Bridging the Week by Gary DeWaal: March 30 to April 3 and 6, 2015 (Manipulation and Manipulative Device; Sue and Be Sued; Alleged Pastor Fraud; Transfer Trades)

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Published Date: April 05, 2015

Two household names in the food industry—Kraft Foods Group and Mondelez Global—were sued last week by the Commodity Futures Trading Commission for allegedly manipulating wheat futures contracts traded on the Chicago Board of Trade during 2011. However, the CFTC chose to charge the firms using both its traditional tools to prosecute alleged manipulation as well as its new tools to prosecute allegedly manipulative or deceptive devices. In addition, the Securities and Exchange Commission filed an administrative proceeding against the operators of a number of collateralized loan obligation funds for misleading investors, and the operators sued the SEC right back in federal court, claiming that the SEC's administrative forum is unconstitutional. As a result, the following matters are covered in this week’s Bridging the Week:

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Manipulation Is Not Hedging Says CFTC in Federal Court Lawsuit Against Kraft Foods Group and Mondelez Global

The Commodity Futures Trading Commission filed a lawsuit against Kraft Foods Group, Inc. and Mondelez Global LLC claiming that trades they entered on the Chicago Board of Trade for the alleged purpose of hedging were in fact entered for the purpose of artificially lowering prices in the related cash market. This activity, claimed the CFTC, was a violation of federal law and the Commission’s rules.

According to a complaint filed by the CFTC in a federal court in Illinois, by November 29, 2011, the companies purchased 3,150 long CBOT December 2011 wheat futures contracts, which was equivalent to 15.75 million bushels or approximately US $93.5 million worth of wheat (November 29 was the first day of the delivery period for the December 2011 wheat futures contract). The companies did this, said the CFTC, with the intent to depress the price of wheat in the cash market.

Although the companies used wheat for their commercial purposes, acknowledged the CFTC complaint, they could not have used the quantity of wheat they potentially controlled at the time of the companies’ long futures purchase without incurring exorbitant costs, said the Commission. This is because they allegedly did not have sufficient storage facilities of their own.

Ordinarily, said the CFTC, the companies purchased wheat in the futures market solely as a hedge against future anticipated purchases in the cash market. Once the companies purchased cash wheat, they offset their futures hedge. The companies did not take delivery of most of the transactions at issue, however, said the Commission. Moreover, of the 1320 contracts the companies did take delivery on, they resold 1188 of their shipping certificates. 

Ultimately, the companies' actions caused the price of cash wheat to decline, alleged the CFTC. According to the Commission, as a result of their activities, the companies realized US $5.4 million in profits.

The CFTC accused the companies of engaging in manipulation and attempted manipulation through their activities, as well as engaging in a “manipulative or deceptive device or contrivance.” Under law, the former allegation requires proof of intent and an artificial price, among other elements, while the latter does not.

The CFTC also charged the companies with violating speculative position limits in connection with wheat futures positions they held on five days in December 2011. Although the companies had a hedging exemption to cover their cash needs that was effective for one year from December 1, 2010, they failed to request renewal of the exemption until December 28, 2011, noted the CFTC.

In addition, the CFTC said that the companies engaged in non-competitive trading in connection with multiples transfers of positions between different accounts that were executed as exchanges for related positions (instead of as transfer trades).

During the period covered by the CFTC’s complaint, Kraft Foods Inc. was the parent of Kraft Food Group, Inc. and its affiliate Mondelez Global LLC. In October 2012, the companies engaged in a corporate restructuring that resulted in Kraft Foods Group being one corporation owned by public shareholders and Kraft Foods Inc., its former parent, being a separate publicly traded company and renamed Mondelez International Inc.

My View: It will be interesting to follow this case to see how the charging of the respondents both under the CFTC’s traditional anti-manipulation authority (click here to access CFTC Rule 180.2) and its newly gotten anti-manipulative or deceptive device or contrivance authority (click here to access CFTC Rule 180.1) plays out. In charging respondents in a federal court with a violation of its new prohibitions, the CFTC solely argued that the companies “intended to affect or acted recklessly with regards to affecting the prices of the December 2011 wheat futures contract and engaged in over acts in furtherance of its intent”—conduct seemingly descriptive of traditional manipulation. In publishing a Q&A related to its new authority (click here to access), the CFTC argued that that its new prohibitions “enhances the Commission’s ability to prosecute manipulation.” However, the relevant provision’s prohibition against using or employing “any manipulative device,” seems limited on its face to activities “to defraud.” It is not clear whom respondents were endeavoring to defraud through their trading activities, even assuming all of the Commission’s facts, as alleged, are true. As I have stated before, CFTC Rule 180.1 is extraordinarily broad and provides little guidance as to what is precisely prohibited activity. (Click here to access the article, “Reflections on the JP Morgan's Settlements -- Human Nature, Internal Controls, and the CFTC's Broad New Anti-Manipulation Authority,” in the September 20, 2013 edition of what is now known as Between Bridges.)


Compliance Weeds: In both the CFTC’s enforcement action against Kraft Foods Group and Mondelez Global filed last week, as well as the Jaypee International disciplinary action discussed in this article, companies appear to have tried to transfer positions between commonly owned accounts through impermissible non-competitive transactions. However, designated contract markets—such as the exchanges of CME Group and ICE Futures U.S.—have express provisions permitting transfers of positions between accounts with the same beneficial ownership subject to certain conditions (e.g., the trades may only be transferred at certain prices) and restrictions on when otherwise offsetting transferred positions may be liquidated outside the market. (Click here, to access CME Group’s Rule 853 regarding transfer trades, and here, to access IFUS’s Rule 4.11 regarding transfer trades.)

My ViewPreviously, respondents in another SEC administrative proceeding —Wing Chau and his firm, Harding Advisory LLC— challenged in a federal court the legitimacy of the administrative forum. They lost their challenge there but were invited to raise their constitutional arguments before the  SEC. (Click here for details in the article, "SEC Okay to Prosecute Cases Before Administrative Tribunals Rather Than Federal Court Says US Judge" in the December 8 to 12 and 15, 2014 edition of Bridging the Week.) Some have argued that the US Supreme Court's 2010 decision in Free Enterprise Fund v. Public Company Accounting Oversight Board (click here to access) provides a basis for an attack on the legitimacy of SEC as well as Commodity Futures Trading Commission administrative proceedings. There, the court held that the board's members were insufficiently accountable to the president of the US to comply with the vesting of executive power in the executive branch as contemplated under the US constitution. The question is whether administrative law judges hearing SEC or CFTC enforcement actions are also too far removed from the president of the US to allow him or her to exercise effective oversight as required by the US constitution. (Click here for an overview of this argument in the article, "A Renewed Fight over SEC's Admin Forum Constitutionality" by Thomas Potter in the October 9, 2014 edition of Law360.) We shall see.

And even more briefly:

And finally:

For more information, see:

CFTC Charges Pastor Used Peregrine Financial Group Collapse as Cover to Help Defraud Congregants:

CFTC Staff Grants No Action Relief Regarding Application of Business Conduct Standards for Swaps With Certain Legacy SPVs:

CME Group Updates Audit Trail Requirements for Electronic Systems Connecting to Globex:

See also, current requirements:

See also, CME Group submission to CFTC explaining different between updated and existing requirements:

Don’t Trade It Again, Shak (at Least Not During the Closing Period):

FINRA Sanctions Brokers for Inadequate Consolidated Reports to Customers:

H. Beck:

LaSalle St. Securities:
JP Turner:

ISDA Proposes Common Principles Be Adopted Globally to Promote Centralized Execution of Swaps:
Access at:

LCH.Clearnet Recommends Standardized Stress Testing of CCPs:

Manipulation Is Not Hedging Says CFTC in Federal Court Lawsuit Against Kraft Foods Group and Mondelez Global:

MFA Argues Against Post-Trade Disclosure of Counterparty to SEF Transactions:

Problematic EFRPs and Wash Trades Sanctioned by CME Group and ICE Futures U.S.:

CME Group:

ICE Futures U.S.:

SEC Charges Investment Advisers and Owner of Misleading Investors in Funds Regarding the Poor Performance of Underlying Assets; Respondents Countersue SEC:

See also, Tilton v. SEC:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 3, 2015. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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