Davisco Foods International, Inc., an international cheese and food ingredient company headquartered in Le Sueur, Minnesota, agreed to settle a complaint filed by the Commodity Futures Trading Commission that it acted as a futures commission merchant without being registered as required by law in connection with a hedging program it administered for its milk suppliers. According to the Commission’s complaint, since 2011, Davisco has entered into arrangements with its milk suppliers (termed Milk Patron Agreements) that contained an option to enter into a “Futures Milk Contracting Program.” Pursuant to this program, claimed the CFTC, the suppliers placed orders with Davisco for CME milk futures contracts that Davisco then executed for its own trading account. Suppliers subsequently received “debits and credits” to their accounts with the firm. The CFTC said, “While [Davisco] solicited and accepted funds, [it] did so only as a pass-through, and any profit and loss was reflected in the Milk Patrons’ accounting.” The CFTC acknowledged that Davisco did not charge any fees in connection with the futures orders and did not profit from the transactions. However, Davisco “received a benefit from offering the FCM services to its clients,” said the CFTC. Davisco resolved this matter by agreeing to pay a US $150,000 fine, but did not admit or deny any of the CFTC’s findings or conclusions in its settlement order. Davisco is a business unit of Agropur, a Canada-based dairy cooperative.

My View: Just last week in a speech before the US Chamber of Commerce, CFTC Chairman nominee J. Christopher Giancarlo said that market enforcement “will remain aggressive and assertive under the Trump Administration.” To support this, he appointed James McDonald, an assistant US Attorney based in New York City, as the next Director of the Commission’s Division of Enforcement (click here for details of Mr. Giancarlo’s most recent speech, and here for details of his appointment of Mr. McDonald).

Hopefully, however, this enforcement action by the CFTC against Davisco is not an example of the type of tough enforcement to come, which aims to make derivatives markets more liquid and investors better protected. That is because, on its face, it is not clear from the Davisco settlement order what the firm did wrong. The settlement order engenders confusion among end-users and agricultural cooperatives that today offer valuable price protection and similar types of risk management programs to our nation’s farmers and livestock growers.

It is Futures 101 that a person acting as a futures commission merchant must be registered as such with the CFTC. However, it is not clear from the CFTC’s settlement order where Davisco crossed the line, if at all.

As best a reader of the settlement order can tell, through its Milk Patron program, Davisco bought milk from its suppliers and offered them an opportunity to obtain a price that was impacted by settlement prices of the relevant CME milk futures contract. It appears that at least some milk suppliers placed orders for futures with Davisco; however, this was for Davisco’s account – although individual suppliers received debits and credits to accounts somehow related to this. Davisco “solicited and accepted funds” for this program from its suppliers – “but only as a pass-through.” Huh? Did the milk suppliers have individual accounts or not? Did they deposit with Davisco funds for margin or something else? Were there marked-to-market payments? Or was Davisco solely offering a commodity option or price protection product of some type based on the CME futures contract? Not clear!

The CFTC’s choice of words is confusing at best, and at worst sends an unclear message as to what was problematic. Was there fundamental wrongdoing with an intent to evade registration requirements? Or was there simply an inadvertent mistake in administration or marketing? If the latter, why bring the case at all? Wouldn’t it be better to privately warn the company to stop engaging in the problematic conduct and issue public guidance to the industry overall?

Aggressive and assertive enforcement is appropriate when there is real wrongdoing – not to articulate new expectations of regulators or to engage in “gotcha” with otherwise law-abiding persons who might have made a good faith mistake with no real harm to anyone – particularly when enforcement budgets are tight. In any case, at a minimum, all regulatory settlement orders should make it clear what was wrong so the industry can continue to conduct an important business for customers while structuring it to avoid a regulator’s wrath. In no case, should there ever be regulation by settlement order.