[Federal Register Volume 60, Number 226 (Friday, November 24, 1995)]
[Notices]
[Pages 58049-58051]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-28699]
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COMMODITY FUTURES TRADING COMMISSION
Customer Orders
AGENCY: Commodity Futures Trading Commission.
ACTION: Order.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
defining a specified category of customer orders transmitted to and
reported from exchange trading pits in an extremely rapid manner. With
regard to such orders, an exchange can demonstrate substantial
compliance with the objectives of Section 5a(b)(3)(B) of the Commodity
Exchange Act (``Act'') without its audit trail recording a transmittal
timestamp on the order ticket.
[[Page 58050]]
DATES: This Order is to be effective January 23, 1996.
FOR FURTHER INFORMATION CONTACT:
De'Ana H. Dow, Special Counsel, or Rachel F. Berdansky, Attorney/
Advisor, Division of Trading and Markets, Commodity Futures Trading
Commission, 2033 K Street, N.W., Washington, D.C. 20581. Telephone
(202) 418-5490.
SUPPLEMENTARY INFORMATION:
I. Introduction
Currently, Commission Regulation 1.35(a-1)(2)(i) requires that
order tickets accurately reflect order receipt time on the trading
floor (``entry time''). Similarly, Commission Regulation 1.35(a-1)(4)
provides that order tickets also must accurately record a timestamp
reflecting when the fill price is reported from the trading floor
(``exit time'').\1\ In October 1995, the heightened audit trail
standards set forth in Section 5a(b)(3)(B) of the Act become effective
to the extent deemed practicable by the Commission. Section 5a(b)(3)(B)
includes a provision that exchanges' audit trail systems shall record,
in addition to the entry and exit times already required by Commission
regulation, the time that each customer order is received by a floor
broker for execution (or when such order is transmitted in an extremely
rapid manner to the broker).
\1\ These entry and exit timestamp requirements now are codified
under Section 5a(b)(3)(B) of the Act.
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The Commission has issued a Flashed Order Advisory (``Advisory'')
that clearly sets forth the standards for customer orders that are
transmitted to and reported from the trading pit in an extremely rapid
manner through hand signals or verbally (``flashed orders'') to be
deemed in good faith compliance with Section 5a(b)(3). The Commission
has concluded that immediately executable flashed orders will not now
require the additional transmittal timestamp, provided that such orders
are in compliance with the Commission's Advisory and that appropriate
recordkeeping and enforcement procedures are in place. Immediately
executable flashed orders satisfying the Advisory's standards and the
terms of this Order will be deemed in substantial compliance with the
objectives of Section 5a(b)(3)(B) of the Act.
Exchanges subject to Section 5a(b)(3)(B) of the Act have informed
the Commission that they cannot yet fully implement the systems
necessary to capture broker receipt times on the trading floor or
transmittal times for customer orders. The exchanges, however, have
taken several steps in anticipation of the additional timestamp
requirement. Among other things, one exchange has already expanded its
computer fields and trade records in order for clearing firms to input
the additional timestamp data. Further, the exchanges are pursuing the
development of electronic systems, including order routing systems, and
portable time clocks that eventually will provide audit trails with the
capability to accurately record such broker receipt and transmittal
times for all customer orders to the extent determined practicable by
the Commission. The Commission intends to gather more information from
the exchanges and brokers concerning their progress toward this goal
and practicability. The Commission will then further assess, based on
information obtained from the improved audit trail implemented by
October 1995, distribution of order types (including market, limit, and
stop orders), and data on order routing and booth processing systems.
II. Background
A. Legislative History
In a report to Congress prior to the enactment of the heightened
audit trail standards found in Section 5a(b)(3) of the Act, the General
Accounting Office (``GAO'') stated that:
[C]omplete timing of trades, including the time the floor
participant receives and executes trades, could help reconstruct the
history of each trade, not only to detect potential abuses, but also
to prove that they occurred.
The GAO report further stated that for audit trail purposes, it is
crucial to capture the time when brokers receive customer orders
because a time is then established when the floor broker assumes
responsibility for promptly and competitively executing the order. GAO
noted that without complete timing information, the history of each
order is incomplete. GAO further stated that floor trade practice
abuses could occur without detection and customers could be
defrauded.\2\
\2\ Futures Markets--Strengthening Trade Practice Oversight,
United States General Accounting Office Report to the Chairman and
the Ranking Minority Member, Committee on Agriculture, Nutrition,
and Forestry, U.S. Senate (September 1989).
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In addition, a futures commission merchant (``FCM'') testified
before the Senate Committee on Agriculture, Nutrition, and Forestry in
support of capturing broker receipt times:
[T]he biggest problem with audit trail isn't when did the order
get filled. The biggest question we have is * * * what exact moment
in time did the broker get the order? That's the key ingredient to a
better audit trail.\3\
\3\ Hearings on S. 1729 before the Senate Committee on
Agriculture, Nutrition, and Forestry, 101st Cong., 1st Sess. (1989)
(statement of Barry J. Lind, Chairman of Lind-Waldock & Company).
The FCM explained that efforts to determine the accuracy of customer
fills are impeded by the window of time between when an order reaches
the floor and is executed, which is generally about two minutes but can
range up to three and one-half minutes.
The Futures Industry Association (``FIA'') also testified before
the Senate Committee on Agriculture, Nutrition and Forestry in general
support of the enhanced audit trail standards. However, the FIA
expressed concern that the new standards effectively would eliminate
order entry methods such as ``flashing'' orders.\4\ Congress responded
to this concern and adopted the specific language found in Section
5a(b)(3)(B) of the Act addressing rapidly transmitted orders. Second
5a(b)(3)(B) of the Act, specifically provides that for customer trades,
among other things, exchange audit trails must record the entry and
exit time for each order and the time that each order ``is received by
the floor broker for execution (or when such order is transmitted in an
extremely rapid manner to the broker) * * *'' (emphasis added).\5\
Thus, for flashed orders, audit trails can capture transmittal time at
the floor trading desk rather than broker receipt time.
\4\ Id. (Statement of John M. Damgrad, President, FIA). The
order entry method is quite different for paper orders and flashed
orders. A paper order is written down by a phone clerk and taken by
a runner to a broker in the trading pit. Paper orders are filled
when the market hits the appropriate price, consistent with the
written order instructions. Flashed orders also are written down on
order tickets by a phone clerk but are hand-signalled or shouted
into the pit to a broker or his clerk, and the order usually is
filled immediately.
\5\ Without the parenthetical in Section 5a(b)(3)(B) of the Act,
it would be difficult, if not impossible, for audit trails to
capture broker receipt time for orders that are rapidly transmitted
via hand-signal or verbally to a floor broker. Because the order
ticket will remain at a floor trading desk until after execution,
the floor broker cannot record order receipt time contemporaneously
on the written order.
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The Commission believes that the broker receipt or transmittal
timestamp would add a valuable component to exchanges' audit trails.
This information would assist in market reconstruction for trade
practice investigation purposes, particularly in identifying dual
trading-related abuses such as trading ahead of customer orders, and
resolving customer complaints about bad fills. The additional time also
would narrow the timing window within which a trade execution could
have occurred, thus providing another
[[Page 58051]]
means of verifying the accuracy of one-minute execution times.
The legislative history of Section 5a(b)(3) of the Act contemplates
that flashed orders can meet the objectives of Section 5a(b)(3)(B)
without the additional transmittal timestamp. The same FCM who
testified concerning the importance of recording broker receipt times,
also testified that it is critical to distinguish between conventional
paper orders and flashed orders because flashed orders present few
audit trail problems due to the speed at which they are filled. For
such orders, the FCM believed that order entry and order fill are
likely to occur in the same minute.
The FCM further testified that a second or a few seconds can be
critical in a fast-moving market and that an additional timestamping
requirement could have a negative impact on customers and the futures
market by reducing the speed and liquidity that are well-established
advantages of the futures markets.\6\ Section 5a(b)(5)(A)(ii) of the
Act, therefore, requires that the Commission afford special treatment
to flashed orders to the extent that substantial compliance with the
objectives of Section 5(a)(b)(3) can otherwise be achieved.
\6\ Hearings on S. 1729, supra note 4 to 4.
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B. Immediately Executable Flashed Orders
The Commission has determined that flashed orders that are
immediately executable are capable of substantial compliance with the
objectives of Section 5a(b)(3)(B) of the Act without an exchange's
audit trail recording the transmittal time on an order ticket. Provided
that, those exchanges where brokers do not record customer fill
information on sequenced trading cards must require that any trade
record prepared by a broker or his clerk reflecting the fill for
flashed orders and the order ticket be retained together.\7\
\7\ Retaining such trade records together with the order ticket
will provide a complete record of how the order was filled and will
assist exchanges, as well as Commission staff, in reconstructing
trades as needed for trade practice investigations.
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Flashed orders permit firms to relay customer orders into, and
order fills out of, trading pits in an extremely rapid fashion. In most
cases where flashed orders are immediately executable, the entry time,
the time the order is flashed and received by the floor broker, and the
execution time should be virtually contemporaneous. Thus, the
``immediately executable'' requirement ensures that the orders are
executed within a very narrow time window and obviates the need for an
additional timestamp.\8\
\8\ Both the entry time and the transmittal time for immediately
executable flashed orders are analogous to the time that a written
order is received by a floor broker for execution.
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``Immediately executable'' is intended to encompass only those
flashed orders that are transmitted as a whole to a single broker and
are immediately executed. This definition of ``immediately executable''
is intended to include a flashed order executed opposite multiple
brokers or traders, provided that all portions of the order are
immediately executed.\9\ Further, a flashed order partially filled
according to the customer's original instructions and the remaining
portion executed immediately pursuant to new instructions would be
within the scope of this Order.\10\
\9\ Thus, flashed orders that are filled in increments over a
period of time will not come within this Order. Without the
additional timestamp, the audit trail for such orders would be
impaired because it would be difficult to relate particular
timestamps to the time at which a broker received a specific portion
of the order to execute.
Orders that are held at the trading desk and then flashed when
the market reaches the desired price also are excluded from this
Order. Of course, for such orders, the initial retention at the
trading desk must be in accordance with their terms. The enhanced
order ticket timestamping requirement for such orders will be
addressed at a later time.
\10\ For example, an order for fifty contracts could be flashed
into the pit to be purchased at a particular price which is near the
prevailing market price. The broker may only fill forty contracts at
that price before the market moves. Upon flash of that fill to the
desk, the remaining ten contracts are then flashed back into the pit
at the new price, executed and flashed back to the desk. If this all
occurs virtually instantaneously, these transactions will be within
the scope of this Order.
Further, flashed orders that are flashed back to the desk as
completely unfilled which are then immediately flashed back to the
pit with new instructions also would be considered ``immediately
executable'' for purposes of this Order.
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Order Relating to Flashed Orders: The Commission's Flashed Order
Advisory provides guidance concerning the necessary elements for a
flashed order to be deemed in good faith compliance with Section
5a(b)(3). The Commission has now determined that an exchange's audit
trail system can demonstrate substantial compliance with the objectives
of Section 5a(b)(3)(B) of the Act for immediately executable flashed
orders.
Accordingly, the Commission Hereby Orders:
That it is appropriate to find that an exchange subject to Section
5a(b)(3) of the Act is in substantial compliance with the objectives of
Section 5a(b)(3)(B), without requiring the additional transmittal
timestamp, for those flashed orders that are:
(1) Capable of immediate execution when received at a floor trading
desk;
(2) Immediately transmitted from a floor trading desk to a floor
broker or floor broker's clerk in a trading pit through hand signals or
verbal communication; and
(3) Filled immediately upon receipt by the floor broker receiving
the order.
Provided that, the exchange meets the current audit trail standards
under Section 5a(b)(2) of the Act, complies with the standards set
forth in the Commission's Flashed Order Advisory, and ensures that
trade records prepared by a broker or his clerk reflecting order fill
are retained together with the order ticket.
The Commission will be providing further guidance concerning the
practicability of requiring the additional broker receipt or
transmittal timestamp referred to in Section 5a(b)(3)(B) of the Act for
types of customer orders other than those addressed by this Order. The
Commission's guidance will be based upon its review of exchange
practices, as well as information the Commission expects to obtain
concerning the current status of order routing systems and
practicability as a result of the exchanges' good faith implementation
of the October 1995 enhanced audit trail standards.\11\
\11\ As part of the Commission's effort to implement Section
5a(b)(3) of the Act, it has already gathered information on order
routing systems and the progress of the exchanges towards
implementing those systems.
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Dated: November 16, 1995.
By the Commission:
Jean A. Webb,
Secretary to the Commission.
[FR Doc. 95-28699 Filed 11-22-95; 8:45 am]
BILLING CODE 6351-01-M
