The Market Itself as Insider Trading
Christine Desan
draft 9/27/14
In 1905, the legitimacy of commodities futures trading – a representative, in
some measure, of speculative exchange more generally -- came before the Supreme
Court. The issue arrived when the Chicago Board of Trade, incorporated by the
state of Illinois in 1859, sued an outfit called Christie Grain & Stock Company. The
Chicago Board of Trade was an enormous exchange, a hall in which members bought
and sold wheat, corn, and other provisions for future delivery. Christie Grain was a
“bucket-shop” – a gambling parlor that used the prices quoted by the Chicago Board
of Trade as the raw stuff of its betting business. Customers of Christie Grain could
place bets on the direction of the market; the proprietor of the shop took the other
side of the deal. By the late 19th century, bucket-shops were springing up across the
United States. As Jonathan Levy has written, bucket-shops “brought futures to the
masses.” Anyone could participate: they could “buy and sell futures,” spreading
interest – and possibly profit – in those speculative trades.1
If the bucket-shops saw their work as essentially “like” the activity that took
place in the wheat and corn pits at the Chicago Board of Trade, that exchange
disdained the comparison. According to it, Christie Grain had unlawfully acquired
the Board of Trade’s price quotations, which were legally protected as trade secrets.
The Supreme Court would eventually agree, but not before facing Christie Grain’s
deeper argument. The Board of Trade, asserted Christie Grain, was “the greatest of
bucket shops,” the mother of them all – and thus could not assert ownership in its
own illegal product. As Christie Grain pointed out, “the pretended buying and
selling of grain. . . without any intention of receiving and paying for the property so
bought, or of delivering the property so sold,” violated Illinois law. That law
Jonathan Levy, Freaks of Fortune: The Emerging World of Capitalism and Risk in
America (Cambridge, MA: 2012). 241.
1
required at least one party to “contemplate delivery” when entering a contract;
otherwise the contract was one for “wagering” and was legally unenforceable.2
The prohibition appeared to apply to the Chicago Board of Trade because an
enormous number of contracts made there – something like 75% according to the
Supreme Court – never involved any “physical handing of grain.” 3 Rather, most
contract obligations were settled by being were set off against a debt generated by
another contract. The parties simply paid off the difference in price, the party who
owed money given a movement in the market handing over that amount to the
party who could claim a profit.4 A train of witnesses at congressional hearings on
Fictitious Dealings in Agricultural Products in the previous decade sharpened the
point. As they emphasized, most the traders in the pits at the Board of Trade never
touched wheat or corn; they were not farmers, or millers, or even shopkeepers.5
Rather, they were speculators in it only for the profits they might make. Finally, this
professional class of traders worked on margin. Financed by banks that used their
purchases as collateral, they operated with a limited amount of their own money at
stake. Under those circumstances, the difference between traders in futures and
gamblers looked thin indeed.6
Given the power of the comparison, the line drawn by the Supreme Court
mattered, both practically and ideologically. Its response effectively set aside the
tangled law on “contemplating delivery” for a new rationale. That rationale
endorsed the activity of trading as one that produced accurate prices. Speculators,
each calculating the course of the future, bid prices into the place they belonged, as
far as anyone could anticipate. As Justice Holmes, obviously bedazzled by the
grandeur of the vision, put it:
Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 198 U.S. Reports
236, 246 (1905); see also Levy, Freaks of Fortune, 242-245 (reviewing case law).
3 Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 246.
4 See Levy, Freaks of Fortune, 235 for a concise description of long and short selling.
5 Levy, Freaks of Fortune, 231-232.
6 See, e.g., Marieke de Goede, Virtue, Fortune, and Faith: A Genealogy of Finance
(Minneapolis: 2005); Roy Kreitner, Calculating Promises: The Emergence of Modern
American Contract Doctrine (Stanford: 2007).
2
As has appeared, the plaintiff's chamber of commerce is, in the first place, a
great market, where, through its eighteen hundred members, is transacted a
large part of the grain and provision business of the world. Of course, in a
modern market, contracts are not confined to sales for immediate delivery.
People will endeavor to forecast the future, and to make agreements
according to their prophecy. Speculation of this kind by competent men is the
self-adjustment of society to the probable. Its value in well known as a means
of avoiding or mitigating catastrophes, equalizing prices, and providing for
periods of want.7
Holmes’s vision saved the “dominant mode of commodity exchange in the United
States” – by 1890, that was futures trading. According to Levy, American farmers
harvested 415 million bushels of wheat in 1888, while in that year, “some 25,000
trillion bushels of wheat sold in futures contracts in the United States . . . were set
off, never delivered.” As Levy teaches us, the Supreme Court had re-interpreted
speculative risk-taking into “risk management.” Financial speculation had become
socially useful; the diffuse actions of many traders stabilized the market.8
The punch line of the story – the transformation of risk-taking into risk
management -- is striking. But it presents us with a puzzle, one that invites us to
take a second look at the nature of the risk-taking and the nature of the risk
management that come together at the end of the story. Holmes’s vision – the vision
that legitimated futures trading --- depended on a robust practice, one that
appeared natural to him. But how that robust practice could come about is a
mystery, given the judicial policing of wagers, an enforcement practice that appears
to have been alive and well in the 19th century.9
The puzzle, once we see it, is written all over Holmes’s decision. Holmes’s
vision turned on his recognition that the Board was “a great market,” one large
enough to move prices for the agricultural world. He saw the power of an
aggregated effect, in other words, only after that effect was actually aggregated. At
that point, the development could seem to have occurred in the regular course of
events. In turn, its unfolding was evidence of its power. As Holmes put it:
Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 247.
Levy, Freaks of Fortune, 234.
9 See supra, note 2.
7
8
legislatures and courts generally have recognized that the natural evolutions
of a complex society are to be touched only with a very cautious hand, and
that such coarse attempts at a remedy for the waste incident to every social
function as a simple prohibition and laws to stop its being are harmful and
vain.10
Holmes’s insight, written as reaction to an existing market, thus reiterates the issue
how the futures market gathered enough momentum to legitimate itself. Judges
who faced the question whether risk-taking could be productive before a robust
market modeled its effect would not, of course, have shared Holmes’s vision.
I want to suggest an answer to the puzzle, if only speculatively (in the spirit
of things). Holmes’s “great market” did not emerge slowly or partially, ignored by
judges who winked it into existence. Instead, the futures market emerged because it
was insulated from judicial review. More, the market that was insulated from
review had a particular shape. It was made up of insiders – members to the
exchanges who had access to financing. If this answer to the puzzle is right, it
matters for two reasons. First, we would conclude that markets do not emerge as
“natural evolutions” but as protected collective activities. Second, those markets , it
would turn out, are contrived on a selective base, represented here by the traders
with membership and access.
How, then, was the futures market sufficiently insulated from review to grow
into a practice so robust that the Supreme Court could see and celebrate its
effectiveness? The law on “contemplating delivery” had been hammered out in a
series of cases that pitted brokers who were members of various exchanges against
their clients, customers they charged a certain amount and then represented on the
exchange, buying and selling on the clients’ behalf. When those deals went bad, the
customers sued, attempting to escape payment to their brokers by claiming that the
contracts binding them were invalid as wagers: neither customer nor broker had
ever “contemplated delivery” of any commodity. The money charged by the brokers
10
Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 247-248.
was sufficient to cover their costs whichever way the market went, but it was void
as consideration of a valid contract.11
While suits by nonmembers produced a series of cases defining futures
trading as wagers given their failure to contemplate delivery, there was no similar
stream of suits by members against members. It may be that the rules of exchange
membership prohibited such actions. Given the amount of trading with exchanges
by speculators on their own accounts, those suits should have been much more
common than suits by nonmembers. Their absence would have allowed a high
volume of trading to occur that did not come before the courts.
Under those conditions, the Supreme Court could adopt the power of the
established practice as its essential rationale. When the Board was finally
challenged by an outsider, Christie Grain, the Court did not try to figure out how
members of the Board of Trade “contemplated delivery.” Rather, the Court simply
found that:
The fact that contracts are satisfied in this way by set-off and the payment of
differences detracts in no degree from the good faith of the parties, and if the
parties know when they make such contracts that they are very likely to have
a chance to satisfy them in that way, and intend to make use of it, that fact is
perfectly consistent with a serious business purpose, and an intent that the
contract shall mean what it says.12
And that was just as well, because it did not appear, of course, that most traders at
the Board of Trade could be distinguished on the ground that they contemplated
delivery any more than those placing bets at the bucket-shop. But if most traders at
the Board were no closer to wheat and corn than their counterparts at Christie
Grain in that sense, they were indisputably closer to those commodities in another
sense. Farmers and merchants could and did use the Board to hedge their products,
while they never used the bucket-shops for that purpose. The Boards’ members
could be distinguished from those at the bucket-shop -- but only because farmers
See, e.g., Embrey v. Jemison, 131 U.S. Reports 336(1889); see also Pickering v.
Cease, 79 Ill. 328 (1875).
12 See Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 248.
11
shared their market, not because of the nature of the activity that took place there.
As the Court put it:
It seems to us an extraordinary and unlikely proposition that the dealings
which give its character to the great market for future sales in this country
are to be regarded as mere wagers or as "pretended" buying or selling,
without any intention of receiving and paying for the property bought, or of
delivering the property sold, within the meaning of the Illinois act. Such a
view seems to us hardly consistent with the admitted fact that the quotations
of prices from the market are of the utmost importance to the business
world, and not least to the farmers -- so important, indeed, that it is argued
here and has been held in Illinois that the quotations are clothed with a
public use.13
The fact that the Board of Trade constituted an exchange with a specialized
membership, one that set it apart, brings us to the second point – the selective
nature of the group that made up the legitimated market. Only members could buy
and sell at the Board of Trade. The Court’s decision was in turn carefully limited to
the contracts made between members. “We speak only of the contracts made in the
pits,” wrote Holmes, “because in them the members are principals. The subsidiary
rights of their employers where the members buy as brokers we think it
unnecessary to discuss.”14 Perhaps most importantly, the Court’s decision
depended on the fact that the Board was a closed community. Membership was
necessary to ensure the effectiveness of setting-off. As Holmes noted, “These
settlements would be frequent, as the number of persons buying and selling was
comparatively small.”15
Far, then, from a practice that had evolved among a group at large, futures
trading had been nurtured within a small community. The membership rules of that
community had allowed the practice to be established. That community in turn
became the beneficiary of the practice. Its members, individuals who operated on a
margin, were the parties who would be paid as the producers of prices “clothed with
a public use.”
Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 249.
Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 250.
15 Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 248.
13
14
Despite that particular and remarkably narrow base, commodities futures
trading could come to seem the paradigmatic market. It was, recall, “a great market”
-- when it was not a very peculiar one. As Holmes continued, generalizing his vision
for a new century, “in a modern market, contracts are not confined to sales for
immediate delivery. People will endeavor to forecast the future, and to make
agreements according to their prophecy.”16 The punch line of Christie Grain was
grand, and it reached far beyond commodities futures trading. That should make all
the more arresting the process that produced it.
Board of Trade of the City of Chicago V. Christie Grain & Stock Co., 198 U.S. Reports
236 (1905).
de Goede, Marieke. Virtue, Fortune, and Faith: A Genealogy of Finance. Minneapolis:
University of Minnesota Press, 2005.
Embrey V. Jemison, 131 U.S. Reports 336 (1889).
Kreitner, Roy. Calculating Promises: The Emergence of Modern American Contract
Doctrine. Stanford: Stanford University Press, 2007.
Levy, Jonathan. Freaks of Fortune: The Emerging World of Capitalism and Risk in
America. Cambridge, MA: Harvard University Press, 2012.
16
Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 247.