U.S. Commodity Futures Trading Comm'n v. Kraft Foods Grp., Inc.

• Decision Date: 18 December 2015
• Docket Number: Case No. 15 C 2881
• Citation: 153 F.Supp.3d 996
• Parties: U.S. Commodity Futures Trading Commission, Plaintiff, v. Kraft Foods Group, Inc., and Mondelez Global LLC, Defendants.
• Court: U.S. District Court — Northern District of Illinois

153 F.Supp.3d 996

U.S. Commodity Futures Trading Commission, Plaintiff,

v.Kraft Foods Group, Inc., and Mondelez Global LLC, Defendants.

Case No. 15 C 2881

United States District Court, N.D. Illinois, Eastern Division.

Signed December 18, 2015

Robert Thomas Howell, III, Rosemary C. Hollinger, Susan J. Gradman, Jennifer Ellen Smiley, Commodity Futures Trading Commission, Chicago, IL, for Plaintiff.

Harry Ploss, pro se.Aaron Stephenson Furniss, Sutherland Asbill & Brennan, LLP, Atlanta, GA, Charles Mark Kruly, Gregory S. Kaufman, Stephen Thomas Tsai, Sutherland Asbill & Brennan LLP, Washington, DC, Timothy Andrew Karpoff, Dean Nicholas Panos, J. Kevin McCall, Nicole Amie Allen, Thomas Edward Quinn, Jenner & Block LLP, Chicago, IL, Ronald W. Zdrojeski, Sutherland Asbill & Brennan LLP, New York, NY, for Defendants.

MEMORANDUM OPINION AND ORDER

John Robert Blakey

, United States District Judge

This matter concerns the alleged misconduct of Defendant Kraft in purchasing and selling wheat and wheat futures. Plaintiff, the Commodity Futures Trading Commission (“CFTC”), brought this action pursuant to 7 U.S.C. § 13a-1

, and alleges four causes of action: (I) use of a manipulative or deceptive device in connection with a contract for sale of a commodity or future, in violation of Section 6(c)(1) of the Commodities Exchange Act (the “Act”), and CFTC Regulation 180.1; (II) manipulation and attempted manipulation of the price of cash wheat and wheat futures in violation of Sections 9(a)(2) and 6(c)(3) of the Act, and CFTC Regulation 180.2; (III) exceeding the speculative position limit with regard to wheat futures in violation of Sections 4a(b) and (e) of the Act, and CFTC Regulation 150.2; and (IV) wash sales, fictitious sales and noncompetitive trading in violation of Sections 4c(a)(1) and (2) of the Act, and CFTC Regulation 1.38(a). [1] Cmplt. Defendants moved to dismiss Counts I and II of the Complaint. [56]. For the reasons explained below, that motion is denied.

I. Background¹

The Defendants are Kraft Foods Group, Inc. (“Kraft”) and Mondelez Global LLC (“Mondelez”). Kraft is one of North America's largest consumer packaged food and beverage companies, and operated the snack food business that is the subject of this Complaint. [1] at ¶¶ 8, 10. During the time period covered by this Complaint, Kraft Foods Inc. owned Kraft. Id . at ¶10. Through a spin-off agreement in which Kraft Foods Inc. altered its corporate structure, Defendant Mondelez came to operate the snack food business formerly operated by Kraft. Id . In the same spin-off, Kraft Foods Inc. became Mondelez International Inc., which now owns Defendant Mondelez Global. The Court's discussion concerns primarily Kraft, not Mondelez, because Kraft operated the snack food business during the relevant time period.

Kraft is one of the largest domestic users of #2 Soft Red Winter Wheat. [1] at ¶ 11. It is this type of wheat, and its futures contracts, which are at issue in this matter. Kraft consumes approximately 30 million bushels of wheat per year, 90 percent of which is milled into flour at its Toledo, Ohio flour mill (the “Mill”). Id . at ¶¶ 11, 14. Kraft can store five million bushels of unprocessed wheat at the Mill. Id . Kraft uses that wheat in the production of snack foods, including Oreo, Ritz, Triscuit, Wheat Thins, and Chips Ahoy! Id . at ¶ 11. Kraft typically purchases wheat on a daily basis throughout the year and strives to maintain a two-month supply in its inventory. Id . at ¶ 14.

To make flour that it can use in snack food production, Kraft requires wheat for milling that meets certain specifications for baking and human consumption. Id . at ¶ 12. These specifications include the permissible numbers of insect damaged kernels and maximum allowable levels of vomitoxin. Id . Vomitoxin is a type of mold that may be produced in wheat infected by Fusarium head blight or scab. Id . U.S. Food and Drug Administration guidance requires a vomitoxin level below one part per million in finished baked goods. Id . Vomitoxin levels in wheat can be reduced through normal wheat milling processes and cleaning technologies, or by blending in wheat with lower vomitoxin levels. Id .

According to Plaintiff, Kraft has two primary options for obtaining the wheat it requires. Id . at ¶ 15. First, it can buy the wheat directly from a grain producer or wholesaler in the cash market. Id . Second, it can purchase wheat futures contracts sold on the Chicago Board of Trade (“CBOT”). Id . at ¶ 17. When Kraft sources through the cash market, it can negotiate wheat specifications to ensure that the wheat meets its requirements. Id . at ¶ 15. It can also negotiate the delivery location and process. Id . at ¶ 16. For instance, Kraft ordinarily will source its cash market wheat from the Toledo region—which includes Ohio, Indiana, Michigan and Ontario. Id . It is not economical for Kraft to take delivery of wheat located outside this region, including wheat housed along the Mississippi River, because of significantly increased shipping costs. Id . Costs of wheat housed outside of the Toledo region are higher because Kraft would have to pay for the wheat to be barged to a location where it could be transferred to rail and then sent on to the Mill. Id . It is not possible for Kraft to barge wheat directly from locations down the Mississippi River to the Mill. Id .

As for the second option, Kraft rarely takes delivery of wheat purchased through futures contract for delivery via the CBOT process. Id . at ¶ 22. A futures contract is a standardized agreement between two parties to purchase or sell a predetermined quantity of a commodity for delivery during a future month, at a price determined at the initiation of the contract. Id . at ¶ 18. For instance, the buyer would agree to pay $50 dollars for 1 bushel of wheat on the day the contract is executed, and the seller would agree to deliver that wheat on an agreed future date. The trader who purchases the commodity is said to have a “long” position, while the trader who sells the commodity has a “short” position. Id . Futures contracts may be settled in two ways: (1) by delivering the actual commodity on the date specified; or (2) by “offsetting” the contract by entering an equal and opposite trade, effectively eliminating the original position. Id . For example, a party would “offset” a long contract for 500 bushels of wheat by purchasing a short contract for 500 bushels.

CBOT Rules govern trading on the Chicago Board of Trade. Under CBOT Rules, each wheat futures contract consists of 5,000 bushels of wheat and the contracts are set for delivery during five different contract months each calendar year: March, May, July, September, and December. Id . at ¶ 19. A futures seller delivers a CBOT wheat contract by tendering a “shipping certificate” to the buyer of the futures contract. Id . That certificate represents an interest in wheat for load-out from a CBOT-approved delivery facility. Id . Shipping certificates may also be bought and sold between traders or exchanged for futures positions. Id .

Wheat acquired via the futures market is typically of a lower quality than wheat from the cash market. Id . at ¶ 20. For example, during the relevant time period, CBOT rules specified that futures wheat from the exchange could have vomitoxin levels of up to 4 parts per million, four times the maximum amount recommended by the FDA for baked goods. Id . at ¶¶ 12, 20. Further, parties who take delivery of CBOT wheat cannot specify delivery location or load out process, nor do they even know the delivery locations for the contracts they have purchased until they receive shipping certificates. Id . at ¶ 21.

Because of the inability to control wheat quality or delivery location, Kraft rarely takes delivery of wheat via the CBOT delivery process and, prior to Fall 2011, had last done so in 2002. Id . at ¶¶ 22, 23. Instead, Kraft normally uses the futures markets to hedge its cash wheat purchases, taking long futures positions that roughly correlate with its actual wheat needs, and then offsetting these positions as it acquires physical wheat in the cash market. Id . The idea behind this approach is to secure a stable supply of wheat in case there are market fluctuations.

In 2011, cash wheat prices for #2 Soft Red Winter Wheat in the Toledo region rose from $5.74 per bushel on June 30, 2011 to $7.72 per bushel on August 26, 2011. Id . at ¶ 24. Over the same time, the price of December 2011 CBOT wheat futures rose from $6.57½ to $7.97. Id . Even though cash wheat prices were rising, there was wheat available in the Toledo cash market for Kraft to satisfy its needs. Id .

Plaintiff alleges that, in response to these elevated cash prices, Kraft deviated from its practice of using the futures markets solely to hedge its cash wheat purchases. Id . at ¶ 25. Instead, Kraft attempted to leverage its status as a large commercial hedger to lower the price of cash wheat. Id . at ¶ 34. According to the Complaint, Kraft “wheat procurement staff developed, and Kraft senior management approved, a strategy to use its status as a commercial hedger to acquire a huge long position in December 2011 wheat futures in order to induce sellers to believe that Kraft would take delivery, load out, and use that wheat in its Mill.” Id . at ¶ 25. In developing that strategy, Plaintiff's claim that Kraft intended that the market would react to its enormous long position by increasing the price of the December 2011 futures contract and lowering the price of cash wheat available in the Toledo region. Id . at ¶ 34.

According to Plaintiff, Kraft executed a “trial run” of this strategy in September 2011, taking delivery of 250,000 bushels of CBOT wheat, which constituted fifty total certificates. Id . at ¶ 27. Thirty-one of the fifty certificates were for wheat located on the Mississippi River. Id . Kraft could not transport this wheat to the Mill upriver via barge and, due to exchange rules, Kraft could not...