North Dakota Law Review Volume 57 Number 1 Article 1 1981 The Commodity Futures Trading Commission and the Return of the Bucketeers: A Lesson in Regulatory Failure M. Van Smith Follow this and additional works at: https://commons.und.edu/ndlr Part of the Law Commons Recommended Citation Van Smith, M. (1981) "The Commodity Futures Trading Commission and the Return of the Bucketeers: A Lesson in Regulatory Failure," North Dakota Law Review: Vol. 57 : No. 1 , Article 1. Available at: https://commons.und.edu/ndlr/vol57/iss1/1 This Article is brought to you for free and open access by the School of Law at UND Scholarly Commons. It has been accepted for inclusion in North Dakota Law Review by an authorized editor of UND Scholarly Commons. For more information, please contact [email protected]. THE COMMODITY FUTURES TRADING COMMISSION AND THE RETURN OF THE BUCKETEERS: A LESSON IN REGULATORY FAILURE M. VAN SMITH* I. INTRODUCTION In 1974, Congress enacted the Commodity Futures Trading Commission Act of 1974 (CFTCA). The CFTCA significantly amended the Commodity Exchange Act and was intended to strengthen and centralize federal commodities regulation. One of the specific purposes of the CFTCA was to end the fraudulent ex- ploitation of the public by bucket shop operators, the "bucketeers" of the 1970s. Unfortunately, rather than putting an end to the bucketeers, there was a recrudescence of the bucketeers under the 1974 Act. Partially in response to the resurgence of the bucketeers, Congress in 1978 passed the Futures Trading Act of 1978 (FTA). Nevertheless, the bucketeers have persevered and pro- liferated. This article will trace the emergence of the bucketeers under the Commodity Exchange Act, their adaptation to the restrictions of the CFTCA, and their perseverance under the FTA. *Member of the California and Colorado Bars; LL.B., University of Colorado, 1959; currently in private practice in Palo Alto, California. NORTH DAKOTA LAW REVIEW II. REGULATION OF COMMODITY OPTIONS A. REGULATION UNDER THE COMMODITY EXCHANGE ACT OF 1936 Commodity options are contracts by which one party pur- chases from another party the right to buy or sell a commodity at an agreed price and within an agreed time.' In 1936, Congress prohibited the trading of options on commodity futures by enacting, the Commodity Exchange Act. 2 'This prohibition was intended to protect commodity futures markets from the disruption caused by option dealers. 3 The Commodity Exchange Act regulated only commodity futures specified by the Act. 4 Thus, the Act did not prohibit options on futures markets not regulated under the Act, commonly known as "world" commodities. 5 The lack of regulation under the Com- modity Exchange Act of the so-called world commodities set the stage for the return of the bucketeers. On April 28, 1971, Harold Goldstein opened an office in Los Angeles to sell options on commodity futures not regulated under the Commodity Exchange Act. Goldstein had stumbled onto a 1. An option to buy is known as a "call," referring to a party's "calling" for the commodity from the other party; an option to sell is known as a "put," referring to a holder's "putting" the commodity to the other party. An option given the holder to either buy or sell is known as a. "double" option, or "straddle"; a double option or straddle is a combination of a put and a call. The price at which the holder of an option can either buy or sell the optioned commodity is the "striking price." When the striking price is the same as the market price of the commodity being optioned, the option is an "at market" option. If, for the holder, the striking price is better than the market price, the option is "in the money"; if the striking price is worse than the market price, the option is "out of the money." The money paid for an option is the "premium." The premium is paid to the "grantor," or "writer," of an option. Commodity options specify a period, ranging from two to fourteen months, during which time the option may be exercised. The date and hour by which an option holder must state that he wants to exercise an option is the "declaration" date. If an option is not declared by the declaration date, it is "abandoned" and the premium is forfeited. The "commission" on a commodity option is a fee for brokering the option. The "break even point" is how much the price of a commodity must change in favor of its holder to pay for the premium and the commission. Options which are traded on an exchange are called "exchange traded" options, and options which are not traded on exchanges are called "dealer" options. For further explanation of these and other terms used in commodity options trading, see CFTC v. Crown Colony Commodity Options, Ltd., 434 F. Supp. 911 (S.D.N.Y. 1977); P. CRACRAFT, LONDON OPTIONS ON COMMODITIES 210 (1977); R. GIBSON-JARvIE, THE LONDON METAL EXCHANGE 134 (1976); S. KROLL &J. SHISHKO, THE COMMODITY FUTURES MARKET GUIDE 258-68 (1973); R. TEWELES, C. HARLOW & H. STONE, THE COMMODITY FUTURES GAME: WHO WINS? WHO LOSES? WHY? 227-29 (1974). 2. Pub. L. No. 74-675, ch. 545, 49 Stat. 1491 (1936) (current version at 7 U.S.C.A. §5 1-24 (West 1980)). 3. H.R. REP. No. 74-421, 74TH CONG., IST SESS. 5 (1935); Hearings on H.R. 3009 Before the House Comm. on Agriculture, 74th Cong., 1st Sess. at 94-95 (1935); P. MEHL, TRADING IN PRIVILEGES ON THE CHICAGO BOARD OF TRADE 75-78 (U.S. Dep't of Agriculture Cir. No. 232, 1934). 4. Commodity Exchange Act, Pub. L. No. 74-675, ch. 545, 1 2.49 Stat. 1491 (1936) (current version at 7 U.S.C.A. § 2 (West 1980)). 5. See Werst v. First Commodity Corp., [1977-1980 Transfer Binder] COMM. FUT. L. REP. (CCH) 20,542 at 22,237 (D. Mass. 1978). COMMODITY FUTURES TRADING loadstone of public cupidity. In less than two years, he pyramided an $800 initial investment into Goldstein-Samuelson, Inc., a cor- poration with offices world-wide which had sold over 175,000 op- tions valued at $88 million. 6 Goldstein-Samuelson represented that its options were backed by a computerized program to buy futures contracts for every option. 7 Goldstein also represented that it covered its obligations by matching every dollar of its customer's profit with a position in the futures markets. 8 Goldstein-Samuelson actually attempted to cover its options with positions in the futures markets only during its first few months in business; efforts to cover options ceased after six months. 9 Although government officials were slow to realize it, Gold- stein-Samuelson's selling of uncovered, or "naked," options was nothing more than the bucket shop under a new guise.10 The quin- tessence of Goldstein-Samuelson's fraud was in representing that its options were bona fide transactions in which holders actually acquired a put or call for the commodities optioned. In truth, Gold- stein-Samuelson's naked options were nothing more than bets which would be settled, if at all, according to fluctuations in com- modity prices. Of 175,000 options it sold, Goldstein-Samuelson at- tempted to deliver the commodity optioned in only four instances, and actually purchased a futures contract in only one instance. 1 As sales of options increased, Goldstein-Samuelson had to take in an ever-increasing amount of new premium money from new in- vestors in order to cover the increased value of the futures contracts previously optioned. Thus, the millions of dollars in sales which 6. Stipulation of All Relevant Facts in Lieu of Trial on Preliminary Injunction for the Plaintiff at 7, SEC v. Goldstein- Samuelson, Inc., No. 73-472 (C.D. Cal., Oct. 11, 1973) [hereinafter cited as Goldstein-Samuelson Stipulation]. 7. Wall St. J.,June 28, 1973, at 38, col. 2. 8. Goldstein-Samuelson Stipulation, supra note 6, at 12. 9. Id. at 6. 10. See People v. Gardner, 72 Cal. App. 3d 641, 140 Cal. Rptr. 238 (1977). The term "bucket shop" originally described places on the east side of London where persons who had cadged leftover beer and liquor would gather together to drink. SeeJ. HILL, GOLD BRICKS OF SPECULATION 39 (1904). Wychoff attributes the term to the practice of selling odd-lot grain "by the bucket." P. WYCHOFF, WALL STREET VENTURES AND ADVENTURES 264 (1968). In time, "bucket shop" came to be used as a term of derision to describe a place where persons placed bets on market quotations. In executing a customer's order to buy or sell commodity futures or securities, a brokerage firm will execute its customer's orders by an exchange transaction. A customer's order to purchase or sell a commodity futures contract must be executed on a commodity futures exchange. A customer's order to buy or sell a security will be executed on a stock exchange or by a brokerage firm dealing with its customer from securities it owns. Bucket shops operate under the guise of being brokerage firms. However, instead of actually executing orders of their customers, bucket shops put orders down as bets. Bucket shops bet that their customers' margin will be lost before they can make a profit. To promote their customers' losing, bucket shops set margins so low that normal market fluctuations do not wipe out customers' margin. Bucket shops also manipulate market quotations so that customers' margins are lost. WYCHOFF, supra, at 33. Should enough customers have winning positions, a bucket shop might arrange to have a market rigged.