On July 12, the Commodity Futures Trading Commission (CFTC) and the CME Group (CME) both announced settled proceedings against Lansing Trading Group, LLC, a commercial agricultural and energy products merchandising company, for attempted manipulation of wheat futures and aiding and abetting an attempted manipulation of the yellow corn futures market. The CFTC imposed a fine of $3.4 million and required remediation of certain internal controls. The CME imposed a fine of $3.1 million. Although the particulars of this case involve the agricultural markets, the implications sweep much further to all users of the futures markets, including commercial energy companies.
The simultaneous imposition of such substantial fines, particularly the highly unusual multi-million-dollar fine imposed by the CME, may signal both a more aggressive enforcement posture at the CME and an energized level of cooperation between the CME as a self-regulatory organization and its oversight regulator as well as the increased use of parallel CFTC and exchange enforcement proceedings concerning the same conduct. The attempted manipulation charge, moreover, may signal again the Commission’s continuing willingness to press the previous boundaries of manipulation theory whenever it finds evidence of a market participant discussing price impact in connection with adopting a certain trading strategy. Market traders should therefore take heed of the hazards of focusing on price impacts of potential trading strategies, and the importance of contemporaneously documenting a strategy’s economic rationale.1
The CME wheat contract is a physical delivery contract, and the delivery instrument is a shipping certificate issued by an exchange-approved warehouse. All certificates are either for wheat with 2 parts per million (ppm) vomitoxin or 3ppm vomitoxin, with a 20-cent per bushel discount applied to the 3ppm certificates. Apparently, in early March 2015, Lansing traders learned that another market participant was going to register what would be considered a large number of 3ppm shipping certificates. The CFTC found that the Lansing traders then formulated a strategy to increase their long wheat spread positions and wheat call option positions when the market price would be falling due to the increased deliverable supply. The traders then planned to purchase all of the 3ppm certificates and later cancel them for load out and delivery.2 Thereby, they would create an impression which the CFTC called “false or misleading” that there was a market demand for this wheat, thus driving up the value of Lansing’s long positions.
Lansing apparently went forward with this plan. It increased its long positions while the wheat contract and associated spread prices were decreasing, bought up the 3ppm shipping certificates and then canceled for load out all of the certificates. To demonstrate the traders’ state of mind, the Commission order focuses on and recites from recorded phone calls in which Lansing traders discuss “the market’s perception and effect of canceling and loading out” the certificates and “the plan and its effect on the price curve....” In addition, the order cites and quotes from calls with an industry newsletter writer “who agreed to disseminate information about Lansing’s intent to cancel and load-out the Wheat Certificates to the market.”
What is most interesting about the CFTC’s discussion is what is absent from it. The order contains no indication of
- the wheat futures price actually moving in a manner that allowed Lansing to profit,
- what Lansing actually did with the wheat it owned (as represented by the shipping certificates) once it canceled the shipping certificates, or
- whether what Lansing did with the wheat was itself profitable or otherwise economically “rational.”
The last two points are particularly noteworthy. Generally speaking, the CFTC has pursued manipulation cases in recent years where it could assert that the activity in the cash market was not economically or commercially rational aside from its effect on the price of the derivative and the associated profit to be made on a position held in that derivative.3 Even in another pending matter where the CFTC has recently alleged a somewhat similar theory of manipulation via a “false signal” to the market regarding demand, the CFTC alleges that the market participant’s conduct in the cash market was not justified other than by the benefit to be gained in the futures market.4 In Lansing, by contrast, the Commission has reasoned that there was sufficient evidence to assert a case of attempted manipulation without identifying any such predicate of uneconomic or commercially irrational behavior.
This settlement is consistent with recent examples of the Commission testing the limits of its manipulation jurisdiction.5 It suggests that the staff continues to be animated often principally by email, instant message or phone calls discussing that either the purpose or the effect of an action would be to affect the price of a commodity position in which the trader has an interest.6 Staff now appears willing to pursue those instances under theories of manipulation not linked to irrational economic or commercial behavior.7 Moreover, this willingness to divorce manipulation from a predicate of irrational economic or commercial conduct suggests that the CFTC may be willing to pursue theories along the lines of the Federal Energy Regulatory Commission’s (FERC) controversial view that market participants have a duty to trade in a manner consistent with market design. In that regard, FERC staff have argued that even rational economic behavior may be viewed as manipulative if a party engaged in it to achieve pricing goals that were not intended by the market mechanism being used in connection with the trading.8 In this case, the CFTC seems to be similarly reasoning that Lansing misused the process of purchasing shipping certificates and canceling them for load out even without the predicate that the conduct was otherwise uneconomic.
Once again, this settlement should serve as a cautionary tale to commercial market participants as to the hazards of discussing the anticipated effect a trading strategy will have on market price and then implementing that trading strategy. It also reinforces the importance of doing everything possible to create contemporaneous records of a trading strategy’s rationale that is based on market fundamentals, commercial need or other economically rational justifications aside from price impact. Without that, CFTC action – and, perhaps, parallel exchange proceedings – will remain a greater risk.