UNITED STATES DISTRICT COURT
FOR THE MIDDLE DISTRICT OF PENNSYLVANIA
___________________________________
)
COMMODITY FUTURES TRADING )
COMMISSION )CIVIL DOCKET NO.96-1855
Three Lafayette Centre)
1155 21st Street, N.W.)
Washington, D.C. 20581,)
)
Plaintiff,)
)
v.)
)
KENT ALLEN AHRENS )
1065 Wetherburn Drive)
York, Pennsylvania 17404,)
)
Defendant.)
___________________________________)
COMPLAINT FOR PERMANENT
INJUNCTION AND EQUITABLE RELIEF
I.
INTRODUCTION
1.As more fully set forth below, defendant Kent Allen Ahrens has engaged in acts or practices that violate Sections 4b(a)(i)-(iii), 4c(b), 4k(3), 4n(3) and 4o of the Commodity Exchange Act, as amended (the "Act"), 7 U.S.C. 6b(a)(i)-(iii), 6c(b), 6k(3), 6n(3) and 6o (1994), and Commission Regulations 4.33(a), 32.9 and 33.10, 17 C.F.R. 4.33(a), 32.9 and 32.10 (1996).
2.Accordingly, pursuant to Section 6c of the Act, 7 U.S.C. 13a-1, the Commodity Futures Trading Commission ("Commission") brings this action to enjoin the defendant's unlawful acts and practices and to compel his compliance with the Act. In addition, the Commission seeks restitution and such other relief as this Court may deem necessary or appropriate.
II.
JURISDICTION AND VENUE
3.This Court has jurisdiction over this action pursuant to Section 6c of the Act, 7 U.S.C. 13a-1, which provides that whenever it shall appear to the Commission that any person has engaged, is engaging, or is about to engage in any act or practice constituting a violation of any provision of the Act or any rule, regulation, or order promulgated thereunder, the Commission may bring an action against such person to enjoin such practice or to enforce compliance with the Act. This Court also has jurisdiction of this action pursuant to 28 U.S.C. 1331 and 1345.
4.Venue properly lies with this Court pursuant to Section 6c(e) of the Act, 7 U.S.C. 13a-1(e), because the defendant is found in, inhabits, or transacts business in this District, and the acts and practices in violation of the Act have occurred within this District, among other places.
5.Unless restrained and enjoined by this Court, the defendant is likely to engage in the acts and practices alleged in this Complaint or in similar acts and practices, as described more fully below.
III.
THE PARTIES
6.Plaintiff Commission is an independent federal regulatory agency which is charged with the administration and enforcement of the Act, 7 U.S.C. 1 et seq., and the Regulations promulgated thereunder, 17 C.F.R. 1.1 et seq.
7.Defendant Kent Allen Ahrens ("Ahrens"), who resides at 1065 Wetherburn Drive, York, Pennsylvania, has never been registered in any capacity with the Commission. From the late 1980s through about June 30, 1995, Ahrens was the principal trader for an index arbitrage trading program conducted on behalf of clients of his employer First Capital Strategists ("First Capital") of York, Pennsylvania, a commodity trading advisor registered as such with the Commission since about February 1987 pursuant to Section 4n of the Act, 7 U.S.C. 6n. The principal client was The Common Fund (the "Fund"), a not-for-profit membership organization that manages investments of university endowment funds. Ahrens joined First Capital in about 1982 as a clerk. After several years of accounting and back office duties at First Capital, he began assisting various of First Capital's traders including the index arbitrage trader. In about 1989 or 1990, Ahrens became solely responsible for day-to-day trading of First Capital's index arbitrage program.
IV.
FACTUAL BACKGROUND
8.The Fund maintains the securities portfolio of its members and attempts to enhance the return on those securities by lending the securities to the market through lending agents. First Capital was founded in 1980 to act as a securities lending agent, and it became the lending agent for the Fund in about 1981 and continued as such through about June 30, 1995. In its securities lending on behalf of the Fund, First Capital loaned Fund securities in the securities lending market and received as collateral the full value of the securities, plus about two percent. Initially, First Capital invested the collateral, typically in the overnight market, and the interest thus earned enhanced the return for the Fund on its portfolio.
The Trading Strategy
9.As the securities lending business became more competitive, First Capital devised strategies to further enhance the rate of return on collateral received through securities lending. In 1985, First Capital proposed, and the Fund agreed, that First Capital engage in index arbitrage transactions.
10.Arbitrage is an attempt to profit from pricing disparities between commodities and/or instruments which will, at some time, resume a normal price relationship. Where futures or options are one component of the arbitrage and the other is the underlying commodity, the respective prices will converge at least by the expiration of trading in the derivative instrument. Arbitrage is considered "low risk" when, among other factors, the positions comprising the arbitrage are established simultaneously, or nearly so, and when it is fully hedged and thus not adversely affected by directional market movements, or other variables.
11.Index arbitrage is a trading strategy that involves buying or selling the securities, or a representative subset thereof, that comprise a stock index such as the S&P 500 Index and selling or buying, respectively, derivative instruments of an equal dollar value on that index such as the Chicago Mercantile Exchange ("CME") S&P 500 futures contracts or options. The price of the basket of securities comprising the S&P 500 Index generally tracks the S&P 500 futures contract price, and those prices converge at least by expiration of the futures contract. Prior to convergence, First Capital attempted to lock in incremental profits when pricing disparities resulted in the futures being either "cheap" or "rich" in relation to the price of the basket of securities. In that situation, First Capital's arbitrage trader would purchase the component of the arbitrage that was cheap while selling the component that was rich.
12.The Fund first authorized First Capital to engage in the index arbitrage strategy in 1985 based on a memorandum describing the strategy prepared by First Capital. While the Fund did not adopt formalized guidelines for index arbitrage trading until September 1993, the strategy was subject to various restrictions which the Fund, First Capital and Ahrens each understood. Index arbitrage trading was to consist of simultaneous, or nearly so, trades in the securities and corresponding futures or options markets, and all positions were to be fully hedged. Speculative trading, whether day trading or position trading, was not permitted; such was also not permitted in the arbitrage accounts of other clients of First Capital. The September 1993 guidelines formalized, but did not replace those restrictions.
13.As First Capital's index arbitrage trader, Ahrens had a practice of "legging" into arbitrage positions, that is, Ahrens placed orders for the different sides, or legs, of the transactions at different times and in different amounts, normally executing the securities orders and then the derivatives, in an attempt to obtain a better spread between the securities and derivatives. Ahrens legged into arbitrage positions for the Fund's account, as well as for accounts of other First Capital clients including the University of Minnesota and Columbia University.
14.Believing that brokers on the futures floors took advantage of his orders, Ahrens attempted to "feint" the market by, for example, initially buying when he intended ultimately to go short. Believing that futures orders for as few as ten contracts had market impact, Ahrens traded extensively in small numbers of contracts throughout the trading day. Although Ahrens believed that he was feinting the market and avoiding market impact while legging into futures positions, he was, in fact, day trading and scalping the market, both of which are speculative trading strategies. Often, Ahrens traded between 1,000 and 3,000 futures contracts on a single trading day for the Fund's account and substantial, but lesser numbers of contracts for other clients' accounts.
15.Ahrens' approach to trading increased the risks in the arbitrage program significantly. Ahrens' legging into transactions over a period of time in the course of a trading day created the risk that the arbitrage opportunity would disappear. Moreover, Ahrens, at times, missed obtaining an execution on one side of the arbitrage, leaving him with an uncovered position on the opposite side.
16.In addition to day trading or scalping, Ahrens engaged in other types of transactions which increased the risks in his trading for the Fund and for other clients, including the University of Minnesota. Ahrens entered into so-called "volatility trades" in which he purchased either long calls or long puts and day traded futures contracts in an attempt to profit from what he considered to be mispriced volatility implied in the options. The volume of futures trading Ahrens undertook in volatility trades bore no relation to the options positions.
The Loss
17.As Ahrens has admitted, to the best of his recollection, in about 1992, while legging into an arbitrage transaction for the Fund, Ahrens was unable to complete one of the legs, and, by the end of the day, the loss in the uncovered leg was about $250,000. Prior to that loss, Ahrens had experienced other losses of substantial but lesser amounts as a result of his legging into positions. Ahrens states that he recouped those losses through speculative trading gains and believed that recovering the $250,000 would not be difficult. Rather than report the loss, Ahrens decided to attempt to recoup it by assuming a substantial, speculative position in S&P 500 futures contracts, or their equivalent in options or securities. At that time, Ahrens thought that the S&P 500 Index would decline or experience a correction of 30%. Accordingly, he placed a directional bet for the Fund's account on the short side of the market.
18.Contrary to Ahrens' belief about the future direction of the market, the S&P 500 Index increased almost continuously through June 1995. To obtain a gain on a price decline sufficient to cover his growing losses, Ahrens increased substantially the size of his outright position. Not long after placing his directional bet, Ahrens' short position grew to 400 to 600 S&P 500 futures contracts. At times, his short position reached the equivalent of between 2,500 and 2,800 S&P 500 futures contracts having a face value of about $600 million.
19.To fund heavy losses incurred on derivative and securities positions, Ahrens sold Fund securities. By the time his unauthorized trading and the corresponding loss were discovered, the loss had grown to about $137 million, which represented the cost of replacing Fund securities Ahrens thus sold.
20.Ahrens concealed from First Capital and the Fund the losses he was incurring for the Fund's account. He was able to conceal his losses largely because he was responsible for trade checking and accounting for his trading results. During the entire period that Ahrens was concealing his losses, he reported to First Capital, and First Capital reported to the Fund, significant profits in the index arbitrage program. The reports were false and misleading, because they did not account for the accumulated losses on Ahrens' directional bet. According to the monthly and quarterly statements of earnings prepared by First Capital for its programs on behalf of the Fund, the index arbitrage strategy represented First Capital's most profitable strategy.
21.Those false reports were used to calculate First Capital's compensation as well as that of Ahrens. With respect to the index arbitrage strategy, the Fund paid First Capital 1/3 of realized profits. First Capital, in turn, paid Ahrens 1/8 of its 1/3 fee.
22.Throughout this period from 1992 through June 1995, Ahrens maintained on his personal computer a mark-to-market report for his positions. Over the period, he supplied First Capital with at least two printed copies of his mark-to-market reports. In each, Ahrens changed the cost data for securities, futures or options positions, sometimes by as much as 200 index points, in order to show profitable trading.
23.Throughout this period, Ahrens concealed and failed to disclose to First Capital or the Fund the fact that he was maintaining a very large, short position which was incurring massive losses.
24.Ahrens participated in making, and made, trading decisions for the accounts of clients of First Capital and supervised another First Capital trader so engaged. He exercised substantial control over how and when to enter into futures and options transactions, as well as the level of trading in the arbitrage accounts he traded for clients. Ahrens also gave advice to First Capital's clients, both directly and indirectly, including advising them on how trades should be executed in index arbitrage strategies, and he participated in solicitations of prospective clients for First Capital. Ahrens, therefore, should have been registered as an associated person of a commodity trading advisor.
25.All orders to make and the making of contracts of sale of commodities for future delivery described herein may have been used for 1) hedging any transaction in interstate commerce in such commodity or the by-products thereof, or 2) determining the price basis of any such transaction in interstate commerce in such commodity, or 3) delivering any such commodity sold, shipped, or received in interstate commerce for the fulfillment of such futures contracts.
V.
COUNT I.
VIOLATIONS OF SECTIONS 4b(a)(i), (ii)
and (iii) OF THE ACT: FRAUD AND DECEPTION
IN CONNECTION WITH FUTURES TRANSACTIONS
26. Paragraphs 1 through 25 are realleged and incorporated herein by reference.
27.During the period of about 1992 through on or about June 30, 1995, defendant Ahrens violated Sections 4b(a)(i), (ii) and (iii) of the Act, 7 U.S.C. 6b(a)(i), (ii) and (iii) in that Ahrens, in or in connection with orders to make, or the making of, contracts of sale of commodities for future delivery made or to be made, on or subject to the rules of contract markets, for or on behalf of other persons, where such contracts for future delivery were or could have been used for any of the purposes set forth in paragraph 25 above, cheated or defrauded or attempted to cheat or defraud such other persons, or willfully made or caused to be made to such other persons false reports or statements thereof or willfully entered or caused to be entered for such persons false records, or willfully deceived or attempted to deceive such other persons in regard to their orders or contracts or the disposition or execution of their orders or contracts, or in regard to acts of agency performed with respect to their orders or contracts, as more fully set forth below:
A.Ahrens engaged in transactions in commodity futures contrary to Fund guidelines and contrary to the authorization given by the University of Minnesota including taking positions which were not matched by an equal but opposite position;
B.Through First Capital, Ahrens misrepresented the profit and loss in his trading;
C.Through First Capital, Ahrens provided the Fund with false statements showing that his trading in equity arbitrage was profitable, when it was losing millions of dollars;
D.Through First Capital, Ahrens falsely represented that his arbitrage positions were fully hedged;
E.Ahrens sold fund securities for purposes not authorized by the Fund, including to raise money to cover losses from unauthorized commodity futures trading; and
F.Ahrens failed to disclose that he had taken a directional bet on the market which was losing millions of dollars.
COUNT II.
VIOLATIONS OF SECTION 4c(b) OF THE ACT AND
REGULATIONS 32.9 AND 33.10: FRAUD AND DECEPTION
IN CONNECTION WITH OPTIONS TRANSACTIONS
28. Paragraphs 1 through 25 are realleged and incorporated herein by reference.
29.During the period of about 1992 through on or about June 30, 1995, defendant Ahrens violated Section 4c(b) of the Act, 7 U.S.C. 6c(b), and Commission Regulations 32.9 and 33.10, 17 C.F.R. 32.9 and 33.10, in that Ahrens entered into transactions involving commodities regulated under the Act which were of the character of options, both over-the-counter and those traded on a contract market, contrary to Commission Regulations 32.9 and 33.10, 17 C.F.R. 32.9 and 33.10, to wit, Ahrens directly and indirectly cheated or defrauded and attempted to cheat or defraud the Fund, made or caused to be made to the Fund false reports or statements thereof or caused to be entered for the Fund false records, or deceived or attempted to deceive the Fund all in or in connection with the entry into and maintenance of commodity option transactions, as more fully described below:
A.Ahrens engaged in transactions in commodity options contrary to Fund guidelines including taking positions which were not matched by an equal but opposite position;
B.Through First Capital, Ahrens misrepresented the profit and loss in his trading;
C.Through First Capital, Ahrens provided the Fund with false statements showing that his trading in equity arbitrage was profitable, when it was losing millions of dollars;
D.Through First Capital, Ahrens falsely represented that his arbitrage positions were fully hedged;
E.Ahrens sold fund securities for purposes not authorized by the Fund, including to raise money to cover losses from unauthorized commodity options trading; and
F.Ahrens failed to disclose that he had taken a directional bet on the market which was losing millions of dollars.
COUNT III.
VIOLATIONS OF SECTION 4o(1) OF THE ACT: FRAUD BY
AN ASSOCIATED PERSON OF A COMMODITY TRADING ADVISOR
30.Paragraphs 1 through 29 are realleged and incorporated herein by reference.
31.During the period of about 1992 through on or about June 30, 1995, defendant Ahrens violated Section 4o(1) of the Act, 7 U.S.C. 6o(1), in that Ahrens, an associated person of a commodity trading advisor, by use of the mails, or other means or instrumentalities of interstate commerce, directly and indirectly, employed devices, schemes, or artifices to defraud First Capital's clients, or engaged in transactions, practices, or a course of business which operated as a fraud or deceit upon such persons, as more fully described below:
A.Ahrens engaged in transactions in commodity futures and commodity options contrary to Fund guidelines and contrary to the authorization given by the University of Minnesota including taking positions which were not matched by an equal but opposite cash position;
B.Through First Capital, Ahrens misrepresented the profit and loss in his trading;
C.Through First Capital, Ahrens provided the Fund with false statements showing that his trading in equity arbitrage was profitable, when it was losing millions of dollars;
D.Through First Capital, Ahrens falsely represented that his arbitrage positions were fully hedged;
E.Ahrens sold fund securities for purposes not authorized by the Fund, including to raise money to cover losses from unauthorized commodity futures and options trading; and
F.Ahrens failed to disclose that he had taken a directional bet on the market which was losing millions of dollars.
COUNT IV.
VIOLATIONS OF SECTION 4k(3) OF THE ACT:
ACTING AS AN ASSOCIATED PERSON OF A COMMODITY
TRADING ADVISOR WITHOUT REGISTRATION
32.Paragraphs 1 through 31 are realleged and incorporated herein by reference.
33.Commencing in about 1989 and continuing through on or about June 30, 1995, defendant Ahrens violated Section 4k(3) of the Act, 7 U.S.C. 6k(3), in that Ahrens was associated with First Capital, a commodity trading advisor, in a capacity which involved the solicitation of client's or prospective client's discretionary account, without having been registered with the Commission as an associated person of First Capital.
COUNT V.
VIOLATIONS OF SECTION 4n(3)(A) OF
THE ACT AND REGULATION 4.33(a): FALSE RECORDS
34.Paragraphs 1 through 33 are realleged and incorporated herein by reference.
35.From at least 1992 through June 30, 1995, defendant Ahrens, pursuant to Section 13(a) of the Act, 7 U.S.C. 13c(a), aided and abetted violations of Section 4n(3)(A) of the Act, 7 U.S.C. 6n(3)(A), and Commission Regulation 4.33(a), 17 C.F.R.
4.33(a), in that Ahrens, in connection with his trading in First Capital's index arbitrage strategy, prepared and maintained false and/or inaccurate records of transactions effected for commodity interest accounts of clients, including the Fund; prepared and maintained false and/or inaccurate daily records of commodity interest transactions, and failed to keep and maintain accurate, current records of the same; and prepared false and/or inaccurate books and records of cash market (securities) and options on securities transactions in which he engaged.
VI.
RELIEF
WHEREFORE, plaintiff respectfully requests that this Court, as authorized by Section 6c of the Act, 7 U.S.C. 13a-1, and pursuant to its own equitable powers:
1.enter a permanent injunction enjoining the defendant from violating the Act and Regulations, as alleged herein;
2.provide for ancillary equitable relief, including restitution and disgorgement; and
3.provide for such other and further relief as this Court deems necessary and appropriate under the circumstances.
Respectfully submitted,
___________________________________
William O. Hoar, Esq.
D.C. Bar No. 178194
Susan F. LaMarca, Esq.
D.C. Bar No. 436950
Attorneys for Plaintiff
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, N.W.
Washington, D.C. 20581
(202) 418-5378
Date: ________________