Opinion ID: 300588
Heading Depth: 2
Heading Rank: 1

Heading: Did Cargill hold a dominant long position in the future?

Text: 51 The first question to be confronted is whether Cargill held a controlling long position in the future. It is evident that a squeeze cannot be successfully executed unless a long has sufficient control of enough futures contracts to force the shorts to come to him to settle their contracts. 52 The Government's case in this aspect lies primarily in the undisputed fact that Cargill held its maximum long position of nearly 2,000,000 bushels until the last fifteen minutes of trading in the future, at which point it controlled 62 per cent of the long interest. On its face, ownership of 62 per cent of the open contracts would appear to be a dominant interest. 53 Cargill, however, argues that the Government's contention is invalid because its emphasis on Cargill's position during the last fifteen minutes of trading is improper. Applying a reductio ad absurdum test to the Government's argument, Cargill points out that: 54 Everyone agrees that the last long in the market in any expiring future will have 100% of the long open interest just as the last short will have 100% of the short open interest.    If the contentions of the CEA here were to be sustained, a 'dominant' and controlling long position and a 'dominant' and controlling short position could be found the last day of trading in every commodity future and every delivery month. 55 To this argument, there appear to be two answers. 56 In the first place, the basic question is whether the long controls a sufficient number of contracts to enable him to affect the market sufficiently so as to exact an arbitrary price for his contracts. Situations may well be imagined where the last long in the market during the last few seconds of trading simply does not have sufficient leverage to affect the price. But in the instant case, it appears to us that Cargill's control of 2,000,000 bushels of futures, constituting 62 per cent of the long interest, with 15 minutes of trading remaining, represents a sufficiently controlling position to warrant consideration of the question whether Cargill actually manipulated prices during this period. 57 Secondly, even conceding the most extreme result argued by Cargill, namely that under the Government's analysis the last long in the market would be a dominant long even though he had only a single contract for 5000 bushels, it is difficult to see where this helps Cargill. For the establishment of a dominant long holding is only one aspect of the Government's case; it still must show that the dominant long exacted an artificial price in settlement of his contract. And if this single dominant long does in fact exact an artificial price for his single contract-and the Government can prove it-this would constitute price manipulation in violation of the Act. 58 Thus we conclude that the finding that Cargill acquired a dominant long position is supported by the weight of the evidence. 59 B. Was there an insufficient supply of wheat available from sources other than Cargill for delivery on the May future? 60 The next essential element of the Government's case is to establish that there were not adequate supplies of wheat other than those controlled by Cargill from which the shorts could fulfill their delivery requirements on the future. Obviously, if there were adequate supplies of deliverable grade wheat available to the shorts to deliver to the longs on the future, Cargill would not be able to exact artificial prices in settlement of its contracts, for rather than paying those prices, shorts would instead procure the wheat and deliver it. 61 In order to properly determine what supplies of wheat should be included in those available for delivery on the future, it is necessary to keep in mind the delivery rules of the Chicago Board of Trade. In order to be acceptable for delivery on the future, wheat had to be stored in warehouses located within the Chicago area which were designated regular for delivery by the Chicago Board of Trade, or during the last three days of the delivery month be on track in the Chicago switching district consigned to a designated warehouse. There were no acceptable delivery points outside the Chicago area. No. 2 soft red winter wheat was the standard grade of wheat which was acceptable in fulfillment of the contract. Hard wheat could also be delivered on the contract without penalty, but the evidence clearly shows that hard wheat was a more expensive grade of wheat and no premium was allowed to the shorts for delivering this grade. 9 62 The evidence as to the availability of these supplies is as follows. It is indisputable that Cargill owned practically all of the available wheat stored in Chicago warehouses. It is also clear that there were practically no supplies of No. 2 soft red winter wheat located within shipping distance of Chicago by the close of trading in the future. 10 However, it appears that there were ample supplies of hard wheat in surrounding areas which could have been shipped to Chicago in time for delivery on the future. Thus the controversy between the parties resolves itself into the question of whether this hard wheat should be considered part of the deliverable supply in determining whether there were stocks available from sources other than Cargill. 63 We conclude that the hard wheat stocks were properly excluded from the available deliverable supply. Case authority under the Commodity Exchange Act which would aid in the determination of this question is meager indeed, and the two cases available appear to have split on the question. In Great Western Food Distributors, Inc. v. Brannan, 201 F.2d 476 (7th Cir. 1953), the Seventh Circuit considered the problem of what supplies should be considered to be available in a corner of the egg market. The three possible sources for delivery on the future were fresh eggs, local refrigerator eggs, and out-of-town eggs. Local refrigerator eggs were the standard deliverable grade on the future. Fresh eggs could be delivered, but their price was higher and no premium was allowed to the short for their delivery. Out-of-town eggs could not be delivered after the close of trading in the future, and even prior to the close of trading, they were not ordinarily delivered because the cost of shipment and added equalizing charge made them more expensive than local refrigerator eggs. The Seventh Circuit therefore concluded that fresh eggs and out-of-town refrigerators should be excluded from the economically available supply. 64 Applying this precedent to our case, we would conclude that out-of-town hard wheat should be excluded from the available supply. Hard wheat was of a higher grade than No. 2 soft red winter wheat, its price was higher, no premium was allowed for its delivery, and the cost of shipment into Chicago for delivery on the future was an additional economic impediment to its delivery. It would be more economic to pay the long a premium than to pay the additional charges for premium wheat plus shipping and handling charges. 65 In apparent conflict with the Seventh Circuit is the Fifth Circuit's decision in Volkart Brothers, Inc. v. Freeman, 311 F.2d 52 (5th Cir. 1962). The Fifth Circuit was considering an alleged manipulative squeeze in the cotton futures market and dealt with the question of what should be considered the available supply of cotton for delivery on the future. There the problem was whether uncertificated, as well as certificated cotton should be considered to be part of the available supply. Certificated cotton only was acceptable for delivery on the future and it was conceded that as of the close of trading in the future, uncertificated cotton could not be certified in time for delivery on the future. Thus the Government contended that it should be excluded from the available supply. The Fifth Circuit disagreed, noting that prior to the close of trading the shorts could have procured the cotton and placed it in the process of certification in time for delivery on the future, and that therefore it should be included in the available supply. 66 The Fifth Circuit reached this conclusion without any economic analysis whatsoever and did not discuss its apparent discrepancy with the Great Western case. Rather it argued that the Government's position simply released the shorts from their delivery obligation in their contract and would result in the futures exchanges becoming gambling enterprises. The Fifth Circuit's decision must be read as holding that squeezes are not a form of manipulation which is prohibited by the Commodity Exchange Act. Regardless of whether one agrees with this theoretical result, the Volkart case cannot be considered as helpful in determining whether the actual economic facts of a squeeze are present in an individual case, for the court did not discuss this problem. We consider later in this opinion whether the Volkart decision that manipulative squeezes should not be regulated is sound, but for purposes of the instant problem in determining what were the available supplies for delivery on the future we do not consider it to be economically realistic. The shorts could usually acquire at considerable extra cost and expense the physical commodity but settle with the longs at an artificially higher price as the lesser of two evils. This would not prevent excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in price condemned in 7 U.S.C. Sec. 6a. 67 There are no Supreme Court precedents on this question under the Commodity Exchange Act. However, in the closely related area of antitrust regulation under the Sherman Act, the Court has given us a test of what products should be considered to be part of the market-i. e. Supply-when determining the existence of monopoly power. 68 The 'market' which one must study to determine when a producer has monopoly power will vary with the part of commerce under consideration. The tests are constant. That market is composed of products that have reasonable interchangeability for the purposes for which they are produced-price, use and qualities considered. United States v. E. I. Du Pont De Nemours & Co., 351 U.S. 377, 404, 76 S.Ct. 994, 1012, 100 L.Ed. 1264 (1956). 69 Applying that test to the Chicago wheat futures market, we do not think that hard wheat should be included in the supply. The evidence shows that soft red winter wheat is grown mainly in the farm areas surrounding the Chicago market and it is consumed chiefly in that area. It is a deliverable grade wheat at par only on the Chicago Board of Trade in contrast to other contract markets, it is the grade which is generally reflected in the wheat futures price and which is ordinarily delivered in satisfaction of the futures contract. Hard wheat is of a higher quality and price than soft red winter wheat, is rarely delivered on the contract, and no premium is allowed if it is. 70 It may be pointed out also that the Chicago Board of Trade apparently did not consider out-of-town hard wheat to be available for delivery on the futures contract, for otherwise it would not have been necessary for them to set up the rather unusual liquidation procedure described above in closing out the remaining open interest following the close of trading in the future. The fact that Cargill warehouse receipts were recirculated many times in order to close out 370,000 bushels of total 420,000 bushel open interest is itself suggestive of what the available supplies were for delivery on the future. 71 Thus we conclude the finding that hard wheat should be excluded from the available supply was in accord with the weight of the evidence. Since there was no soft red winter wheat available in significant quantities from sources other than Cargill, the conclusion is inescapable that the shorts could not fulfill their contracts, at least to the extent of 2,000,000 bushels, without coming to Cargill for either the offsetting contracts or the warehouse receipts. 72 C. Did Cargill exact an artificially high price in settlement of its long futures contracts? 73 This is the crucial element of the Government's case and the most hotly disputed issue before us. For if, despite the fact that it had the power and opportunity to do so, Cargill did not in fact cause an artificial price it cannot be guilty of manipulation. Actually, there are two questions involved here-was the price which Cargill received for its futures contracts artificially high, and if so, did Cargill cause it? 74 In order to determine whether the price of the future was artificial, some standards or tests must be used to compare normal prices with the prices alleged to be artificial. The Government proposes four different tests for determining whether the price of the May future was artificial and asserts that Cargill's demanded price fails all of them. 75 The first three tests proposed by the Government constitute an historical analysis of the May 1963 futures prices in comparison with the prices for the preceding nine years on the Chicago Board of Trade. We find no serious differences between the parties as to these three tests and shall only summarize them here. First, the Government contends that the record 18 5/8 cents price rise of the future in the last two days of trading was not comparable to movements in the past nine years, and in fact in six of those years the futures price actually declined. Secondly, the Government contends that the spread between the May and July wheat future in 1963 increased a record 18 5/8 cents during the last two trading days, and that no comparable movement occurred during the prior nine years, in seven of those years the spread remaining the same or decreasing. Thirdly, the Government contends that the May 1963 futures price was considerably out of line with the Kansas City futures price as compared with these prior years. 76 We think that the Government's tests with respect to these movements of the futures price are proper and that the weight of the evidence clearly supports the finding that they were abnormal in 1963. Cargill really makes no substantial attack on these findings, although it does rather belatedly suggest in its reply brief that in fact the May 1963 prices were very similar to the May 1958 prices, and thus there was nothing unusual about them. However, even Cargill's own figures demonstrate substantial discrepancies in the May 1963 movements as compared with the May 1958 movements, its argument ignores the other years, and it also ignores the fact that the Government has pointed out that the Department of Agriculture investigated the May 1958 wheat futures prices and found them to be artificial, but no prosecution followed because it was not determined that they were intentionally brought about. 77 The fourth test proposed by the Government for determining the artificiality of the futures price is whether it bore a proper relationship to the price of cash wheat in May 1963 and particularly at the close of trading on May 21. Cargill vigorously joins issue with the Government at this point and the parties are in total disagreement as to what the cash value of wheat was at this time. 78 This is an important element of the Government's case and some more detailed discussion of the mass of conflicting evidence is warranted. In one point, the parties are in apparent agreement. In theory at least the price of the future should be approximately 2 1/2 to 3 cents less than the price of the cash wheat, the discount reflecting warehouse loadout charges; the price of the future may also be depressed somewhat below the cash price because of the uncertainties as to when and what grade of wheat may be delivered. 11 The problem with matching theory to fact lies in the difficulty of determining the cash price of wheat, for actual cash trades on the Chicago spot market are relatively infrequent 12 and the prices of individual transactions may vary greatly depending on the positions of the parties, the quantity involved, and the time of the transaction. 79 The Government's evidence as to the cash price of wheat can be summarized as follows: First of all, the Government relies on an analytical study by a Department of Agriculture expert which established that the average economic value of No. 2 soft red winter wheat at Chicago during May 1963 was within the range of $2.10-2.17. Secondly, it relies on the cash prices of wheat quoted by the Grain Market News, a publication of the Department of Agriculture, which quoted cash prices as substantially below the futures price. Thirdly, it points out that the cash prices as quoted by both the Grain Market News and the Sosland cards, a trade publication, fell rather sharply following the close of trading in the future, and argues that this shows that the cash prices were artificially high due not to basic demand by users but rather by demand from the speculators for delivery on the future. 80 The Government also points out that the prices received by Cargill for its Spanish sales of $2.13 1/2 and $2.09 per bushel, which sales were made only a few days before the end of trading, were substantially below the prices it ultimately received for its futures, and that the prices Cargill received for its remaining grain after the settlement on the contracts were substantially below those prices. While there were some cash sales made on May 20 and 21 in the price range of $2.28 per bushel, there were many other cash sales made between May 20 and May 31 at substantially lower prices. 13 81 An incident which occurred during the settlement of the open contracts following the close of trading also sheds some light on the cash value of wheat at that time, as well as Cargill's opinion of that value. Goodbody and Company was one of the nine commission firms which had customers with outstanding short contracts in the May future at the close of trading and purchased warehouse receipts from Cargill for $2.28 1/4. After delivering these receipts in satisfaction of the short contracts of its customers, Goodbody discovered that through an error one of its customers was long 10,000 bushels, and an effort was made to sell the receipts in question. They were first offered to Cargill who refused to buy them; Cargill also suggested that Goodbody try to locate some of the unresolved shorts from the May contract because an outstanding short would pay more to close out his position than Cargill could economically afford to pay. The receipts were then offered to two mills in the area who bid approximately $2.05 per bushel for them. They were finally sold to another commission firm for $2.18 per bushel, which delivered them in satisfaction of short contracts of its customers. 82 As against the Government's evidence as to the cash price of wheat, Cargill presented the following evidence. First, it relied on Sosland card, a trade publication, quotations of the cash prices of wheat which were higher than the Grain Market News quotations, and contended that this was a more reliable source. Secondly, it relied on testimony of two expert witnesses who maintained that the futures price was not out of line with the cash price. It also relied on the testimony of various trade witnesses who testified generally that they thought the futures price reflected basic supply and demand factors. And it relied heavily on the fact that on May 20 and 21 it had made cash sales of wheat for a price of $2.28. It may be pointed out that even assuming that the cash value of wheat was $2.28, according to the theory agreed on by Cargill and the Government, the futures price should then be about $2.25 to reflect the loadout charge. Yet Cargill's sell order was in the range of $2.27-$2.28 1/4. 83 The evidence on this particular point is conflicting, but the preponderance is in favor of the Government. The finding that the futures price was artificially high and did not reflect basic supply and demand factors for cash wheat is supported by the weight of the evidence. And in addition the other three tests proposed by the Government very clearly support the ultimate conclusion that the futures price was artificially high. 84 The question now is whether the artificially high price was caused by Cargill. The Government contends that it was Cargill's withholding of its 2,000,000 bushels of contracts until the last few minutes of trading which caused the dramatic rise in price. Cargill however contends that the price rise simply reflected the traders' judgment that, because of the loadout of the previous weekend for the Spanish sales resulting in the depletion of Chicago supplies, the price of cash wheat would have to rise to meet unfilled mill demand in the area, and that its method of liquidation had nothing whatsoever to do with the price rise. 85 This would seem to be a case where the market pattern speaks for itself. On Friday, May 17, before the Spanish sales were known to the public, the future closed at $2.09 1/2, a price incidentally very close to that for which Cargill made its last Spanish sale. On Monday, May 20, after the Spanish sales were known, the price of the future advanced 9 3/4 cents over the previous day's close. This price rise was gradual throughout the day and was probably attributable to the decrease in supplies. On May 21, the future opened slightly higher than the previous day's close and then gradually declined. It eventually reached a low of $2.15 1/4 at 11:02 and then gradually rose again. At 11:45, the time when Cargill placed its sale order, it was trading at $2.20, which was about 1 1/2 cents over the previous day's close. In other words, throughout the day prior to Cargill's last minute sale the market was resistant to any further increase in the price of the future. Cargill's sell order was at prices 7 and 8 cents over what the future was then selling for, and it was able to get these prices because there was nowhere else for the shorts to go to offset their contracts. It seems clear that the only reason the price advanced so rapidly during the last few minutes of trading was because of Cargill's dominance of the long interest and the high prices it set for liquidation. 86 Cargill argues that its market behavior was not particularly unusual and that other experienced grain merchandisers analyzed the market conditions similarly to Cargill. It points out for example that Ralston-Purina, Inc. and Central Soya Company, both experienced grain merchandisers, had speculative long positions in the May 1963 wheat future and both liquidated their positions at a profit on the last day of trading. It is interesting to compare the transactions of these companies with those of Cargill. 87 Cargill established its speculative long position on April 15 at a time when it had substantial uncommitted stocks in its warehouse. It increased those holdings until May 15, when it held 1,930,000 bushels. After selling 40,000 bushels on May 20, it purchased another 100,000 bushels during the early periods of trading on May 21 and then liquidated those holdings during the last fifteen minutes of trading in the very narrow range of $2.27-$2.28 5/8. 88 Ralston established its long position with the purchase of 150,000 bushels on April 30. It did not increase this position during the month of May. It did not establish its speculative long position until after it had sold all its stocks of wheat, so that it did not own any unhedged and uncommitted stocks. Its liquidation on the last day of trading was as follows: 89 25,000 bushels at $2.18 1/2 50,000 bushels at $2.20 3/4 25,000 bushels at $2.21 1/2 50,000 bushels at the close of trading at $2.28 5/8. 90 It liquidated in that broad range because it wanted to get an average price for the day and could not be certain of the bottom or the top of the market range. 91 Central Soya liquidated its short hedges on its uncommitted stocks on May 1. It did not establish its speculative long position until May 16, when it purchased 220,000 bushels. It did not increase that position. 150,000 bushels of its long futures were liquidated on May 20 for an undisclosed price (but obviously one at $2.19 or less since that was the high for that day). The remaining 70,000 bushels were liquidated on May 21 at $2.22. 92 Mr. Ferguson, a commission broker and witness called by Cargill, testified that he advised his long customers on May 21 to liquidate their contracts a little bit at a time throughout the day in order to get an average for the day. He also testified that, I would not be inclined to show any broker, just for the sake of his nerves, a 2,000,000 sell order for the last 15 minutes, just for the sake of his nerves. 93 The above evidence suggests that Cargill's method of liquidation cannot be considered to be ordinary market behavior. 94 D. Was the squeeze intentionally caused by Cargill? 95 Cargill was no novice in futures trading and knew of market conditions which could cause a squeeze. It possessed a very valuable piece of information unknown to the trade at large, namely that it owned practically all the wheat available for delivery on the May future. Furthermore, being a large merchandiser in the Chicago area, it was in a particularly advantageous position to take advantage of the potential squeeze in disposing of its supplies as well as being able to take delivery of whatever wheat might be found by the few shorts able to avoid the squeeze in the futures market. Its behavior in liquidating its contracts was clearly intentional and was highly unusual market behavior; and the method of liquidating the unresolved open interest following the close of trading was also unusual and clearly controlled by Cargill. 96 Aside from the obvious inferences to be drawn from the objective facts in this case, there is other evidence in the record which shows that Cargill knew exactly what was going on. On May 6, an inter-office telegram was sent which stated: 97 Excellent wheat summary. Question is how much wheat going to be available June 15 so we can figure old crop needs and what it going to cost our pals. 98 In an interview with the Department of Agriculture investigators, a Cargill executive said that the Spanish business came about at a good time because without it, if Cargill had bulled the market, there would have been criticism. He also said that the sell order was not placed until the last minute because he waited and watched because he knew the market was going up. This was knowledge other traders did not have. 99 Cargill also argues that it fully intended to take delivery of cash wheat if the futures price did not reach at least $2.27 because it felt it could profitably market the wheat at that price. The evidence is otherwise. It is to be remembered that the wheat market at the end of May was in transition from old crop to new crop. New crop wheat is much cheaper than old crop wheat. Thus both users and merchandisers seek to keep their old crop supplies at the lowest level possible at the end of the crop year in order to be able to take advantage of new crop prices as soon as the new crop is available. It is inconceivable that Cargill would want to take 2,000,000 bushels of old crop wheat to try to merchandise before the new crop came in. In fact Cargill's officers themselves testified that Cargill was liquidating its stocks to the zero point. 100 If Cargill believed it could merchandise 2,000,000 bushels of cash wheat at $2.27 it is difficult to understand why just the prior weekend it had sold 600,000 bushels to Spain at $2.09. Furthermore, even after the close of trading in the future Cargill did not take delivery of cash wheat but liquidated the bulk of its remaining open position by selling its own warehouse receipts. And it would not even buy back the 10,000 bushels that had been mistakenly sold to Goodbody. 101 The extraordinary price fluctuations of the futures market on May 20 and 21, 1963, on the Chicago Board of Trade were the largest in recent history and had very little relationship to basic supply and demand factors on No. 2 soft red winter wheat. None of the other markets was so affected. The cash market in Chicago was to a limited degree cornered due to the depletion of local supplies. This small corner however does not appear to have been manipulated but came about normally from accelerated liquidation of the old wheat crop. There was no appreciable demand for additional cash wheat except for a few mill grind requirements. The long futures holders were not standing for delivery but for the maximum possible price, which Cargill was able to obtain to a substantial degree by bulling the futures market in the last 7 minutes of trading and in employing the method of liquidation utilized after the trading closed. Cargill did not sell at the market price but set the market price by reason of its dominant long position in the closing 7 minutes. The cash market quickly adjusted to the demand at the close out of the old crop and prices dropped substantially to where they were prior to the last few days of the futures trading. 102 The conclusion is well founded that these severe fluctuations were caused by Cargill's manipulative actions and such severe fluctuations constitute a threat to a free and orderly market. It is difficult for us to perceive how Cargill can ignore the fact that its second Spanish sale at $2.09, which was offered on May 15 and confirmed on May 18, is a true indicator of an unmanipulated cash market. This constituted a good economic sale, which we may concede, but it is difficult to view the true cash market at $2.28 a few days later. 103 The 18 5/8 cents rise in the futures price would have to be caused primarily by Cargill's dominance of the long futures market during the closing minutes of trading and its liquidation thereafter of its long futures. The shorts as a practical matter had nowhere else to go except to Cargill and Cargill knew it. The Spanish sales while completely legal did temporarily deplete local supplies and laid the base for a squeeze by the dominant longs. The rise of futures to the maximum permissible of $2.28 5/8 was no corrective action to bring futures in line with the cash market, which was substantially lower up to the last day of trading and returned to its previous lows for the month after the squeeze had been effected and the shorts liquidated. It thus appears that Cargill exploited its position in this tight situation, while most of the other longs did not. 104 We conclude that the squeeze was intentionally brought about and exploited by Cargill. 105 Cargill also argues that it cannot be found guilty of manipulation because it was relying on Volkart Bros., Inc. v. Freeman, 311 F.2d 52 (5th Cir. 1962), and the advice of its counsel that all its activities were perfectly legal. We cannot agree that reliance on the Volkart decision can preclude a finding that Cargill was guilty of manipulation if this court should conclude that Volkart was wrongly decided or not determinative in the instant case. In the first place, the Volkart decision does not represent a clearly defined line of cases establishing a definitive standard of acceptable conduct under the statute prohibiting manipulation; it is in substantial conflict with both Great Western Distributors, Inc. v. Brannan, 201 F.2d 476 (7th Cir. 1953) and G. H. Miller & Co. v. United States, 260 F.2d 286 (7th Cir. 1958). Cargill was clearly picking and choosing which precedent it would follow. And the Volkart decision has been criticized by commentators. 14 Secondly, Cargill was playing close to the line of even the Volkart decision. Both the hearing referee and the Judicial Officer pointed out distinctions between this case and Volkart. 15 Finally the Judicial Officer took into consideration Cargill's alleged reliance on Volkart and suspended all sanctions. We do not believe anything more is required if we conclude that this manipulation is in fact prohibited by the Commodity Exchange Act. Compare Simpson v. Union Oil Co., 396 U.S. 13, 90 S.Ct. 30, 24 L.Ed. 13 (1969), reversing 411 F.2d 897 (9th Cir.). 106 We turn now to a discussion of the Volkart case. 107