[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