[Federal Register Volume 62, Number 134 (Monday, July 14, 1997)]
[Notices]
[Pages 37563-37566]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-18370]
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COMMODITY FUTURES TRADING COMMISSION
Coffee, Sugar & Cocoa Exchange, Inc. Petition for Exemption From
the Dual Trading Prohibition in Affected Contract Markets
AGENCY: Commodity Futures Trading Commission.
ACTION: Order.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
granting the petition of the Coffee, Sugar & Cocoa Exchange, Inc.
(``CSCE'' or ``Exchange'') for exemption from the prohibition against
dual trading in its Sugar #11 futures contracts.
DATES: This Order is effective July 8, 1997.
FOR FURTHER INFORMATION CONTACT: Duane C. Andresen, Special Counsel,
Division of Trading and Markets, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st St., N.W., Washington, DC 20581;
telephone (202) 418-5490.
SUPPLEMENTARY INFORMATION: On October 19, 1993, the Coffee, Sugar &
Cocoa Exchange, Inc., (``CSCE'' or ``Exchange'') submitted a Petition
for Exemption from the Dual Trading Prohibition for its Sugar #11 and
Coffee ``C'' futures contracts. Subsequently, the Exchange submitted an
amended petition on March 21, 1997.1 Upon consideration of
these petitions and other matters of record, including Exchange
submissions and undertakings
[[Page 37564]]
in response to the November 1994 audit trail tests designed and
reviewed by the Commission and conducted by the Exchange, compliance
with the order ticket customer identification requirement of Commission
Regulation 1.35, dual trading surveillance data required under the
Commission's August 12, 1996 Audit Trail Report, and disciplinary and
investigatory actions undertaken by the Exchange between September 1995
and December 1996, the Commission hereby finds that CSCE meets the
standards for granting a dual trading exemption contained in Section
4j(a) of the Commodity Exchange Act (``Act'') as interpreted in
Commission Regulation 155.5. 2
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\1\ In its amended petition, the Exchange petitioned for the
dual trading exemption for six contract markets: Coffee ``C'', Sugar
#11 and Cocoa futures and futures option contracts. This Order is
applicable to the Sugar #11 futures contract market, which currently
is the only affected contract market at the Exchange.
\2\ The record consists of the CSCE's petition and amendment
thereto and supporting and supplemental documents, the November 1994
audit trail accuracy and sequencing tests conducted by the Exchange
that were designed and reviewed by the Commission, dual trading
surveillance, windows data and customer identification information,
and documents submitted by the Exchange in support of a rule
enforcement review of the Exchange presented to the Commission on
September 30, 1996.
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Subject to CSCE's continuing ability to demonstrate that it meets
applicable requirements, in particular, appropriately investigating
potential trading to disadvantage a customer order and passing a
Commission re-test of the performance of the Exchange's audit trail
system in January 1998, 3 the Commission specifically finds
that CSCE maintains a trade monitoring system which is capable of
detecting and deterring, and is used on a regular basis to detect and
to deter, all types of violations attributable to dual trading and, to
the full extent feasible, all other violations involving the making of
trades and execution of customer orders, as required by Section 5a(b)
and Commission Regulation 155.5. The Commission further finds that
CSCE's trade monitoring system includes audit trail and recordkeeping
systems that satisfy the Act and regulations. 4 In assessing
the Exchange system, the Commission has considered that system as a
whole.
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\3\ In this connection, the Commission will review the CSCE's
implementation of the upgrade to its electronic Ring Reporter System
to include entry of the selling broker's identity to enhance
matching of time and sales prints to specific trades. Subsequent to
the CSCE committing to undertake this audit trail improvement, it
became one of the changes offered by the Exchange in order to be
found by the Commission to be within a safe harbor with respect to
the enhanced independence and sequencing requirements of Section
5a(b)(3) of the Act, which became effective in October 1995. Among
other things, such an upgrade can provide improved calibration of
the Exchange's imputed timing system based on independent
observations of trades verifying attributed times. At the time that
the Commission informed the Exchange that it qualified for a safe
harbor, the Exchange had represented that it would implement the
upgrade in the second quarter of 1996. The Exchange has represented
in connection with updating its petition that it will commence a
test pilot in July 1997.
\4\ Sections 4j(a)(3) and 5a(b) of the Commodity Exchange Act
and Commission Regulations 1.35 and 155.5, 17 CFR Secs. 1.35, 155.5.
Section 4j(a)(3) requires the Commission to exempt a contract market
from the prohibition against dual trading, either unconditionally or
on stated conditions, upon finding that the trade monitoring system
in place at the contract market satisfies the requirements of
Section 5a(b), governing audit trails and trade monitoring systems,
with regard to violations attributable to dual trading at such
contract market. Commission Regulation 155.5 requires a contract
market to demonstrate that its trade monitoring system is capable of
and is used to detect and to deter dual trading abuses and to
demonstrate that it meets each element required of the components of
such a system.
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With respect to each required component of the trade monitoring
system, the Commission finds as follows:
1(a) Physical Observation of Trading Areas
CSCE's trade monitoring system satisfies the requirements of
Section 5a(b)(1)(A) in that CSCE maintains and executes an adequate
program for physical observation of Exchange trading areas and
integrates the information obtained from such observation into its
compliance programs. The Exchange physically observes trading areas by
conducting daily floor surveillance during the open, close, and at
random times during each trading day. CSCE also performs floor
surveillance when warranted by special market conditions, such as
exceptional volatility or contract expirations. The Exchange uses
information obtained from such surveillance in evaluating audit trail
data and otherwise in executing its compliance programs.
(b) Audit Trail System
The Exchange's trade monitoring system satisfies the audit trail
standards of Section 5a(b)(1) in that it is capable of capturing
essential data on the terms, participants and sequence of transactions.
The system obtains relevant data on unmatched trades, errors and
outtrades as required by Section 5a(b)(1) of the Act. The Commission
further finds that CSCE accurately and promptly records the essential
data on terms, participants, times (in increments of no more than one
minute in length) and sequence through a means that is unalterable,
continual, independent, reliable and precise, as required by Section
5a(b)(3) of the Act. Consistent with the guidelines to Regulation
155.5, the Commission finds that CSCE also demonstrated the use of
trade timing data in its surveillance systems for dual trading-related
and other abuses.
(1) One-Minute Execution Time Accuracy and Sequencing
CSCE's trade timing system imputes a one-minute execution time for
every trade.5 Trade times are imputed based upon time and
sequencing data entered by both buyers and sellers for customer and
proprietary trades, including trading card and line order entry
sequence numbers, certain execution times required to be manually
entered, time and sales data and 30-minute bracket codes.6
The manually-recorded time for the first trade on the card provides a
starting reference point for each subsequent trade on that card. The
ending reference point is derived from the next verified manually-
recorded time following the trade, either on the same card or the first
time on the next trading card.
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\5\ An imputed timing system does not capture the actual trade
execution time but derives a time from other timing and trade data.
As the Commission previously has noted with respect to audit trail
generally, its tests have focused on assessing the consistency of
the underlying trade data with execution times submitted according
to Commission Regulation 1.35(g) ``because there is no benchmark for
determining actual execution times and sequence.'' Commission Report
on Audit Trail Accuracy and Sequencing Tests at 5 (June 1995).
\6\ CSCE does not use order ticket timestamp data in the
processing logic for imputing times. Instead, the system attempts to
obtain and use a time and sales print for all trades, extensive
sequencing data (such as line numbers) and the various required
manually entered times to impute trade execution times. Order ticket
entry and exit times have been verified in the course of tests of
the CSCE audit trail as being consistent with imputed times. CSCE's
planned enhanced system would add third party confirmation of the
selling broker's identity in a majority of cases, thereby further
ratifying sequence information.
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The November 1994 audit trail tests designed and reviewed by the
Commission and conducted by the Exchange 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 CSCE's imputed system were computed.
The level of consistency and verifiability of imputed times with
underlying documentation sorted by the computer algorithm exceeded 90
percent. Additionally, the time imputed by the system was within a
window length of two minutes or less for more than 90 percent of the
trades deemed accurate.7 More recently, data
[[Page 37565]]
for April 1997 reflect window lengths of two minutes or less for more
than 90 percent of all trades in the affected contract market.
Separately, the Exchange provided the Commission with the results of
four Audit Trail System reviews conducted during the period of
September 1995 through December 1996 demonstrating that more than 90
percent of trade times in three different futures contracts were
consistent with time and sales data during this time
period.8
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\7\ To the extent that the time imputed by a computer algorithm
is consistent with required trade documentation, time and sequence
data and time and sales information for the subject trade and
surrounding trades, and the imputed time falls within a two-minute
level of precision as measured by the size of the final time window
assigned by such algorithm, that imputed time will be considered to
be reliable and precise under Commission test procedures.
\8\ This is a less stringent measure than the full
reconciliation with underlying manual information and records that
will be accomplished by Commission staff during the course of the
audit trail re-test.
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(2) Unalterable, Continual, Independent, Reliable, and Precise Times
The Commission finds that trade records generated by CSCE,
including order tickets and trading cards, are recorded in nonerasable
ink and that alterations are completely recorded. Trading card
collections occur within 15 minutes after each half-hour time bracket,
and members must submit trade data by one-half hour after the end of
the bracket period in which the trade was executed. Trade data,
therefore, are provided periodically to the Exchange at no more than
hourly intervals, which is continual.
Trade times are independently obtained through a reliable means, to
the extent practicable. Specifically, trade time and sequence data,
which include separate entries by buying and selling brokers or
traders, are entered into an electronic data base which then sorts all
relevant data pursuant to a computer algorithm.9
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\9\ The enhanced Ring Reporter System will further improve the
Exchange's level of compliance with the Act's standards of
independence, continual provision of timing data and precise
sequencing.
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(3) Broker Receipt Time
The Commission finds that it is not practicable at this time for
CSCE to record the time that each order is received by a floor broker
for execution at CSCE.
(c) Recordkeeping System
CSCE satisfies the requirements of Section 5a(b)(1)(B) by
maintaining an adequate recordkeeping system that is capable of
capturing essential data on the terms, participants, and sequence of
transactions. The Exchange uses such information and information on
violations of such requirements on a consistent basis to bring
appropriate disciplinary actions.
CSCE conducts trading card and order ticket reviews three times a
year for a representative sample of customer orders and personal trades
and uses information from these reviews to generate investigations. The
Commission's review of a sample of order ticket account identifiers
demonstrated in excess of 95 percent compliance with the requirement
that the account identifier relate back to the ultimate customer
account.
(d) Surveillance Systems and Disciplinary Actions
As required by Sections 5a(b)(1) (C), (D) and (F), in general CSCE
uses 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. In addition, CSCE assesses meaningful penalties
against violators and refers appropriate cases to the Commission.
On a daily basis, CSCE's different management information system
programs analyze trade data to detect possible instances of dual
trading-related and other trading abuses. Systems are designed to
permit subjection of all relevant trade data to these reviews. The
computerized exception reports generated by the Exchange are designed
to identify such suspicious trading activity as accommodation trading,
including direct and indirect trading against, direct and indirect
trading ahead, and improper cross trading.10 Investigators
can design customized exception reports to identify certain specific
trading activity to isolate suspicious trading patterns, to filter and
to sort data within reports and to expand review activities.
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\10\ On a recent date, for example, CSCE's trading ahead
reviews, which isolate brokers receiving better prices than
customers fairly contemporaneously, identified .493 percent of
trades in all futures and futures option contracts for further
review.
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During the period of September 1995 through December 1996, the
Exchange initiated 181 investigations and/or reviews into all types of
possible abuses. Based on examination of its computerized surveillance
reports, CSCE initiated 87 dual trading-related investigations during
that period, of which seven resulted in referrals to the BCC. With
regard to disciplinary actions, CSCE assessed $65,175 in fines and
ordered $1,926.40 in restitution in eleven dual trading-related cases
involving 14 members.
(e) Commitment of Resources
The Commission finds that CSCE meets the requirements of Section
5a(b)(1)(E) by committing sufficient resources for its trade monitoring
system, including automating elements of such trade surveillance
system, to be effective in detecting and deterring violations and by
maintaining an adequate staff to investigate and to prosecute
disciplinary actions. For fiscal year 1996, CSCE committed 25 personnel
to Compliance and Market Surveillance and reported its total self-
regulatory costs to be $4,113,400. CSCE reported volume for this period
as 11,315,979 contracts and number of trades as 2,084,916.
Accordingly, on this date, the Commission hereby grants CSCE's
Petition for Exemption from the dual trading prohibition for trading in
its Sugar #11 futures contract, subject to the Exchange passing a
Commission re-test of its audit trail system.
For this exemption to remain in effect, CSCE must demonstrate on a
continuing basis that it meets the relevant statutory and regulatory
requirements. The Commission will monitor continued compliance through
review of specific investigations and through its rule enforcement
review program and any other information it may obtain about CSCE's
program. It is the Commission's understanding that CSCE intends to
complete its upgrade to its Ring Reporter System to include the entry
of the selling broker's identity to enhance matching of time and sales
prints to specific trades. Although the Commission has found that CSCE
can meet the standards of continual provision of data, and independence
to the extent practicable, and has found that it is not practicable at
this time to capture a broker receipt time, the Commission reserves the
ability to reconsider what is practicable as technology for order
routing becomes more widely available.
The provisions of this Opinion and Order shall be effective on the
date on which it is issued and shall remain in effect unless and until
it is revoked in accordance with Section 8e(b)(3)(B) of the Commodity
Exchange Act, 7 U.S.C. Sec. 12e(b)(3)(B). If other CSCE contracts
become affected contracts after the date of this Order, the Commission
may expand this Order in response to an updated petition that includes
those contracts.
It is so Ordered.
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Dated: July 8, 1997.
Jean A. Webb,
Secretary to the Commission.
[FR Doc. 97-18370 Filed 7-11-97; 8:45 am]
BILLING CODE 6351-01-P
