QUEEN'S BENCH DIVISION
Strand, London, WC2A 2LL
B e f o r e :
| MAREX FINANCIAL LIMITED
|- and -
|FLUXO-CANE OVERSEAS LIMITED
S/A FLUXO COMERCIO E ASSESSORIA INTERNACIONAL
(instructed by Messrs. Simmons & Simmons) for the Claimant
The defendants were not represented
Hearing date: 19 October 2010
Crown Copyright ©
MR JUSTICE DAVID STEEL :
a) the liability of FCA under the Guarantee shall not be discharged or affected in any way whatsoever by reason of the winding up, dissolution, administration, bankruptcy or re-organisation of FCO or any change in its status or ownership (clause 3.2.1); and
b) before exercising any if its rights under the Guarantee, Marex shall not be obliged to make any demand on FCO, or take any action or obtain judgment in any court or tribunal against FCO, or make or file any claim or proof in a bankruptcy or winding up or dissolution of FCO (clauses 4.1.1 to 4.1.3).
i) wished to open an electronic trading account and had traded futures and options through an electronic trading system before;
ii) had more than 2 years' experience of options and index options and commodity futures and options;
iii) intended to trade with Marex on the LIFFE market (although in the event, FCO also traded futures and options on the Inter-Continental Exchange ("ICE"), a US exchange operated by ICE Futures US Inc.);
iv) and preferred to receive monthly statements by post and daily statements by e-mail.
1.1. Clause 2.1: "Subject to Applicable Regulations: This Agreement and all Transactions are subject to Applicable Regulations so that: (i) if there is any conflict between this Agreement and any Applicable Regulations, the latter will prevail; and (ii) we may take or omit to take any action we consider necessary to ensure compliance with any Applicable Regulations and whatever we do or fail to do in order to comply with them will be binding on you."
1.2. Clause 2.2: "Exchange Action: If an Exchange (or intermediate broker or agent, acting at the direction of, or as a result of action taken by, an Exchange) takes any action which affects a Transaction, then we may take any action which we, at our discretion, consider desirable to correspond with such action or to mitigate any loss incurred as a result of such action. Any such action shall be binding on you."
1.3. Clause 3.1: "Execution only: We deal on an execution-only basis and do not advise on the merits of particular Transactions, their taxation consequences or the composition of any account."
1.4. Clause 4.1: "Charges:…we will charge you interest (both before and after any judgment) on any amount you failed to pay us when it was due calculated at the rate determined by us to be the cost of funding such overdue amount ("Default Interest") unless you pay such charges at the time they are incurred…".
1.5. Clause 10.7: "Market disruption (a) In the event of severe market disruption and/or price volatilities which may result or may have resulted in the current market value of a commodity which is the subject-matter of any outstanding Transaction falling to an unacceptable level, we reserve the right to take one or more of the following courses of action: (i) to close out any Transaction where significant loss has occurred or is expected by us; ..."
1.6. Clause 11.1: "Margin call: You agree to pay us on demand such sums by way of margin as are required from time to time under the Rules of any relevant Exchange (if applicable) or as we may in our discretion reasonably require for the purpose of protecting ourselves against loss or risk of loss on present, future or contemplated Transactions under this Agreement".
1.7. Clause 13.1: "Events of Default: If at any time: (a) a Party fails to make any payment when due under or to make or take delivery of any property when due under, or to observe or perform any other provision of this Agreement and such failure continues for two business days after notice of non-performance has been given by the other Party to the defaulting Party…(d) a Party is unable to pay its debts as they fall due or is bankrupt or insolvent, as defined under any bankruptcy or insolvency law…; or any indebtedness of a Party is not paid on the due date therefor…; (e) a Party ... disaffirms, disclaims or repudiates any obligation under this Agreement ... (k) it is necessary or desirable for a Party's protection/any action is taken or event occurs which a Party considers might have a material adverse effect upon a Party's ability to perform its obligations under [the] Agreement…(each an "Event of Default")".
1.8. Clause 14.1: "Default: On an Event of Default or at any time after we have determined, in our absolute discretion, that you have not performed (or may not be able or willing in the future to perform) any of your obligations to us, we shall be entitled without prior notice to you: …(iii) to close out, replace or reverse any transaction, buy, sell, borrow or lend or enter into any other transaction or take, or refrain from taking, such other action at such time or times and in such manner as, at our sole discretion, we consider necessary or appropriate to cover, reduce or eliminate our loss or liability under or in respect of any of your contracts, positions or commitments; and/or (iv) to treat any or all Transactions then outstanding as having been repudiated by you, in which event our obligations under such Transaction or Transactions shall thereupon be cancelled and terminated".
1.9. Clause 14.2: "Method: … We may terminate this Agreement immediately if you fail to observe or perform any provision of this Agreement or in the event of your insolvency. Upon terminating this Agreement, all amounts payable…become immediately due and payable including (but without limitation): (a) all outstanding fees, charges and commissions; and (b) any dealing expenses incurred by terminating this Agreement; and (c) any losses and expenses realised in closing out any transactions or settling or concluding outstanding obligations incurred by us on your behalf".
1.10. Clause 15.1: "General exclusion: Neither we nor our directors, officers, employees or agents shall be liable for any direct or indirect losses, damages, costs or expenses incurred or suffered by you under this Agreement (including any Transaction or where we have declined to enter into a proposed Transaction) unless arising directly from our or their respective gross negligence, wilful default or fraud. In no circumstances shall we have any liability for consequential or special damage. …"
1.11. Clause 15.2: "Indemnity: You shall pay to us such sums as we may from time to time require in or towards satisfaction of any debit balance on any of your accounts with us and, on a full indemnity basis, any losses, liabilities, costs or expenses (including legal fees), taxes, imposts and levies which we may incur or be subjected to with respect to any of your accounts or any Transaction…or as a result of…any violation by you of your obligations under this Agreement (including any Transaction) or by the enforcement of our rights".
1.12. Clause 16.2: "Notices: Unless otherwise agreed, all notices, instructions and other communications to be given by one of us to the other under this Agreement shall be given to the address or fax number and to the individual or department specified in the account opening form in respect of you and or by notice in writing by such party. (a) Any notice, instruction or other communication shall be deemed to take effect in the case of fax, on dispatch and, in the case of airmail or first class pre-paid post, five Business Days after dispatch. Notices, instructions and other communications made pursuant to this Agreement or any Transaction shall not be effective if given by electronic mail. (b) Each notice, instruction or other communication to you (except confirmations of trade, statements of account, and margin calls shall be conclusive unless written notice of objection if received by us within five Business Days of the date on which such document was deemed to have been received."
1.13. Clause 16.4: "Time of essence: Time shall be of the essence in respect of all obligations of yours under this Agreement (including any Transaction)".
1.14. Clause 17.1: "Governing law: A Transaction which is subject to the Rules of an Exchange shall be governed by the law applicable to it under those Rules. Subject thereto, this Agreement shall be governed by and construed in accordance with English law".
"Following our review of your trading activities with us and based on the information available to us as of 1st November 2007, we propose to classify you as an "Eligible Counterparty" where we conduct "eligible counterparty business" (as defined in the FSA Rules). In respect of all other business we conduct with or for you, we will treat you as "Professional Client".
You are entitled to request for a different client categorisation. However, we advise that due to our business profile, we are unable to conduct business with Retail Client.
As MiFID further introduces various changes in the way we do business with you, we have to change our Terms. Existing separately negotiated clauses, stand-alone agreements and master agreements with you continue to apply. We invite you to visit our website at www.marexfinancial.com to view our Best Execution Policy, Conflicts of Interest Policy and details of services that we provide.
Please sign and return the Acknowledgment Schedule of the Terms to the above address. We accept confirmation of your consent to the Terms by email at email@example.com or by facsimile at 44 020 7655 6024. If you have not expressly consented to the Terms, we will deem your acceptance and your willingness to continue business with us under the Terms if you continue to place order with us on or after 1st November 2007.
If you have any questions on the above, please contact us at the above email address or your usual Account Executive."
i) The bracketed words in clause 14.1 of the Terms of Business appeared in clause 15.1 of the New Terms of Business as "(or we reasonably believe that you will not be able or willing in the future to perform) any of your obligations to us"; and
ii) There was no provision in clause 18.2 of the New Terms of Business (corresponding to clause 16.2 of the Terms of Business) that notices, instructions and other communications made pursuant to the Agreement would not be effective if given by electronic mail.
Marex owes a duty of best execution to clients categorised as Professional Clients where we execute orders on your behalf and where we receive and transmit client orders. ...
The Best Execution obligation will not apply when we execute orders for Eligible Counterparties (as defined under MiFID)."
"My calculations show that your futures equivalent position increased yesterday by about 5000 contracts so that your position was in excess of 80,000 lots entering today's trading. My review indicates that increase was primarily the result of additional selling of futures although deltas did have some impact as well. It is hard to understand how you are trying to reduce your position when you continue to sell thousands of lots of futures. As the price of the market contract is down today we expect to see a substantial decrease in your short futures position."
"As of receipt of this email, the Exchange is directing you to stop selling the March '08 Sugar 11 futures contract and to cease any other trading strategies that would result in an increase in your Mar '08 short position. You are further directed to immediately cancel all sell orders involving the Mar '08 futures contract as an outright or a spread or any other orders that would increase your short Mar'08 position. These instructions result from your continued violation of your single month position limit and the significant increase in your Mar '08 short position yesterday. Further, data received in this office indicates that you have now exceeded your 65,000 lot all months position limit as well. Please take immediate steps to correct this situation.
In addition, we are currently considering other steps the Exchange may take to ensure that you bring your positions in compliance with your position limits. You have now been in violation of your position limit for 10 business days."
"Your March '08 position had been in violation of the single month position limit established for Fluxo-Cane Overseas Ltd. for 10 consecutive days entering today's trading. If your trading activity today did not bring the position in compliance with the position limit, the Exchange will invoke the authority provided by ICE Futures U.S. Rule 6.13 on Monday, January 14, 2008 and instruct firms carrying your positions to reduce such positions by the close of trading on Tuesday, January 15."
"I am writing to advise you that a special meeting of the Board of Directors of ICE Futures U.S., Inc ("the Exchange") was held on January 15, 2008, at which the following actions were taken pursuant to Exchange Rule 21.29:
(1) the Board of Directors determined that there is a substantial question as to whether a " Financial Emergency" , as such term is defined in Chapter 21 of the Exchange Rules, exists with respect to Fluxo-Cane Overseas, Ltd. and you; and
(2) the Board of Directors determined that all orders for the account of Fluxo-Cane Overseas Ltd. and its affiliates (including you) ("Fluxo" ) in the Sugar No. 11 Futures Contract and any options on such contract may only be placed or executed by through a clearing member and not by or through any other person.
The decision of the Board of Directors with respect to the placement of order, as specified above, becomes effective on Wednesday, January 16, 2008 upon the posting of a Release to Members of the Exchange's website, and will remain in effect until further notice. The decision of the Board of Directors was based upon the facts, including but not limited to, that: Fluxo has significantly exceeded the position accountability levels established for it by the Exchange with respect to the futures equivalent position permitted to be held by Fluxo in the March 08 Sugar No. 11 delivery month and in all delivery months of the Sugar No. 11 contract, combined; Fluxo has refused to brings its positions into compliance with the levels established by the Exchange, notwithstanding repeated requests to do so by the Exchange; and Fluxo has increased its short futures equivalent position when instructed to reduce such position in the March 08 delivery month.
Due to the gravity of the situation, it was not practicable for the Exchange to afford you a hearing before taking action. Accordingly, you and Fluxo may request a hearing before the Board regarding the actions described above. Any such request should be made in writing to the undersigned within five business days of the date hereof, and should specify when you would be available for such a hearing and whether you will appear in person or through counsel or other representative.
On a separate but related matter, in addition to the actions described above, please be further advised that, pursuant to Rule 6.13, the Exchange has instructed each firm carrying positions for Fluxo in the Sugar No. 11 Futures Contract and/or options thereon to:
(a) reduce Fluxo's short futures equivalent position in the March 08 Sugar No. 11 delivery month to not more than a specified level, based on the proportion of Fluxo's position carried by such firm, such that by the close of business on January 23, 2008 Fluxo is in compliance with the position limits established for it by the Exchange with respect to the March 08 delivery month, and to not increase the futures equivalent position carried in all Sugar no. 11 delivery months combined, beyond its current level,
(b) not accept any orders, electronic or otherwise, that would result in an increase of Fluxo's short futures equivalent position in the March 08 Sugar No. 11 delivery month or its short futures equivalent position in all delivery months combined; and
(c) not approve the transfer of any Sugar No. 11 futures or options contracts carried for Fluxo to an account at another clearing member, without first notifying the Exchange of the intended transfer.
You may obtain further details directly from your clearing members regarding the position reductions that have been requested of each such firm, or contact Susan Gallant at the Exchange at 212-748-4030.
Please be aware that the foregoing action is not intended in any way to preclude the clearing members from further reducing positions or taking any other action which they may deem necessary or proper in light of the relevant circumstances."
"Effective immediately and until further notice, all orders for futures and/or options contracts in the ICE Futures U.S. Inc. Sugar No. 11 Contract for the account of Fluxo-Cane Overseas Ltd. and its affiliates (including, but not limited to, Manoel Garcia) may only be accepted directly from a clearing member of ICE Clear US, Inc. and from no other person."
"With respect to the Exchange's instructions issued this morning to certain Clearing Members, including your firm, to reduce futures equivalent positions in the March '08 Sugar No. 11 contract held by Fluxo-Cane Overseas Ltd. and its affiliates ("Fluxo"), we understand that given the circumstances that existed today with the timing of the notifications and trading activity that may have occurred prior to the instructions, it may have been necessary to receive in or give out positions for Fluxo today. However, effective with the start of business tomorrow, January 17, 2008, [Original emphasis] the Exchange is hereby directing that Clearing Members may not receive positions in from or give positions out to other Clearing Members for Fluxo. This means that trading activity for Fluxo should be cleared by the Clearing Member through which the orders were submitted.
With respect to omnibus accounts, orders may be submitted by the firm carrying Fluxo's positions as long as the firm has the Clearing Member's consent and such orders are consistent with the instructions to reduce Fluxo's short futures equivalent position in the March '08 Sugar No. 11 position carried by that Clearing Member."
"35... There was clear concern amongst Marex management (including my colleague James Hearn who had been monitoring the situation closely) because of the unprecedented nature of the events which had occurred and the effects that they were having on the market. I was additionally concerned because Fluxo was my client. As at 16 January 2008, however, all margin calls had been paid. I was also able to speak to Mr. Garcia again and he confirmed to me that he was on his way to the airport and that he was seeking to arrange a meeting/conference call for the next day in New York, in which he proposed to allay the concerns of his brokers. At that stage I did not appreciate quite how many brokers that call would come to involve."
i) At 9.14 a.m., Marex e-mailed a margin call of £95,390.37 in respect of ICE's 20% increase in margin on FCO's Sugar No. 11 positions as at close of business on 16 January 2008.
ii) At 10.50 a.m., Marex sent an updated margin call of US$3,130,843.37 to FCO reflecting the significant market movement that morning.
iii) At 1.36 p.m., Mr McGuigan spoke to an FCO trader who stated that he had "sent the instructions to the people that take care of the wire transfers" and that as soon as he received the Swift confirmation of payment he would forward it to Marex.
iv) In the event, however, contrary to what Mr McGuigan was told by the FCO trader, no confirmation of payment was sent, or payment made, by FCO to Marex.
v) Between 2.24 and 2.25 p.m., Mr McGuigan exchanged instant messages with the same FCO trader, asking again about the outstanding margin call. The response this time was that there was "nothing until Mr. Garcia's [i.e. the all broker] conference call".
"[Mr McGuigan]: ... Now I appreciate your situation is that you're waiting on Manoel coming out of the conference call ... and we're waiting for that ... but it's gone from 3 o'clock to 4 o'clock to 5 o'clock and ... you know ... I'm beginning to have less power and my bosses, the directors of the company, are saying to me we either need to have the margin payment made or we need to have orders to buy something.
[Maria Pia]: I know. I know all that OK. ... You've told us, everyone's told us. I told you there is nothing we can do so if you need something to get done, then just do whatever you need to get done, but there is nothing we can do. I cannot give you orders. ... I can not do anything without Manoel's [i.e. Mr Garcia's] consent."
"15. It was at this stage, on Thursday afternoon, that a management meeting was held in which I discussed the issue with other senior managers of the business including Mark Slade, Gavin Prentice and Charlie Lesser. Although we did not have all of the facts, certain things seemed clear to us. First, Fluxo and ICE were involved in a major disagreement. Second, ICE was acting in what seemed to us to be a highly aggressive manner, unprecedentedly so. Third, it was clear that Marex needed to comply with the Exchange's requirement to reduce Fluxo's positions. Fourth, Fluxo who had previously had a good margin call payment history with Marex, was unable to confirm that the current call or future calls would be met. And finally, the man at the centre of the storm, Mr Garcia, had decided to fly overnight from Brazil to New York to attend a meeting/conference call with Fluxo's many brokers, at which everything would apparently be explained. This was most unusual behaviour. Meanwhile, the market continued to rally, and the losses on the position continued to mount. Marex needed to be in a position to protect itself, if needs be, from the possibility of significant losses on Fluxo's trading account.
16. It was decided during the course of this management meeting that unless Mr. Garcia could provide some comfort in relation to the size of his overall commitment and a commitment to pay both the outstanding and future margin calls Marex would be left with no alternative in those circumstances but to start to liquidate Fluxo's positions. We were looking for some positive confirmations from Mr. Garcia. My recollection is that, at least initially, we expected to get them. The all broker call was a call set up in advance. It was clearly important and I certainly expected a man of Mr Garcia's reputation and importance in the market to have something positive to say during that call.
17. Our concerns were not allayed by the fact that the conference call which Mr. Garcia had arranged and which was originally scheduled for 3.00pm (London Time) on 17 January 2008 was postponed from 3.00pm (London Time) to 4.00pm (London Time) and then 5.30pm (London Time). It did not start until about 6.10pm (London Time) when Mr. Garcia finally joined the call."
"As per our previous telephone conversations, we are under instruction by the exchange to reduce your NY#11 Sugar position on a daily basis, and to reach a net short of 6200 lots or less by Wednesday 23rd.
We have attempted to speak with Senior Garcia throughout the day, but with no success. The conference call/meeting has been postponed twice, and we await another attempt to speak.
There is an outstanding margin call today, in excess of $3m – and we do require a response.
We want to assist and support you during this difficult period, but we are not receiving any information, whilst the market rallies.
We reserve all our rights to take any action that we may deem appropriate as per the terms of our account with you."
"35. ... The question of how to reduce the FCO short position was discussed at some length as well as whether FCO was in a position to and would meet margin calls. During the course of the discussions one of the brokers spoke to the President of ICE about the situation.
36 In due course a dispute arose on the pleadings as to whether an agreement was reached at this meeting to the effect that FCO's short position would be reduced in a coordinated manner with one clearing house carrying out all the necessary transactions on the exchange including the use of spreads. This issue was the subject of a summary judgment application by the claimants. In due course it was held by the Court of Appeal that no such agreement or indeed any agreement had been reached and accordingly this issue has fallen away: see  EWCA Civ 406."
"[Jeff Bauml of BNP] ... I just spoke to [David Yeres] and he said they [are] on their way and will be about 40, 45 minutes. On that I also pointed out to him that the first question that has to be answered immediately if not sooner is the status of the margins because ... every commission house on the hook right now want[s] to know what the status is on margin calls, ..."
"[Michael Overlander]: Now again, Andy I know that you're concerned about disclosure issues, and I do understand that but ... generically speaking I think we're probably all in the same boat. Nobody's got any [margin] money and nobody's had any orders.
"[Unknown]: ... are we in unison in preparing after the client describes what's led up to this, and what they intend to do, that this basically [is] the end of the road for him, in terms of, you know, reacting to his position, and that he's got to get out of his position. He's got to show that he's getting out of it today ... and if he doesn't, that we're going to, you know, get out of this position for him.
[Unknown]: I think fundamentally ... he needs to start to demonstrate ... for all of us that he's making some tangible efforts to adhere to the requests of the Exchange, which are obligations now upon us, and if he can't give us the commitments to satisfy our obligations, then we're going to have to take our own actions.
[Unknown]: Because we're the guys on the boat, all of us, and we're the clearing members, we're the people in front of the Exchange. I agree with you Tom [i.e. Tom Cohen of Bear Stearns]. It's not like it's an option, we have to do this, and we have to do it today.
i) First, as Mr Hearn describes, he was "shocked that virtually every brokerage firm in sugar was also on the conference call". This made it clear to him that "this was a big problem and would have an effect on the market as a whole".
ii) Secondly, it was clear from Mr Garcia's early explanations during the meeting that at least two of FCO's brokers (Fimat/Newedge and ADM) had already liquidated or were in the process of liquidating FCO's positions.
iii) Thirdly, Mr Garcia made it clear to the brokers that"with this crazy moment I need to protect my company until I have idea what will be the next movement from everyone. ... Unfortunately I have no more control ..."
"[Michael Overlander of Sucden]: ... Manoel ... In terms of margin calls that have been called for all day, will you be meeting those?
[Mr Garcia]: I told you I have to know all the movements, each one. I will stop [payment] because it makes no sense to go to the infinitum with everyone [losing] their minds, liquidating partially or totally and so on, ... and out of my control."
"[Lou Kayapa of BNP]: That's not really the choice that the Exchange has given us, and I think that you owe a lot of margin money to a lot of the people around this table, and on the phone. The Exchange has instructed all of us in letters and by phone calls to reduce the positions, and I think we need to know that the margin money that you owe us currently is coming in, the margin calls that were made this morning from yesterday are coming in, and that the margin calls based on market movement today ... [are] going to be met and I haven't heard an affirmative response from you on that.
[Mr Garcia]: Well I think that I told you. We will stop payment until we know what everyone will do, and if you will do it properly. ..."
"[Unknown]: "With regards to the margins calls that we made to you this morning ... are you in a position to pay us for those calls?
[Mr Garcia]: First of all I don't know yet how much was because I stayed here. I went to hotel to be prepared for here, I had a meeting with my lawyer and I went to here. I will look this afternoon the numbers, but the problem is not if I have or not the source for that. It is that we are in a system that there is no more limits. We don't know how much we have cost this buying side without ... certain protection."
"[Unknown]: Is there some way you can get the numbers [of outstanding margin calls] now and tell us whether you can make those, that obligation that is the margin that is due on the basis of prior days, not today's but prior days?
[Mr Garcia]: Our decision up to now is to not pay up to have any agreement what we can do or not do together. ..."
"37. As regards the issue of margin Mr Garcia recognised that there was a significant sum owed but no payment would be made until the attitude of the other brokers became clear and in particular whether they were minded to cooperate."
"15. Mr Garcia's basic position was that Fluxo-Cane had decided not to pay any margin unless and until some agreement was reached for a co-ordinated reduction. ... Whatever its contractual commitments may have been, it is plain that Fluxo-Cane had no incentive to pay margin unless it got such co-ordination….It seems to me that Mr Garcia also made it clear that, even if co-ordination could be agreed, he would have to consult the company's bankers before he could give any form of commitment, at least going forward, since, as he put it at the meeting, it "make[s] no sense to pay margin calls today and have no support for tomorrow'".
"[Unknown]: ... We [i.e. the brokers] are all going to meet the margin call to the Exchange because that's what we do, right? If you [are] looking to have a dispute with the Exchange, I think you need to handle it with the Exchange, and leave the brokers out of that dispute. I think that needs to be done by you meeting the monetary obligations on a prompt basis of the margin calls outstanding. ..."
"[Unknown]: ... I think that the situation you are putting everyone in here by not meeting your margin calls on a timely basis, ... I don't think that will lead to ... ultimately a good situation. And I think if you [are] looking for an orderly liquidation of those positions, I can probably say with a reasonable amount of [assurance], looking at the people around this table, ... that that will not occur probably if the funds do not come in, because everyone's going to be looking to cover their own positions."
"[Unknown]: Did you [give] any orders today to buy?
[Mr Garcia]: No because ... I stopped. First of all the idea was to decide here. And second, since the morning, the system was disturbed. ..."
"19. ... When Mr. Garcia ultimately joined the meeting, he said, on behalf of Fluxo, that he could make no commitment to the payment of margin calls at the current price levels and that he could not give any orders to buy or sell in relation to Fluxo's positions (which was in direct contravention of the Exchange's express instructions).
20. It was my understanding, based on what Mr. Garcia said on the call, that Mr. Garcia was not aware of the size of Fluxo's overall exposure and that he was not able to confirm that Fluxo was able to pay its debts as they fell due. Despite having spent a whole day dealing with these issues and being advised by his lawyers, it appeared to me that Mr. Garcia was a man who had lost control and who was unaware of the risks to which Fluxo was exposed.
21. Hearing these initial comments, Charlie Lesser and Mark Slade broke-off from the conference call to discuss the situation by mobile. I was with Mark Slade. We needed to make a decision as to what should be done in order to protect both Fluxo and Marex. Taking into account all the circumstances together with Fluxo's non-payment of margin, failure to confirm that the margin would be met and the market disruption and volatility, it was decided that Marex was entitled to and that it was in the best interests of both the client and ultimately the company to start to liquidate Fluxo's positions."
It is to be noted with regard to Mr Hearn's comments about "market disruption and volatility", the price of March 2008 Sugar No. 11 futures had risen from about 11.75 to above 12.50 between 6.30 a.m. and 6.30 p.m.
"46. The call began with an attendance call. As the individual brokers indicated their attendance it became clear not only that many, if not all, of the market's major brokers were affected, but also that certain brokers (such as New Edge), who should have been on the call, were not on the call. It was confirmed by Mr. Garcia later on the call that New Edge and ADM had liquidated Fluxo's positions prior to the start of the call.
52. Mr. Garcia had been unable to provide the comfort that we were looking for at the start of the brokers' call. It was our understanding, based on what he had said, that Mr. Garcia was not aware of the size of Fluxo's overall exposure and that he was not able to confirm that Fluxo was able to pay its outstanding margin obligations at that point or at any point in the future. He was also not prepared to give any buy orders."
"Marex chose not to close-out all of Fluxo's positions on the evening of 17 January 2008. While this was done partly due to a lack of liquidity on the market, it was also part of a strategy to manage the position."
"[Mr Hearn]: I just need you to be aware that ... we are at the moment down millions of dollars in the trade which is coming out of our pocket at the moment. If we do not have the comfort that the margin call is going to be paid, we are left with no alternative but to liquidate the position. I need you to be aware of that.
[Mr Garcia]: Okay, okay. Do your decision. Thank you and goodnight."
i) notified FCO by e-mail of the final position on its account, which was referred to as "an updated margin call" - the final account showed that FCO owed Marex a total sum of US$4,469,428.97, including a sum of US$223,334 in respect of unpaid commission relating to business executed by Marex for FCO but given up to and cleared by third party brokers (although Marex does not pursue its claim for this unpaid commission against FCO or, by extension, FCA);
ii) served a final request for payment of the outstanding amount of US$4,469,428.97 and notice of termination of the Agreement by letter of the same date; and
iii) demanded payment of the same amount by FCA under the Guarantee.
Marex's entitlement to liquidate FCO's positions
"I reject an alternative case that has been advanced by Fluxo-Cane to the effect that it had five business days in which to pay margin by reference to Rule 5.01 of the ICE Rules. As Sucden says, while this Rule defines "reasonable time" as "less than 5 Business Days", it is plain that this is in the context of and for the purposes of the Rules themselves. The Rules lay down a maximum period within which margin must be paid in order to comply with ICE Rules and avoid regulatory sanction. The Rules do not purport to, and do not, lay down some minimum period to which the payer is absolutely entitled. Nothing in the ICE Rules prevents a broker and customer from agreeing a shorter period between themselves as a matter of contract."
i) One of FCO's traders told Mr McGuigan between 2.24 and 2.25 p.m. that there would be no payment until the all broker meeting;
ii) Mr Garcia's daughter told Mr McGuigan during the 4.32 p.m. telephone call on 17 January 2008 that there was nothing that could be done by FCO before the all broker meeting;
iii) Early during the all broker meeting, Mr Garcia repeatedly made clear that FCO would not be paying any outstanding margin unless and until an agreement was reached for a co-ordinated liquidation of FCO's positions with all brokers. The imposition of this condition was, of course, fundamentally inconsistent with FCO's obligation to pay margin "on demand".
i) The extent and manner of the intervention by ICE in respect of FCO's positions had been extraordinary and unprecedented, and indicated that there was a very serious issue between ICE and FCO.
ii) The entire market knew that FCO was hugely short and would need to buy back a large part of this short position to comply with ICE's directions.
iii) There had already been a spike in the price of Sugar No. 11 contracts on the day of ICE's announcements and directions on 16 January 2008.
iv) There was a continuing rally in that futures price throughout 17 January 2008, starting at about 11.75 at the beginning of the trading day and ending up above 12.50.
v) The risk of loss with every 0.01 ct/lb increase in that price was very considerable, exceeding US$80,000 for FCO's Sugar 11 positions alone. A 0.1 ct/lb increase would thus cause a deterioration of more than US$800,000 in FCO's account. (Indeed, the size and complexity of FCO's account with Marex as at 16 January 2008 was such that the Value at Risk (VAR) was in excess of US$4 million.)
vi) FCO had failed and refused to meet its outstanding margin obligations, not just to Marex but to many other brokers, who were all concerned and deeply unhappy about the situation.
vii) Furthermore, FCO was refusing to give any firm commitment that it would meet its outstanding or future margin obligations, unless and until an all broker agreement for co-ordinated liquidation had been reached with FCO and, even then, subject to further discussion with its bankers.
viii) Mr Garcia was not even sure at the time of the total outstanding margin obligations of FCO and was not prepared to provide any assurance as to FCO's ability to satisfy those obligations.
ix) Nor was he prepared to give any orders to liquidate any of FCO's positions before a global agreement had been reached, notwithstanding the ICE's direction for immediate daily reductions.
x) There was plainly huge uncertainty as to whether any agreement of any kind was going to be reached between the large number of brokers taking part in the meeting. Hence, on Mr Garcia's own approach, there was a real and substantial risk that no further margin payment would be made by FCO at all and that what would happen immediately after, if not during, the meeting would be mass liquidation of FCO's positions by all brokers.
xi) At least two other (and probably more) brokers had already started to liquidate FCO's positions before the meeting and were continuing to do so during the meeting.
The conduct of the liquidation
i) Best Interests Obligation, i.e. an obligation to act honestly, fairly and professionally in accordance with the best interests of FCO; and
ii) Best Execution Obligation, i.e. an obligation to take all reasonable steps to obtain, when executing orders, the best possible result for FCO taking into account the relevant execution factors.
"(1) A firm must act honestly, fairly and professionally in accordance with the best interests of its client (the client's best interests rule)." (COBS 2.1.1)
"A firm must take all reasonable steps to obtain, when executing orders, the best possible result for its clients taking into account the execution factors." (COBS 11.2.1)
"[The] general market understanding [is] that best execution and best interests obligations do not apply in a situation where a broker is liquidating positions on behalf of a client who is in a state of default"
"... Moreover, in my view, the requirements of best execution and bests interests would cease to apply if the client is deemed to be in default, when I believe the broker would have a wide discretion in limiting and closing down the set of positions, which could now constitute a direct risk exposure for the broker itself."
"76. ... As regards the best interests of the client, this is a difficult concept in circumstances where the client is refusing to pay margin and expecting [the broker] to close out as best it can. [The broker] was in effect trading on its own account. Furthermore the interests of [the broker] were in common with FCO namely to limit the loss that might be sustained as a result of the liquidation. Thus I reject the suggestion if it be made that [the broker was] obliged by COBS 2.1.1 to manage FCO's position as if still acting as FCO's broker but at its own risk and without the provision of margin."
"2.6 ... It needs to be recognised that futures and options brokers are not normally in the business of taking outright risk positions, since they generally have neither the market expertise nor the level of capital required to do so. ...
2.7 It is also worth pointing out that a broker left with client positions is generally in a more risky situation than a client, such as Fluxo, who is classified as a hedging client. Such a client has the potential to delivery physical commodities against its derivatives positions, and the derivatives losses if any will be offset by profits on the physical positions. The broker by contrast will only have one side of the client's position, and thus end up with a purely speculative position of someone else's choosing. In my view, a reasonable broker in such circumstances would be concerned to eliminate the risks as quickly as possible."
"... I am quite satisfied that Dr Fitzgerald is correct to express the view that it is only with the benefit of hindsight that it can be seen that liquidation during the period 22 to 25 January 2008 would have been most advantageous. The market might have risen, as Mr Levy thought it would, or Mr Garcia might have been proved correct in his conviction that the market would fall. I am satisfied that following the action taken by the Exchange, the liquidation of Fluxo-Cane's positions was going to be extremely problematic, as indeed both Mr Garcia and Mr Overlander foresaw. I very much doubt in these circumstances whether there is a single template by reference to which it can be said that liquidation was, or was not, negligent."
i) the persistent failure on the part of Mr Garcia to pay margin or give orders to buy;
ii) the extraordinary and unprecedented intervention of ICE in respect of FCO's positions;
iii) the severe impact that such intervention had had on the market on 16 January 2008;
iv) the continuing and significant upward trend in prices throughout 17 January 2008 (rising from 11.77 to 12.57 ct/lb between 6.30 a.m. and 6.30 p.m.);
v) the sheer number of brokers who held FCO's positions and were affected by the problems of unpaid margin and need to reduce positions;
vi) the uncertainty as to whether any co-ordinated way forward would be possible, failing which mass liquidation was likely to follow;
vii) the general uncertainty, speculation and panic that was rife throughout the market at that time.
i) that the ICE requirement was for daily reductions of FCO's positions, so that reductions were required on 17 January 2008, for which Mr Garcia had refused to give any orders to any brokers (including Marex) unless co-ordinated liquidation by all brokers was agreed upon; and
ii) more fundamentally, that the liquidation action that Marex took on the evening of 17 January 2008 and continued on the morning of 18 January 2008 was not merely designed to comply with the ICE's Notice to Liquidate Positions, but represented Marex's exercise of a right to close out FCO's positions generally in circumstances in which one or more Events of Default had occurred and Marex had properly determined that FCO had not performed or might not be able or willing in the future to perform its margin obligations.
"There are several points that need to be made, in my view, with respect to this complaint. First, it is apparent that no-one actually trading on a derivatives market can guarantee to achieve prices equivalent to the average daily price, since that price is known only at the end of the day, after all trading is complete. Second, the price of 12.70¢ per lb includes the block trade, which did not occur during the trading day on 18/1/08. In my view, the actual achieved Marex average price (without the block trade) of 12.51¢ per lb is so close to the actual overall average price of 12.40¢ quoted by Fluxo, as to remove any cause for complaint."
"... from the opening [of 18 January 2008] the March No 11 futures price traded down to a low of 11.80¢ per lb, before recovering sharply. Marex purchased a net 2394 March No 11 futures contracts (i.e. excluding the block trade) between 06.30 London time and 10.38 London time. All of this trading took advantage of the declining sugar price, and Marex achieved an average price of 12.51¢ per lb. In my view, the purchase of those futures during a falling market at an average price of 12.51¢ per lb, represented a thoroughly reasonable approach to the liquidation process, which achieved a successful result for the Fluxo account."