to the CEA, the department said the interbank market participants are sophisticated and informed institutions, unlike the participants on organized exchanges, which in some cases, include individuals and small traders who may need to be protected by some form of governmental regulation.

The court determined that the transactions between Salomon and Tauber were off-exchange transactions, individually negotiated, and that Tauber is a sophisticated investor.

"Tauber's argument was that he is not a sophisticated investor, and so the CFTC should have been watching over him," says a market participant. "The bottom line is that there is no regulation out there, and he should have known the rules of the game."

The possible argument the court's decision does raise is whether exchanges such as the Chicago Mercantile Exchange (CME) and the Philadelphia Stock Exchange, are likewise exempt from CFTC regulation since the court upheld the language of 'futures,' sources say.

A source in Chicago says since there is no difference between a forward outright and a future, the regulatory framework is not quite on a level playing field.

"What Tauber was saying is a legitimate argument--there is no difference between what is traded on the exchanges and what he traded with Salomon. He is trying to do an IMM look-a-like, and is saying that should be under the same jurisdiction. The CFTC doesn't want to get involved in that, because then they would have to regulate the interbank market," says the source in Chicago.

"So why are the exchanges regulated and not the interbank market?" he asks. "The argument was that the CFTC has to protect the retail investor who really doesn't know any better. Tauber tried to claim he wasn't a sophisticated investor, but the courts found differently."

The CFTC may have indicated just that intent in its recent study on OTC derivatives (see below). The CFTC says it will consider recommending to Congress legislation that would affirm its view that the Treasury amendment does not extend to the sale of futures and options on foreign currency to the general public.

"What the exchanges want is a level playing field," says the Chicago source. "They want to see the interbank markets regulated, as they are, or want the exchanges unregulated, like the interbank markets."

The CFTC is the main U.S. regulatory body for exchange-traded futures and options. Last year, the commission was given the power to exempt certain futures contracts from a number of regulations that currently apply to exchange-traded products. The CME has applied for exemption from requirements of the CEA for its 'rolling spot' foreign currency futures and options contracts. The comment period was recently extended by the CFTC to December 15.

"This case gives more evidence to why 'rolling spot' should be exempt. We are looking for the institutional investor, the market-savvy person, for this contract," says a CME official.