[Federal Register Volume 62, Number 140 (Tuesday, July 22, 1997)]
[Notices]
[Pages 39213-39214]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-19177]



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COMMODITY FUTURES TRADING COMMISSION


New York Cotton Exchange 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 New York Cotton Exchange (``NYCE'' or 
``Exchange'') for exemption from the prohibition against dual trading 
in its Cotton No. 2 futures contract.

DATES: This Order is to be effective July 16, 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., NW., Washington, DC 20581; 
telephone (202) 418-5490.

SUPPLEMENTARY INFORMATION: On September 28, 1995, the New York Cotton 
Exchange (``NYCE'' or ``Exchange'') submitted a Petition for Exemption 
from the Dual Trading Prohibition for its Cotton No. 2 futures 
contract. Subsequently, the Exchange submitted a corrected petition and 
an update on November 21, 1995, and March 14, 1997, respectively. Upon 
consideration of these petitions and other matters of record, including 
staff review of Exchange audit trail test results to Commission-
specified tests, 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 during the period of September 1995 through January 1997, 
the Commission hereby finds that NYCE 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 
155.5.1
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    \1\ The record consists of the NYCE's petition and amendment 
thereto and supporting documents, the Commission's January 1997 
audit trail test, dual trading surveillance, customer identification 
information, and documents submitted by the Exchange as part of a 
rule enforcement review of the Exchange initiated by the Commission 
in February 1997.
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    Subject to NYCE's continuing ability to demonstrate that it meets 
applicable requirements, the Commission specifically finds that NYCE 
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, 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 NYCE's 
trade monitoring system includes audit trail and recordkeeping systems 
that satisfy the Act and regulations.2
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    \2\ Sections 4j(a)(3) and 5a(b) of the Commodity Exchange Act 
and Commission Regulations 1.35 and 155.5, 17 CFR Sec. 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:
    (a) Physical Observation of Trading Areas--NYCE's trade monitoring 
system satisfies the requirements of Section 5a(b)(1)(A) in that NYCE 
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. NYCE 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 and outtrades as required by Section 5a(b)(1) of the Act. The 
Commission further finds that NYCE 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 NYCE also demonstrated the 
use of trade timing data in its surveillance systems for dual trading-
related and other abuses.

One-Minute Execution Time Accuracy and Sequencing

    NYCE's manual trade timing system captures a one-minute time for 
both the buy and sell sides of every trade and sequences all customer 
and proprietary trades. In an audit trail test conducted by Commission 
staff in January 1997, the accuracy and sequencing rates of NYCE's 
trade times exceeded 90 percent. Separately, the Exchange provided the 
Commission with four months of data from the period of November 1996 to 
February 1997 demonstrating that more than 90 percent of trade times in 
the cotton futures contract were consistent with time and sales data 
during this time period.

Unalterable, Continual, Independent, Reliable, and Precise Times

    The Commission finds that trade records generated by NYCE, 
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 for clearing within one hour after 
each one-half hour trading period. Trade data, therefore, are provided 
periodically to the Exchange, which is continual.
    Trade times are independently obtained through a reliable means, to 
the extent practicable, since individual times separately submitted for 
each side of a trade can be compared to each other, to underlying trade 
data, and to time and sales. NYCE's trade timing system also produces 
precise sequencing.

Broker Receipt Time

    The Commission finds that it is not practicable at this time for 
NYCE to record the time that each order is received by a floor broker 
for execution at NYCE.
    (c) Recordkeeping System--NYCE satisfies the requirements of 
Section 5a(b)(1)(B) by maintaining an adequate recordkeeping system 
that is able to capture essential data on the terms, participants, and 
sequence of transactions. The Exchange uses such information and 
information on violations of such requirements on a

[[Page 39214]]

consistent basis to bring appropriate disciplinary actions.
    NYCE conducts either annual or quarterly trading card and order 
ticket reviews for a representative sample of customer orders and uses 
information from these reviews to generate investigations. Commission 
staff review of a sample of order ticket account identifiers 
demonstrated 97 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 
Section 5a(b)(1) (C), (D) and (F), NYCE 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, NYCE 
assesses meaningful penalties against violators and refers appropriate 
cases to the Commission.
    On a daily basis, NYCE reviews trade registers and computerized 
surveillance reports to detect dual trading-related and other trading 
abuses. All relevant trade data are included in these reviews. The 
Exchange reviews its trade register daily and surveillance exception 
reports at least three times a week. The exception reports are designed 
to identify such suspicious trading activity as trading ahead, trading 
against, preferential trading (withholding or disclosing orders), 
accommodation trading, prearranged trading, improper cross trading, and 
misallocating orders.\3\
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    \3\ On a recent date, for example, NYCE's trading ahead review, 
which isolates brokers receiving better prices than customers fairly 
contemporaneously, identified one percent of trades in all futures 
and futures option contracts for further review.
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    From September 1995 through January 1997, the Exchange initiated 89 
investigations into all types of possible abuses. Based on examination 
of its computerized surveillance reports, NYCE initiated 48 dual 
trading-related investigations during that period, two of which 
resulted in referral to the Business Conduct Committee. In 1996, NYCE 
assessed $31,000 in fines, suspended a member for 14 days, issued three 
cease and desist orders, and agreed to a voluntary transfer of 
membership in three dual trading-related cases involving three members.
    (e) Commitment of Resources--The Commission finds that NYCE 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, NYCE expended $1,039,729 in salaries for self-regulatory 
personnel and reported its total self-regulatory costs to be 
$2,712,516. NYCE reported volume for this period as 6,228,285 
contracts.
    Accordingly, on this date, the Commission Hereby Grants NYCE's 
Petition for Exemption from the dual trading prohibition for trading in 
its Cotton No. 2 futures contracts.
    For this exemption to remain in effect, NYCE must demonstrate on a 
continuing basis that it meets the relevant statutory and regulatory 
requirements. The Commission will monitor continued compliance through 
its rule enforcement review program and based on any other information 
it may obtain about NYCE's program. Although the Commission has found 
that NYCE meets the standards of independence and continual provision 
of data 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 and trade reporting becomes more widely 
available.
    The provisions of this 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 NYCE 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.

    Dated: July 16, 1997.
Jean A. Webb,
Secretary to the Commission.
[FR Doc. 97-19177 Filed 7-21-97; 8:45 am]
BILLING CODE 6351-01-P