THE CHICAGO COMMODITIES SCANDAL : Cashing In on Confusion in the Pits : Indictment Shows How Market Conditions Can Lead to Abuses

Martin J. Dempsey and James D. Nowak had close trading ties to many other brokers and traders in Chicago Board of Trade’s busy and volatile soybean trading pit. Unfortunately for them, one trader they did business with was a man named Richard Carlson.

Unknown to the two brokers, Carlson was really Richard Ostrom, an undercover agent for the Federal Bureau of Investigation. Dempsey and Nowak allegedly proceeded to engage in numerous fraudulent trades with Ostrom to enrich themselves at their customers’ expense.

Thanks in part to information provided by the FBI agent, federal prosecutors obtained indictments Wednesday against Dempsey, Nowak and 17 other brokers and traders in the CBOT’s soybean pit.

A look at the indictments reveals how brokers and traders like Dempsey and Nowak allegedly engaged in systematic and illegal collaboration to defraud customers of thousands of dollars or to hide taxable income from the Internal Revenue Service.

It also shows how volatile market conditions inherent in many futures pits can lead to abuse.

The summer of 1988 was a volatile period for soybeans, and thus a good time for brokers and traders like Dempsey and Nowak. A devastating Midwest drought had threatened to wipe out much of the nation’s soybean crop, causing prices on soybean futures contracts to shift violently.

Brokers and traders often thrive on such volatility. A futures contract is a commitment to deliver or take delivery of a specified amount of a commodity at a specified price at a specified time. When prices are moving as fast as they were last year, volume is active and traders who trade for their own accounts can make or lose hundreds of thousands of dollars in a matter of hours.

Dempsey was both a broker and trader. As a broker for various customers, he executed their orders in the pit in exchange for a commission. When volume is heavy, he could make a lot of money. And as a trader working for his own account, he could also make money by correctly guessing price moves and trading on them.

That dual role created a conflict of interest that Dempsey apparently did not want to pass up. On a few occasions when Dempsey incurred losses, his customers were an easy mark to absorb them, the indictments allege.

On June 9, 1988, prosecutors say Dempsey created an intentionally erroneous trade, called an “out trade” in futures jargon, in order to pass a $29,700 personal trading loss to undercover agent Ostrom. Dempsey later repaid Ostrom with funds skimmed from customers.

On June 28, 1988, Dempsey incurred a $70,000 personal trading loss. But again, rather than incur the loss, Dempsey shifted it on a prearranged basis to various collaborators, called “bagmen,” prosecutors say. One bagman was FBI agent Ostrom, who accepted $34,000 of that loss in exchange for Dempsey’s agreement to repay that debt in part through past and future theft of customer funds.

Sometimes the schemes worked the other way, as other traders passed gains to Dempsey.

Dempsey, for example, intentionally created an out trade with undercover agent Ostrom resulting in a $36,000 gain to Ostrom, the indictments allege. It was later passed back to Dempsey and others through pre-arranged trades.

There were other ways Dempsey and other broker-traders would defraud customers, the indictments charge.

For example, they would engage in a practice called “front running,” prosecutors say. Knowing that a certain customer’s order would likely move the market, Dempsey and other defendants would trade ahead of those orders so they personally could pocket the profits when those customer orders were executed.

They also would allegedly manipulate and prearrange trades to pass stolen customer money between their accounts or to get themselves the best possible prices at the expense of customers. They would conspire to keep the most favorable trades for themselves. Some of the broker-traders also used fraudulent trades to conceal taxable income on profitable trades from the Internal Revenue Service, prosecutors allege.

Nowak, for example, collaborated several times with FBI agent Ostrom and another indicted trader, Charles W. Bergstrom, according to the indictments.

In January 1988, for example, prosecutors charge that Nowak engaged in prearranged trades to make it appear that he had lost $15,000 and Bergstrom had earned $15,000. That allowed Nowak to reduce his taxable income from other profitable trades and thus cut his tax liability.

For these and other alleged abuses, Nowak, Bergstrom and Dempsey were charged with racketeering under the Racketeer Influenced and Corrupt Organizations act.

Nowak, 47, of Elk Grove Village, Ill., also was charged with 56 counts of mail and wire fraud, 180 counts of violating the federal Commodities Exchange Act, filing a false tax return and conspiracy to defraud the IRS.

Bergstrom, 42, of Flossmoor, Ill., also was charged with 21 counts of mail and wire fraud; 87 counts of violating the federal Commodities Exchange Act; and one count each of lying to a federal agency, filing a false tax return and conspiracy to defraud the IRS.

Dempsey, 52, of Glen Ellyn, Ill., also was charged with 37 counts of mail and wire fraud and 83 counts of violating the Commodities Exchange Act.

All three could not be reached to respond to the allegations.

THE EXCHANGES, THE CHARGES

Chicago Mercantile Exchange

Yen

One yen contract = 12.5 million yen

Average daily volume (1989 year to date): 32,808 contracts

Total volume for 1988: 6,433,132

Traders/brokers charged: 21

Charges: Mail and wire fraud, Commodity Exchange Act violations, Securities Exchange Act violations, RICO and RICO conspiracy charges.

Swiss Franc

One Swiss franc contract = 125,000 Swiss francs

Average daily volume (1989 year to date): 25,190 contracts

Total volume for 1988: 5,283,406

Traders/brokers charged: 3

Charges: Mail and wire fraud, Commodity Exchange Act violations, prearranged trading, racketeering conspiracy.

Chicago Board of Trade

Treasury Bonds

One T-bond contract = $100,000 in long-term Treasury bonds

(No average daily volume figure for 1989 year to date available.)

Total volume for 1988: 70,307,872

Traders/brokers charged: 3

Charges: Racketeering conspiracy, mail and wire fraud, Commodity Exchange Act violations, prearranged trading

Soybeans

One soybean contract = 5,000 bushels of No. 2 yellow soybeans

(No average daily volume figure for 1989 year to date available.)

Total volume for 1988: 12,497,096

Traders/brokers charged: 19

Charges: Mail and wire fraud, Commodity Exchange Act violations, lying to a federal agency, RICO and RICO conspiracy, filing false tax returns, conspiracy to defraud the IRS, prearranged trading

Los Angeles Times

* MAIN STORY: Part I, Page 1

* RELATED STORIES: Pages 4, 5, 6