March 23, 2017

Are Dairy Farmers Getting Their Fair Share?

 |  By: Bloomberg News

As far as staples go, dairy is pretty central to the American diet. After all, knowing the cost of a gallon of milk remains a campaign-trail test for whether a politician is out of touch. Dairy farmers, though, have fallen on hard times, as milk sales continue to decline.

But now, industry insiders in a long-running class action claim those farmers haven’t been getting their fair share in this multi-billion dollar industry. The litigation, filed by dairy farmers in 2009, names DairyAmerica and its affiliate California Dairies as defendants. The plaintiffs allege that DairyAmerica and its members, cooperatives like California Dairies which acquire dairy products from farmers and sell them in bulk, have been actively misleading U.S. regulators about the price they charge for nonfat dry milk, which goes into everything from infant formula to candy bars. In doing so, the farmers claim, the cooperatives sought to boost profits at their expense—by millions of dollars.

The defendants deny the allegations, claiming honest mistakes were made in a complex calculus driven by century old laws. Indeed, the dairy market operates very differently from other segments of the U.S. economy. Statutes with names like the 1922 Capper-Volstead Act, which allows farmers to form cooperatives, and the 1937 Agricultural Marketing Agreement Act, authorizing pricing rules to keep milk prices stable, continue to hold sway. Cooperatives are required by these laws to report prices to the U.S. Department of Agriculture and state regulators, which use the data to decide how much money goes to back to the farmers.

That’s where things got sticky, the farmers contend.

“I don’t think there’s another industry in the U.S. economy that is as heavily price regulated,” explained Andrew Novakovic, a professor at Cornell University’s Charles H. Dyson School of Applied Economics & Management. “Part of that arrangement is a level of trust that the USDA, which is largely responsible for that price regulation, will make sure that everything is on the up and up.” 

Level playing fields

While the dairy industry’s structure is unique, allegations of collusion in American agribusiness are not. In September, a series of class actions alleged companies producing 90 percent of the country’s poultry, including Tyson Foods Inc. and Pilgrim’s Pride Corp., were conspiring to restrict production and drive up prices. (They denied any wrongdoing.) Meanwhile, contract farmers who raise the birds are waiting to see if the Trump administration finalizes Obama-era rules that would create a more level playing field between poultry farmers and the companies that manage their production.

The circumstances facing poultry farmers and dairy farmers differ in many ways, but in both industries, profits seem to elude the people actually producing the food. Dairy farmers contend milk co-ops have sacrificed the interests of the farmers who created them. That’s because the large dairy cooperatives that created and run DairyAmerica, which is really a marketing company, have competing interests. On the one hand, they sell milk on behalf of farmers and should therefore look for high prices. On the other, they process that milk into finished products and stand to benefit from a low price on their primary ingredient. 

Novakovic cautions that, even if prices were misreported, “there’s a plausible scenario that the board simply messed up and wasn’t trying to do something wrong, but was just inept,” he said. This is an overly forgiving view of a multinational business, though, argued George Farah, a partner at Cohen Milstein Sellers & Toll PLLC, who represents the farmers. “The notion that these large, for-profit corporations that have processing interests are merely democratic structures that are always attending to the interests of farmer members is naive,” Farah said. “The reality is they have an interest in lower-priced raw milk because raw milk is often the largest cost input in making a finished dairy product.”

Nonfat dry milk and skim milk powder appear in so many products that they make up a significant portion of the $35 billion U.S. dairy market. Americans consumed more than a billion pounds of the stuff last year, according to USDA data. And that’s only half the story, since exports account for 55 percent of U.S. production. In the fall of 2014, no fewer than 113,421 metric tons of nonfat dry milk and skim milk powder were sold abroad, beating out every other dairy category, according to a January 2015 report by Dairy Management Inc. and the National Milk Producers Federation. DairyAmerica sells six different kinds of dried milk products, including three nonfat dry milk powders. 

Ten-year saga 

In March 2007, The Milkweed, a dairy industry publication in Wisconsin, reported that DairyAmerica had been misreporting the price it charged for some milk products. The Fresno, Calif.-based association of farmer-owned cooperatives sold $1.6 billion in dairy items in 2013 . The USDA investigated and in February 2008 found that milk prices had indeed been misrepresented, and that farmer paychecks were suffering as a result. The government pegged the amount at around $50 million for the period from April 2006 to April 2007.  

To set the prices dairy farmers must be paid for raw milk, the USDA’s National Agricultural Statistics Service [NASS] and state agencies rely on the cooperatives to report the prices they charge retailers, foreign governments, food manufacturers, and other major dairy buyers. NASS then takes those prices—of cheese, butter, dry whey, and the nonfat dry milk that goes into processed foods—and puts them into formulas. They are “complex by design,” says Pete Hardin, The Milkweed’s editor, though ultimately, the higher the price of cheese, the more a farmer should make.

But something strange happened in the summer of 2006. The combination of a July heat wave and a constriction in global dairy production sent prices for nonfat dry milk through the roof on the spot market at the Chicago Mercantile Exchange. The Milkweed reported, however, that NASS prices weren’t tracking the CME.

“Great puzzlement spread through the dairy industry,” The Milkweed wrote. “Why was the NASS price for non-fat dry milk so low?” The publication’s conclusion: “DairyAmerica was reporting low-ball figures to USDA.”

The USDA agreed, calling DairyAmerica’s misreporting a “significant lapse.” (The company has repeatedly denied any wrongdoing.) So, in March 2009, a group of dairy farmers filed a proposed class-action lawsuit against DairyAmerica and California Dairies for negligence. The plaintiffs haven’t made a damages claim, though The Milkweed has estimated the number to be as much as $1 billion.

DairyAmerica has said in court filings that it was acting in the best interests of member farmers and that any mistakes were unintentional. Because of a string lawsuit consolidations, a dismissal, reversal, and plenty of allegations of foot dragging, the plaintiffs didn’t gain access to DairyAmerica documents until 2014 or begin taking testimony until 2015. As declarations have been made public, though, the farmers amended their complaint to include claims the defendants intentionally misrepresented prices and even violated the Racketeer Influenced & Corrupt Organizations Act, or RICO. 

Fonterra deal revelation 

The first DairyAmerica employee to provide testimony on behalf of the farmers was Ralph Douglas White, a former director of sales who reported to Chief Executive Officer Richard Lewis.

Between 2002 and 2007, the USDA said prices derived from long-term contracts including export agreements should be excluded from price submissions (with limited exception), according to a court-filed declaration by White. This made sense, since the USDA was trying to gauge current prices. In long-term contracts, sellers often agree to below-market rates in exchange for the certainty of sales over an extended period of time.

NASS rules specifically require the exclusion of prices set 30 or more days before a transaction is actually completed. In other words, if a buyer agrees to purchase milk at a set price 45 days from now, that price shouldn’t be reported because it’s likely to be lower than if the sale were completed today.

“NASS prices are designed to reflect current market prices,” White stated, adding that he discussed these instructions with Lewis and other Dairy America employees and board members. He “suggested” to Lewis that DairyAmerica stop including prices tied to long-term contracts “because the figures reported to NASS were intended to reflect current market prices.”

White said that, in response, Lewis told him that “sales data from exports should be reported to NASS regardless of whether they were part of long-term contracts and regardless of whether doing so contradicted the instructions from NASS.” 

White said DairyAmerica’s misreporting was going on as early as 2002. But the practice as he described it may have gone unnoticed elsewhere had the cooperatives not entered into a long-term contract with New Zealand dairy giant Fonterra Cooperative Group Ltd. The 2006 deal came just as a dairy shortage was about to send prices skyward. By including the prices of the Fonterra contract, which would generally be lower, NASS prices remained noticeably depressed when compared with the market at large.

“If DairyAmerica had complied with NASS’s instructions,” White said, “then raw milk prices would have continued to climb unabated, and DairyAmerica would have incurred substantial losses for its cooperative members when it sold nonfat dry milk via Fonterra.”

The defendants argued that White’s allegations weren’t facts but opinions. They sought to throw out the racketeering claims and narrow their potential liability to the one-year period described by the USDA in 2008. DairyAmerica said in court filings that it “believed it was complying with the law” and that any errors were innocent accounting mistakes. 

In late April 2016, the federal judge presiding over the case in California dismissed the primary RICO claim, but left untouched a claim of conspiracy to violate RICO against California Dairies. The judge wrote that while it may not have actually committed the acts required to violate RICO, California Dairies did agree “to further the endeavor which, when completed, would constitute a substantive RICO violation.” The court also allowed allegations of negligent and intentional misrepresentation to move forward.

Most importantly, though, he denied DairyAmerica’s attempt to limit claims to just those orders the USDA inspected. Instead of being on the hook for just one year, DairyAmerica is being sued for transactions from January 2002 through April 2007.

Two sets of books

With the motion to dismiss behind them, the plaintiffs obtained declarations from two additional witnesses. A former export documentation supervisor at DairyAmerica (whose name was redacted from court documents) and Candice Bimemiller, the company’s former credit manager. Both described how the cooperatives allegedly misreported prices to the USDA, the California Department of Food and Agriculture, and even the Mexican government.

The anonymized supervisor claimed she was instructed by Lewis, the DairyAmerica CEO, to create a database with two sets of figures. “The first set of figures would consist of accurate figures from the actual sales of nonfat dry milk in the export market to foreign customers. The second set of figures would consist of fabricated export sales figures that were created internally at DairyAmerica,” the supervisor alleged.

The second set were taken from fake invoices created internally with “lower prices than those contained in the contract signed by the foreign customer,” the supervisor claimed. Between 2001 and 2008, “DairyAmerica only reported fabricated, artificially-lower export sales figures” to both regulating agencies.

In doing so, the amount of money the cooperative was required by law to pay farmers for their milk was kept artificially low. (DairyAmerica rejected the supervisor’s allegations in court filings, but wouldn’t comment further. California Dairies didn’t respond to a request for comment.)

DairyAmerica went to great lengths to conceal the accurate numbers, the supervisor asserted. “Each month,” she said, employees “would gather boxes of accounting documents, including the invoices and contracts reflecting accurate export prices, and load them into a truck and drive them to an off-site storage facility” a week before state auditors were scheduled to visit. The supervisor said employees were told not to speak with them.

The Mexican government was also hoodwinked in the scheme, the supervisor alleged in her declaration. A major purchaser of nonfat dry milk from DairyAmerica, Mexican officials “insisted” on an audit in 2003. Lewis then instructed her, she alleged, “to reconcile the two sets of figures in the export documentation database.” 

“Specifically,” the supervisor said, “Richard Lewis instructed me to account for the discrepancy between the fabricated export sales figures and the accurate export sales figures by inventing and adding a non-existent ‘administrative fee’ to each export sale listed in the database.” Lewis then presented the doctored documentation to the auditors, according to her testimony. In 2009, about six months after the farmers’ lawsuit was filed, the supervisor said she was fired. “My termination was surprising to me, as I had consistently received very positive reviews for my work.” In the last review before her termination, she said she received a score of 56 out of 60. 

Bimemiller, who said she met with Lewis weekly to discuss domestic sales, stated in her declaration that she was regularly told to defy NASS instructions and not reveal company practices to auditors.

“He would instruct me to delay, by a week, the reporting of particular nonfat dry milk sales that he selected,” Bimemiller stated in her declaration. “The sales prices that Mr. Lewis selected for delays in reporting were typically those priced above a specified value and, less frequently, those priced below a specified value.”

Suing themselves

The latest amended complaint in the lawsuit sought to add two defendants: Dairy Farmers of America and Land O’Lakes, two of the largest dairy cooperatives in the country and former members of DairyAmerica. The farmers alleged they were involved in a conspiracy to mislead California regulators. Dairy Farmers of America rejected the claims, saying it was “not involved in [its] management.” Land O’Lakes says it “vehemently oppose[s] any attempt” to be added to the litigation.

DairyAmerica, meanwhile, responded to the latest version of the lawsuit by saying in court papers that the anonymized supervisor was a “low level employee without a college degree” who “has a misunderstanding of the transactions.” It denied the existence of a second set of books and pointed instead to a forensic accounting analysis contending that the transactions at issue were all proper. 

Despite years of tit-for-tat filings and courthouse vitriol, settlement talks between the farmers and the cooperatives have been under way for some time. In the end, those negotiations are likely to resolve the litigation instead of a trial, thanks to an ironic twist: Because dairy cooperatives run on the contributions of their members, when farmers sue them, they are in many ways suing themselves.

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