On March 27, 2017, the Commodity Futures Trading Commission (“CFTC”) announced it entered into a consent order with Davisco Foods International, Inc. (“Davisco”), a dairy company, to settle allegations that Davisco acted as a futures commission merchant (“FCM”) for its milk suppliers without registering as an FCM. Section 4d of the Commodity Exchange Act defines an FCM as an entity that is “engaged in soliciting or accepting orders for…the purchase or sale of a commodity for future delivery” that would be required to be traded on an exchange, and which “in connection with such acceptance of such orders” accepts money or property to margin or secure any trades that results therefrom. FCMs must register with the CFTC, and their operations are subject to a number of requirements, including net capital minimums, segregation of customer funds, and customer disclosure requirements.

According to the CFTC, Davisco’s contracts with its milk suppliers contained an option to enter into a “Futures Milk Contracting Program.” The CFTC order finds that participants in this program placed orders with Davisco for CME Class III Milk futures contracts, which Davisco submitted to its broker under Davisco’s name. Davisco then adjusted payments to the milk suppliers based on the settlement prices of those contracts. According to the CFTC, Davisco did not profit from these activities, but did receive an unspecified business benefit. By accepting orders for futures contracts, accepting some form of payment for those futures orders, and then placing orders on an exchange, Davisco was acting as an FCM. This is irrespective of how the underlying agreement was structured. The acceptance of the order with payment and the placing of the order were sufficient for the CFTC to find a violation of Section 4d. The relatively low monetary penalty assessed indicates that the CFTC is cognizant that this case did not involve customer fraud or manipulation, and that Davisco appears not to have unduly profited from its actions. As a simple registration violation, it warranted a relatively low fine.

The case, however, serves as a cautionary tale to industry participants. It is common for end-users’ agreements with suppliers to have provisions where payments to the supplier are tied to the price of certain futures contracts, such that the price paid to the supplier will rise or fall with the value of the futures contract. Ordinarily, such arrangements should not require an end-user to register as an FCM. The issue here appears to have been that Davisco’s contracts did not simply reference the futures contracts for purposes of determining prices paid to the supplier, but that Davisco was actually accepting and executing futures orders on behalf of its suppliers, and then adjusting payments based on the settlement price of those contracts. The use of an exchange-traded product in this manner triggered the need for registration and the resulting regulatory action. This enforcement action may signal that the CFTC will be scrutinizing end-users’ contracts with suppliers for similar provisions. Accordingly, end-users should review their supply contracts and forward contracts to ensure that there are no provisions that could be construed as allowing them to place orders for futures, or other exchange-traded contracts, on behalf of suppliers and to adjust payments to suppliers based on the price of those contracts.