Michael Gent a software designer in connection with the marketing of "Recurrence," a computer program for trading commodity futures contracts. The Recurrence System generated buy and sell signals for Swiss franc futures contracts and, later, Japanese Yen contracts, based on certain market patterns. Customers were instructed to obtain a market reporting service to feed market prices into a computer loaded with the Recurrence program.
Based on that information, the program would generate buy and sell signals that customers were instructed to follow automatically. The CFTC accused AVCO of misrepresenting the past performance of the Recurrence System, primarily by basing performance claims on "hypothetical" trading models rather than actual trades.
Gent was found not to be responsible for any of AVCO's misconduct. Finally, he asserted that as a software publisher he was not within the statutory definition of a CTA, and that if the CEA were construed to cover him, the registration requirements violated the First Amendment. The Second Circuit affirmed the lower court's judgment in virtually all respects. The scope of "in connection with. Instead, the court held that misrepresentations concerning the performance of a computer trading program related directly to the trades recommended by the program and were, therefore, "in connection with" the purchase or sale of futures contracts.
In support of its view of the "in connection with" requirement, the court cited expansive interpretations of that phrase adopted by the Second Circuit in Saxe v E. In Saxe, misrepresentations about the degree of risk associated with commodities trading, including the claim that a particular trader was "an experienced commodities trading advisor which [sic] would use a sophisticated computerized trading program custom-tailored to [the plaintiff's] investment objectives;" were found to be "in connection with" commodities transactions, even though the defendant did nothing more than recommend an advisor who placed trades for the plaintiff.
Based on these two cases, the Second Circuit had little trouble finding that misrepresentations in AVCO's advertisements for the Recurrence System constituted fraud in connection with commodities trading.
A CTA is defined in Section la 5 A of the CEA to include any person who "for compensation or profit, engages in the business of advising others, either directly or through publications, writings, or electronic media, as to the value of or the advisability of trading in [futures contracts. AVCO did not fit within any statutory exclusion to that definition because the Recurrence System's recommendations responded to specific market conditions and were not "generally" or "regularly" disseminated 7.
In Lowe, the Securities and Exchange Commission had sought to enjoin a former investment advisor whose registration had been revoked for criminal conduct from publishing a newsletter containing investment advice. The former advisor argued that he could not be required to register because he fit within an exclusion from the definition of "investment advisor" under the Investment Advisors Act of for "a publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation.
The Court thus avoided the question whether the registration provisions of the Investment Advisors Act constituted an unconstitutional prior restraint on speech-an issue that clearly troubled several justices.
The language of the CEA does not, in the view of the Second Circuit, support a similar interpretation, particularly since, unlike the Investment Advisors Act, the CEA limits the statutory exclusion to publishers whose advisory services are " solely incidental to the conduct of their business or profession.
The defendants' misrepresentations were made in advertisements for the trading system. The advertisements were commercial speech because they did no more than "propose a commercial transaction Commercial speech in general warrants less protection than other forms of expression. To obtain First Amendment protection at all, commercial speech may not be misleading. The court's analysis of whether AVCO could be required to register as a CTA and enjoined from publishing its software was more complicated.
In fact, the court made several observations that appeared to favor the defendants. First, the court noted that prior restraints are the least tolerable infringement on First Amendment rights and rarely can be justified as a means to prevent future misrepresentations or abuse.
The court also rejected the argument that the Recurrence System itself constitutes commercial speech because, by providing recommendations and guiding the user in making investments, the software does more than "propose a commercial transaction.
Rather, the Recurrence System was an automatic trading program. Users were told to follow mechanically the signals without second-guessing; there was nothing to interpret and no "intercession of the mind or will of the recipient. Since the program was not protected speech, "CO could be required to register as a CTA, and its failure to do so could be punished without violating the First Amendment.
The court recognized that some purchasers of the trading system may have used it as a source of information and advice without following its trading recommendations mechanically, but indicated that AVCO could be required to register for its "non-speech" activities, even if it also engaged in protected speech.
Because the injunction issued by the District Court prevented AVCO and Vartuli from selling any trading system without first registering with the CFTC- even one that gave discretion to the user or was used for educational purposes - the Second Circuit concluded the injunction was overbroad in that it enjoined advice that would constitute protected speech. The District Court was instructed to limit the injunction to the dissemination of systems for automatic trading of futures contracts. With regard to defendant's argument that AVCO's customers were not "clients" within the meaning of Section 40 1 and Rule 4.
If the argument had been raised below, the District Court was instructed to address it. Moreover, the reasoning used to arrive at that conclusion calls into question the justification for requiring the promoters of the system to register as "advisors" under the CEA. The court failed to recognize the expressive character of a computer trading program. In both cases, the courts recognized the authority of the CFTC to pursue fraud cases against providers of non-personalized trading advice without running afoul of the First Amendment.
In CTS, the Seventh Circuit affirmed the enforcement of an administrative subpoena against a publisher of impersonal commodities trading advice and affirmed the principle that the publisher was subject to the anti-fraud provisions of the CEA despite a First Amendment challenge. CFTC 17 and Taucher v. Born 18 , have addressed that issue. Both courts followed the reasoning of Justice White in Lowe and found that the registration provisions of the CEA as applied to providers of impersonal trading advice constituted an illegal prior restraint in violation of the First Amendment.
The Second Circuit in Vartuli chose not to follow these opinions, at least with respect to marketers of computer trading programs whose programs demand rigid adherence to buy and sell signals. This aspect of the Vartuli court's reasoning is troubling. While there is little question that computer software has a functional component, it is difficult to argue that a computer trading program does not convey information and express a view about market patterns that warrants First Amendment protection The Second Circuit's heavy reliance on the fact that the seller of the computer program urges its users to follow its recommendations automatically for the best results, or that users of the trading system, in fact, do follow the buy and sell signals seems misplaced.
The trading program as a whole is conveying trading advice, and that advice can be evaluated, tested, debated and accepted or not as the market determines. The First Amendment protects the open and free exchange of ideas relating to the financial markets.
Technical analysis and computer programs surely have a legitimate role in that exchange. The recommendations generated by a trading system are not entitled to any less constitutional protection simply because they are to be followed rigidly or in their totality. Ironically, even if the First Amendment does not bar licensing by the CFTC of computer trading systems, the reasons offered by the Vartuli court for finding the Recurrence System outside the scope of the First Amendment provide an equally compelling justification for not requiring CFTC registration.
AVCO sold a system that was to be followed automatically. The court recognized the purpose of the program was to "induce action without the intercession of the mind or the will of the recipient. Since the Recurrence System was designed to function with little, if any, customer involvement, it did not foster the kind of fiduciary bond that characterizes an advisor-client relationship and justifies registration.
There was little danger that AVCO would develop the kind of relationship with its customers that facilitates intimidation, fraud or overreaching.
AVCO was simply selling a trading product. Accordingly, there appears little need for it to register as a trading advisor. In March of last year, prior to the Second Circuit's decision in Vartuli, the CFTC amended those requirements to create an exemption for CTAs offering standardized advice through newsletters, telephone newslines, Web sites and non-customized computer software In order to take advantage of the exemption, a CTA may not direct client accounts i.
Thus, while Vartuli holds that the CFTC may require sellers of computer trading programs to register, the CFTC has decided to exempt non-customized trading programs from the registration requirement.
Although the Vartuli decision on the issue of registration was rendered moot by the CFTCs action, the Second Circuit's conclusion that computer trading systems generally are not protected speech may have implications far beyond the commodities field. Whether this restrictive interpretation of the scope of the First Amendment will be extended to other computer software bears watching.
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