(Reuters) — Allegations of fraud and manipulative trading by Kraft Foods in derivatives markets are garnering attention beyond the fact that a household food and beverage-maker has been thrust into a regulatory doghouse normally reserved for the world's largest banks.

The case could also affect the rest of the U.S. corporate market as the Commodity Futures Trading Commission seeks to expand the definition of manipulation in derivatives markets by using a new enforcement tool provided by Dodd-Frank Wall Street Reform and Consumer Protection Act regulations for the first time since the law's passage.

"If Kraft is found guilty, it will significantly expand the ability of the CFTC to prosecute firms transacting in large size in derivatives markets," said Robert Zwirb, former CFTC lawyer and consulting attorney at Cadwalader Wickersham & Taft L.L.P. "The CFTC's use of Rule 180.1 has yet to be tested, and with Kraft's apparent intention to litigate this matter, we may soon find out just how powerful a tool the provision will be."

CFTC Rule 180.1 allows the agency to allege and prosecute fraud and manipulation in derivatives markets without having to prove that the firm in question intended to be fraudulent or manipulative. The agency only has to prove the firm acted in a reckless manner.

Kraft is being pursued for breaches of a number of rules, including 180.2 — a well-worn anti-manipulation provision — and others. But it is the first test of the new 180.1 rule that makes this case stand out.

At issue in the case is a set of large orders placed by Kraft in the wheat futures market in November 2011 that were later stopped just prior to delivery.

The firm bought $93.5 million of futures contracts set to deliver wheat in December, well over the firm's storage capacity of $50 million of wheat, which was 80% full at the time, according to the CFTC complaint.

Kraft later stopped the order prior to delivery and bought wheat in the cash market. During that time, cash prices declined and the spread between December and March futures narrowed, netting the company a $5.4 million profit, according to the CFTC.

The play could be construed as a basic arbitrage strategy — futures and cash prices were dislocated at the initiation of the strategy, but upon convergence the firm adjusted its position in the interest of good business. But lawyers say the firm has some explaining to do based on the sheer size of the position. The futures order would have delivered 15 million bushels of wheat and constituted 87% of open interest in the wheat futures market at one point.

"Kraft has some difficult facts to contend with … in 35 years of practicing in this area, including at the CFTC, I have never seen a situation in which a trader held 87% of the open interest in the spot month contract," said one commodity derivatives lawyer.

Kraft has yet to respond, so lawyers can only guess what the defense will be. Kraft and Mondelez International, a spinoff entity included in the complaint, have said in reports they plan to "vigorously litigate this matter."

The Kraft case will be the first time use of the provision reaches court. The CFTC cited Rule 180.1 in its enforcement action against JPMorgan Chase & Co. for its London Whale transgressions, but the bank settled out of court.

The widened standard is a product of agency complaints that former enforcement standards around manipulation were too weak, since proving intent is a difficult standard to meet.

"In my opinion Kraft/Mondelez may be guilty of something, but I don't think the transgressions fit under the new provisions," said another former CFTC lawyer.

Corporate thoughts

The finding in the case will be key for U.S. corporates that use futures markets in large size for hedging product sales or feedstock purchases — as was the case for Kraft in connection with wheat.

U.S. corporates have fought against being roped into a proposed tightening of limits on the size of speculative positions a firm can take in commodity derivatives markets — another rule Kraft is alleged to have violated. As such, the case is likely to take on increasing importance for U.S. corporates as they continue to deal with Dodd-Frank-driven changes to derivatives markets.

"The case has implications for all end-users that hedge risks in futures markets because it underscores that the requirements of the commodities laws, and the need for strong compliance procedures, are not limited to the likes of banks and trading firms who we typically view as being regulated by the CFTC," said Melvin Brosterman, partner in the litigation practice at Stroock & Stroock & Lavan L.L.P.

"If Kraft can be charged, so can any end-user."