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: In Re Commodity Exchange

December 21, 2012


The opinion of the court was delivered by: Robert P. Patterson, Jr., U.S.D.J.


On September 12, 2011, Plaintiffs filed a consolidated class action complaint ("the Complaint") claiming that Defendants J.P. Morgan Chase & Co., J.P. Morgan Clearing Corp., J.P. Morgan Securities Inc., and J.P. Morgan Futures Inc. (together, "JPMorgan" or the "JPMorgan Group Defendants"), as well as twenty unnamed "John Doe" Defendants (collectively, "Defendants"), violated Sections 9(a) and 22(a) of the Commodity Exchange Act, 7 U.S.C. §§ 13(a), 25(a), and Section 1 of the Sherman Antitrust Act, 15 U.S.C. § 1. (Compl. ¶¶ 1-2, 22-29, 199-210, ECF No. 85.) The Complaint alleges that Defendants violated these acts by combining, conspiring, and agreeing to manipulate the prices of silver futures and silver options contracts traded on the Commodity Exchange Inc. ("COMEX") on June 26, 2007 and also between March 17, 2008 and October 27, 2010 (together, the "Class Period"). (Id. ¶ 1.) The Complaint further alleges that, as a result of Defendants' unlawful conduct, Plaintiffs, a proposed class of individuals who transacted in COMEX silver futures and options contracts during the Class Period, "lost money and were injured in their property." (Id. ¶ 21.)

On December 12, 2011, the JPMorgan Group Defendants filed a motion to dismiss the Complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. (Defs. Mot. to Dismiss, ECF No. 91.) While argument was pending on the motion to dismiss, Plaintiffs filed a motion to compel limited discovery on April 17, 2012. (Pls. Mot. to Compel Ltd. Disc. ("Mot. to Compel"), ECF No. 104.) For the reasons stated below, the motion to dismiss is GRANTED and the motion to compel is DENIED.


A. COMEX Silver Futures Contracts

A silver futures contract is an agreement to buy or sell a fixed amount of silver at a date in the future. (Compl. ¶ 34.) Market participants may trade silver futures contracts on COMEX, a centralized market division for the trade of various precious metals in the New York Mercantile Exchange ("NYMEX"). (Id. ¶¶ 31-32.) For trading purposes, COMEX specifies the trading units, price quotations, trading hours, and trading months, as well as the minimum and maximum price fluctuations and margin requirements. (Id.) COMEX also provides standardized futures contracts with delivery dates that fall within the month that a futures contract is executed; the two calendar months thereafter; any January, March, May, or September occurring within twenty-three months of the execution month; or, any July or December occurring within sixty months of the execution month. (Id. ¶ 33.) Typically, "[t]he 'soonest' two expirations are referred to as the 'front' months, and [these months] are the most actively traded." (Id.)

At any given time, participants in the silver futures market are generally split evenly between "long position holders" (buyers who must take delivery of physical silver at contract expiration) and "short position holders" (sellers who must make the delivery at contract expiration). (Id. ¶¶ 30, 35.) Only a small percentage of silver futures contracts, however, result in "delivery" (the consummation of the contract by physical exchange between a buyer and a seller). (Id. ¶¶ 30, 36.) Rather, traders generally "offset" their futures positions before a futures contract matures by purchasing or selling an equal number of futures contracts prior to maturation. (Id. ¶ 36.) A trader's realized profit or loss is quantified as the difference between the initial purchase or sale price and the price of the offsetting transaction. (Id.)

B. Silver Futures Options Contracts

Silver traders may also offset futures positions by purchasing a silver futures options contract, which gives a purchaser the right, but not the obligation, to buy or sell a security at a specified price (the "strike price") on or before a specified date (the "options expiry"). (Compl. ¶¶ 37-42.) Two types of COMEX silver options contracts exist: "calls" and "puts." (Id. ¶ 37.) Call options are usually purchased when a buyer expects the prevailing price of silver to rise, while put options are usually purchased when a buyer expects the prevailing price to fall. (Id.) In order to keep an option open, the buyer of an option contract may pay the seller of the option an "option premium." (Id.)

At expiry, options will either be "out-of-the-money" or "in-the-money." (Id. ¶¶ 37-43.) A call option will be out-of-the-money when the prevailing price of silver is less than the call option strike price. (Id.) In such a situation, the holder of the call option has no economic incentive to buy silver futures contracts at a strike price higher than the prevailing market price, and the seller of the call option benefits by getting to keep the option premium. (Id.) The holder of a call option would, however, have an economic incentive to exercise his option to buy silver futures contracts if the prevailing price of silver exceeds the call option strike price. (Id.) In that situation, the call option would be in-the-money and the seller of the call option would be responsible for covering the difference between the strike price and the prevailing market price. (Id.) The opposite conditions apply to put options. An in-the-money put option occurs when the prevailing price of silver falls short the call option strike price. (Id. ¶ 41.) When this situation arises, the holder of the put option will likely exercise his right to sell the silver futures contract at a strike price that is higher than the prevailing market price. (Id.) Conversely, when the prevailing price of silver exceeds the call option strike price, the put option would be out-of-the-money.*fn2 (Id.)

In order to value options, traders often use the Black-Sholes Pricing Model. (Id. ¶ 44-45.) This model is described as:

[A] formula that creates a "delta," which estimates the equivalent futures position for an options portfolio. An option that is well in the money close to expiration will have a delta of approximately 1 for a call or negative 1 for a put, meaning that owning the option is equivalent to being long 1 futures contract for the call or short 1 futures contract for the put. Likewise, an option that is far out of the money close to expiration will have a delta of approximately 0, because it is unlikely that the option [will] move to an in-the-money position.

As an option nears a point of being in the money, the delta of the option approaches 0.5. Many option traders use the measure of delta expressed in the Black-Sholes type models to hedge their delta exposure. This means that if they hold many options, even if the delta is substantially less than one (and the option is out of the money), they may need to sell or buy futures to hedge their delta exposure. So, for example, if a trader is short 100 out-of-the-money puts whose delta is 0.25, in order to be "delta neutral," the trader must sell 25 futures contracts. (Id.)

C. The Commodity Futures Trading Commission

In 1974, Congress established the Commodity Futures Trading Commission (the "CFTC") as an independent government agency to regulate commodity futures and option markets in the United States. See 7 U.S.C. § 1 et seq. The CFTC is charged with protecting market users and the public from fraud, manipulation, and abusive practices in the commodity futures marketplace. Id. Should the CFTC suspect an attempted or perfected manipulation of the silver futures market, the CFTC has broad authority to investigate and, if appropriate, to pursue enforcement actions. Id. §§ 7, 13(a)(2).

In 2004, the CFTC began receiving complaints that large commercial traders were manipulating the silver futures market. (See Defs. Mem. in Supp. of Mot. to Dismiss ("Defs. Mem.") at 2-4, ECF No. 92.) The CFTC summarized the general nature of these allegations as follows:

With silver consumption exceeding new production for many years, it is generally acknowledged that the production deficit has been primarily filled by a drawdown of stocks. Some argue that this decline in silver stocks cannot persist and, since stocks have fallen to low levels, silver prices should have been rising sharply. There is further conjecture that, over the past 20 years, a group of commercial traders . . . have held short futures positions that are so large that they cannot serve legitimate hedging purposes because they cannot be backed by real silver. These traders have allegedly used these "naked" short positions to downwardly manipulate the price of silver. Moreover, the argument goes, this alleged 20-year-long manipulation of the silver market has created the conditions ripe for a huge price spike because stocks have reached dangerously low levels. (Decl. of Amanda F. Davidoff in Supp. of Defs.' Mot. to Dismiss ("Davidoff Decl."), Ex. A ("May 14, 2004 CFTC Letter to Silver Investors") at 1-2, Dec. 12, 2011, ECF No. 90.)

In response to these complaints, the CFTC launched an investigation. The results of the investigation led the CFTC to conclude that the allegations of manipulation were unsupported and "lack[ing] a coherent explanation of how such a manipulation could [have] occur[ed], or a plausible explanation for a motive." (Id. at 5.) This conclusion notwithstanding, between 2005 and 2007, the CFTC received numerous new complaints that the silver futures market was being manipulated downward. (See Davidoff Decl., Ex. B ("May 13, 2008 CFTC Report on Large Short Trader Activity in the Silver Futures Market") at 1.) The CFTC investigated, but in a May 2008 report announced that it had again found "no evidence of manipulation in the silver futures market." (Id.)

The CFTC launched a third investigation into claims that the silver futures market was being manipulated in late 2008. (Compl. ¶ 7.) On March 25, 2010, the CFTC held a public meeting to "examine futures and options trading in the metals markets." (Id. ¶¶ 175.) It was not until October 26, 2010, however, that CFTC Commissioner Bart Chilton publically announced the existence of the investigation which had begun in late 2008. (Id. ¶ 7(c).) In so doing, the Commissioner commented that he believed there had been repeated, fraudulent efforts "to persuade and deviously control" prices in the silver markets. (Id.) The day after the Commissioner's announcement, the first of the complaints later consolidated in this class action was filed.*fn3 Since launching the investigation in 2008, the CFTC has engaged in discovery, but it is noted that the CFTC has yet to file a complaint against any party in the market manipulation that the Commissioner announced to be going on. (See Status Conference Hr'g Tr. ("2/25/11 Tr.") 52-53, Feb. 25, 2011; see also Defs. Mem. at 4.)


On September 12, 2011, Plaintiffs filed this consolidated class action Complaint alleging that (1) Defendants*fn4 manipulated the prices of COMEX silver futures and options contracts during the Class Period in violation of Sections 9(a) and 22(a) of the Commodity Exchange Act, 7 U.S.C. §§ 13(a), 25(a), (Compl. ¶¶ 199-202); (2) "JPMorgan knowingly aided, abetted, counseled, induced, and/or procured" the alleged violations of the Commodity Exchange Act in violation of Section 22(a)(1), 7 U.S.C. § 25(a)(1), (Compl. ¶¶ 203-05); and (3) JPMorgan entered "an agreement, understanding or concerted action between and among JPMorgan and the John Doe Defendants," and "[i]n furtherance of this agreement, JPMorgan fixed, maintained, suppressed and/or made artificial prices for COMEX silver futures and options contracts" in violation of Section 1 of the Sherman Act, 15 U.S.C. §1, (Compl. ¶¶ 206-10). The Complaint further alleges that Defendants accomplished their manipulation of the COMEX silver market using diverse means, including: "(a) a dominant and manipulative short position and market power manipulation; (b) repeated manipulative and uneconomic trades and trade manipulation; (c) false trades made to facilitate a trade manipulation; and (d) other acts." (Compl. ¶ 2.)

A. Market Power Manipulation

The Complaint first alleges that, between March 17, 2008 and August 2008, JPMorgan "gradually acquired control" from Bear Stearns of COMEX silver futures and options totaling approximately 130 million ounces. (Compl. ¶¶ 3(a), 69.) By this large acquisition, in combination with JPMorgan's previously held COMEX short positions, it is alleged that JPMorgan acquired substantial market power in COMEX silver futures contracts. (Id. ¶¶ 3, 68-87.) Indeed, Plaintiffs claim that, by August 5, 2008, JPMorgan held "significantly more net short COMEX silver positions than the next three largest traders on COMEX combined." (Id. ¶¶ 3(b), 79, 86.) Plaintiffs also assert that, based on their analysis of CFTC Bank Participation Reports and a CFTC "Commitment of Traders" Report, "from August 5, 2008 forward, JPMorgan held approximately 20-30% of the total short open interest in all COMEX contracts." (Id. ¶ 86 (emphasis in original).) As JPMorgan acquired control of these large COMEX short positions, the Complaint alleges that the price of COMEX silver prices substantially decreased because "[b]y itself such a concentrated short position moved COMEX silver futures prices down." (Id. ¶¶ 87, 3(c) (emphasis added).) The Complaint further asserts that COMEX silver prices did not begin to rise until after the CFTC held its March 25, 2010 public hearing into the allegations that futures and options trading in the metals markets were being manipulated. (Id. ¶ 3(d).) After this date, the Complaint states, COMEX silver prices substantially outperformed COMEX gold prices. (Id.)

B. Manipulative and Uneconomic Trades

The Complaint next alleges that, during the Class Period, JPMorgan profited by using its dominant position in the silver futures market to make "large manipulative trades that repeatedly caused sudden, unreasonable and artificial fluctuations in COMEX silver prices." (Compl. ¶¶ 4(a), 46.) The Complaint describes these manipulative trading "episodes" as follows. (Id. ¶¶ 4, 55-58, 110-13.)

1. Silver Futures Trading Activities of June 26, 2007 The Complaint alleges that according to one unidentified witness, on June 26, 2007-the date when options on the July 2007 silver futures contract expired-JPMorgan "purchased sizeable out-of-the-money puts in July 2007 futures between the strike prices of $12.75 and $12.00." (Id. ¶ 55.) The Complaint posits that JPMorgan made these purchases because it "knew that if silver future prices traded below these strike prices, [it] could reap a profit by exercising [its] options, i.e., selling the futures contract[s] at the higher strike price." (Id.) The Complaint also asserts that "JPMorgan intentionally drove the price of July 2007 silver futures lower through large volume trades and 'spoof orders'" placed "just above the price at which the market was trading." (Id. ¶ 56.) The "spoof orders" were allegedly never meant to be executed, but instead were meant to "provide a strong, deceptive signal that the market [wa]s head[ing] in a certain direction." (Id.) According to Plaintiffs:

JPMorgan placed these large volume (spoof) sell orders for silver futures just above the price at which the market was trading. Those orders served as a ceiling or weight on the market that deceptively encouraged other traders to sell futures in the belief that the market was going to trade lower, because large sell orders implied some fundamental weakness in the market price. (Id.)

Then, when the prices decreased on June 26, 2007 to a low of $12.15 per ounce, the Complaint alleges, JPMorgan made a huge profit by exercising its put options and by purchasing futures contracts from traders who were forced to cover their own short put positions to remain "delta neutral." (Id. ¶ 57.) Because, after trading closed on June 26, 2007, the prices for July 2007 futures allegedly "ceased to descend and trading stabilized," (id. ¶ 61), the Complaint alleges that "[s]imply viewing the price movement of July futures . . . on June 26, 2007 provides concrete evidence" that JPMorgan caused the July silver prices to move to artificially low level levels, (id. ¶ 59). The Complaint also alleges that, "[h]istorically, silver futures movements are often correlated with gold price movements[, but on June 26, 2007, t]here was no new information that came to market . . . that would have provided the catalyst for such a strong downward move in price." (Id. ¶ 60.)

In addition, Plaintiffs assert that JPMorgan executed its trades on June 26, 2007 through, among others, a futures floor broker named Marcus Elias, who was "a former classmate and wrestling teammate of Chris Jordan, a senior silver trader at JPMorgan." (Id. ¶ 58.) As alleged in the Complaint, Elias acknowledges that, on June 26, 2007, "he executed purchase trades for JPMorgan at or near the lows of the market" and also "executed sell orders on behalf of JPMorgan in the morning . . . and then purchased futures on behalf of JP Morgan subsequently as the market bottomed." (Id.)

2. Silver Futures Trading Activities on August 14-15, 2008 The Complaint next alleges that JPMorgan's 2008 acquisition of the 130 million ounces in silver futures and options previously held by Bear Stearns gave JPMorgan an even greater financial incentive to manipulate the prices of silver futures on August 14-15, 2008, which was just before the expiration of the September ...

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