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U.S. Commodity Futures Trading Commission v. Kraft Foods Group, Inc.

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

December 18, 2015

U.S. Commodity Futures Trading Commission, Plaintiff,
Kraft Foods Group, Inc., and Mondel ē z Global LLC, Defendants

          For U.S. Commodity Futures Trading Commission, Plaintiff: Robert Thomas Howell, III, Rosemary C. Hollinger, U.S. Commodity Futures Trading Commission, Chicago, IL; Susan J. Gradman, Commodity Futures Trading Commission, Chicago, IL; Jennifer Ellen Smiley, Commodity Futures Trading Commission, Division of Enforcement, Chicago, IL.

         Harry Ploss, Plaintiff, Pro se.

         For Kraft Foods Group, Inc., Mondelez Global LLC, Defendants: Aaron Stephenson Furniss, PRO HAC VICE, Sutherland Asbill & Brennan, LLP, Atlanta, GA; Dean Nicholas Panos, J. Kevin McCall, Nicole Amie Allen, Thomas Edward Quinn, Jenner & Block LLP, Chicago, IL; Gregory S. Kaufman, PRO HAC VICE, Sutherland, Asbill & Brennan, Washington, DC; Ronald W. Zdrojeski, PRO HAC VICE, Sutherland Asbill & Brennan LLP, New York, NY; Stephen Thomas Tsai, PRO HAC VICE, Sutherland Asbill & Brennan LLP, Washington, DC.


         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. Background[1]

         The Defendants are Kraft Foods Group, Inc. (" Kraft" ) and Mondelē z Global LLC (" Mondelē z" ). 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 Mondelē z came to operate the snack food business formerly operated by Kraft. Id. In the same spin-off, Kraft Foods Inc. became Mondelē z International Inc., which now owns Defendant Mondelē z Global. The Court's discussion concerns primarily Kraft, not Mondelē z, 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 $6.57 1/2 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 require that the wheat be loaded directly on to rail transport. Id. This meant that two separate modes of transport were needed to get the wheat to the Mill. Id. As a result of their test run, Plaintiff claims that Kraft knew it could not assume that CBOT wheat would be easily transportable to the Mill. Id. Around the same time as the " trial run," Kraft submitted a public comment to the CFTC requesting that the CBOT require wheat delivery facilities be connected to rail service. Id. at ¶ 28. Kraft's position was not adopted. Id.

         Plaintiff alleges that in October 2011, despite the results of its trial run, Kraft wheat procurement staff proposed to Kraft senior management a strategy of buying $90 million of December 2011 wheat futures in order to depress the price of cash wheat and inflate the price of futures wheat. Id. at ¶ 29. In an October 20, 2011 email to Kraft's Chief Financial Officer and other senior management, the Kraft Senior Director of Global Procurement explained the strategy as follows:

Given our proposal to 'take physical delivery in Dec' of 15 mm bushels at 50 cents per bushel below the commercially offered price results in the savings of $7mm. In addition, there is a key market dynamic that is important to understand: Once the market sees that Kraft is 'stopping' December wheat, we anticipate the futures curve will begin to flatten, reducing the profitability of wheat storage, thereby reducing the commercial wheat basis to Kraft. We will then have the option of redelivering the wheat acquired through the futures market. This will then quickly reverse the negative cash flow impact. Id. at ¶ 30.

         In considering this proposal, Kraft senior management required that the futures position not exceed $50 million by the end of December, so Kraft procurement staff agreed to sell at least $40 million of the proposed $90 million position by the end of the month. Id. at ¶ 31. Kraft senior management then approved the proposal to buy $90 million of December 2011 wheat futures. Id.

         Kraft, according to Plaintiff, did not have a bona fide commercial need for $90 million of wheat -- which would have amounted to about 15 million bushels, or a six-month supply for the Mill. Id. at ¶ 32. Kraft had never before possessed that amount of wheat and its wheat storage facility at the Mill, which could accommodate only 5 million bushels, was already more than 80% full. Id. at ¶ ¶ 14, 32-33. To take delivery of 15 million additional bushels of wheat, Kraft would have had to locate additional storage and pay additional costs of approximately five cents per bushel for nearly all of the 15 million bushels for up to six months. Id. at ¶ 33. Kraft also would have had to pay additional shipping costs for any wheat coming from the Mississippi River area, including transport by rail and barge. Id. at ¶ 27. In addition, in order to use CBOT wheat to create flour that met its baking specifications, Kraft would have had to buy and store higher quality wheat from the cash market to blend with the lower-quality CBOT wheat. Id. To do that, Kraft would have needed to locate and pay storage costs for far in excess of 15 million bushels. Id. Thus, according to Plaintiff, Kraft did not really intend to take delivery of the 15 million bushels of wheat. Id. at ¶ 34. Kraft intended for the market to react to its huge long position, which was an indication that Kraft's demand for December wheat was being met through the futures market, by lowering the price of cash wheat due to the lack of demand from Kraft. Id. This would later allow Kraft to obtain wheat in the cash market at lower prices. Id.

         Kraft wheat procurement employees executed the strategy as planned, ultimately accumulating 3,150 long December 2011 wheat futures contracts by November 29, 2011, the first day of the delivery period. Id at ¶ 35. Kraft's position was equivalent to 15.75 million bushels, or approximately $93.5 million of wheat. Id. at ¶ 35. Kraft's position exceeded the speculative position limit set by the CBOT of 600 contracts. Id. at ¶ 44. Specifically, on December 2, 5, 6, 7 and 8, Kraft exceeded the position limits by 2,110, 2106, 1,666, 1,226 and 226 contracts, respectively. Id. at ¶ 49. As of December 7, 2011, Kraft's long position constituted 87% percent of the CBOT December 2011 wheat futures open interest. Id.

         A December 2, 2011 email between the Kraft Senior Director of Global Procurement and Kraft senior management explained the result of the strategy:

" As you may recall, we established a long Dec Wheat/Short March Wheat spread at 35 cents (Mar premium to Dec) for the purpose of taking delivery of CME wheat, representing a $7MM saving over commercially sourced wheat. Since Monday we have " stopped" 2.2MM bushels of wheat at a cost of $13.2MM. As expected, the Dec/Mar spread has narrowed to app[roximately] 11 cents resulting in a marked to market gain of $3.6MM on our open spread position. Meanwhile, with the narrowing spread, the cash wheat basis has declined from cents to cents over Dec futures. As we begin purchasing this cheaper basis commercial wheat, we will unwind the existing spread position. If all goes according to plan, we will still save $7MM on the commercial cost of wheat vs where it was a few weeks ago as well as make $2-3MM on reversing out of the Dec/Mar wheat spread." Id. at ¶ 36.

         Ultimately, Kraft obtained 1,320 shipping certificates for December 2011 CBOT wheat, which represented a total of 6.6 million bushels. Id. at ¶ 38. However, the shipping certificates that it received were all for wheat located in warehouses on the Mississippi River, which would have cost $1.21 per bushel to transport to the Mill. Id. at ¶ 37. Kraft ultimately took delivery of just 660,000 bushels (132 contracts) of that wheat, which was less than 5% of the wheat position it carried in early December. Id. After prices in the cash market fell, Kraft resold 1188 of its December 2011 shipping certificates for $35,725,074. Id. On December 9, 2011, Kraft offset all of its 826 remaining long futures contracts (80% of the open interest), which amounted to 78.3% of the trading volume that day. Id. ¶ 39. The Plaintiff claims that it is telling of Kraft's improper motive that it did not purchase a similar quantity of wheat in the cash market as it had previously purchased in the December 2011 futures market. Id. According to Plaintiff, if Kraft had really needed all of the $90 million in futures wheat for its operations, it would have bought the same amount of wheat on the cash market. Id. at ¶ 39.

         Plaintiff claims that, as a result of Kraft's actions, the December 2011 wheat futures prices increased from $5.75 on November 28, 2011 to $6.12 on December 2, 2011. Id. at ¶ 40. Cash wheat prices in Toledo declined from $6.16 per bushel on December 2, 2011 to $5.86 per bushel on December 9, 2011. Id. These price shifts resulted in Kraft pocketing over $5.4 million in profits. Id.

         II. Legal Standard

         Under Rule 12(b)(6), the Court must construe the Complaint in the light most favorable to the Plaintiff, accept as true all well-pleaded facts and draw reasonable inferences in its favor. Yeftich v. Navistar, Inc., 722 F.3d 911, 915 (7th Cir. 2013); Long v. Shorebank Dev. Corp., 182 F.3d 548, 554 (7th Cir. 1999). Statements of law, however, need not be accepted as true. Yeftich, 722 F.3d at 915. Rule 12(b)(6) limits this Court's consideration to " allegations set forth in the complaint itself, documents that are attached to the complaint, documents that are central to the complaint and are referred to in it, and information that is properly subject to judicial notice." Williamson v. Curran, 714 F.3d 432, 436 (7th Cir. 2013). To survive a motion under Rule 12(b)(6), the Complaint must " state a claim to relief that is plausible on its face." Yeftich, 722 F.3d at 915. " A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Id.

         Additionally, arguments concerning the adequacy of the evidence, or based on unsupported factual assertions not found in the Complaint, are not properly resolved on a motion to dismiss. See Geinosky v. City of Chicago, 675 F.3d 743, 745 n. 1 (7th Cir. 2012) (Rule 12(b)(6) motion must be decided only on the complaint itself and information that is subject to proper judicial notice); Corbett v. White, 00 C 4661, 2001 WL 1098054, at *3 (N.D. Ill. Sept. 5, 2001) (" purpose of motion to dismiss is to test the sufficiency of the complaint, not to decide its merits" ). This is especially true where those arguments are directly contradicted by allegations in the Complaint. To the extent any of Defendants' arguments suffer from those flaws, they will not be considered here.

         Finally, the parties dispute whether Count I must be pled with the particularity required of a fraud claim under Federal Rule of Civil Procedure 9(b). See [57] at 10; [64] at 12-13. That issue is addressed below in the section concerning Count I.

         III. Analysis

         A. Overview of Relevant Law

         At issue in the present motion are Plaintiff's two manipulation based causes of action, Counts I and II. Because there are multiple sections of the Act that prohibit manipulation, and the differences between those sections are crucial to the Court's analysis, it is useful to first examine the provisions themselves and their relation to one another. The provisions at issue break down into two groups, which also map the Complaint's organization: (1) Count I alleges violations of the new prohibitions of manipulation (which are Section 6(c)(1) and Regulation 180.1); and (2) Count II alleges violations of the old prohibitions of manipulation (which are Sections 9(a)(2) and 6(c)(3), along with Regulation 180.2).

         Section 9(a)(2) has long been a part of the Act, and makes it a violation for any " person to manipulate or attempt to manipulate the price of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity, or to corner or attempt to corner any such commodity." 7 U.S.C. § 13(a)(2).[2]

         Section 6(c)(3)'s operative language also has long been part of the Act, and that section makes it unlawful for " any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap or of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity." 7 U.S.C. § 9(3). While Section 6(c)(3) was created as part of the 2010 Dodd-Frank amendments to the Act, its operative language was taken from the version of Section 6(c) existing before those amendments. Regulation 180.2 was passed following the passage of Dodd-Frank, and also mirrors the pre-amendment version of 6(c). See 17 C.F.R. § 180.2. Regulation 180.2 is titled " Prohibition on price manipulation," and reads: it " shall be unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap, or of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity." 17 C.F.R. § 180.2.

         In applying Regulation 180.2, the Commission has stated that " it will be guided by the traditional four-part test for manipulation that has developed in case law arising under 6(c) and 9(a)(2)." Final Rule: Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on Price Manipulation, 76 Fed.Reg. 41,398, 41,407 (July 14, 2011). The four part test mentioned by the Commission was developed in case law construing Section 9(a)(2) and the pre Dodd-Frank version of Section 6(c), see In re Soybean Futures Litig., 892 F.Supp. 1025, 1045 (N.D. Ill. 1995), which did not include the newly added Section 6(c)(1) language. See 7 U.S.C. § 9 (2009).

         The new manipulation provisions, Section 6(c)(1) and Regulation 180.1, were added to the Act through the 2010 Dodd-Frank Amendments and subsequent CFTC regulation. See Pub. L. No. 111-203, July 21, 2010, 124 Stat 1376; 17 C.F.R. § 180.1. Section 6(c)(1) makes it " unlawful for any person, directly or indirectly, to use or employ, or attempt to use or employ, in connection with any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity, any manipulative or deceptive device or contrivance, in contravention of" Commission regulations." 7 U.S.C. § 9(1). This new authority was intended to " augment the Commission's existing authority to prohibit fraud and manipulation" under Section 9(a)(2). Final Rule, 76 Fed.Reg. at 41,401. Regulation 180.1, enacted pursuant to Section 6(c)(1), further explains that under Section 6(c)(1) it is unlawful for " any person, directly or indirectly, in connections with any contract for future delivery on or subject to the rules of any registered entity, to intentionally or recklessly: (1) use or employ or attempt to use or employ, any manipulative device, scheme, or artifice to defraud; . . . (3) engage, or attempt to engage, in any act ...

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