[Federal Register Volume 62, Number 219 (Thursday, November 13, 1997)]
[Notices]
[Pages 60865-60870]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-29893]
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COMMODITY FUTURES TRADING COMMISSION
Chicago Board of Trade Petition for Exemptions From the Dual
Trading Prohibition Set Forth in Section 4j(a) of the Commodity
Exchange Act and Commission Regulation 155.5
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of intent to condition and proposed order granting
conditional exemptions from the prohibition on dual trading in 13
affected contract markets.
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SUMMARY: For the reasons set forth in the Proposed Order Granting
Conditional Dual Trading Exemptions (``proposed Order''), the Commodity
Futures Trading Commission (``Commission'') intends to grant, subject
to the stated conditions, the petition of the Chicago Board of Trade
(``CBT'' or ``Exchange'') for exemptions from the dual trading
prohibition in Section 4j(a) of the Commodity Exchange Act (``Act'')
and Commission Regulation 155.5 for its Wheat, Corn, Soybean, Soybean
Meal, Soybean Oil, U.S. Treasury Bond, 10-Year Treasury Note, and 5-
Year Treasury Note futures contracts and the option contracts on the
Corn, Soybean, U.S. Treasury Bond, 10-Year Treasury Note, and 5-Year
Treasury Note futures. Pursuant to the Act and Commission Regulation
155.5(d)(8)(C)(iii), CBT may submit written supplemental data, views or
arguments and will have an opportunity to make an oral presentation to
the Commission before the Commission makes its final determination.
DATES: If CBT intends to make an oral presentation, it must submit its
request in writing no later than ten days after receipt of this
proposed Order. CBT must submit any written supplemental data, views or
arguments within 30 days of receipt of this proposed Order.
ADDRESSES: CBT's request for oral presentation and submission of
written supplements are to be sent to the Office of the Secretariat,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, N.W., Washington, D.C. 20581.
FOR FURTHER INFORMATION CONTACT: Rachel Fanaroff Berdansky, Special
Counsel, or Duane C. Andresen, Special Counsel, Division of Trading and
Markets, Commodity Futures Trading Commission, Three Lafayette Centre,
1155 21st Street, N.W., Washington, D.C. 20581; telephone: (202) 418-
5490.
SUPPLEMENTARY INFORMATION: A floor broker engages in dual trading when
he or she executes a customer's order during the same trading session
in which he or she executes, directly or indirectly, a trade in the
same contract for his or her own account or an account in which he or
she has an interest. Dual trading can afford floor brokers the
opportunity to abuse customer orders if audit trail information and
surveillance are insufficient to permit the detection of such abuses.
Specifically, a dual trading floor broker can directly commit abuses of
customer orders such as trading ahead or against those orders and also
has an informational advantage for his or her personal
trading.1 Section 4j(a) of the Act and Regulation 155.5
prohibit dual trading and establish trade monitoring standards that
must be met in order for contract markets to be exempted from the
prohibition.
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\1\ The Commission has previously discussed in several
instances, including its November 28, 1994 Report to Congress on
Futures Exchange Audit Trails, the possible abuses attendant to dual
trading. See also the Commission's Proposed Regulation Prohibiting
Dual Trading by Floor Brokers, 56 FR 13025 (March 9, 1993).
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The Commission intends to issue the following proposed Order
granting CBT conditional dual trading exemptions pursuant to Section
4j(a) of the Act and Commission Regulation 155.5. In accordance with
Regulation 155.5(d)(8), CBT may submit to the Commission in writing any
supplemental data, views or arguments within 30 days of receipt of this
Notice and proposed Order. In addition, CBT may request, in writing
within ten days of receipt of this Notice and proposed Order, an
opportunity to make an oral presentation to the Commission. If CBT
submits a request for an oral presentation, the Exchange will be
notified by the Commission of the date and the terms under which CBT
may make such presentation. Public notice of such an oral presentation
also will be provided in accordance with the requirements of the
Government in the Sunshine Act, 5 U.S.C. 552b (Supp. I 1995).
Proposed Order Granting Conditional Dual Trading Exemptions
On October 25, 1993, CBT submitted a Petition for Exemption from
the Dual Trading Prohibition contained in Section 4j of the Act and
Commission Regulation 155.5 for its Wheat, Corn, Soybean, Soybean Meal,
Soybean Oil, U.S. Treasury Bond, 10-Year Treasury Note, and 5-Year
Treasury Note futures contracts and the option contracts on the U.S.
Treasury Bond and 10-Year Treasury Note futures. The Exchange corrected
that petition on December 2, 1993. Subsequently, by letters dated March
25 and May 14, 1994, CBT supplemented its petition to include the
option contracts on its Corn, Soybean and 5-Year Treasury Note futures
since such contract markets had reached average daily volumes of 8,000
contracts and, thus, had become affected contract markets (``affected
contract markets'') as defined in the Act and regulations
thereunder.2 CBT updated its petition on January 17, 1997,
with respect to all 13 of its affected contract markets. Notice of the
public availability of the CBT's updated exemption petition was
published in the Federal Register on February 20, 1997.3
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\2\ Affected contract market means a contract market with an
average daily volume equal to or in excess of 8,000 contracts for
each of four quarters during the most recent volume year. Commission
Regulation 155.5(a)(9). See Section 4j(a)(4) of the Act. As noted by
the Commission in promulgating Regulation 155.5, a contract market
trading on an exchange floor will be considered separate from a
contract market in the same commodity trading a screen-based trading
system. The Commission further stated that, while not excluding
electronic trading from the dual trading prohibition, the Commission
was retaining the flexibility to consider the matter further. See 58
FR 40335 (July 28, 1993). The Commission is not addressing screen-
based trading in this proposed Order.
\3\ 62 FR 7754 (February 20, 1997). The Commission did not
address the Exchange's dual trading exemption petition in 1994 in
large part because of the Exchange's prior representation that it
intended to automate the entry of trade execution times by
developing a handheld electronic trading terminal. By letter dated
June 22, 1994, CBT informed the Commission that the proposed
handheld terminal would not be in place by the October 1995 deadline
for compliance with the heightened audit trail standards set forth
in Section 5a(b)(3) of the Act. Because CBT had not sufficiently
demonstrated that its existing audit trail system met current and
future standards, the Commission required the Exchange to
demonstrate its ability to meet the audit trail requirements using
Commission-designed tests and, thus, deferred consideration of the
Exchange's petition. Subsequent to evaluating the results of the
tests, the Commission offered CBT the opportunity to supplement its
petition.
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[[Page 60866]]
Upon consideration of CBT's petition, as supplemented, and other
data and analysis, including, but not limited to:
Exchange audit trail test results reconciling imputed times to
underlying trade documentation and verifying data on ``window sizes'';
actions taken in response to the Commission's November 1994 Report to
Congress on Futures Exchange Audit Trails, June 1995 Report on Audit
Trail Accuracy and Sequencing Tests (``Audit Trail Report''), and
August 12, 1996 Report on Audit Trail Status and Re-Test (``Audit Trail
Re-Test Report'');
Commission trade practice investigations and compliance reviews
conducted in conjunction with rule enforcement reviews or other
investigatory or surveillance activities; 4
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\4\ A list of the specific documents considered in connection
with this proposed Order will be made available to the Exchange upon
request. Copies of any documents not originally furnished by CBT
also will be made available upon request.
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the Division of Trading and Markets Memorandum dated October 28, 1997;
and upon review of each element of CBT's trade monitoring system and of
CBT's trade monitoring system as a whole, the Commission finds that the
Exchange's trade monitoring system does not fully satisfy the
requirements of Sections 5a(b) and 4j(a)(3) of the Act and Regulation
155.5 in that the audit trail, recordkeeping, and physical observation
of trading areas components are deficient. The Commission finds that
corrective actions are sufficient and appropriate to meet those
standards. In addition, the Commission finds that, based on an analysis
of the composition of trading (by transaction size and volume) of
certain distant contract expirations and option markets, there is a
substantial likelihood that the broad scope of the dual trading
prohibition specified under Section 4j of the Act and Regulation 155.5,
which applies to a contract market as a whole, would harm the public
interest in hedging or price basing in less liquid months of the
affected contract markets. Therefore, the Commission has determined to
grant CBT conditional exemptions from the dual trading prohibition of
Section 4j of the Act and Regulation 155.5 in its 13 affected contract
markets.
The Commission is granting the Exchange's petition subject to the
Exchange taking the corrective actions specified below and implementing
and enforcing the dual trading restriction described in the Appendix to
this proposed Order. The Commission has concluded that the proposed
dual trading restriction, which imposes a prohibition on dual trading
in actively traded months but has no impact on less actively traded
back months, is appropriate as a method to deter dual trading-related
abuses and other customer abuses. The Commission's limited restriction,
as opposed to the statutory dual trading ban, strikes a balance between
the need to preserve liquidity in certain low volume months and the
need to protect customers from the potential abuses that are associated
with dual trading.
The Commission Hereby Finds as follows:
Components of Exchange's Trade Monitoring System
Audit Trail System
One-Minute Execution Time Accuracy
The Exchange's audit trail system fails to record ``reliably
accurate'' trade times in increments of no more than one minute in
length as required by Section 5a(b)(2) of the Act, Regulation 1.35(g),
and Appendix A to Regulation 155.5. 5 Specifically, the
Exchange has not established for any of its 13 affected contract
markets that 90 percent or more of imputed trade times, as assigned by
the Exchange's trade timing system, are reliable, precise, and
verifiable as demonstrated by being imputed within a timing window of
two minutes or less (``90 percent performance standard''). Thus, an
impermissible amount of the trade timing data, an integral part of an
exchange's trade monitoring system, is not reliably accurate in
accordance with that standard and thus negatively impacts the
Exchange's surveillance systems and investigatory and disciplinary
action programs.
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\5\ Commission Regulation 1.35(g) requires that ``[a]ctual times
of execution shall be stated in increments of no more than one
minute in length.'' Section 5a(b)(2) of the Act, among other things,
codified that timing requirement by stating that an exchange's audit
trail system shall, ``consistent with Commission regulation,
accurately record the times of trades in increments of no more than
one minute in length.'' Section II of Appendix A to Commission
Regulation 155.5 requires that a contract market, in describing its
audit trail system in a petition for exemption from the dual trading
prohibition, ``[d]emonstrate the highest degree of accuracy
practicable (but in no event less than 90% accuracy) of trade
execution times required under regulation 1.35(g) (within one
minute, plus or minus, of execution) * * *.'' In addition, the
contract market must ``[d]emonstrate the effective integration of
such trade timing data into the contract market's surveillance
system with respect to dual trading-related abuses.'' For contract
markets that impute trade execution times, Appendix A requires that
the contract market provide a description of the trade imputation
algorithm, ``including how and why it reliably establishes the
accuracy of the imputed trade execution times.''
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The Commission has made clear that a reliably accurate imputed
trade execution time only can be demonstrated by a timing window that
narrows the time assigned to the trade to a two-minute period within
which the trade is most likely to have occurred. Even where an exchange
can demonstrate a trade timing window of two minutes or less, it is not
possible to determine where within that window the trade occurred. This
underscores the critical need for compliance with the 90 percent
performance standard.
CBT's Advanced Computerized Trade Reconstruction (``Advanced CTR'')
system imputes an execution time for every trade. 6 Trade
times are imputed based upon entry and exit timestamps on order
tickets; time and sales reports; trading card numbers and sequence of
trades on trading cards; certain handwritten execution times; times
that trades were submitted for clearing; 15-minute bracket codes;
calculated differentials for spread trades; identification of spread
legs and types of spread trades; and any available times resulting from
electronic order entry or trading systems. Based on these data,
Advanced CTR determines various time spans within which a trade is
likely to have been executed and ultimately assigns an imputed
execution time for the trade.
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\6\ An imputed timing system does not capture the actual trade
execution time but derives a time from other timing and trade data.
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The audit trail tests designed and reviewed by the Commission and
conducted by the Exchange in response to a November 23, 1994 Commission
letter involved a determination of the consistency of imputed trade
execution times with all underlying audit trail records and data. Based
upon that process, trade timing accuracy and sequencing rates for CBT's
imputed system were computed. 7 In reviewing
[[Page 60867]]
the results of the test designed to evaluate trade timing accuracy,
Commission staff determined that, although 91 percent of CBT's trade
times satisfied the standard for consistency with the underlying data,
only 41 percent of those trade times had timing windows of two minutes
or less and thus could be verified. 8 In March 1996, the
Commission conducted a re-test of CBT's audit trail system. Although
92.7 percent of CBT's trade times satisfied the standard for
consistency with the underlying data, only 69.2 percent of the trade
times had timing windows of two minutes or less and thus could be
verified.
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\7\ To the extent that the time imputed by a computer algorithm
was consistent with required trade documentation, time and sequence
data and time and sales information for the subject trade and
surrounding trades, that time was deemed accurate. If that imputed
time fell within a two-minute level of precision as measured by the
size of the final time window determined by such algorithm, that
imputed time was considered to be verifiable, reliable and precise.
Thus, the Commission stated in its Audit Trail Report, ``90 percent
of CBT trade times satisfied the standards [of consistency with
underlying data] for Test I. However, for 59 percent of the trade
times deemed accurate, available data are not sufficiently precise
to verify that the one-minute audit trail time chosen was actually
within the minute of execution.'' Audit Trail Report at 17.
Under the 90 percent performance standard, only trade times
assigned by the Exchange's imputed timing system within timing
windows of two minutes or less are reliably accurate. As noted
above, Commission staff deems accurate those trades for which the
imputed trade times are consistent with all underlying audit trail
records and data, as determined by manual review. When comparing
windows data for accurate trades and all trades, the Division has
found that a higher percentage of accurate trades are assigned
imputed times that fall within windows of two minutes or less and
thus meet the 90 percent performance standard. However, the
resulting percentage difference between accurate and all trades
generally has not exceeded one percent. In addition, since the use
of all trades data facilitates exchange submission of timing windows
percentages because such data do not have to be generated in
conjunction with an accuracy test, which requires an analysis of
extensive trade documentation, the Commission finds that the use of
all trades data provides an acceptable basis for determining windows
performance.
\8\ In response to recommendations made in the Audit Trail
Report, the Exchange modified its trading card procedures such that
a member can record only one time bracket per trading card, record
no more than six trades per trading card, and use only one-sided
trading cards to record for each trader all personal buy and sell
trades in sequence. Additionally, the Exchange implemented
recommendations that it enforce certain data recordation and
submission requirements, requirements to record correct customer
type indicator codes, and timestamping procedures for flashed
orders.
The Exchange also made a number of improvements to its trade
timing system. CBT now requires a trade submission indicator for
flashed orders, uses seconds in the imputed timing system, when
available, including seconds from order ticket timestamps, requires
member firms to input the seconds from order entry and order
confirmation timestamps into the trade entry system, reprogrammed
CTR to impute proper execution times for trades executed during the
close, and upgraded synchronized timestamp clocks to record times to
the nearest second. The Exchange also made programming improvements
to its timing algorithm.
CBT declined to implement two Commission recommendations: that
members record and use manual execution times for at least the first
and sixth trades on trading cards, and that the Exchange include the
identity of traders in the spread time and sales.
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Subsequent to the re-test, the Exchange provided windows data for
all affected contract markets in response to Commission requests. For
December 19, 1996, the overall percentage of trades with timing windows
of two minutes or less was 67 percent. For subsequent dates, the
Exchange computed windows data separately for each affected contract
market in addition to computing overall windows data. The overall
percentage of trades with timing windows of two minutes or less was 84
percent on March 26, 1997, and 85 percent on May 28, 1997; June 5,
1997; and June 10, 1997. For those same dates, the percentage of trades
with timing windows of two minutes or less computed separately for each
affected contract market ranged from 58 to 89 percent on March 26,
1997; 74 to 89 percent on May 28, 1997; 69 to 91 percent on June 5,
1997; and 70 to 90 percent on June 10, 1997. 9 Thus, the
Exchange has not demonstrated that its imputed trade execution times
are sufficiently reliable, precise, and verifiable in that it has not
established that 90 percent or more of such times are imputed within
timing windows of two minutes or less.
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\9\ May 28, 1997; June 5, 1997; and June 10, 1997 were selected
by Commission staff using a random sampling method. The Exchange
also provided similar percentage data for three days of its own
choosing. The overall percentage of trades with timing windows of
two minutes or less was 87 percent on May 13 and May 20, 1997 and 88
percent on May 15, 1997. For those same dates, the percentage of
trades with timing windows of two minutes or less computed
separately for each affected contract market ranged from 74 to 90
percent on May 13, 1997; 72 to 91 percent on May 15, 1997; and 68 to
90 percent on May 20, 1997.
The Exchange submitted data indicating that 90 percent or more
of the imputed trade times in its Soybean futures contract had
timing windows of two minutes or less on one of the three dates
selected at random by Commission staff and on all three dates
selected by the Exchange. Although the Commission considers timing
windows data for all dates provided, the dates selected by persons
other those affiliated with the Exchange are accorded greater weight
in determining whether an affected contract market attains the 90
percent performance standard. Overall, the windows data for the
Soybean futures contract market does not demonstrate consistent
compliance with the 90 percent performance standard.
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The negative impact on the components of the Exchange's trade
monitoring system resulting from its failure to satisfy the 90 percent
performance standard is exacerbated because CBT does not require the
recordation of a member's personal and customer trades in sequence.\10\
Given the absence of such a recordation requirement, reliably accurate
trade times are essential for effective determination of the sequence
of trades. Where the sequence of customer and personal trades is not
determined, possible dual trading-related abuses, such as trading ahead
of customer orders and trading against customer orders, could go
undetected.
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\10\ Notably, although there are differences in various systems
among the exchanges, the three other exchanges for which the
Commission has granted unconditional exemptions from the dual
trading prohibition require that customer and personal trades be
recorded sequentially on a single trading document. Similar to CBT,
one of those exchanges, the Coffee, Sugar and Cocoa Exchange, Inc.,
also uses an imputed timing system to assign trade execution times.
Such sequencing also can be achieved by recording personal and
customer trades in sequence on one set of sequentially numbered
trading documents. As the Commission noted in discussing the results
of CBT's first audit trail test, ``recordation of a member's
personal and customer trades in sequence should be the Exchange's
objective.'' Audit Trail Report at 20. Section 5a(b)(3) of the Act
provides, among other things, that an exchange's audit trail system
must record accurately and promptly essential data on all trades,
including execution time, through a means that is adequately precise
to determine the sequence of customer and personal trades, to the
extent practicable as determined by the Commission by rule or order.
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Other Components of CBT's Audit Trail System
With regard to the requirement that trade data be provided
continually to the Exchange in accordance with Section 5a(b)(3)(A)(ii)
of the Act, exchange audit trail systems must provide trade data,
including trade timing information, on a periodic, but not necessarily
real-time, basis.\11\ Such information also must be obtained in a
timely manner. The Exchange requires that clearing members submit trade
data for clearing within one hour after the end of each hour on the
half-hour. However, as explained below, the Exchange fails to enforce
the requirement that trading cards be collected and timestamped in a
timely manner. This failure calls into question the Exchange's ability
to assure that trade data are provided continually to clearing.
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\11\ See Audit Trail Re-Test Report at 39.
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With regard to unalterability, as mandated by Section
5a(b)(3)(A)(i) of the Act, the Exchange's trade records are
unalterable, since they are recorded on trading cards and order tickets
in nonerasable ink. Trade corrections also are not permitted to obscure
original data. \12\
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\12\ The Commission requires retention of a record of any
cancellations, changes, or corrections to trades. Commission
Regulation 1.35(d) and the Outtrade Interpretation, 54 FR 37004
(September 6, 1989). The Commission amended Regulation 1.35(d)(7),
effective October 21, 1996, to require that the correction of
erroneous information on trading records be accomplished in such a
manner that the originally recorded information must not be
obliterated or otherwise made illegible. 61 FR 42999 (August 20,
1996). In December 1996, CBT amended its Floor Practices Rule 332.05
and 332.07 to comport with the Commission's amendment to Regulation
1.35(d)(7).
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CBT's imputed timing system, which uses data from sources other
than the trader, as well as data provided by the trader, to derive
times, also meets the Section 5a(b)(3)(A)(iii) standards for
independence, to the extent
[[Page 60868]]
practicable.\13\ The Exchange's existing system uses, among other
things, data generated by both buyers and sellers for personal trades,
including trading card numbers and sequence of trades on trading cards,
certain execution times required to be entered manually, entry and exit
timestamps on order tickets, time and sales data and 15-minute bracket
codes to impute trade execution times.
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\13\ See Audit Trail Re-Test Report at 40.
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The Exchange requires that personal trades be recorded in sequence,
consistent with Commission regulations, by requiring that members
record such trades in sequence on pre-numbered trading cards.\14\ The
Exchange adopted a single-sided trading card on which all personal buy
and sell trades are required to be recorded sequentially in response to
an Audit Trail Report recommendation. However, as noted elsewhere, the
Exchange does not require the recordation of a member's personal and
customer trades in sequence. Given the absence of such a recordation
requirement, reliably accurate trade times are essential for effective
determination of the sequence of trades.
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\14\ Commission Regulation 1.35(d)(2) requires that each member
of a contract market recording purchases and sales on trading cards
must record such purchases and sales in exact chronological order of
execution on sequential lines of the trading card.
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CBT enforces its audit trail requirements and integrates audit
trail data into its surveillance system for dual trading-related
abuses. However, because the Exchange's trade surveillance system
incorporates into its data, including exception reports, an
impermissible amount of imputed execution times that are not reliably
accurate, the effectiveness of the Exchange's integration of audit
trail data is diminished.
As required by Section 5a(b)(1)(B) of the Act, CBT's trade entry
and outtrade resolution programs capture certain essential data on
cleared trades, unmatched trades, and outtrades.
Finally, with regard to broker receipt times, the Commission finds
that it is not practicable at this time for CBT to record the time that
each order is received by a floor broker for execution. Immediately
executable flashed orders, however, are in substantial compliance with
the objectives of Section 5a(b)(3)(B) of the Act, as stated previously
by the Commission in its Order on flashed orders and broker receipt
times.\15\
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\15\ 60 FR 58049 (November 24, 1995).
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Physical Observation of Trading Areas
CBT's trade monitoring system does not provide for physical
observation of trading areas in accordance with Section 5a(b)(1)(A) of
the Act in that the Exchange does not conduct daily floor surveillance
on the open and close to the extent practicable in each affected
contract market as required by Appendix A to Regulation 155.5. As part
of the Exchange's Market Open/Close Floor Surveillance Program, CBT
currently conducts floor surveillance on the open for only half of the
affected contract markets and on the close for the remaining half. The
Exchange conducts some additional open/close floor surveillance as part
of other specialized surveillance programs. The Exchange does conduct
floor surveillance at random times and when special market conditions
warrant. Information obtained during floor surveillance is integrated
into the Exchange's other compliance activities. During 1996, the
Exchange initiated two investigations based upon floor surveillance
observations.
Recordkeeping System
The recordkeeping component of CBT's trade monitoring system fails
to comply with Section 5a(b)(1)(B) of the Act because it does not
satisfy the trading record collection and timestamping requirements of
Regulation 1.35(j). These requirements are essential to maintaining the
basic integrity of trading records used in the Exchange's system to
capture essential data on the sequence of transactions in that they
ensure the removal of such records from the member's possession in a
timely manner and thereby limit the opportunity to alter records, to
fabricate trades, or otherwise to use trading records to disadvantage
customer accounts. Only approximately 67 percent of the trading cards
selected for review by Commission staff were submitted to the clearing
member within 15 minutes of the 30-minute trading interval and
timestamped promptly to the nearest minute following collection as
required by Regulation 1.35(j). The Exchange, however, does use
information from the records and violations of recordkeeping
requirements to bring disciplinary actions.
In addition, because CBT does not meet the 90 percent performance
standard, the system captures an impermissible amount of trade timing
data that is not reliably accurate. This circumstance is compounded by
the fact that CBT does not require the recordation of personal and
customer trades in sequence. As a result, the Exchange's recordkeeping
system is limited in its capability to capture essential data on the
sequence of customer trades.
CBT generally conducts back office audits of trading cards and
order tickets at each clearing member firm twice a year for a
representative sample of customer orders and personal trades. CBT also
uses a computerized tracking system to monitor member compliance daily
with certain trade timing and sequencing requirements, regularly
examines trading records during the course of investigations for
possible recordkeeping violations, and uses information from these
audits to generate investigations. The Exchange requires that the
account identifier reflected on the floor order ticket relate back to
the ultimate customer account.
Surveillance Systems and Disciplinary Actions
The inclusion of an impermissible amount of trade timing data that
is not reliably accurate in the Exchange's trade monitoring system
diminishes the capability of the Exchange's trade surveillance system
to review trade data effectively, and as a result, possible dual
trading-related abuses could go undetected. Further, the lack of
reliably accurate trade timing data diminishes the capability of the
Exchange's disciplinary program to bring appropriate disciplinary
actions against violators. In other respects, the Exchange's trade
surveillance system may be capable of reviewing and is used to review
trading data on a regular basis to detect possible dual trading-related
abuses and other customer order abuses. In addition, CBT did bring
disciplinary actions against offenders and issued meaningful penalties
against violators.\16\ Therefore, CBT has demonstrated the capability
to use information generated by its trade monitoring and audit trail
systems on a consistent basis to bring appropriate disciplinary action
for violations relating to the making of trades and execution of
customer orders as required by Sections 5a(b)(1)(C), (D) and (F) of the
Act. Further, CBT refers appropriate cases to the Commission.
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\16\ This proposed Order does not address certain disciplinary
actions taken by the Exchange regarding the March 1996 Wheat futures
contract expiration. Those matters are before the Commission in a
separate proceeding.
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On a daily basis, CBT reviews Trade Practice Investigation Reports
and uses its Sophisticated Market Analysis Research Technology system,
a framework for reviewing such data, to detect possible instances of
dual trading-related abuses and other trading abuses. All relevant
trade data, including account numbers, are
[[Page 60869]]
included in these reviews. Among the computerized exception reports
generated by the Exchange and reviewed daily are those designed to
identify such suspicious trading activity as trading ahead of a
customer, trading against a customer, preferential trading and wash
trading and to review outtrade resolution and U.S. Treasury Bond
futures contract broker association top step trading.\17\
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\17\ Broker association members trading on the top step of the
U.S. Treasury Bond pit are subject to trading restrictions. These
restrictions limit the amount of customer and personal trades
members can execute opposite each other in the most active contract
month. Members cannot trade more than 20% of their monthly volume
(brokerage and personal trades) opposite members of their broker
association. The members also cannot trade more than 20% of their
monthly volume against members of a contiguous broker association.
In total, the members cannot trade more than 30% of their monthly
volume against members of their own and a contiguous broker
association.
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During 1996, CBT initiated 309 investigations into all types of
trading related abuses. Of the 86 investigations opened and closed
during this period, 34 percent were closed within the four-month
objective set forth in Commission Regulation 8.06, and an additional 28
percent were closed within four to six months. Thus, approximately 62
percent of the investigations opened and closed during 1996 were closed
in six months or less. CBT should improve the timeliness of its
investigations or provide the reasons that such investigations require
more than four months to complete. During that same period, the
Exchange opened and closed 45 dual trading-related investigations, and
referred nine of those investigations to a disciplinary committee. CBT
assessed substantial penalties in 13 disciplinary actions involving
dual trading-related abuses.
Commitment of Resources
The Commission finds that CBT commits sufficient monetary resources
to its trade monitoring system to be effective in detecting and
deterring violations attributable to dual trading. The Exchange
maintains an adequate staff to conduct investigations and to develop
and prosecute disciplinary actions. For calendar year 1996, the
Exchange reported that it committed 141 personnel to the Exchange's
various self-regulatory activities and reported its total self-
regulatory costs to be $15,456,317. CBT's reported volume for this
period was 222,438,505 contracts, and the number of trades was
17,675,749. However, CBT should allocate its resources as appropriate
to improve its trade monitoring system, as discussed above.
Accordingly, the Commission Hereby orders that:
The Exchange must implement the following corrective actions:
(1) achieve compliance with the 90 percent performance standard,
(2) significantly improve compliance with the requirement that trading
records be collected and timestamped in accordance with Commission
regulations, and
(3) conduct floor surveillance daily on the open and close for each
affected contract market.
The Commission Further orders that:
Until such time as the Exchange demonstrates that its trade
monitoring system satisfies the relevant standards, the Exchange shall
be subject to the following condition: Within 60 days from the
effective date of a final Order, the Exchange must implement and
enforce the limited dual trading restriction described in the Appendix
to this proposed Order, which is less restrictive than the dual trading
prohibition of Section 4j of the Act and Regulation 155.5. Such dual
trading restriction currently would apply to the following affected
contract markets: Wheat, Corn, Soybean, Soybean Meal, Soybean Oil, U.S.
Treasury Bond, 10-Year Treasury Note, and 5-Year Treasury Note futures
contracts and the option contracts on the Corn, Soybean, U.S. Treasury
Bond, 10-Year Treasury Note, and 5-Year Treasury Note futures.
Accordingly, the Commission proposes to grant CBT'S Petition for
Exemption, subject to the stated conditions, from the dual trading
prohibition for trading in its Wheat, Corn, Soybean, Soybean Meal,
Soybean Oil, U.S. Treasury Bond, 10-Year Treasury Note, and 5-Year
Treasury Note futures contracts and the option contracts on the Corn,
Soybean, U.S. Treasury Bond, 10-Year Treasury Note, and 5-Year Treasury
Note futures.
If, at any time, CBT believes that it can demonstrate to the
Commission's satisfaction that it meets, for an affected contract
market subject to this Order, all of the standards set forth in this
Order, including, but not limited to, those in Section 5a(b) and
Regulation 155.5, the Exchange may petition for an unconditional
exemption to the dual trading prohibition for that affected contract
market.
Unless otherwise specified, the provisions of this proposed Order
shall be effective on the date on which it is issued as a final Order
by the Commission, and the condition shall become effective as stated
herein and shall remain in effect unless and until removed, as provided
above, or revoked in accordance with Section 8e(b)(3)(B) of the
Commodity Exchange Act, 7 U.S.C. 12e(b)(3)(B). Failure of CBT to abide
by the condition of a limited dual trading restriction will
automatically cause the dual trading prohibition set forth in Section
4j of the Act and Regulation 155.5 to go into effect.
If other CBT contract markets become affected contract markets
after the date this Order becomes final, the Exchange would be
required, absent submission of a dual trading exemption petition, to
restrict dual trading in those affected contract markets in accordance
with the dual trading prohibition set forth in Section 4j of the Act
and Regulation 155.5. Further, if CBT demonstrates to the Commission's
satisfaction that an affected contract market subject to this Order has
ceased to meet the Regulation 155.5(a)(9) affected contract market
threshold, that contract market no longer would be subject to this
Order.
Dated: November 7, 1997.
By the Commission:
Edward W. Colbert,
Deputy Secretary.
Appendix--Dual Trading Restriction
a. Restriction
A floor broker is prohibited from executing customer orders in
an affected contract market month, as defined below, during the same
pit trading session in which the floor broker executes directly, or
initiates and passes to another member for execution, a transaction
in any such affected contract market month for (1) the floor
broker's own account, (2) any account in which the floor broker's
ownership interest or share of trading profits is ten percent or
more, (3) any account for which the floor broker has trading
discretion, or (4) any other account controlled by a person with
whom such floor broker is subject to trading restrictions under
Section 4j(d) of the Act to the extent such section is applied by
Commission regulation or order.
b. Affected Contract Market Month (Volume)
Affected contract market month means: (1) For each affected non-
agricultural contract market, any contract market month with an
average daily trading volume of 10,000 contracts or more as
determined by, at the election of the Exchange, either (i) trading
in a contract month by position in relation to the front month
contract, as defined below, during the prior six calendar months or
(ii) trading in the previous calendar month; and (2) For each
affected agricultural contract market, any contract market month
with an average daily trading volume of 10,000 contracts or more as
determined by trading in the previous calendar month. For this
purpose, daily trading volume means the total number of contracts
sold (or bought) in any contract month of an affected contract
market during a trading day, with the average computed as set forth
above and excluding ex-pit transactions as permitted under
[[Page 60870]]
contract market rules that have been made effective under the Act.
There will be a two business day allowance at the beginning of each
calendar month for computation and member notification purposes.
c. Affected Contract Market Month (Front Month)
Front month means, for each affected contract market, the month
which is either the expiration or delivery month which is nearest to
expiration or at the Exchange's discretion the expiration or
delivery month which is next nearest to expiration when the contract
month nearest to expiration is five business days or less from the
first notice day or last trading day for cash settled contracts for
futures contracts or the expiration date for futures options
contracts. If a front month is not subject to a prohibition pursuant
paragraph b. above, then it shall, nonetheless, be an affected
contract market month and be subject to a prohibition unless, on the
basis of historical data, that front month reasonably can be
expected to have an average daily trading volume of less than 500
contracts.
d. Exceptions
Dual trading shall be permitted under exceptions consistent with
Commission Regulation 155.5(c)(4) in accordance with Exchange rules
which the Commission has permitted to go into effect pursuant to
Section 5a(a)(12)(A) of the Act and Regulation 1.41.
Notice of Intent To Condition and Proposed Order Granting Conditional
Dual Trading Exemptions to the Chicago Board of Trade, Supplemental
Statement of Commissioner John E. Tull, Jr.
I am happy to support the Commission's action proposing to grant
the CBOT conditional dual trading exemptions for its affected
markets. I am troubled, however, by that part of the Commission's
Proposed Order which orders the CBOT to conduct floor surveillance
daily on the open and close for each affected market when such
surveillance is not required by the Act or the Commission's
Regulations. Appendix A to Regulation 155.5 states that such
surveillance should be conducted to the extent practicable. In my
opinion, the Commission should not attempt to instruct an exchange
regarding the allocation of its resources with such specificity.
Such management decisions are better left to the exchange
leadership, which has hands-on, daily contact with the markets at
issue. Management should have the discretion to assign exchange
personnel as needed to monitor ``hot'' markets or pits with trading
activity of concern.
Opinion of Commissioner Barbara Pedersen Holum, Concurring in Part and
Dissenting in Part, on the Disposition of the Chicago Board of Trade's
Dual Trading Petition
For the reasons set out below, I concur with the findings of the
proposed Order but I dissent from the proposed Order's imposition of
a Commission-designed dual trading restriction.
Section 4j(a)(3) of the Commodity Exchange Act requires the
Commission to exempt a contract market conditionally from the dual
trading prohibition of Section 4j(a) of the Act upon finding that:
(1) There is a substantial likelihood that a dual trading suspension
would harm the public interest in hedging or price basing at the
contract market, and (2) other corrective actions are sufficient and
appropriate to bring the contract market into compliance with the
standards of Section 5a(b) of the Act by effectively detecting and
deterring dual trading-related abuses. The Commission has determined
that the Chicago Board of Trade's trade monitoring system fails to
satisfy the standards necessary for an unconditional exemption, but
that it meets the criteria for granting a conditional exemption. In
addition, the Commission has determined to impose a dual trading
restriction on the CBT a as condition to the exemption. Given these
findings, I agree with the majority's view that the CBT should be
granted a conditional exemption. However, I dissent from the
proposed Order because it would impose a Commission-designed dual
trading restriction on the CBT as a condition to the exemption.
Consistent with the statutory framework of self-regulation, I
believe that the CBT should adopt its own rules to detect and deter
dual trading abuses. When the CBT's trade monitoring system as a
whole is determined by the Commission to meet the objectives of the
Act by detecting and deterring dual trading abuses, the CBT would be
granted an unconditional exemption.
[FR Doc. 97-29893 Filed 11-12-97; 8:45 am]
BILLING CODE 6351-01-P
