Until the Supreme Court stepped in on Monday, the $1.5-trillion-a-year trade in commodity futures was a game played almost exclusively according to "house rules."
If the house rules were unfair, or the house changed the rules or didn't bother to enforce them and allowed some players to cheat, the other players could do little but complain to the federal referee--the Commodity Futures Trading Commission.
Only the CFTC could enforce the federal law forbidding fraud and price manipulation, and the CFTC, to be charitable, had a reputation as a one-eyed referee. Two full years after the silver market collapsed, wiping out many investors and pushing some brokers to the brink of bankruptcy, the CFTC still hasn't figured out whether everyone was playing by the rules.
From now on, however, players in the commodity game will be able to go directly to the federal courts to see that the rules are kept, the Supreme Court has decided.
In a decision that ripped the fabric of the legal umbrella shielding the commodity industry from lawsuits, the court said commodity traders can sue their brokers and even the big commodity exchanges themselves for violating federal law.
The ruling gives commodity traders many of the same legal protections that securities investors have long enjoyed, said New York lawyer Leonard Toboroff, who represented clients in three of the four cases that were decided by the Supreme Court.
"The markets are going to be cleaned up as a result of this," said Toboroff, citing a string of commodity scandals: the 1979 silver market collapse, the rigging of orange juice prices in 1978, the manipulation of coffee prices in 1977 and the one on which the Supreme Court ruled--the 1976 default in the potato market.
There was a shortage of potatoes that year, and the price jumped to a record $19 a hundred pounds before the two biggest processors in the country began driving the price down by selling futures contracts to deliver potatoes they didn't have.
The two, J.R. Simplot and Peter Tagares, had long-term agreements to supply frozen french fries to McDonald's and to supermarkets and couldn't afford to pay high prices for potatoes.
When it came time to deliver on their futures contracts, Simplot and Tagares refused, defaulting on contracts for 100 million pounds of potatoes. The CFTC eventually kicked them out of the futures market, but other potato traders lost millions.
On behalf of trader Neil Leist, Toboroff sued Simplot, Tagares, the New York Mercantile Exchange and most everybody else involved in the incident. A New York court ruled that federal commodity laws did not specifically permit Leist to sue, but after a series of appeals, the Supreme Court ruled that an implied right exists.
The ruling was the most stunning setback for the powerful futures industry since Congress last year outlawed the commodity tax straddle, a gimmick that had allowed commodity traders to avoid paying $1 billion a year in taxes.
Like the tax loophole, the legal loophole exempting commodity exchanges and brokers from lawsuits had been defended vigorously by the industry as essential to its survival.
Without the ability to use the commodity markets to avoid paying taxes, investors would take their money elsewhere, industry lobbyists pleaded a year ago. Liquidity in the marketplace would evaporate, the efficiency of the markets would be threatened and prices would become unstable, the industry warned. None of that happened when the tax law was changed.
Without protection from lawsuits, the commodity exchanges will be so harassed by frivolous legal attacks that they will be unable to function, the industry and its advocates have been telling Congress this year.
As with the tax loophole that was challenged in Congress and the federal courts--and eventually lost on both fronts--the industry's exemption from private lawsuits has been under attack in both the legislative and executive branch.
Rep. Dan Glickman (D-Kan.) persuaded the House Agriculture Committee to adopt an amendment giving commodity traders the right to sue their brokers, and under limited circumstances to sue the commodity exchanges as well.
"We've got to have the right to sue if we're going to have honest markets," agrued Glickman, whose amendment was opposed by the Futures Industry Association, the big commodity exchanges in Chicago and New York and by the CFTC itself.
Monday's 5-4 decision surprised Glickman and the commodity industry, but no one was as stunned as CFTC Chairman Philip McBride Johnson, who before being appointed by President Reagan was regarded as the dean of commodity lawyers, the author of the definitive text on the subject.
For Johnson the Supreme Court ruling was both a political and intellectual setback. In his recently published book, Johnson argued that Congress never intended to give individuals the right to sue the commodity exchanges. In testimony before Congress, Johnson repeatedly opposed granting "a private right of action" against the exchanges.
Ironically, while the CFTC chairman argued in Congress against the right to sue, his agency was on the winning side in the Supreme Court. Before Johnson became CFTC chief, the agency's General Counsel John Gaine filed a friend of the court brief supporting the right to sue. Gaine won in court, but not before losing his job.