Monday, April 06, 2015

Kraft Foods Earned a Tasty Profit by Manipulating Wheat Futures, Says CFTC

By Lene Powell, J.D.

The CFTC charged Kraft Foods Group and its former affiliate Mondelēz Global with manipulating and attempting to manipulate the price of cash wheat and wheat futures. In a move approved by senior management, Kraft allegedly bought $90 million of wheat futures—about six months’ supply—without intending to take delivery, correctly calculating that this would depress cash wheat prices and increase wheat futures prices. The strategy allegedly earned Kraft over $5.4 million in profits (CFTC v. Kraft Foods Group, Inc., April 1, 2015).

The complaint also alleges that Kraft violated speculative position limits and conducted non-competitive, off-exchange futures trades.

“A market participant who is not happy with cash prices available to it may not resort to manipulative trading strategies in an attempt to artificially lower that price,” said CFTC Director of Enforcement Aitan Goelman in a statement.

In an SEC filing on the same day, Kraft disclosed that the CFTC had filed a complaint against it, but said the allegations involve the business now owned and operated by Mondelēz, which was spun off in 2012. An agreement between Kraft and Mondelēz provides that the latter will predominantly bear any costs and penalties, so Kraft does not expect the case to have a material adverse effect on its financial condition, operations or business.

Manipulative conduct. According to the complaint, Kraft uses about 30 million bushels of wheat per year in products like Oreo cookies and Triscuit crackers. Kraft is one of the largest domestic end users of #2 Soft Red Winter Wheat, the variety of wheat deliverable against the CBOT wheat futures contract.

Cash wheat prices were high in the late summer of 2011, and Kraft allegedly used a manipulative strategy to depress them. In October of that year, wheat procurement staff suggested to senior management that Kraft should buy $90 million of December 2011 wheat futures in early December 2011. Kraft did not have a bona fide commercial need for this massive amount of wheat, and did not intend to take delivery of it. The expectation was that the futures market would react to Kraft’s enormous long position by increasing the price of the December 2011 futures contract while reducing the differential between the December futures price and the price of the cash market wheat.

Management approved the strategy, and staff then executed the strategy. According to the CFTC, Kraft’s actions caused cash wheat prices in Toledo to decline and the December 2011/March 2012 wheat futures spread to narrow, which was favorable to Kraft. As a result, Kraft earned over $5.4 million in profits.

Position limits violations. A CFTC regulation on position limits restricts wheat futures positions to 600 contracts in the spot month, 5,000 contracts for any single contract month, or 6,500 contracts for all months combined. CBOT has the same levels. Hedge exemptions are available upon application, but Kraft had not renewed its one-year exemption, and also did not have a bona fide exemption. Kraft and Mondelēz held long positions in December 2011 wheat that exceeded the CBOT’s 600-contract speculative spot month position limit by as much as 2,110 contracts, said the CFTC.

Fictitious trades. According to the CFTC, Kraft conducted an off-exchange transaction between two Kraft accounts carrying long and short positions for its wheat futures, in which Kraft’s short position was offset by its long position. These transactions were cleared as EFP or “exchange for physical” transactions, in which futures are exchanged for the physical commodity. EFPs are allowed only if they are between independent parties and are conducted and cleared on-exchange, and must be documented.

Kraft did not actually transfer physical wheat in connection with any of the EFP transactions, and also did not create any of the required documentation. Therefore, the EFPs were impermissible and Kraft violated Section 4c(a) and Regulation 1.38(a), the CFTC argued.

Sanctions requested. The CFTC asked the district court to enter an order of permanent injunction and impose a civil monetary penalty and disgorgement.

The case is No. 15-2881.

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