United States District Court, D. Nebraska
U.S. COMMODITY FUTURES TRADING COMMISSION, Plaintiff,
JONATHAN W. ARRINGTON, ELITE MANAGEMENT HOLDINGS CORP., MJM ENTERPRISES LLC, MICHAEL B. KRATVILLE, and MICHAEL J. WELKE, Defendants.
MEMORANDUM AND ORDER
LAURIE SMITH CAMP, Chief District Judge.
This matter is before the Court on the Motion for Summary Judgment (Filing No. 97), filed by the Plaintiff, U.S. Commodity Futures Trading Commission ("CFTC") against Defendant Michael B. Kratville. For the reasons stated below, the CFTC's Motion for Summary Judgment will be granted.
The CFTC filed its Complaint on May 23, 2011 (Filing No. 1) alleging that Defendants Jonathan Arrington ("Arrington"), Michael B. Kratville ("Kratville"), Michael J. Welke ("Welke"), Elite Management Holdings Corp. ("EMHC"), and MJM Enterprises LLC ("MJM") (collectively "Defendants") fraudulently induced more than 130 individuals to invest $4.7 million in commodity pools operated by Defendants, in violation of the Commodity Exchange Act (the "CEA" or the "Act"), 7 U.S.C. §§ 1 et seq., and its implementing regulations, 17 C.F.R. §§ 1.1 et seq. 2.
The facts below are admitted by the parties, or are stated in the briefs and supported by pinpoint citations to admissible evidence in the record and not properly resisted as required by NECivR 56.1 and Fed.R.Civ.P. 56.
I. Origin of Elite Investment Group
In or around 2004, Kratville and Welke were members of an "investment club" run by Arrington and Neil Labelle ("Labelle"), called Elite Index Investment Group. Through a $25, 000 investment in January 2004, Kratville joined Elite Index Investment Group, which was incorporated in February 2004, and began trading, as early as September 2003. Elite Capital Management Group, LLC, operated Elite Index Investment Group and another "investment club, " Elite Aggressive Growth Group, established in February 2004. At some point during the summer of 2005, Labelle assigned Elite Index Investment Group and Elite Aggressive Growth Group to Arrington. At that time, some or all members received their funds back. Kratville got his money back in May 2005, receiving slightly less than he invested, because his Elite Index Investment Group investment resulted in a loss. Neither Elite Aggressive Growth Group nor Elite Index Investment Group showed consistent profitability.
FXIG was a trading group, run by Fred Honea ("Honea") in Spain, that reported monthly trading returns ranging from 8.6% to 34.6% per month from May 2002 through May 2005. FXIG reported that it traded in the spot and futures markets for commodities, precious metals, and foreign exchange ("forex"), and that it operated as a pool so every account's return would be the same. FXIG promised high returns with limited risk because no more than ten percent of an individual's funds would be invested at any one time.
Kratville learned about FXIG from his friend Steven Vlach ("Vlach"). After Kratville learned about FXIG, he invested by sending $10, 000 to $15, 000 to Vlach. FXIG moved money from Vlach's account to create at least one account for Kratville. When Vlach talked to Kratville about FXIG, he cautioned him, stating he should get his original money out as soon as he doubled his money-because funds like FXIG can go awry or do really well and then hit a snag. Kratville later introduced Arrington and Welke to FXIG. In or around July or August 2005, Arrington, Kratville, and Welke traveled to Las Vegas to meet Honea and learn more about FXIG. Arrington, Kratville, and Welke never saw any trading statements because Honea refused to show them.
III. Background of "Elite" Companies
Arrington, Kratville, and Welke formed Defendant Elite Management Holdings Corporation ("EMHC") in July or August 2005, to pursue investment opportunities, and they decided to invest with FXIG. Kratville, Arrington, and Welke were all equal owners of EMHC, and they were all officers; with Kratville serving as secretary. EMHC became the holding or parent company for the two pools assigned from Labelle to Arrington-Elite Index Investment Group and the Elite Aggressive Growth Group (the "Elite Pools"). In or around January 2006, Kratville, Arrington, and Welke also opened Elite Management Index Fund ("EMIF"), managed by EMHC. Neither Arrington, Welke, nor Kratville registered EMHC with the CFTC as a commodity pool operator, nor did they register individually as associated persons of a commodity pool operator. EMHC never registered or filed an exemption of registration with the CFTC.
The Elite Pools had target return structures that capped the returns to which an individual pool participant would be entitled in a given month. Arrington, Kratville, and Welke were to keep all returns above the monthly caps, and all business expenses were to be borne by them. The returns were to be made by investing in FXIG.
Kratville had several roles in EMHC. When a prospective pool participant appeared interested in investing, Kratville referred the name to Arrington. Kratville, Arrington, and Welke communicated with each other about whom they were contacting to invest with the Elite Pools. Kratville was originally a signatory on at least two bank accounts for EMHC, but Arrington removed Kratville as a signor for the accounts as of December 27, 2006.
Kratville also acted as the attorney for EMHC and the Elite Pools, and appeared before the Nebraska Department of Banking and Finance ("NDBF") in that capacity. Kratville had input into the decision to use FXIG; identified prospective pool participants; and spoke with potential pool participants about investing in the Elite Pools. Kratville reviewed and contributed to the Elite Pool website, brochure, prospectus, and monthly newsletter called "eWires, " when they were used to solicit prospective pool participants. Kratville used both telephones, mail, and emails to communicate with Arrington, Welke, prospective pool participants and pool participants about EMHC and the Elite Pools, and helped pool participants access the Elite Pools' website.
IV. Solicitation of Elite Pool Participants
In August 2005, Kratville began to provide information about the Elite Pools to prospective pool participants, including family and friends. That month, Kratville emailed at least two prospective pool participants, telling them that he formed an investment company that would pay people 4-6% per month "because of the ability of our trader to generate consistent profits of at least 6% every month since 2002." (Filing No. 100-5 ¶ 4; Filing No. 102-6 at ECF 12.) Kratville provided the prospective pool participants with a link to the EMHC website and stated, "I have been a part of this fund since 2002" and "expect to hit the 6% mark again by the end of the month... for the 40th month in a row." (Filing No. 100-5 ¶ 4; Filing No. 102-6 at 12.) Neither Kratville's email nor the EMHC website referenced FXIG.
In the months following August 2005, Kratville represented to prospective pool participants that the Elite Pools had returned at least four to six percent per month for several months. Kratville noted that there was a risk with the investment, but stated that the risk was limited because only a small portion of the fund was invested at any time. The Defendants did not mention any association with FXIG. Their website also stated that only a portion of the fund was invested at any time.
Kratville followed up with one of his clients, Ed Voges ("Voges"), several months after making representations to prospective investors. In his emails to Voges, Kratville stated, "We have hit at least 6% every month since 5/02... and we don[']t get paid unless we hit your goal level first, and we charge no fees." (Filing No. 100-5 at ECF 14.) Kratville also stated, "We are an investment club exempt from the SEC rules... so no filings." ( Id. at ¶ 3, ECF 20.) Kratville stated "our main clients are people in our age group with IRAs and 401ks that can be rolled over into our fund and where people are looking to let it grow for a minimum of 3 years. We accept cash, of course, but we feel we do the most good for people that roll over tax-deferred vehicles." ( Id. at ECF 16.)
Although the EMHC website did not mention FXIG, the EMHC website and marketing materials adopted FXIG's trading strategy as its own. The EMHC website made several representations about its trading record and strategy stating, "Our Executive Trader and trading group designed our Special Growth Strategy over a 10 year[s] of testing and trading. The principal investment markets that this strategy utilizes are equities, commodities, precious metals and currencies." (Filing No. 102-2 at ECF 3.) The website also stated that this strategy has "had many multi-million offers to buy the system, but the desire has been, and still is to help the small guy build a nest egg and to remain entirely proprietary." ( Id. ) The website advertised that EMHC's "Special Growth Strategy" used "sophisticated procedures to prevent losses." ( Id. ) Specifically, the website explained, "No more than 10% of principal is invested at one time, yet the results are unparalleled." ( Id. ) The website stated that the investment goal was a 4, 4.5, or 5 percent monthly-capped return, compounded monthly depending on the principal investment. The website touted, "Over the last 48 month[s] this strategy has met its return goals every month." ( Id. )
Kratville forwarded the monthly newsletter eWire to potential pool participants to see if they were interested in the pool. The newsletters included representations about the trading returns, and stated that EMHC hit the maximum target goal for several months in a row. The eWires newsletters did not refer to FXIG. Kratville reviewed the EMHC prospectus and brochure with prospective pool participants; sent other prospective pool participants the brochure in the mail; and directed Arrington to contact prospective pool participants to provide them with the brochure and prospectus.
The brochure and prospectus also made several representations about EMHC's trading strategy, including that the pool's special growth strategy was designed over a 12year period of testing and trading; that the strategy had attracted multi-million dollar offers to buy the system; that even though there was no guarantee monthly target goals could be met, such goals had been met every month since 2002; and that a successful local attorney-Kratville-was an active long-term investor in EMHC. The prospectus listed EMHC's primary broker as TradeStation Securities in Florida, and its clearing house broker as R.J. O'Brien in Chicago, Illinois; and stated the investments were equities, commodities, precious metals, and currency, in both the futures and spot markets. Neither the brochure nor the prospectus stated that money would be sent out of the country, and Kratville did not tell potential pool participants that investments would be sent out of the country. EMHC never had trading accounts at TradeStation Securities or R.J. O'Brien, and, while the Elite Aggressive Growth Group did hold accounts there, those accounts had ceased trading by the end of April 2005-before the Defendants began soliciting pool participants and before EMHC was formed. Neither EMHC nor the Elite Pools had a proprietary trading system, and the Defendants never received any offers to purchase their system.
Kratville explained to his friend Pat Shannon ("Shannon") in October 2005, that if he told people about FXIG, no one would invest with the Elite Pools. In an email between Welke and Kratville, Welke stated "that it would be best if they didn[']t know who ou[r] people are...I just think we should try to hold on as long as we can without giving out any names or info since that is our secret ingredient' which is our recipe for success." (Filing No. 101-2 at ECF 42-43.) With respect to sales agents, Kratville told Shannon that EMHC could not hire anyone who had a license because "there are reporting rules for people with licenses if they are working with funds that are not licensed like ours." (Filing No. 103-1 at ECF 17.) Kratville explained to Shannon that the sales agents they were hiring "have connections with lots of rich people" and that they raised $1.5 million in 2005 "all in less than 4 months... hoping to hit $10 million in principal in 2006... then we can all retire for real." ( Id. )
Between July 7, 2005, and April 30, 2006, EMHC received almost $2.3 million in funds from pool participants. The Elite Pools paid approximately $100, 000 back to pool participants and sent $1.7 million to be traded on behalf of the Elite Pools. All the Elite Pool funds were commingled, and the Elite Pools were set up so pool participants would share losses equally, based on the amount invested.
V. Inquiry from Nebraska Department of Banking and Finance
On May 15, 2006, Arrington received a letter from the NDBF regarding the investments sold by EMHC through its website, which he forwarded to Kratville. The letter referenced the EMHC website; asked for detailed business descriptions and copies of all promotional materials used; and inquired as to the identity of EMHC's traders. The letter stated that neither the offer or sale of the investments or other securities could continue until the status of EMHC was determined.
Kratville spoke with an attorney the following day, inquiring about the jurisdiction of the NDBF. Kratville asked "if we open up another LP in another state, refund the money to Nebraska residents, and then have people give us back the money we just gave them to put into the new LP located outside of Nebraska... do you think that would suffice?" (Filing No. 102-6 at ECF 39.) The attorney explained the jurisdictional reach of the NDBF was broader than that. In a subsequent email from Kratville to Arrington, Kratville said "[d]espite [the attorney's] advice, I think the better course of action is to not refund the monies at this time and try and stretch out the discussion process as long as possible (I have some ideas on that) until the point where [they] likely [will] tell us to shut down.... I am curious whether we need to consider LPs in just another state or whether we need to even move it offshore. Just an idea." (Filing No. 102-6 at ECF 41.) On May 25, 2006, Kratville, Arrington and Welke created NIC, LLC ("NIC") and MJM Enterprises, LLC ("MJM") in Wyoming. On June 5, 2006, Arrington, Kratville, and Welke met and decided that MJM would be allowed to open bank accounts in Iowa. Arrington opened bank accounts in Iowa on behalf of EMHC and at least one of the Elite Pools.
Kratville drafted and sent a response to the NDBF inquiry on May 26, 2006. In his letter, Kratville explained that he, Arrington, and Welke directed the investment club's strategy on a daily basis and therefore the three of them were the "trading group, " as had been referenced on the website. He also stated that Arrington was the "executive trader, " though he noted that all three had extensive trading experience. Kratville and Welke met with the NDBF on June 16, 2006. At that meeting, Kratville and Welke represented that Kratville, Welke, and Arrington were the sole officers of EMHC, and they made decisions by consensus. Kratville represented that EMHC invested in commodities and currencies but did not mention FXIG. Kratville told the NDBF that there were no pool participants from any other states; that no more than 10 percent of anyone's principal was at risk at any one time; and that the Elite Aggressive Growth Group had made at least 5% every month for 48 months.
The NDBF determined that EMHC failed to disclose to investors the risks of investing in commodities; the details regarding the multi-million dollar offers to buy their alleged trading system; information supporting the 48-month 5%-plus earnings claim; and Arrington's, Kratville's and Welke's trading qualifications. The NDBF asked that the Elite Pools complete a full recession-returning everyone's money, both principal and gain- explaining that because they were selling securities, and their structure, numbers, and representations were flawed, full recession would be the only adequate cure for the flaws. The NDBF explained that if EMHC did not agree to shut down and return all investor funds, the NDBF would sue them. Kratville and Welke agreed to follow the NDBF's directive and to notify Arrington.
VI. Representations to Pool Participants about the NDBF Inquiry
During the last week of May 2006, before their meeting with the NDBF, Arrington, Kratville, and Welke held a meeting for the pool participants of the Elite Pools. At the meeting Kratville and Arrington both spoke. Kratville announced that the State of Nebraska had issues with how the Elite Pools were set up, but nothing was wrong, and that everything continued to go well with the Elite Pools. Kratville, Arrington, and Welke sent out two letters dated July 5, 2006, to every pool participant. The first letter, identical to a letter Kratville sent the NDBF for approval, stated that after consideration and cooperation with the NDBF, Kratville, Arrington, and Welke decided to dissolve the investment clubs, effective July 2006. The letter then provided the account balance that would be returned to the pool participant. The letter asked the pool participant to have the letter notarized, indicating that the pool participant had received his or her funds.
A second letter sent to pool participants-but not provided to the NDBF-stated "[w]ith the dissolving of the current [Elite Pools], and you now joining NIC, LLC, we wanted to provide you with an accurate rollover balance. This is an internal document for you only. Do not provide this information to anyone." (Filing No. 100-5 at ECF 35.) The letter listed the pool participant's balance and instructed the pool participant to contact Kratville, Arrington, and Welke with any questions.
Kratville emailed the letters to pool participant Voges and, in conversations with Voges, explained that the NDBF did not like limited partnerships, such as the Elite Pools. Kratville told pool participant Gary McConnell ("McConnell") that because of the legal organization of the Elite Pools or a tax problem, they had to open the new entity. Kratville told other pool participants that the rollover documents were part of a routine inquiry or were simply a formality. When he told pool participants about the rollover, Kratville stated that everything would remain the same, including the traders and the risk limitation, and the only thing that would be different was the name. After the rollover, several of the pool participants of the Elite Pools became pool participants of NIC LLC ("NIC Pool"), the pool managed by MJM. MJM never registered or filed an exemption of registration with the CFTC.
Kratville, Arrington, and Welke collected copies of the first letter, signed by the Elite Pool participants living in Nebraska, and Kratville sent them to the NDBF. In one of Kratville's letters to the NDBF, Kratville stated "I have been telling people that the clubs are shut down and when the state's inquiry is concluded that we expect to meet with you to find out exactly what guidelines you will have us follow and that we hope to open back up at that time...." (Filing No. 102-4 at 139-140.) Kratville noted allegations against the investment club, and stated, "We have done everything that you have asked, have been cooperative in every way imaginable, and so we find it disturbing that someone is now providing false information to you." ( Id. )
When preparing his response to the NDBF, Kratville emailed Arrington and Welke, stating "it is quite clear to me that if the State ever finds out we have the Wyoming entity and we have moved everyone over, that they will go after our nuts." (Filing No. 102-6 at ECF 44.) He went on to say, "in an abundance of caution, I deleted everything on my computer that refers to FXIG or Elite. If the state would ever come grab our computers, the less on them the better. I would advise us to store any such documents on little zip drives, portable drives, on Hotmail or Yahoo accounts, etc." ( Id. ) He further stated he did not "have any of our emails in" his Outlook, and "[b]etter safe than sorry." ( Id. )
Between May 15, 2006 (the time the NDBF directed the Defendants to stop soliciting and accepting funds for the pools) and August 31, 2006, Defendants collected more than $680, 000 in funds from pool participants. A little over $3 million in pool participants' funds was invested in the investment club as of that date. Of this amount, Defendants had paid pool participants back almost $250, 000; had sent a little over $2 million to be traded; and had taken or spent more than $400, 000.
VII. Concerns With FXIG
Kratville learned of more problems with FXIG at the same time he, Arrington, and Welke were working on the rollover of pool participants to the NIC Pool. Specifically, the traders for FXIG took the month of June 2006 off, and the website was unavailable for much of the summer. By late August or early September, FXIG posted that 41% of its funds were in open negative trades. Kratville raised questions with other FXIG investors during this time, as well as with Arrington and Welke. Kratville said 39% of the fund was in negative trades in September 2006 and noted that he had no basis to ascertain the value of the Elite Pools' account. (Filing No. 102-6 at ECF 48.) By November, FXIG reported the negative trade figure was 37% of the fund. In December, FXIG announced that it would transfer all remaining funds to Sharndor Logistics and that dollars would be converted to units-each dollar of principal would be a class A unit and each dollar of growth would be a class B unit.
VIII. Statements to NIC Pool Participants
NIC Pool participants received statements showing their returns were 6% for July 2006, 3% for August 2006, 6% for September 2006, 3.02% for October 2006, 3.5% for November 2006, and 3.07% for December 2006. NIC Pool participants did not receive any notification of any problems at FXIG, and their trading statements continued to show the pool participants' entire principal intact. The Defendants' reports suggested the entire pool was worth approximately $3.06 million in July 2006, $3.21 million in August 2006, $3.72 million in September 2006, $4.21 million in October 2006, $4.38 million in November 2006, and $4.89 million in December 2006. During that time, however, even assuming the money at FXIG was not yet lost, the total worth of the trading accounts ranged from $3.01 million in July 2006 to $3.9 million in December 2006-all below the reported returns. The percentages that should have been reported based on the trading were 3.89% for July 2006, 3.52% for August 2006, 0.28% for September 2006, 0 for October 2006, 0.17% for November 2006, and -7.76% for December 2006.
During this time, Kratville had discussions with Arrington and Welke about reports to NIC Pool participants. In those emails, Kratville agreed that quarterly postings would avoid monthly reporting issues. (Filing No. 102-6 at ECF 51.)
IX. FXIG's Total Loss in 2007
By February 2007, Sharndor posted that the funds they received for FXIG members were less than a penny on the dollar, (Filing No. 103-3 at ECF 2), and Kratville emailed Arrington and Welke that he was "frustrated because we are handling ot[he]r peoples' money and basically have had to hide these problems from our investors." (Filing No. 102-6 at ECF 68.) At one point, Kratville noted "it seem[s] like it is almost all gone" and "we should just file bankruptcy now." (Filing No. 102-6 at ECF 79, 84.) In March 2007, Honea posted that he tried to make back losses but further withdrawals crashed the system, and he could not estimate how long it would be to make the customers whole. Kratville emailed Arrington and Welke about meeting that week and stated "Bankruptcy is the only option right now legally. But I am open to options." (Filing No. 102-6 at ECF 84.) On April 18, 2007, Kratville emailed Welke and Arrington about the necessity of coming up with a timeline to show "when F [Fred Honea] locked the accounts from taking money out... what we did to deal with Fred, to obtain more info, to press him for more info, etc." (Filing No. 102-6 at ECF 88.)
In the first few months of 2007, Kratville discussed the upcoming statements owed to the pool participants, stating "[t]he idea of doing an April 1st report scares the hell out of me, " and he mentioned that April 1st was a "ticking time bomb." (Filing No. 102-6 at ECF 68, 69, and 73.) Kratville acknowledged that the investments were almost gone and they would be lucky to recover ten percent of their funds, noting it "create[d] a hell of an issue for us come April 1st." (Filing No. 102-6 at ECF 79-80.) The NIC Pool participants received statements for the first three months of 2007 showing positive returns and no loss of principal. The statements showed a 3.20% return for January, 3.30% return for February, and a 4.50% return for March. The total balance that Defendants reported to all of the pool participants was about $5.1 million in January 2007, $5.3 million in February 2007, and $5.8 million in March 2007.
The NIC Pool's actual results were, taking into account the loss at FXIG in February 2007, 6% in January 2007, -79.27% in February 2007, and 6% in March 2007. The total balance the Defendants had in their trading accounts was $4.2 million in January 2007, $889, 000 in February 2007 (realizing the loss at FXIG), and $1.1 million in March 2007. On April 18, 2007, Kratville emailed Arrington and Welke suggesting that, based on concerns as to whether they could ever withdraw money from FXIG, they should post something on the website that "won[']t arouse a lot of suspicion" such as: "In auditing all 3 of our traders' information for the first quarter, we have a few questions that we want to go over with one of our traders and after we do so, we may post a different number for the quarter." (Filing No. 102-6 at ECF 89.) NIC Pool participants received statements reporting 3.01% growth for April 2007, 3.04% growth for May 2007, and 3.03% for June 2007. By June 2007, the Defendants were reporting a total of $6.31 million in balances to pool participants. In reality, the pool lost money each of those months, and, as of the end of June 2007, the pool should have reported a balance of $690, 218.88. The percentages reported should have been - 5.95%, -10.61%, and -26.11% for April, May, and June 2007, respectively. Through the end of April 2007, Kratville, Arrington, and Welke collected more than $4.3 million in pool participant funds, they paid out approximately $550, 000 in returns, and they sent a net $3 million to trading entities.
In March 2007, Kratville met with NIC Pool participant and long-time friend, BJ Tobin ("Tobin"). Tobin was one of the two pool participants that knew about Honea and FXIG. Tobin expressed concern about whether the NIC Pools were in trouble. Kratville told Tobin they were using "several traders, not just one" and that he had no information about how FXIG had done for a few months. (Filing No. 102-6 at ECF 83.)
In February 2007, Kratville, Arrington, and Welke discussed a variety of ways to try to recover the money. Kratville worried that "someone will find out that we have been acting illegally too. If this thing blows up, I will lose my bar license... My other fear is that if th[is] blows up that I will lose all of my assets paying our members. Playing hardball cou[l]d result in [the] state and feds finding out what we were doing...." (Filing No. 102-6 at ECF 71.) In May 2007, Kratville communicated with another FXIG investor about recovery efforts. Kratville stated that Arrington was going to Spain to recover funds for "our investors." (Filing No. 103-1 at ECF 20-37.)
Beginning as early as October 2007 and through as late as January 2008, NIC Pool participants learned of the loss of the value of their accounts. By the end of 2007, Kratville, Arrington, and Welke had collected $4.6 million in pool participants' funds, they had paid out almost $850, 000 in returns to existing pool participants, and had sent a net of approximately $3 million to trading entities. In total, there were 112 pool participants, counting couples as one pool participant. As NIC Pool participants learned of the loss, or suspected something was wrong, many contacted Kratville, who told them he never joined MJM or its pool, NIC. (Filing No. 99-1 ¶ 16, Filing No. 100-3 ¶ 25, Filing No. 100-2 ¶ 19, Filing No. 100-4 ¶ 11, Filing No. 100-5 ¶ 23.) Kratville provided the CFTC with documents purporting to show he resigned from MJM and NIC on June 23, 2006. The resignation documents drafted by Kratville included stipulations that he continue to be informed about any traders used by MJM or NIC; that any information he ...