St. John's Law Review Volume 55 Number 2 Volume 55, Winter 1981, Number 2 Article 2 The Manipulation of Commodity Futures Prices William D. Harrington Follow this and additional works at: https://scholarship.law.stjohns.edu/lawreview This Article is brought to you for free and open access by the Journals at St. John's Law Scholarship Repository. It has been accepted for inclusion in St. John's Law Review by an authorized editor of St. John's Law Scholarship Repository. For more information, please contact [email protected]. THE MANIPULATION OF COMMODITY FUTURES PRICES WILLIAM D. HARRINGTON* The spectacular growth of commodity futures trading on the eleven national exchanges during the past decade' has culminated in a sharp increase in reported incidents of manipulation of mar- kets and prices.2 Although the most cursory examination of the law in this area makes clear that there is little law to look at,' what does exist offers much more than often is recognized in the way of developing and articulating coherent legal principles which may be used to distinguish legitimate business activity from manipulation. The sparsity of case law is anomalous, however, when it is borne in mind that one of the principal goals of the Commodity Exchange Act 4 (the Act), and of its legislative predecessors,5 was * A.B., College of the Holy Cross, 1966; J.D., Columbia University, 1969; M.B.A., Co- lumbia University, 1970. 1 See FuTuREs INDusTRY AsSOCLxrxON, INC., Bull. Nos. 3884 & 3903 (1980). The growth in commodity futures trading since 1970 is startling. Although 11.5 million futures contracts were reported in 1970, this figure had grown to 77 million contracts by 1979, a 700% in- crease. Id.; Wall St. J., Jan. 2, 1980, at 20, col. 2. In 1980, the trading volume exceeded 90 million contracts valued at nearly 5 trillion dollars. Forbes, Jan. 19, 1981, at 65-66. 2 In 1979 alone, there were five reported incidents of manipulation: the March Maine potato default on the New York Mercantile Exchange, the March wheat squeeze on the Chicago Board of Trade, and the December coffee, copper, and silver squeezes in New York and Chicago. See Prinsky, Decade Saw Substantial Industry Growth and Difficulties in Dealing With Success, Wall St. J., Jan. 2, 1980, at 20, col. 2. See also Shao, Coffee Ex- change Curbs Futures Trading; Step Is Tied to ProducingNations' Role, Wall St. J., Nov. 23, 1979, at 26, col. 2. Publicity of manipulation in the domestic markets in 1980 was dominated by contro- versy over the purported Hunt Silver Squeeze. See Bernstein, Engelhard's Not-So-Sterling Deal with the Hunts, Fortune, May 19, 1980, at 84-88; Rowan, A Talkfest with the Hunts, Fortune, Aug. 11, 1980, at 162-68; Trustman, The Silver-Scam: How the Hunts Were Out- foxed, Atlantic, Sept. 1980, at 70-81; Commodity Exchange, Inc. & Comex Clearing Associa- tion, Inc., Chronology of Activities Relating to the Silver Market from September 1979 through March 1980 (Apr. 14, 1980). 3 See David G. Henner, 30 Agric. Dec. 1151, 1275 (1971). In Henner, Judicial Officer Campbell concluded that, at the time, no more than 650 cases of record could be found relating to domestic futures transactions. Id. Although that figure is somewhat higher today, fewer than 50 cases have been found which concern manipulation and, of these, fewer than 10 may be viewed as significant in terms of their predictive value. 4 7 U.S.C. §§ 1-22 (1976 & Supp. I1I 1979). ' The Grain Futures Act of 1922, ch. 369, 42 Stat. 998 (1922), was amended in 1936 and 1981] FUTURES PRICE MANIPULATION the prevention of, and punishment for, market manipulation.' Since neither the statute nor the pertinent rules promulgated by the various exchanges7 define manipulation, the only legal guide- lines to be found are those few judicial and administrative prece- dents in which particular activities associated with specific price movements have been held to constitute or fall short of manipula- tion.8 Yet, because many of the cases either involve the most egre- gious examples of manipulation, 9 or yield results and articulate standards different from their predecessors, some commentators have urged the adoption of inflexible, elliptic, and incautious defi- nitions of the term. It is this writer's view that, while the case law is still in its formative stages, it provides a sound basis for analysis and continues to delineate the boundaries of manipulative trading behavior. With a view toward developing a working definition of "mar- ket manipulation," this Article begins with a brief and necessarily simplified overview of the economic background of exchange trad- ing10 and manipulation.1' The Article then summarizes and ana- lyzes the relevant legal developments in the area.12 Finally, it sug- renamed the Commodity Exchange Act, ch. 545, 49 Stat. 1491 (1936). An earlier statute, the Futures Trading Act, ch. 86, 42 Stat. 187 (1921), previously had been declared an unconsti- tutional exercise of the taxing power. See Hill v. Wallace, 259 U.S. 44 (1922). See generally Rainbolt, Regulating the Grain Gambler and His Successors, 6 HOFsTRA L. REv. 14-17 (1977); Schneider & Santo, Commodity Futures Trading Commission: A Review of the 1978 Legislation, 34 Bus. LAW. 1755 (1979). 6 See Commodity Exchange Act § 3, 7 U.S.C. § 5 (1976); 80 CONG. REc. 6161, 6164 (1936) (remarks of Sen. Pope); 62 CONG. Rac. 9406, 9414 (1922). See generally Hieronymus, Manipulation in Commodity Futures Trading: Toward a Definition, 6 HOFSTRA L. REV. 41 (1977); Comment, Manipulation of Commodity Futures Prices, 21 U. CHI. L. REv. 94, 103 n.54 (1953). The first exchange in the United States to recognize futures trading was the Chicago Board of Trade, which was organized in 1848. Campbell, Trading in Futures Under the Commodity Exchange Act, 26 GEO. WASH. L. Rlv. 215, 216 (1958). Commodity futures trad- ing is presently regulated by the Commodity Futures Trading Commission in accordance with the Commodity Exchange Act. See 7 U.S.C. § 4a (1976 & Supp. III 1979). s See Hieronymus, supra note 6, at 42. There have been attempts at a statutory defini- tion. See notes 199-201 and accompanying text infra. 9 See, e.g., Cargill, Inc. v. Hardin, 452 F.2d 1154 (8th Cir. 1971), cert. denied, 406 U.S. 932 (1972); Volkart Bros. v. Freeman, 311 F.2d 52 (5th Cir. 1962). 10 For the better treatments in the area of commodity futures trading, see J. BAER & 0. SAXON, COMMODrrv EXCHANGES AND FUTURES TRADING (1949); T. HIERONYMUS, ECONOMICS or FUTURES TRADING (2d ed. 1977); S. KROLL & I. SHISHKO, THE COMMOrTv FUTURES MAR- KET GUIDE (1973); R. TZwELxs, C. HARxow & H. SToNE, THE COMMODrry FUTURES GAME (2d ed. 1974). " See notes 14-63 and accompanying text infra. 12 See notes 64-165 and accompanying text infra. ST. JOHN'S LAW REVIEW [Vol. 55:240 gests a path which the law of price manipulation of commodity futures should follow and the modes of analysis which should and should not be applied in that development.1 s THE MECHANICS OF EXCHANGE TRADING To understand the behavior which constitutes futures market manipulation, it is essential to appreciate the fundamental mechanics of futures trading itself, the relationship of the futures market to the actuals market with which it coexists and, finally, the nature and function of a commodity futures exchange. A com- modity futures transaction 14 is basically a simple sales con- tract-standardized pursuant to the rules of a particular commod- ity exchange 15-wherein a seller ("short") agrees to sell and deliver a specified quantity of a commodity in a future month ("delivery month") to the purchaser ("long") at a specified price." While the futures market will necessarily attract "speculators," who seek only to profit from price fluctuations, the futures contract originally emerged as a device designed to protect commercial traders in the actuals or "cash" market from the severe financial loss they could incur as a result of even slight shifts in commodity prices by ena- bling them to "hedge" their positions.18 Thus, speculators bear the " See notes 166-201 and accompanying text infra. Commodity futures contracts are commonly distinguished from "forward" contracts, a term which refers generally to that class of commercially motivated cash commodity sales which contemplate actual delivery of the commodity, but in which delivery is deferred for purposes of commercial convenience or necessity. See C.F.T.C., Office of the General Coun- sel, Memorandum dated Sept. 5, 1978, as amended Sept. 11, 1978, [1977-1980 Transfer Binder] COMM. FUT. L. REP. (CCH) 1 20,772. The distinction is grounded in section 2(a)(1) of the Act, 7 U.S.C. § 2 (1976 & Supp. III 1979), which provides, in pertinent part, that "[tihe term 'future delivery' as used herein shall not include any sale of any cash commodity for deferred shipment or delivery." Id. Such contracts are thus excluded from the prohibi- tions of section 4h, 7 U.S.C. § 6h (1976 & Supp. III 1979). 15 See CHICAGO BOARD OF TRADE, COMMODITY TRADING MANUAL 26 (1971) [hereinafter cited as CBT MANUAL]; GENERAL ACCOUNTING OFFICE, REGULATION OF THE COMMoDITY Fu- TURES MARKETS - WHAT NEEDS TO BE DONE 5 (1978) [hereinafter cited as GAO REPORT]. The only element of the futures contract which is negotiated by the parties is the price. CBT MANUAL, supra, at 26. Thus, the exchange standardizes the size of the lots to be con- tained in each contract, the specified grade acceptable for delivery, and the delivery points. Id. 16 T. HIERONYMUS, supra note 6, at 31. See Campbell, supra note 7, at 216. 17 See generally General Guide, COMM.