[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