In early August, the United States Court of Appeals for the Ninth Circuit revived a class-action lawsuit brought by dairy farmers against DairyAmerica and California Dairies, Inc. If this general issue sounds a little familiar, that is probably because the misreporting of nonfat dry milk prices and the effects on producer income was a well-covered topic several years ago when the issue was first uncovered. I am not one to presume anything about another’s background knowledge, especially about events that occurred over six years ago or about matters involving topics as arcane as milk pricing and federal civil procedure. So here is a short primer on what DairyAmerica and CDI allegedly did wrong, why this matters to dairy farmers and what the Ninth Circuit’s recent opinion means to the lawsuit.
First, we need to harken back all the way to 2006. During the later parts of that year, the prices for nonfat dry milk reported by USDA’s Dairy Market News began diverging from the prices for NFDM reported by USDA National Agricultural Statistics Service . Now usually, those two prices track each other relatively closely.
For example, during the beginning of 2006, the difference between the prices for any given week were within a few pennies of each other. But as the year progressed, the spread between the two prices began to widen dramatically. Depending on the measurement you wish to employ, the NASS price for NFDM was lower than actual prices by as much as $1 per pound or more. Something was amiss.
Eventually, the USDA began an investigation and audit of the prices reported to NASS. The audit resulted in tens of millions of pounds of previously reported NFDM sales being excluded from prior surveys.
Because the NASS prices are used to establish the minimum federal order prices for milk in Class II, Class IV and, in certain instances, Class I milk, the reporting of low NFDM prices directly result in lower federal order minimum prices.
After the audit, revised prices were published and USDA Agricultural Marketing Service , the agency that oversees the federal milk marketing order program, issued a report on June 28, 2007, concluding that the reporting errors resulted in $50 million in classified producer income not being collected. The reported $50 million in reduced producer income appear to be the lowest reasonable estimate of the actual losses to producer income.
The reporting situation has changed since these errors occurred. The price reporting function was made mandatory in 2008. Since then USDA-AMS has verified the information submitted by reporting plants by reviewing sales records against the information submitted by the plants. In the past, this was all done on paper.
In February of this year, USDA finalized rules mandating that information be submitted electronically, which provides for better record-keeping and more timely information. The current situation, mandatory electronic reporting subject to routine verification, is a marked improvement over what existed in 2006.
Could errors happen again? Possibly, but they are more likely to be discovered and corrected. And do these changes do anything to address the underlying questions about end-product pricing formulas? No.
With that background, the lawsuit against DairyAmerica and CDI can be looked into. The gist of the lawsuit filed in the United States District Court for the Eastern District of California is that DairyAmerica, as the largest seller of NFDM in the country, improperly included prices for sales of NFDM in its reports to NASS.
The instructions for NASS reporting applicable at the time specifically instructed the firms reporting sales to exclude the volumes and prices for sales on contracts that were set more than 30 days before the transaction was to take place. In essence, the majority of contracts priced on forward contracts were to be excluded from the NASS prices.
Why would NASS want to exclude forward price contracts from its reports? Simply, the purpose of the NASS reports is to determine the current value of NFDM in the marketplace. Similarly, the end-product pricing formulas used by the federal milk marketing order program are intended to discover the value of raw milk used in the various classes of milk by starting with the current value of the end product – in this case nonfat dry milk.
If a contract for the sale of NFDM were established in a long-term contract, say a period of one year, including that contracted price in a report of current prices six months later would not accurately reflect the value of NFDM in the marketplace at the time of reporting. In all likelihood, the then-current price of NFDM would have moved from the forward contracted price depending on market conditions.
In reviewing the case, the judge assigned wrote:
“It is not disputed that, during the time in question, DairyAmerica submitted pricing information to the NASS survey that improperly included wholesale prices for forward contracts for NFDM. Plaintiffs allege, and Defendants do not appear to dispute, that approximately 90 percent of the contracts executed by DairyAmerica and reported in the weekly NASS surveys were forward contracts that should not have been reported in the NASS surveys according to Dairy Market Enhancement Act (DMEA) procedures.”
Now, there is nothing wrong with selling any commodity on a long-term contract. As long as the parties to the sale are comfortable with the terms of the forward contract, then a long-term agreement allows both the buyer and seller to fix the volumes and prices (or price formulas) for a set period of time.
Each side to the forward contract is partially protected against price changes. The buyer is protected from falling prices; the seller is protected from price increases. But in a market where commodity prices are rising, the forward priced contract will necessarily lag behind the market price.
And that may be what happened in this instance. The market price for NFDM rose higher than a forward contracted price. But the lower forward contracted price got reported to the NASS survey and that dragged down both the NASS survey and the FMMO prices.
The lawsuit against DairyAmerica alleges further that the underreporting of prices was systematic. It alleges that DairyAmerica and its members profited by depressing the price of NDFM. It also alleges that CDI, as the cooperative member charged with operating DairyAmerica, is liable for the misreporting.
So why was the case on appeal? Initially, the district court found that the minimum prices established by USDA are immune from being challenged in a lawsuit under the “filed rate doctrine,” a legal doctrine that insulates companies subject to governmentally established pricing (called “filed rates”) from suit if the established prices are adhered to.
The Ninth Circuit agreed that the filed rate doctrine applied. But it held that the USDA had “adequately expressed its disapproval” of the federal order prices resulting from the misreporting by DairyAmerica. Because the USDA had disapproved of the prices, the case was free to proceed.
So what is next up? Quite a bit before the case concludes. The district court initially dismissed the case in February 2010. That’s why the Ninth Circuit Court, an appeals court, was just recently reviewing the case. DairyAmerica included four arguments in its past successful motion to dismiss, and the filed rate doctrine was only one of those arguments.
The district court only considered the filed rate doctrine argument and stopped its analysis there, never reaching the other arguments. My first expectation is that DairyAmerica will re-file its motion to dismiss the case again, raising one or more of the three arguments not yet addressed by the district court.
If the case is not dismissed on one of those arguments, the case will still have to proceed through certification of the dairy farmer class. Most of us are somewhat familiar with class-action lawsuits. In short, the class-action lawsuit permits a single lawsuit to proceed on behalf of a sufficiently numerous group of plaintiffs, all of whom share a common injury.
Before a class action can proceed, the plaintiffs who have actually filed the lawsuit must demonstrate to the court that the case should proceed as a class action. Only then will the case proceed to consideration of the dairy farmers’ claims.
The case illustrates a characteristic on many lawsuits in its temporal length. Today we sit six years after the initial recognition of price reporting issues, five years after the USDA reports on the effects of the misreported prices and over three years from the filing of the initial lawsuit.
Yet the case will likely proceed for many more months before it is resolved. Despite the fact that, as the court of appeals noted, “We know that prices would have been different but for the misreporting, because the NASS issued retroactive revised prices for part of the relevant period after DairyAmerica acknowledged its erroneous reporting, and AMS calculated the increase in the prices of NFDM for the period between April 29, 2006 and April 14, 2007,” there is no guarantee of a recovery for dairy farmers any time in the near future or at all. PD