At any given time, participants in the cheese industry may have an interest in buying or selling cheese for immediate delivery. Historically, they could do so by identifying a buyer or seller through their contacts and relationships in the industry or by participating in various centralized markets throughout the United States where industry participants gathered to buy and sell cheese. From 1974 to 1997, NCE was the central market of, and functioned as a surplus market for, cheese. It also served as the primary price discovery mechanism for cheese produced in the United States. In general, before 1987 cheese prices on NCE experienced little volatility, because USDA purchased cheese to ensure that cheese prices did not fall below a certain level. After mid-1988, the volatility of cheese prices increased sharply because of lower price supports for milk, and NCE’s role in price discovery took on additional importance until it closed in 1997. While price volatility does not indicate that manipulation is occurring, the increased volatility in cheese prices, the corresponding effect on milk prices, and a perceived lack of oversight of NCE raised concerns about potential price manipulation. Following a series of investigations and congressional hearings involving NCE, a joint committee composed of a dairy industry trade group and NCE solicited proposals for a new site for the spot cheese market. CME was selected and the spot cheese market began operating there in May 1997. CME, the largest futures exchange in the United States, is a publicly traded corporation that offers a marketplace where various commodities such as dairy products are traded through futures contracts or spot markets. Various financial instruments are also traded on CME. Like NCE, the CME spot cheese market functions as a surplus market for cheddar cheese. Industry participants consider the CME spot cheese market a public price discovery mechanism, and prices are published daily. Contracts for the sale of all varieties of cheese in the United States are generally set using the prices of cheddar cheese established at CME as the reference price. For example, a contract may specify that cheese will be sold based on the previous week’s average price of cheddar cheese set at the CME. The contracts often include a premium or a discount on the current price of cheddar cheese on CME based on factors such as the quality and type of cheese and other costs such as transportation. One of the federal programs designed to assist dairy farmers is the federal milk marketing order (FMMO) program, which is designed in part to improve the income of dairy farmers by stabilizing market conditions and establishing minimum milk prices. Under this program, USDA uses national dairy market price information—including cheese prices—to set the minimum prices that processors must pay for unprocessed milk in specified marketing areas or orders. FMMOs established a four-tier classified pricing system for setting minimum milk prices on a monthly basis, based upon the intended use of the milk. In general, FMMO class prices are determined by formulas that use wholesale dairy product prices. For example, the Class III milk formula uses monthly averages of weekly average butter, cheese, and dry whey prices to set the minimum price of milk that is used in the production of cheeses. According to one industry participant, pricing a commodity based on the prices of products that the commodity is used to produce is unusual. Prior to using the NASS survey as a component to calculate minimum milk prices, USDA used cheese prices from NCE directly as an input in its milk pricing formula. As concerns were raised from industry sources and others about manipulation of cheese prices at NCE, USDA developed the NASS survey of cheese prices as an alternative to using NCE prices. In 1997, USDA stopped using NCE prices in its minimum milk pricing formulas and began using data provided by the NASS survey of cheese prices. USDA has continued to use the NASS survey of cheese prices in certain milk pricing formulas as trading in the spot cheese market occurred at the CME. The CME spot cheese market shares a number of operational and structural similarities with NCE and has certain characteristics that could make the CME spot cheese market susceptible to price manipulation. Like NCE, CME is primarily a surplus market where small amounts of blocks and barrels of cheddar cheese meeting certain technical specifications are traded. Many market participants that traded at NCE also trade at the CME spot cheese market. Moreover, certain market conditions at the CME spot cheese market, including a small number of trades and a small number of traders who make a majority of trades, continue to make this market particularly susceptible to manipulation. NCE and CME share many similarities, including certain trading rules, products traded, the volume of cheese traded, and market participants, but there are differences. According to CME officials, technical rules specific to the CME spot cheese market were developed from the rules used to operate NCE and rules already established by CME for an existing spot butter market. For example, CME trades the same cheese products that were traded on NCE—carloads of 40-pound blocks and 500-pound barrels of cheddar cheese. The CME spot cheese market continues to be a surplus market for cheese on which relatively small amounts of cheese are traded relative to the overall size of the U.S. cheese market. Unlike some commodities, most cheese in the United States is traded through long-term contracts, which generally use the CME spot cheese market price as the reference price and previously used the NCE price. NCE had between 30 and 40 members, including major participants in the cheese and dairy industry, such as large agricultural cooperatives, cheese manufacturers, and processors of cheese. These members accounted for the vast majority of cheese handled and processed in the United States. Likewise, major cheese and dairy industry members participate on CME, including many companies that traded cheese on NCE. CFTC officials estimated that 13 of the 31 CME spot cheese market participants accounted for 60 percent of all cheese produced, processed, or marketed in the United States in 2004. These participants in the spot cheese market represent diverse segments of the cheese and dairy industries, including dairy cooperatives representing many farmers and industry participants that produce, manufacture, and process large quantities of cheese. However, two differences exist between the CME spot cheese market and NCE. First, the names of participants involved in NCE trading were made public. Each member could designate up to five individuals as traders, and the buyer and seller were reported for each trade. Trading at the CME spot cheese market is conducted through a network of professional brokers, the standard practice in many commodities, and the buyer and seller are not publicly reported. However, according to some dairy industry participants, they generally know which brokers represent specific buyers and sellers. Second, trading on NCE occurred only once a week for one 30- minute session. Trading takes place at the CME spot cheese market every weekday for at least 2 minutes and up to 16 minutes, depending on the interest of market participants. Despite the move to CME, the spot cheese market remains a thin market, which in combination with the presence of a small number of traders that make a majority of trades and the spot cheese market’s pricing structure contributes to questions about the potential for price manipulation. A thin market generally has either few transactions; transactions that represent only a small proportion of the total transactions, including those that are priced off that market; or both. CME and CFTC DMO officials, some market participants, and academics generally agree that the CME spot cheese market is a thin market. Little trading occurs on the CME spot cheese market, and the trading that does take place consistently represents a small proportion of the total volume of cheese produced in the United States. According to CFTC officials, from 1998 to 2005, the volume of cheese traded at CME generally represented less than 2 percent of all cheddar cheese and less than 1 percent of all cheese produced in the United States annually. This characteristic is not unique to the CME spot cheese market, as other agricultural commodity markets, such as the CME spot butter market, are also thinly traded. In addition, as shown in table 1, on average only one or two transactions were completed during each trading session in the barrel market, and the average was less than one for most years, indicating that on some days no cheese was traded. The one exception was 1997, when the average number of transactions on the barrel market was more than eight, because the market did not have daily trading at that time. Similarly, on average, fewer than three trades during each trading session were completed in the block market each year. Academic analyses and cheese and dairy industry participants have raised a number of concerns associated with thin markets being susceptible to manipulation. These concerns include the following: Dominant traders may be able to attempt to manipulate prices more easily in thin markets. Prices in thin markets may not reflect supply and demand, even without manipulative behavior by dominant traders. As noted, thin markets raise concerns about the potential for manipulation because of the small number of participants and transactions involved in the market and the ease with which prices can be impacted. For example, in thinly traded markets each individual participant’s activity tends to be more influential than it would be on a market with more transactions and more participants. As a result, it may be easier for a market participant to move prices in a preferred direction over a short period of time with relatively few completed or unfilled transactions. Further, individual transactions to buy and sell cheese that set the market price may not accurately reflect supply and demand. Further, the CME spot cheese market has a small number of traders who make the majority of trades, another factor that contributes to questions about possible price manipulation. Relatively few market participants account for the majority of trading at the CME spot cheese market, as shown in figure 1. Between January 1, 1999, and February 2, 2007, two market participants purchased 74 percent of all block cheese, and three market participants sold 67 percent of all block cheese.