What Constitutes Manipulation In The commodity Futures Trading Markets? We’re Still Waiting For An Answer
The Commodity Exchange Act in broad terms prohibits the use of any manipulative or deceptive device or scheme in connection with the contract of sale of any commodity in interstate commerce1 and manipulation or attempt to manipulate the price of any swap or commodity in interstate commerce or for future delivery.2
At this year's Sohn Investment Conference, Dan Sundheim, the founder and CIO of D1 Capital Partners, spoke with John Collison, the co-founder of Stripe. Q1 2021 hedge fund letters, conferences and more D1 manages $20 billion. Of this, $10 billion is invested in fast-growing private businesses such as Stripe. Stripe is currently valued at around Read More
What began as a lawsuit instituted by the Commodity Futures Trading Commission3 which promised to address the question of what constitutes manipulation in the futures market in violation of the Act has now ended inconclusively, and given rise to an interesting, and somewhat bizarre, dispute over whether the CFTC violated a consent order in settlement of the suit by making public statements about the resolution. We’ll get to that contretemps. But first, it’s productive to examine just how it all started.
The CFTC’s Complaint is quite detailed. It alleged that Kraft buys a lot of wheat—about 30 million bushels per year. So it’s an active buyer in the commodity markets. In order to purchase that wheat for use in products like Oreos, Chips Ahoy!, Triscuits, Ritz Crackers and Wheat Thins, Kraft has two primary options: it can purchase wheat directly from a grain producer or wholesaler in the cash market; or it can purchase wheat futures sold on the Chicago Board of Trade. The first method is the preferred option. Wheat acquired on the futures market is typically of a lower quality than that sourced in the cash market.
Besides, if you take delivery of CBOT wheat, you don’t have the ability to specify (or even know far in advance) the delivery location. Because of the inability to control wheat quality or delivery location, Kraft rarely takes delivery of wheat via the futures market and, according to the CFTC, had historically used futures only as a hedge.
That is why, the CFTC contended in its lawsuit, it was unusual for Kraft to have acquired a huge long position in December 2011 wheat futures. According to the CFTC, Kraft was carrying a futures position substantially larger than its actual needs. And what is more, Kraft maintained the position as part of a plan, at odds with its historic practices, to redeliver some portion of the position, in excess of 15,000,000 bushels, into the futures market.
The CFTC alleged that Kraft lacked facilities to store the wheat and would have incurred exorbitant costs to do so. Kraft never intended to take delivery of the 15 million bushels, but rather would have the market believe it would take delivery. The market would then react to Kraft’s long position with a reduction in the price of cash wheat available, which would allow Kraft to obtain wheat in the cash market at more favorable prices. Kraft, the CFTC concluded, intended to profit from its futures position as the result of a narrower spread between two of its futures contracts as part of the same scheme.
The CFTC described the scheme in intricate detail. In doing so, it quoted at length from internal emails Kraft’s chief of procurement sent to senior management. So it appears that there was a source inside the company. Based on the evidence the CFTC amassed, the agency contended that, once all of Kraft’s commercial needs were met, its activities sent a misleading message of high demand to the markets for both cash wheat and wheat futures, so that resulting prices were influenced by the false signals Kraft created, not actual supply and demand.
By the CFTC’s calculation, Kraft’s scheme resulted in an increase in wheat futures prices and a decline in cash wheat prices. As a result of these price shifts, the CFTC alleged, Kraft realized a gain of more than $5.4 million.
The industry was awaiting the outcome of the suit. The CFTC’s characterization of Kraft’s actions as a violation of the Act’s anti-manipulation rule squarely projected the issue whether a market participant which exercised power in the market short of cornering the market could violate that rule.
It was disclosed on March 25, 2019, approximately four years after institution of the lawsuit, that the parties had settled. But no details were made public until August 15, when it was announced that the terms included a civil penalty of $16 million, an injunction against Kraft from manipulating or attempting to manipulate the price of any commodity and, perhaps most surprising of all, that neither party would make any public statement about the lawsuit other than to refer to the terms of the settlement agreement and public documents in the case.
Such gag orders usually constrain defendants—so that they are unable to trumpet their exoneration—but not the public bodies which prosecute them. Those bodies customarily issue statements to underscore their regulatory efforts and explain to the regulated community and the public why the enforcement action was necessary.
But where the main action ended, a new controversy arose. On August 15, one day after the settlement was finalized, the CFTC issued a press release touting the settlement. In the release, Keith Tarbert, the CFTC’s Chair, was quoted as saying that, “Market manipulation inflicts real pain on farmers by denying them the fair value of their hard work and crops.”
Commodity Futures Trading Dissent
Two of CFTC’s Democratic Commissioners released a separate statement. While citing the restriction on public statements, and insisting the prohibition had been included in the settlement terms at the behest of the judge, they noted that the settlement amount was nearly three times the unlawful profit the CFTC alleged defendants had realized from their scheme and that the matter had been brought to “a successful resolution.” The two Commissioners said, “The Commission is speaking loudly and clearly as well: those who manipulate or attempt to manipulate our commodity markets will be prosecuted and punished.”
Kraft was incensed, accused the CFTC and the two Commissioners of violating the settlement agreement and went back to the trial judge, asking that he hold all three in contempt of court. While CFTC lawyers argued the statements didn’t violate the settlement agreement because Commissioners can’t be prohibited from stating their own opinions, the CFTC nevertheless agreed to temporarily remove the statements from its website.
The judge took the highly unusual step of ordering that the CFTC’s Chair and the two Democratic Commissioners appear in court to answer questions about the statements. Courts customarily protect regulators from attempts to have them explain their actions. Here, the statements are pretty clear, and it’s not evident how live testimony will shed any light on the issues.
So, what does all this mean? It’s hard to see that it will amount to anything of significance, apart from the Commissioners’ having to endure the public embarrassment of a scolding by an irate judge and indignant defense lawyers.
One glaring omission from the settlement agreement is the absence of findings of fact and conclusions of law, which an agency like the CFTC often uses to provide guidance as to a regulatory agency’s interpretation of the law. Companies and the legal community, which were looking to the case for that guidance on the sweep of the Act’s anti-manipulation rule, will have to find it elsewhere. And they may have no choice but to behave as though the CFTC won, at least for the time being.
About Crow & Cushing
Crow & Cushing is a law firm in Princeton, New Jersey, specializing in serving the alternative investment industry. Our services cover the securities and commodities laws as well as general corporate matters on behalf of a clientele that includes hedge funds, investment advisers, futures trading firms, commodity pool operators, fund administrators, futures brokers, broker/dealers and family offices. The Newsletter deals with issues we hope will be of interest to our clients and friends.
For additional information, please contact the law firm of Crow & Cushing at 609-252-9015.
Charles S. Crow
David P. Cushing
Janice A. Kioko
Mark D. Schorr
Francis G. Tanczos
1 7 U.S.C. §9(1); 17 C.F.R. §180.1.
2 7 U.S.C. §§9(3), -13(a)(2); 17 C.F.R. §180.2.
3 U.S. Commodity Futures Trading Comm’n v. Kraft Food Group, Inc., Docket No. 15-2881 (N.D. Ill. filed April 1, 2015).