(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, Sept 4 (Reuters) - The dismissal by U.S. District Judge Katherine Forrest of a barrage of lawsuits alleging foul play in the aluminium market does not mark the end of this particular story.
Only the London Metal Exchange (LME) appears to be in the clear after the same judge ruled earlier that as an “organ” of the UK government the LME is immune from any lawsuit under the Foreign Sovereign Immunities Act.
Some of the aluminium companies alleging antitrust violations against LME warehouse operators and their parent companies will be allowed to replead their case, if they choose to do so.
Another, Eastman Kodak, which has brought a complaint against Goldman Sachs, filed too recently to be included in the Aug. 29 ruling.
There is also a separate series of lawsuits, led by Duncan Galvanizing, with similar allegations about the impact of load-out queues at some LME warehouses on the zinc market.
Hidden from the public gaze are the inquiries, ongoing as far as anyone knows, into LME warehousing by U.S. and European regulators.
But Judge Forrest has set a high threshold for any remaining lawsuits to make it to a full trial, finding that the unprecedented rise in physical premiums in the aluminium market “was an unintended consequence of rational profit maximizing behavior rather than the product of conspiratorial design”.
At the heart of this legal and regulatory quagmire is one undisputed fact, the explosion in the U.S. Midwest physical aluminium premium relative to the underlying LME futures price.
Equally undisputed is the negative impact of this explosion on aluminium consumers, given a lack of any mechanism to hedge against what had up to 2009 been a fairly static input into the “all-in” price paid by a U.S. buyer. The Midwest premium was, until the launch of a futures contract by CME earlier this year, determined by Platts based on data collected from buyers and sellers.
Or, to quote Judge Forrest, “the complaints allege, and on this motion the Court accepts as true, that between 2009 and 2012 (...) inefficiencies developed in aluminium pricing”.
Beyond that kernel of truth, however, everything gets a bit more complex.
Even defining who has been impacted and to what extent is tricky, given the long value-add chain from aluminium producer to end consumer.
Two sets of plaintiffs, one grouping several end-users involved in the manufacture of everything from boats to swimming-pool enclosures, and one grouping two California residents and a pizzeria, were deemed too far down the chain to be able to make a claim of any sort. Those suits were dismissed with no right to replead.
As Judge Forrest expressed it: “Their injury is paying a price for a product partially made from aluminum that partially incorporates the Midwest Premium”.
Another batch of lawsuits came from entities further up the chain. Characterised as “first-level purchasers”, they encompass extruders, powder manufacturers and bottlers as well as two companies that didn’t consolidate their claims with the others; Mag Instrument Inc, which makes aluminium flashlights, and Agfa Corp, which makes lithographic plates.
These companies have been allowed to replead their cases.
But none purchased aluminium directly from the LME, so were not directly affected by the increase in storage costs caused by the development of long load-out queues at LME warehouses.
“The court notes that some of these plaintiffs may have purchased aluminum from others who themselves purchased aluminum from a trader or broker (...) it is not clear from the complaint whether they are truly ‘first-level’ purchases.”
Moreover, there is confusion even about how to define which part of the aluminium supply-chain was impacted, Judge Forrest lamenting that “all told, individually or collectively, plaintiffs allege fourteen potential markets”.
“A less complicated market structure would present fewer complex issues.”
Even if those permitted to replead overcome such basic issues of definition, Judge Forrest’s rejection of any allegation of conspiracy marks a higher hurdle.
The lawsuits were brought against three LME warehousing companies and their owners: Metro (Goldman Sachs ), Pacorini (Glencore ) and Henry Bath (JP Morgan ).
The core allegation was that they colluded to buy LME-registered aluminium, using the accumulated stocks to create load-out queues at their respective warehouses with the intention of benefiting from the higher premium.
But such allegations of collusion appear to be based on little more than the fact that all three were members of the LME, shareholders in the LME (prior to its sale to Hong Kong Exchanges and Clearing ) and in a couple of cases had representatives sitting on the same LME committees.
Joint participation in an LME committee, even the warehousing committee, is “insufficient” proof of collusion, while a shared ownership interest in the LME “does not lead to a plausible inference of communication between them, or between them and the warehouse defendants”.
Nor was there any evidence of inappropriate internal communications between warehouse companies and parent companies, according to Forrest.
Not just a case of no “smoking gun”, no gun at all, it seems.
But the highest hurdle of all to any successful legal action was Judge Forrest’s conclusion that LME warehousers were simply attempting to maximise their own profitability rather than to force up the Midwest Premium.
And on this particular count, the focus is on Metro, dominant LME storage player in Detroit, sitting in the heart of the U.S. Midwest aluminium market.
It was here that the load-out queues first started and, critically, started before Goldman Sachs bought the company in 2010.
If warehouses were already in the queue-creation business prior to 2010, Forrest queried, “what reasonable motivation would Goldman, JP Morgan and Glencore have had to acquire them? To get them to agree to do that which they were already doing? And at significant cost”.
Faced with an unprecedented deluge of unwanted aluminium during the Global Financial Crisis and the subsequent hunger by traders to buy and hold that metal to reap the profits available from playing the contango on the LME curve, Metro, and subsequently Goldman, simply made the most of the unexpected windfall.
“There is no allegation that Metro owns any aluminium, can control when warrants are cancelled, whether they are moved to an LME-approved warehouse or a non-LME warehouse, or where that warehouse is located.”
In short, “that warehouses which make money from storage found longer storage periods desirable is only sensible. Why, indeed, would they want anything else?”
The real driver of the lengthening load-out queues at Detroit was the cancellation of metal by financial players of all shapes and sizes, looking to move it to cheaper off-market storage to maximise their own profits from the stocks-financing trade, Forrest found.
“As trader rather than user dynamics took root in the LME warehouses, the level of Premium became driven by trading dynamics rather than actual supply and demand of aluminum users.”
Forrest’s ruling vindicates both Goldman Sachs and Martin Abbott, former chief executive of the LME, who very publicly argued that the queues were a manifestation of bigger macroeconomic drivers.
In particular, the post-crisis zero-interest rate environment both allowed stocks financiers access to “cheap” money with which to buy aluminium and provided incentive to earn the “interest” generated by the contango structure of the LME aluminium contract.
A warehouse system designed for modest load-out rates by industrial users was overwhelmed when banks, traders and hedge funds wanted to move millions of tonnes out at the same time.
So is that the end of the story for any further legal action?
Not necessarily. Missing from Forrest’s ruling is any consideration as to whether the linkage between load-out queues and rising premiums evolved beyond its accidental beginnings.
This in large part reflects the focus of the lawsuits on Detroit, Metro and Goldman.
A key part of Forrest’s legal judgement was that neither warehouser nor owner stood to reap any benefit from a rising Midwest premium since “defendants do not compete on the price of aluminum because they do not sell it; rather they trade warrants or sell storage space (...) none of which has anything to do with the Midwest Premium.”
That is undoubtedly true of Goldman Sachs, but does it hold true across all LME-traded metals and all LME-registered warehousers and their parents?
The remaining lawsuits may help provide the answer to that lingering question but they must overcome the high hurdles set by Judge Forrest if they are to do so. (Editing by Susan Thomas)