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Manipulation of Commodity Futures Prices-The Unprosecutable Crime

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Manipulation of Commodity Futures Prices-The Unprosecutable Crime Jerry W. Markhamt The commodity futures market has been beset by large-scale market manipulations since its beginning. This article chronicles these manipulations to show that they threaten the economy and to demonstrate that all attempts to stop these manipulations have failed. Many commentators suggest that a redefinition of "manipulation" is the solution. Markham argues that enforcement of a redefined notion of manipulation would be inefficient and costly, and would ultimately be no more successful than earlierefforts. Instead, Markham arguesfor a more active Commodity Futures Trading Commission empowered not only to prohibit certain activities which, broadly construed, constitute manipulation, but also to adopt affirmative regulations which will help maintain a 'fair and orderly market." This more powerful Commission would require more resources than the current CFTC, but Markham argues that the additionalcost would be more than offset by the increasedefficiencies of reduced market manipulation. Introduction ......................................... 282 I. Historical Manipulation in the Commodity Futures Markets ..... 285 A. The Growth of Commodity Futures Trading and Its Role ..... 285 B. Early Manipulations .............................. 288 C. The FTC Study Reviews the Issue of Manipulation ......... 292 D. Early Legislation Fails to Prevent Manipulations .......... 298 II. The Commodity Exchange Act Proves to Be Ineffective in Dealing with M anipulation .................................. 313 A. The Commodity Exchange Authority Unsuccessfully Struggles with M anipulation ................................ 313 B. The 1968 Amendments Seek to Address the Manipulation Issue. 323 C. The 1968 Amendments Prove to be Ineffective ............ 328 tPartner, Rogers & Wells, Washington, D.C.; Adjunct Professor, Georgetown University Law Center; B.S. 1969, Western Kentucky University; J.D. 1971, University of Kentucky; L.L.M. 1974, Georgetown University. Mr. Markham has served as Chief Counsel of the Enforcement Division of the Commodity Futures Trading Commission (1975-1978), as Secretary and Counsel of the Chicago Board Options Exchange, Inc. (1974-1975), and as an attorney at the Securities and Exchange Commission (1972-1974). Copyright © 1991 by the Yale Journal on Regultion 281. Yale Journal on Regulation Vol. 8: 281, 1991 III. The CFTC Is Created in Order to Deal with the Issue of Manipulation and Market Disruption ..................... 331 A. The 1974 Amendments ............................. 331 B. The CFTC's New Powers Prove to be Ineffective .......... 334 C. CFTC ManipulationDecisions Nullify the Manipulation Prohibition ..................................... 352 D. The CFTC Has Not Been Successful in Its Efforts to Prevent and Punish Manipulation ........................... 356 IV. A Better Methodology is Needed to Prevent and Attack Manipulation and Disruptive Market Activities ............... *'*..." 358 A. A Better Definition of Manipulation is Not a Cure ......... 358 B. More Effective Regulation is Needed in the Form of Requirements that Seek to Attain the Goal of a "Fairand Orderly" Market . 361 C onclusion .......................................... 376 Table of Manipulation Cases Brought by the CEA and CFTC ....... 379 Introduction The Commodity Futures Trading Commission ("CFTC") was created in 1974 as part of a congressional effort to regulate the trading of commodity futures contracts' more effectively and to prevent the large scale price manipu- 1. Commodity Futures Trading Commission Act of 1974, PuB. L. No. 93-463, 88 Stat. 1389 (1974). In brief, a futures contract provides for the buyer (the "long") to purchase and the seller (the "short") to sell a specified quantity of a specified commodity at a specified future date. Futures contracts are standardized, permiting them to be offset on the exchanges. For example, a trader holding a short contract could enter into an offsetting long contract and thereby cancel out the initial obligation. To do so, however, requires that the offsetting contract provide for delivery in the same delivery month as the initial contract. Most futures contracts are settled by offset. Cash settlement may also be used in some futures contracts, particularly financial futures contracts on stock indexes. Because futures contracts are standardized, the only negotiable term is the price which is set by an auction process on the floor of the futures exchanges. See generally Ryder Energy Distribution v. Merrill Lynch Commodities, 748 F.2d 774 (2d Cir. 1990) (discussion of futures trading); Katara v. D. E. Jones Commodities, 835 F.2d 966 (2d Cir. 1987) (same); Leist v. Simplot, 638 F.2d 283, 286-88 (2d Cir. 1980), aff d sub nom. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, 357-58 (1982) (same); Messer v. E.F. Hutton & Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) 9 24,002, at note 1 (11th Cir. 1987) (same); H.R. REP. No. 975, 93d Cong., 2d Sess. 149 (1974); CFTC, SEC AND FEDERAL RESERVE BOARD, A STUDY OF THE EFFECTS ON THE ECONOMY OF TRADING IN FUTURES AND OPTIONS, Ch. II, at I (1984) (same); 11TREASURY DEPARTMENT/ FEDERAL RESERVE BOARD STUDY OF TREASURY FUTURES MARKETS, Ch. 1, at 9-14 (1979) (description of futures trading), CHICAGO BOARD OF TRADE, COMMODITY TRADING MANUAL 10 (1982) (same) [hereinafter COMMODITY TRADING MANUAL; F. HORN & V. FARAH, TRADING IN COMMODITY FUTURES 7-9 (1979) (same); P. JOHNSON, COMMODITIES REGULATION § 1.10 (1982) (same) [hereinafter COMMODITIES REGULATION]. Manipulation of Commodity Futures Prices lations2 that have plagued the national economy since the inception of futures trading over one hundred years ago.3 But congressional concern with price manipulation and abuses did not lessen as a result of the creation of the CFTC. To the contrary, events such as the Silver Crisis of 1980, the Stock Market Crash of 1987 and the battle in the soybean pit in 1989 between Ferruzzi Finaziaria S.P.A. and the Chicago Board of Trade have continued to give rise to concerns that futures markets are susceptible to manipulation and price distortion.' These concerns are very real because under present law the crime of manipulation is virtually unprosecutable, and remedies for those injured by price manipulation are difficult to obtain. Moreover, even where a prosecution is successful, the investigation and effort necessary to bring a case will involve years of work, enormous expenditures, as well as an extended trial. Manipulation in the commodity futures market takes many forms. Prices may be manipulated through rumors or false information conveyed into the marketplace.5 Prices may also be manipulated through rigged trades or through "capping" or "pegging," by which market prices are set at artificial levels, for margin purposes, price setting and other reasons.6 But the most significant form of manipulation, and the one of greatest concern, is the market power manipulation. This type of manipulation requires large resources. The trader in such a manipulation is buying so many futures contracts and such large quantities of the underlying commodity that its market power is sufficient to create and sustain a manipulated or artificial price. One type of market power manipulation is the so-called "comer." Here the trader has control of all or virtually all of the available supplies of the commodity that underlie the futures contracts held by the trader. In such a case, the sellers or "shorts" must pay prices dictated by the trader controlling the supply of the commodity.7 Another form of marketpower manipulation is the "squeeze" in which the trader acquires 2. As will be discussed below, manipulations may take many forms, but the standard imposed by the government in determing their existance is whether: (1) a trader had the ability to influence market prices; (2) the trader specifically intended to do so; (3) an artificial price resulted; and (4) the trader caused the artificial prices. In re Cox [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) 23,786 (C.F.T.C. 1987). 3. See discussion, infra notes 23-44 and accompanying text. 4. See discussion, infra notes 370-474 and accompanying text. 5. See discussion, infra notes 593-96 and accompanying text. 6. The purpose of this type of manipulation is to move futures prices for a brief period in order to affect the posted opening or closing prices. See Hearings on Russian Grain Transactions, Hearings Before The Senate Permanent Subcommittee on Investigations of the Committee on Government Operations (Part 1), 93d Cong., 1st Sess. 166 (1973) [hereinafter Hearings on Russian Grain Transactions]. It has been stated that this type of manipulation is very difficult to detect and prove. "It involves heavy trading, usually concentrated on the opening or closing of the market." Id. 7. This type of manipulation results in "an unnatural relationship between futures prices and cash prices." Such manipulation also "tends to draw the cash commodity to ... delivery points in unusual amounts" and takes "the commodity out of its normal channels of movement from producer to consumer." This frequently results in an oversupply of the commodity at the exchange delivery point and an undersupply at other points of distribution. Hearings on Russian Grain Transactions, supra note 6, at 164-65. Copyrlght 0 1991 by the Yale Joumnalon Regulation Yale Journal on Regulation Vol. 8: 281, 1991 a large futures position in a situation where there is a shortage
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