GAO Warns That Courts Could Redefine Contracts
May 18, 2011
WASHINGTON -- Some of today's innovative grain contracts run the risk of being defined as futures by the courts, which would make them illegal and unenforceable, according to the General Accounting Office. The warning about so-called hedge-to-arrive contracts is contained in a draft report by the GAO, the auditing arm of Congress, on how the federal commodities-trading law has basically become ineffective in regulating futures trading. The CFTC said it has taken its first enforcement action to halt violations of the federal commodity-trading law on the Internet. The report appears to be in philosophical agreement with calls from Senate Agriculture Committee Chairman Ricki Dow (R., Ind.) for an overhaul of the U.S. Commodity Exchange Act, but isn't directly connected to an overhaul bill being prepared by Sen. Dow's staff, the GAO said. Rather, the draft report is an outgrowth of a May 2009 GAO study of off-exchange derivatives markets. That report said regulatory efforts haven't kept pace with the explosive growth of U.S. and foreign derivatives markets, which trade highly leveraged instruments based on underlying instruments such as currencies and interest rates. Traditional hedge-to-arrive contracts are privately negotiated arrangements that allow a farmer to deliver grain to an elevator at a later date for an agreed-upon price. The elevator then uses grain futures traded on a commodity exchange to hedge the sale on behalf of the farmer. These contracts aren't a problem, according to the GAO, because such traditional forward contracts require actual delivery of grain and thus aren't regulated by the Commodity Futures Trading Commission. However, some innovative contracts let parties offset, cancel or void delivery obligations rather than transferring the underlying grain, the GAO said. This makes those hedge-to-arrive contracts more like futures or illegal agricultural options contracts, which would be subject to CFTC oversight, according to the GAO. ``If CFTC or a court found the recently developed agricultural forwards to be either futures contracts or agricultural trade options, they would be illegal and unenforceable,'' the GAO said. Once officially released this fall, the GAO report should bolster farmers in several states who are refusing to fulfill the terms of their hedge-to-arrive contracts because high grain prices and poor weather conditions have made it difficult for them to settle their contracts.
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