CHICAGO — Allegations by the Commodity Futures Trade Commission that Kraft Foods illegally manipulated wheat futures and cash wheat prices in 2011 mischaracterize the actions of Kraft at that time and do not meet the legal standards necessary for bringing the case forward, according to a dismissal motion filed June 1.
The motion for dismissal was filed with the U.S. District Court of the Northern District of Illinois, Eastern Division. It was filed jointly by Kraft Foods Group, Inc. and Mondelēz Global L.L.C., the defendants in the case (referred to in the document as Kraft).
Kraft moved for dismissal two months after charges were filed by the C.F.T.C., alleging the market manipulations. In seeking to rebut the government’s accusations, Kraft offered a glimpse into the wheat purchasing practices of one of the largest flour users in the United States.
Looking to put the case into perspective, Kraft said it differs from a typical C.F.T.C. defendant in numerous ways. To begin with, Kraft does not speculate in the commodities but actually uses them to bake consumer products. Kraft also is atypical in that it is one of the largest food companies in the United States, the motion said (again referring to Kraft and Mondelēz as a single company).
“Many of Kraft’s products — such as Oreos, Chips Ahoy!, Ritz, Triscuits and Wheat Thins — require large amounts of flour, which Kraft mills from the wheat it purchases,” the company said.
Kraft estimates its wheat use at 30 million bus per year. This figure equates to roughly 13.3 million cwts of flour, or 3% of total wheat flour use in the United States. Because Kraft is principally a soft wheat user, the company’s annual flour use equates to about 10% of the U.S. soft wheat total.
It was challenges meeting its market requirements for soft wheat that prompted Kraft to decide to take delivery against the company’s long futures positions, the company said. Kraft blamed the C.F.T.C. for failing to address market flaws that triggered the company to choose this course of action.
“For years, the price of wheat on the cash market has borne little relation to the price of wheat on the futures market,” the motion said. “The C.F.T.C. has assured the public that correcting this imbalance is at ‘the core of its mission,’ and that an accurate pricing mechanism benefits ‘producers… millers, purchasers, bakeries’ and ultimately, ‘the American public.’ The C.F.C.T.’s assurances to the contrary, Kraft operates in the wheat market as it actually exists — not the wheat market as the C.F.T.C. has idealized it. For years, that market has been dysfunctional.”
Turning to the specifics of the case, Kraft said in late 2011 the company made a “rational decision” in the face of a “dwindling wheat supply and high prices in the cash market.” This decision was to purchase and take delivery of less expensive wheat futures.
Once Kraft took this action, the company began receiving wheat in unfavorable locations (as opposed to having cash wheat delivered to its Toledo mill) and the cash wheat market price began to fall as sellers saw one of the country’s largest buyers covering its needs elsewhere.
With circumstances changing, Kraft made a second business decision — to unwind its December futures position and begin buying cash wheat at lower prices.
“These decisions and consequences do not transform Kraft’s conduct into a fraud or a manipulation,” the motion said. “They are instead an example of a consumer of wheat ‘seeking the best price for its commodity,’ an activity the C.F.T.C. recognizes as ‘legitimate, indeed critical price-creating force in the futures market.’”
In response, the C.F.T.C. has charged the company with fraud and manipulation” in what Kraft said is the commission’s first case testing the limits of its new fraud-based anti-manipulation powers, the motion said.
Making its case for dismissal, Kraft said the commission’s complaint does not tell the court how Kraft deceived the market.
“They do not, for example, suggest that Kraft made any statement (much less a false or misleading statement), concealed its conduct or in any way signaled its allegedly fraudulent intent in an effort to trick the market,” Kraft said.
Kraft said the complaint also lacks a claim such as an intent by Kraft to create an artificial price.
“In short, the C.F.T.C.’s case comes down to this: when faced with higher wheat prices in one market and lower wheat prices in another, Kraft was required by law to purchase wheat in the more expensive market,” Kraft said. “According to the C.F.T.C., to do otherwise is a fraud and a manipulation. The commission can make this claim only by distorting its antifraud and anti-manipulation authorities beyond their statutory contours.”
Kraft said the commission fails to allege a specific deceptive device and omits any reference to classic forms of market manipulation such as wash sales, matched order or rigged prices.
Offering a deeper look into its 2011 strategy and actions, Kraft said it traditionally buys its wheat on the cash market. Futures are purchased or sold as a hedge to protect the company from adverse cash market price swings.
“Thus, the company’s activities in the wheat futures market typically involve purchase ‘long’ wheat futures that match its anticipated cash needs,” the company said. The company unwinds this position when it purchases cash wheat, which is offset with the simultaneous sale of futures contracts.
“This strategy depends on wheat cash and future prices converging as the delivery date draws near,” Kraft said. “For years, however, the price of wheat future contracts has failed to converge with the price of cash wheat, resulting in a market in which the relationship between the futures and cash prices for wheat has become unpredictable.”
As the summer of 2011 turned to fall and cash prices for wheat were rising, Kraft was led to consider using the futures not only as a hedge but as a source of wheat through the delivery mechanism.
“Kraft, however, had not taken delivery on a wheat futures contract in nearly a decade,” the company said.
In September 2011, the company “conducted a trial run” to explore the feasibility of this option.
“As it began taking delivery, Kraft obtained some wheat four locations near its Toledo mill and some wheat from farther distances,” the company said. “Kraft therefore concluded that the process was, if slightly cumbersome, certainly feasible given the costly alternative of purchasing cash wheat.”
In October, the strategy continued to make sense, the motion said. Futures prices were 50c a bu beneath the cash wheat price. For a company the size of Kraft, this price spread equated to a potential savings of $7 million.
“Kraft thus acted as would any rational business: it used the futures market to ensure it had a source of wheat,” the motion said.
As it was preparing to take delivery, Kraft said a glitch emerged in its plans. Kraft senior management, concerned about expending a large amount of cash before the end of the year, “required that the futures position could not exceed $50 million.” As a result, Kraft reduced its wheat futures positions.
At the end of November, Kraft took delivery of shipping certificates for 6.6 million bus of wheat, almost 42% of its long position.
“In just a few days’ time, Kraft ‘loaded out’ 660,000 bus of wheat, representing 26% of its monthly demand,” the company said.
Quickly though, cash wheat prices moved lower as Kraft continued taking delivery. As a result, Kraft shifted its approach, liquidating its futures positions and resuming the purchase of cash wheat.
The sequence of events unfolded as Kraft executives had expected they would.
“In effect, the cash wheat market saw legitimate demand that was being satisfied in a competing market (the futures market),” Kraft said. “The result was what one would expect: the cash price began to fall, and the prices for cash and futures wheat began to converge.”While C.F.T.C. rules prohibit manipulative and deceptive activities, the rules do not “prohibit failing to disclose one’s trading strategies,” Kraft said.