    Futures Markets: Heightened Audit Trail Standards Not Met But Progress
    Continues (Letter Report, 09/25/96, GAO/GGD-96-177).

    Pursuant to a congressional request, GAO provided information on the
    Commodity Futures Trading Commission's (CFTC) actions to enforce Futures
    Trading Practices Act (FTPA) audit trail provisions.

    GAO found that: (1) 7 U.S. futures exchanges are in compliance with FTPA
    1-minute trade timing and sequencing standards; (2) CFTC is unable to
    determine the status of four other exchanges until it reviews the
    results of the audit trail tests; (3) audit trail test results for the
    Chicago Board of Trade (CBT) and the Chicago Mercantile Exchange (CME)
    are not precise enough to verify their compliance with existing audit
    trail standards; (4) none of the exchanges fully complied with the
    heightened audit trail standards as of October 28, 1995; (5) CFTC has
    delayed requiring some audit trail enhancements to existing systems due
    to assurances that electronic trading terminals would be in place by the
    statutory deadline; (6) CFTC has granted the Coffee, Sugar & Cocoa
    Exchange and the New York Mercantile Exchange temporary relief from the
    FTPA statutory deadline; (7) CBT and CME were not in compliance with the
    heightened FTPA guidelines after additional retests; (8) CFTC has not
    determined the practicability of certain FTPA provisions, including the
    requirement to capture broker receipt time for customer orders; (9) CFTC
    plans to act on exchange petitions for exemption from the dual trading
    ban; and (10) CFTC needs to keep Congress informed of its actions to
    facilitate additional FTPA audit standards.

    --------------------------- Indexing Terms -----------------------------

     REPORTNUM:  GGD-96-177
         TITLE:  Futures Markets: Heightened Audit Trail Standards Not Met
                 But Progress Continues
          DATE:  09/25/96
       SUBJECT:  Commodities exchanges
                 Securities regulation
                 Commodity futures
                 Brokerage industry
                 Securities fraud
                 Auditing standards
                 Self-regulatory organizations
                 Audit oversight
                 Noncompliance
                 Reporting requirements

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    Cover
    ================================================================ COVER

    Report to Congressional Requesters

    September 1996

    FUTURES MARKETS - HEIGHTENED AUDIT
    TRAIL STANDARDS NOT MET BUT
    PROGRESS CONTINUES

    GAO/GGD-96-177

    Audit Trail Standards

    (233462)

    Abbreviations
    =============================================================== ABBREV

      CBT - Chicago Board of Trade
      CFTC - Commodity Futures Trading Commission
      CME - Chicago Mercantile Exchange
      COMEX - Commodity Exchange, Inc.
      CSCE - Coffee, Sugar & Cocoa Exchange
      FTPA - Futures Trading Practices Act of 1992
      NYCE - New York Cotton Exchange
      NYMEX - New York Mercantile Exchange

    Letter
    =============================================================== LETTER

    B-261761

    September 25, 1996

    The Honorable Richard G.  Lugar
    Chairman
    The Honorable Patrick J.  Leahy
    Ranking Minority Member
    Committee on Agriculture, Nutrition,
     and Forestry
    United States Senate

    The Honorable Pat Roberts
    Chairman
    The Honorable E (Kika) de la Garza
    Ranking Minority Member
    Committee on Agriculture
    House of Representatives

    In August 1989, the Department of Justice, in cooperation with the
    Commodity Futures Trading Commission (CFTC), conducted an undercover
    investigation at the Chicago Board of Trade (CBT) and the Chicago
    Mercantile Exchange (CME).  The investigation disclosed illegal
    trading practices designed to enrich participants.  In a September
    1989 report to Congress,\1 we concluded that most of the types of
    illegal practices disclosed could have been detected with improved
    audit trails--the physical records of the price and time of each
    trade.\2 We recommended that CFTC heighten audit trail standards by
    requiring a more accurate and comprehensive record of trades.
    Congress incorporated the then existing audit trail standards, as
    well as heightened standards, in the Futures Trading Practices Act
    (FTPA) of 1992 (P.L.  102-546).  The FTPA required that, not later
    than 2 years after its enactment, CFTC report to Congress on the
    progress of U.S.  futures exchanges in meeting the audit trail
    standards and include recommendations on the appropriateness of
    extending the October 28, 1995, deadline for meeting the standards or
    for modifying them.  CFTC addressed two issues in its November 1994
    report to Congress:  (1) exchange compliance with the existing trade
    timing standards and (2) exchange progress toward complying with the
    heightened standards.\3 CFTC did not recommend any extension of time
    or modification to the standards.  The FTPA further required that we
    report our views on the issues CFTC addressed in its report.  As
    agreed with your committees, our objectives were to report on the
    status of exchange compliance with the existing and heightened
    standards as well as CFTC actions to enforce the FTPA audit trail
    provisions.

    --------------------
    \1 Futures Markets:  Strengthening Trade Practice Oversight
    (GAO/GGD-89-120, Sept.  7, 1989).

    \2 An audit trail generally consists of customer order tickets and
    timestamps, trading cards, trade execution times, and exchange
    records of price changes.

    \3 Report to Congress on Futures Exchange Audit Trails (CFTC, Nov.
    1994).

       BACKGROUND
    ------------------------------------------------------------ Letter :1

    Futures contracts obligate the holder to buy or sell a specific
    amount or value of an underlying asset, reference rate, or index
    (called the underlying)\4 at a specified price on a specified future
    date.  This obligation can be met through delivery of the underlying
    or by cash settlement.  Futures contracts are designed to manage the
    risk of changes in the value of underlying assets, rates, and indexes
    by allowing market users to economically replicate investments in
    them.  By buying and selling futures, users can either assume or
    transfer the risk of price fluctuations.  The futures markets also
    serve a price discovery function by establishing a price at which a
    buyer and seller will complete a transaction.  These prices are often
    used in setting the terms of other contracts.

    Futures contracts are bought and sold at centralized auction markets
    called exchanges.  In the United States, futures contracts are
    usually traded through a competitive system, called "open-outcry," in
    which floor participants verbally make bids and offers to each other
    at centralized exchange locations, called "trading pits or rings."\5
    Two types of floor participants execute trades in these pits--floor
    brokers and floor traders.  Floor brokers execute trades for
    customers and may also execute trades for their personal or employer
    accounts.  In contrast, floor traders execute trades only for their
    personal accounts.

    According to industry officials, U.S.  futures markets are largely
    used by institutions rather than individual "retail" investors.
    These institutions include banks, insurance companies, mutual funds,
    corporate pension plans, large corporations, and various federal,
    state, and local governmental entities.  Institutional users expect
    near instantaneous execution of their orders to secure targeted
    prices, especially when price movements in the futures markets become
    rapid.  Delays in order execution can increase the risk of a user not
    obtaining a targeted price ("price slippage") and can thereby affect
    the success of the user's market strategy.

    The U.S.  futures markets are self-regulated by the 11 active futures
    exchanges,\6 with CFTC providing federal oversight.  Weaknesses in
    controls over futures trading can provide dishonest floor
    participants with the opportunity to cheat customers and to conceal
    this cheating by manipulating the recorded price and time of trades.
    The FTPA requires that each exchange maintain and use controls to
    monitor trading in order to deter and detect such illegal activities.
    These controls must include audit trail systems that capture
    essential data on trade participants, terms, times, and sequencing.

    CFTC audit trail standards in effect prior to the enactment of the
    FTPA required that exchange audit trail systems (1) assign trade
    times accurate to within 1 minute of trade execution--referred to as
    the 1-minute trade timing standard and (2) sequence trades for each
    floor broker and floor trader.  All U.S.  futures exchanges were
    required to comply with these standards.  They were subsequently
    written into the FTPA along with the heightened standards, which
    required that audit trail data be continually provided to the
    exchange in an unalterable manner and that it be precise, complete,
    and independent.\7

    The FTPA made compliance with most of the heightened requirements
    subject to a CFTC determination on the practicability of
    implementation.  Also, exchanges having a minimum average daily
    trading volume of less than 8,000 contracts in each of its contract
    markets could qualify for an exemption from the heightened standards
    if they could demonstrate substantial compliance with the act's audit
    trail standards and trade monitoring requirements.

    In November 1994, five exchanges were covered by the heightened
    standards because of their trading volume:  (1) CBT; (2) CME; (3) the
    Coffee, Sugar & Cocoa Exchange (CSCE); (4) the Commodity Exchange,
    Inc.  (COMEX); and (5) the New York Mercantile Exchange (NYMEX).  As
    of the quarter ended on September 30, 1995, a sixth exchange--the New
    York Cotton Exchange (NYCE)--exceeded the minimum volume criteria and
    became subject to these standards.  Because it had just recently
    become subject to the standards, in October 1995, CFTC gave the
    exchange additional time to demonstrate good faith progress towards
    compliance with them.\8 CFTC plans to test NYCE's audit trail system
    beginning in October 1996.  As a result, this report does not discuss
    NYCE compliance with the heightened standards.

    Futures exchanges use one of four types of systems to meet audit
    trail standards--manual, imputed timing, pit card timestamping, and
    computer trade matching.  Five of the 11 active U.S.  futures
    exchanges use manual systems to record trade times--COMEX, the Kansas
    City Board of Trade, the Minneapolis Grain Exchange, NYCE, and the
    New York Futures Exchange.  Under these systems, floor traders and
    brokers manually record the time of all trades in sequence on trading
    cards.  Four active exchanges--CBT, CME, CSCE, and the MidAmerica
    Commodity Exchange--use imputed timing systems.  These systems use
    computer-based algorithms to assign times to trades after they have
    occurred.  They use information from audit trail documentation,
    including data recorded by floor traders and brokers and data
    generated independently of them.\9 NYMEX is the only exchange using
    the pit card system.  Under this system, the exchange assigns a time
    to each trade by timestamping a card that the seller is required to
    submit within 1 minute of trade execution.  Finally, one active U.S.
    exchange, the Philadelphia Board of Trade, uses computers to match
    and execute trades.\10

    Electronic systems for meeting audit trail requirements are currently
    under development--including an electronic hand-held trading terminal
    and electronic order routing systems.  Although the FTPA does not
    mandate the use of any particular system to meet the heightened
    standards, Congress knew that three exchanges--CBT, CME, and
    COMEX--had voluntarily committed to developing electronic hand-held
    trading terminals when it considered the legislation.  The exchanges
    expected that these electronic terminals would help meet the FTPA
    audit trail standards and also reduce costs by, among other things,
    reducing trading errors and administrative expenses.  The FTPA
    legislative history indicates that Congress encouraged CFTC not to
    require fundamental changes to existing audit trail systems if doing
    so would cause disproportionate expense or might delay implementation
    of electronic systems.\11

    Under the FTPA, an exchange ultimately must demonstrate compliance
    with the act's audit trail standards to continue acting as a market
    in futures contracts.  The act provides CFTC with the authority to
    issue a deficiency order should an exchange fail to comply with its
    audit trail standards.  The act also sets forth conditions under
    which dual trading\12 will be banned in high-volume markets.
    However, it allows CFTC to grant an exemption from the ban to an
    exchange that can show, among meeting other requirements, that it
    complies with the act's audit trail standards.  All exchanges covered
    by the ban have filed petitions for an exemption, and these petitions
    are still pending.  Because the ban on dual trading takes effect when
    CFTC acts to deny an exchange exemption petition, the ban has yet to
    take effect on any covered exchange.\13

    --------------------
    \4 The underlyings include agricultural and other physical
    commodities, bonds, interest rates, currency exchange rates, and
    stock indexes.

    \5 Some exchanges also use computerized trading systems that operate
    during and/or outside regular exchange hours.

    \6 A twelfth U.S.  futures exchange, the AMEX Commodities
    Corporation, is inactive.

    \7 See page 9 for further details on the heightened standards.

    \8 At this time, CFTC also addressed the status of the four active
    low-volume exchanges that were eligible for exemption from the
    heightened audit trail standards.  It exempted three exchanges from
    the standards--the Kansas City Board of Trade, the New York Futures
    Exchange, and the Philadelphia Board of Trade--and deferred a
    decision on the Minneapolis Grain Exchange until its trade monitoring
    system was improved.

    \9 Although exchange systems differ, data used to impute times
    include exchange records of price changes, preprinted trading card
    and line-sequence numbers, manually-recorded execution times for
    certain trades, time bracket designations, and order ticket
    timestamps.

    \10 If active, the AMEX Commodities Corporation would also use
    computers to match and execute trades.

    \11 See 138 Cong.  Rec.  S17,868 (daily ed.  Oct.  8, 1992)
    (statement of Sen.  Leahy).

    \12 Dual trading allows floor brokers to trade for their own and
    customer accounts in the same trading session.

    \13 CME, however, voluntarily banned dual trading in all of its
    high-volume contract months about 1-1/2 years before the enactment of
    the FTPA.

       RESULTS IN BRIEF
    ------------------------------------------------------------ Letter :2

    Regarding the status of exchange compliance with the existing
    standards, CFTC stated in its November 1994 report to Congress that 7
    of 11 U.S.  futures exchanges\14 were in compliance with the existing
    1-minute trade timing and sequencing standards.  CFTC stated that it
    could not determine the status of the remaining four exchanges--CBT,
    CME, CSCE, and NYMEX--until it reviewed the results of audit trail
    tests that it directed the exchanges to conduct.  CFTC reported in
    June 1995\15 that, of the trade times assigned by the audit trail
    systems of the four exchanges tested, CBT and CME test results were
    not precise enough to verify compliance with the existing standards.
    CFTC reported in August 1996 that the results of March 1996 retests,
    although improved, were still not precise enough to verify compliance
    with the existing standards.\16

    Regarding the status of exchange compliance with the heightened
    standards, CFTC did not find that any exchange fully complied with
    the heightened audit trail standards as of the October 28, 1995,
    statutory deadline.  Consistent with congressional intent, CFTC had
    delayed requiring some audit trail enhancements to existing systems
    based on exchange assurances that electronic trading terminals would
    be in place by the statutory deadline.  However, these systems were
    not operational as of October 28, 1995, and exchange officials raised
    concerns about when they would be fully functional.  In the absence
    of electronic trading terminals and considering audit trail test
    results, in June 1995, CFTC required CBT, CME, CSCE, and NYMEX to
    make additional improvements to their existing systems.  CFTC
    subsequently concluded, based on exchange implementation of these
    improvements, that CSCE and NYMEX had made good faith efforts to
    comply with the heightened standards.  As provided for by the FTPA,
    CFTC determined that these exchanges, as well as COMEX, had qualified
    for a safe harbor and thus for temporary relief from the act's
    statutory deadline.  CFTC did not indicate when this relief would
    expire.  It notified the remaining two exchanges--CBT and CME--that
    further tests of their compliance with the 1-minute trade timing and
    heightened standards were required.  In August 1996, CFTC reported
    that although the March 1996 retest results showed further
    improvements in their audit trails, CBT and CME were not in
    compliance with the heightened standards.  CFTC did not address
    whether the exchanges had made a good faith effort to comply with the
    act and thereby qualified for a safe harbor.  Instead, it gave them
    until January 1, 1997, to make further improvements.  In addition,
    CFTC acknowledged that it has not yet determined the practicability
    of certain provisions of the act, including the requirement to
    capture the broker receipt time for customer orders.  CFTC also
    reported that it plans to act on exchange petitions for exemption
    from the dual trading ban, beginning with COMEX in September 1996.

    CFTC is responsible for ensuring exchange compliance with the audit
    trail provisions of the FTPA and has taken steps to do so.  CFTC
    tested exchange audit trail systems to assess compliance and, where
    they were found to be deficient, required the exchanges to implement
    improvements.  In the absence of full compliance, CFTC identified the
    exchanges that had made good faith efforts to comply, as provided for
    in the act.  Also, the exchanges we reviewed agreed to implement
    almost all of the improvements that CFTC recommended in June 1995.
    Finally, in August 1996, CFTC reported on its additional plans for
    enforcing compliance with the heightened standards.  Thus far,
    however, CFTC has not found any covered exchange to be in full
    compliance with the FTPA heightened audit trail standards.  In
    addition, full implementation of electronic trading terminals is
    uncertain, questions about the practicability of certain of the
    heightened standards remain, and the dual trading provisions of the
    act have not been fully implemented.  Congress has been kept informed
    of the status of compliance with the act's audit trail provisions, at
    least in part, as a result of the reporting requirement and statutory
    deadline established by the act.  However, these have now expired.
    Ensuring that Congress continues to be kept informed of exchange
    progress and CFTC actions to facilitate that progress could be
    pivotal to securing eventual compliance with the act's audit trail
    standards.

    --------------------
    \14 CFTC included the AMEX Commodities Corporation, the inactive
    exchange, in its report.  CFTC excluded the MidAmerica Commodity
    Exchange--a subsidiary of CBT--because this exchange uses the same
    audit trail system as CBT.

    \15 Report on Audit Trail Accuracy and Sequencing Tests (CFTC, June
    1995).

    \16 Report on Audit Trail Status and Re-Tests (CFTC, Aug.  1996).

       OBJECTIVES, SCOPE, AND
       METHODOLOGY
    ------------------------------------------------------------ Letter :3

    To report on the status of exchange compliance with the existing and
    heightened standards and CFTC actions to enforce the FTPA audit trail
    provisions, we reviewed CFTC's (1) November 1994 report to Congress
    on audit trails; (2) June 1995 report on the results of exchange
    audit trail testing; (3) November 3, 1995, letters to four exchanges
    with agency conclusions related to their good faith efforts to comply
    with the FTPA; (4) August 1996 report on the status of exchange audit
    trail compliance and the results of further exchange audit trail
    testing; (5) other relevant CFTC studies and reports; and (6) the
    legislative history of the FTPA.  We interviewed officials at CFTC
    headquarters in Washington, D.C., and at CFTC's Central Regional
    Office to discuss the FTPA audit trail standards and CFTC efforts to
    evaluate exchange compliance with them.  We also interviewed CBT,
    CME, CSCE, and NYMEX officials to discuss their views on the
    standards and their efforts to comply with FTPA and CFTC
    requirements.  We chose these four exchanges because CFTC selected
    them for initial audit trail testing.  We also reviewed documents
    from these exchanges that described their audit trail systems and the
    results of exchange audit trail testing.

    We conducted our audit work between March 1995 and August 1996,
    primarily in Washington, D.C., and Chicago, in accordance with
    generally accepted government auditing standards.  We obtained
    written comments on a draft of this report from CFTC, CBT, CME, and
    CSCE.  These comments are discussed at the end of this letter and are
    reprinted in appendixes II through V.  CFTC, CBT, CME, CSCE, and
    NYMEX provided additional technical comments on the draft report,
    which were incorporated as appropriate.

       CFTC COULD NOT DETERMINE CBT OR
       CME COMPLIANCE WITH THE
       1-MINUTE TRADE TIMING STANDARD
    ------------------------------------------------------------ Letter :4

    CFTC could not determine whether CBT or CME--the two largest futures
    exchanges--complied with the 1-minute trade timing standard before
    issuing its November 1994 report to Congress or after subsequent
    testing of their audit trail systems.  Before issuing its November
    1994 report, CFTC required the exchanges to submit documentation of
    their audit trail systems' compliance with the FTPA audit trail
    standards.  On the basis of this and other evidence, CFTC found that
    7 of 11 exchanges were in compliance with the 1-minute trade timing
    and sequencing standards.  CFTC concluded that the remaining four
    exchanges--CBT, CME, CSCE, and NYMEX\17 --had not yet proven their
    audit trail systems met the standards.  CFTC also required these
    exchanges to conduct two tests in 1994 to measure the capabilities of
    their audit trail systems.  The first test addressed compliance with
    the 1-minute trade timing and sequencing standards and required that
    at least 90 percent of sampled trade execution times be consistent
    with the timing information and sequence recorded on supporting trade
    documents.\18 CFTC conducted another round of comparable tests at CBT
    and CME in March 1996.

    CFTC reported in June 1995 that CBT and CME test one results were too
    imprecise to verify compliance with the 1-minute trade timing
    standard.  These two exchanges use computer-based algorithms to
    impute or estimate trade execution times after the fact.  The
    computer, based on timing information recorded on trade
    documentation, calculates a span of time, or timing window, during
    which a trade probably took place and then selects a likely execution
    time within that window.  For exchanges with imputed timing systems,
    CFTC required, as part of the test, that the average length of the
    timing windows be 2 minutes or less to approximate the 1-minute trade
    timing standard.\19 Although 90 percent of imputed trade times of
    sampled trades at CBT and CME were found to be accurate (i.e.,
    consistent with the supporting documentation), the length of many
    timing windows was in excess of 2 minutes.  At CBT, 41 percent of the
    accurate trade times had timing windows of 2 minutes or less.  At
    CME, 72 percent of the accurate trade times had timing windows of 2
    minutes or less.  CFTC concluded that these results were too
    imprecise to verify compliance with the 1-minute trade timing
    standard and later, as discussed on page 12, recommended that CBT and
    CME implement numerous audit trail improvements.  The March 1996
    retests at CBT and CME showed that these numbers had improved to 69
    percent and 80 percent, respectively, but were still short of the
    90-percent precision level CFTC sought.

    Test one results at both CSCE and NYMEX exceeded the 90-percent
    accuracy requirement.  Further, at CSCE, which also uses an imputed
    trade timing system, 91 percent of these accurately timed trades had
    timing windows of less than 2 minutes, thus meeting the accuracy
    requirement.  At NYMEX, however, the sequence of trades determined by
    times stamped on pit cards by exchange employees was often different
    from the sequence recorded by traders and brokers on trading
    cards.\20 NYMEX is addressing this problem with a new integrated
    trading/pit card.  (See app.  I for details.)

    --------------------
    \17 These were four of the five exchanges covered by the heightened
    standards at that time.  CFTC did not require the fifth
    exchange--COMEX--to test its audit trail system, because it provided
    documentation of its compliance with the 1-minute trade timing
    standard.

    \18 The second test is discussed in the next section of this report.

    \19 A trade time selected from within a 2-minute or shorter window
    was considered likely to be within 1 minute of the actual time of
    execution as required by the 1-minute trade timing standard.

    \20 NYMEX does not use an imputed timing system, so timing windows do
    not apply.

       CFTC HAS NOT FOUND ANY EXCHANGE
       IN FULL COMPLIANCE WITH THE
       HEIGHTENED STANDARDS, BUT FOUND
       THAT PROGRESS CONTINUED TO BE
       MADE
    ------------------------------------------------------------ Letter :5

    The heightened standards required additional improvements to exchange
    audit trails.  As of October 28, 1995, when the standards took
    effect, the electronic trading terminals that exchanges had begun to
    develop that might bring some exchanges into compliance with them
    were not fully operational, and significant delays were envisioned.
    In the absence of the terminals, CFTC did not find any of the
    exchanges covered by the heightened standards to be in full
    compliance with them.\21 Given this situation, the statute required
    that CFTC consider any circumstances that prevented compliance
    despite an exchange's good faith effort--thus qualifying an exchange
    for a statutory safe harbor.  COMEX received a de facto determination
    that it had made a good faith effort in November 1994, when CFTC
    determined its manual audit trail system did not require testing.  In
    November 1995, based on exchange audit trail test results and
    implementation of recommended audit trail improvements, CFTC notified
    CSCE and NYMEX that they had qualified for a safe harbor but deferred
    a decision on CBT and CME until further testing.  CFTC reported in
    August 1996 that, although the results of further testing showed
    considerable improvements, CBT and CME did not demonstrate compliance
    with the heightened standards.  CFTC gave the exchanges until January
    1, 1997, to make further improvements.  In addition, CFTC has yet to
    address the practicability of certain of the audit trail provisions
    of the act, including the broker receipt timing requirement, but
    agency officials told us that CFTC plans to do so.  It also plans to
    act on exchange petitions for exemption from the dual trading ban
    beginning in September 1996.

    --------------------
    \21 As discussed in the background section of this report, six
    exchanges were covered by the heightened standards as of the
    statutory deadline.  Only five of these exchanges are discussed below
    because CFTC does not plan to assess NYCE's compliance with the
    heightened standards until October 1996.

          THE HEIGHTENED STANDARDS
          REQUIRE IMPROVED AUDIT
          TRAILS
    ---------------------------------------------------------- Letter :5.1

    In addition to meeting the requirements of the existing 1-minute
    trade timing and sequencing standards, including capturing the
    essential data on the participants, terms, times, and sequencing of
    all trades, the heightened standards require that this information be
    continually provided to the exchange in an unalterable manner and
    that it be precise, complete, and independent.  Continually providing
    data to an exchange could reduce the opportunity for floor brokers
    and traders to illegally alter the trading record.\22 The requirement
    that the data be unalterable is to prevent floor brokers or traders
    from changing a trading record without detection.

    Also, while existing CFTC regulations required exchanges to sequence
    trades, the act requires exchange audit trail systems to be
    sufficiently precise to determine, to the extent practicable, the
    sequence of all trades by each floor trader and floor broker.  Exact
    trade sequencing would help detect trading abuses, such as trading
    ahead of customer orders.\23 In addition, the FTPA now requires the
    exchanges to obtain, to the extent practicable, more complete timing
    information for customer orders, including the time an order is
    received on the exchange floor, received by the floor broker for
    execution, and reported from the floor as executed.  More complete
    times could also improve an exchange's ability to accurately sequence
    trades.

    Finally, the act requires that the execution time for each trade be
    recorded independently of the person making the trade or derived
    through automatic or other similarly reliable means.  Independent or
    automatic trade recording could increase the reliability of the data
    collected by preventing the broker or trader from falsifying the
    record.  The FTPA made compliance with this and most of its other
    audit trail requirements subject to a CFTC determination on the
    practicability of implementation.  The FTPA authorized CFTC to defer
    the deadline for compliance with the heightened standards if it
    determined that circumstances beyond the control of an exchange
    prevented compliance, despite affirmative good faith efforts to
    comply.  Also, the act required CFTC to exempt an exchange from the
    heightened standards if the average daily trading volume in each of
    its contract markets was less than 8,000 contracts and if it could
    demonstrate substantial compliance with the act's audit trail
    standards and trade monitoring requirements.

    --------------------
    \22 CFTC officials told us that the word "continual" implies
    periodic, not continuous data provision, and that the current CFTC
    requirement that exchanges collect trading cards and customer order
    tickets within 15 minutes of the end of each exchange-designated
    trading period (which lasts either 15 or 30 minutes, depending on the
    exchange) plus multiple intraday trade matching are forms of
    continual provision of trade data to the contract market.

    \23 Trading ahead occurs when brokers buy (or sell) for their
    personal accounts or an account in which they have an interest, while
    having in hand any executable customer order to buy (or sell) for
    others in the same contract month at the market or at the same price.

          ELECTRONIC TRADING TERMINALS
          WERE NOT FULLY OPERATIONAL
          AND HAVE BEEN SIGNIFICANTLY
          DELAYED
    ---------------------------------------------------------- Letter :5.2

    Three of the exchanges covered by the heightened standards have
    worked on electronic trading terminals for recording and processing
    trades, but none of these terminals is fully operational.  The
    terminals were intended to provide the exchanges with continual and
    unalterable audit trail data that would be more precise, complete,
    and independent.  However, they are limited in their ability to
    create a "perfect" audit trail.  For example, CFTC officials told us
    that data could be altered before being entered into the terminals.
    CME officials also indicated that, while the terminals can record the
    precise time that a floor trader or broker begins to record a trade,
    the floor trader or broker may be forced to delay entering trade
    information in order to execute other customer or personal trades.
    CFTC officials told us that, consistent with the FTPA, the agency has
    never taken the position that electronic trading terminals are the
    only way to meet the heightened standards.  These officials also said
    that the agency will determine the extent to which the terminals
    satisfy the statutory standards based on the particulars of their
    individual design and operation.

    COMEX began developing a hand-held terminal in 1986 for recording and
    timing trades.  NYMEX acquired the rights to this project when it
    merged with COMEX in 1994, making COMEX an operating division.  NYMEX
    subsequently decided not to pursue the project because of
    developmental problems and because it believed that its manual audit
    trail system met the requirements of the FTPA.  After the initial
    results of the CFTC/Department of Justice undercover investigation
    were announced, CBT and CME began a joint venture to automate trade
    recording and timing by developing a hand-held automated data input
    terminal, called AUDIT.  According to CBT and CME, as of June 30,
    1996, they had incurred expenditures of $14.2 million and $9.1
    million, respectively, in external and internal costs to develop
    AUDIT.\24 The exchanges initially told CFTC that AUDIT would be
    operational by the October 28, 1995, statutory deadline for
    implementing the FTPA heightened audit trail standards.  However, CBT
    and CME informed CFTC before the issuance of its 1994 report that
    AUDIT would not be operational by October 1995.  The exchanges have
    since indicated that further delays in implementation would occur and
    that the planned capability of AUDIT to handle customer trades would
    be delayed, perhaps significantly.  CBT officials told us that they
    expect delays in implementing the customer trade processing
    capability of AUDIT because of the need to develop an order routing
    system for a new trading floor that is under construction.  CME
    officials also told us that, although the exchange is continuing with
    its efforts to implement AUDIT, it is now considering the use of
    off-the-shelf technology for customer trade processing because of
    AUDIT software development problems.

    In addition to AUDIT, CBT and CME are developing other electronic
    systems that could enhance audit trails and contribute to compliance
    with the act's provisions.  CBT and CME have jointly developed an
    automated trade order processing system, called TOPS Route.  Both
    exchanges have also developed and continue to enhance universal
    broker work stations, called Electronic Clerk at CBT and CUBS at CME.
    CBT is also developing a booth work station called Computer Order
    Management, Entry, and Timing, or COMET.  TOPS Route rapidly
    transmits orders from a firm's office to its booth on the trading
    floor and records the time that an order is received at the booth and
    the time it is filled.  CUBS and Electronic Clerk organize orders
    received on the floor and provide the time that the broker receives
    an order, the time the order is filled, and the time the broker
    confirms the order fill to the firm's booth on the trading floor.
    COMET provides a mechanism for delivering and receiving order
    information and other messages into and out of the trading pit.
    According to CME, TOPS Route is expected to be implemented for most
    clearing firms,\25 while the extent of CUBS implementation will
    depend on space constraints and the differing needs of brokers.  In
    June 1996, CME began a 6-month pilot program in one of its markets
    under which TOPS Route and CUBS are integrated to form a continuous
    order routing system.  CBT expects TOPS Route and COMET/Electronic
    Clerk to be substantially implemented when its new trading floor
    opens in February 1997.

    These automated order routing systems could enhance audit trails by
    meeting the FTPA requirements for recording the time an order reaches
    the exchange floor, the time the broker receives an order, and the
    time the order fill is recorded.  According to CFTC officials, these
    systems should result in better timing data for orders by augmenting
    existing sequencing information.

    --------------------
    \24 In contrast to CBT, CME's internal costs include only direct
    project costs.

    \25 Clearing firms are members of an exchange clearing house.  All
    trades of nonclearing members must eventually be settled through a
    clearing member.

          CFTC GAVE CBT AND CME
          ADDITIONAL TIME TO IMPROVE
          THEIR AUDIT TRAILS
    ---------------------------------------------------------- Letter :5.3

    CFTC determined that CSCE and NYMEX had made good faith efforts to
    comply with the heightened standards, thus qualifying them for a
    statutory safe harbor.  COMEX was in effect granted a safe harbor in
    November 1994 when it was not required to test its audit trail
    system.  CFTC reported that COMEX had produced evidence that its
    manual system met the 1-minute trade timing standard.  CFTC initially
    deferred a decision on whether CBT and CME had made a good faith
    effort to comply with the heightened standards until after a retest
    of their audit trail systems.  After its March 1996 retests, CFTC
    gave the exchanges additional time to improve their audit trails
    without determining whether they had qualified for a safe harbor.

    To assess progress towards compliance with the heightened standards
    in the absence of electronic systems, in 1994, CFTC required four
    exchanges--CBT, CME, CSCE, and NYMEX--to perform a second test of
    trade sequencing capabilities, using more exacting criteria than were
    used for the first test.  According to CFTC officials, these criteria
    were designed to approximate the precision or enhanced sequencing
    requirements of the heightened standards.  As with the first test,
    CFTC required that 90 percent of sampled trades be accurately
    sequenced.  The test results showed that only CSCE met the 90-percent
    accuracy requirement for all samples tested.  CFTC recommended that
    NYMEX implement 9, CBT implement 17, and CME implement 18 additional
    improvements to their audit trail systems to increase timing
    precision and show progress towards compliance with the heightened
    standards.  Although CSCE passed the test, CFTC recommended that CSCE
    implement six improvements to its audit trail system.  At the same
    time it made these recommendations, CFTC urged the exchanges to
    continue efforts to implement electronic systems.\26 (See app.  I for
    a list of CFTC's recommendations.)

    According to CFTC, prompt implementation of the recommended audit
    trail improvements would demonstrate a good faith effort toward
    meeting the heightened standards.  A finding of good faith would mean
    that an exchange had satisfied the statutory requirement for progress
    and, therefore, was entitled to a safe harbor.  CFTC found that both
    CSCE and NYMEX had made good faith efforts to comply with the
    standards by the statutory deadline.  CSCE agreed to implement all
    but one recommendation.  However, CFTC concluded that this
    recommendation did not relate to trade timing accuracy and,
    therefore, was not material to a good faith finding.  NYMEX agreed to
    implement all but one audit trail recommendation but offered CFTC an
    acceptable alternative.  Both CBT and CME agreed to implement almost
    all of CFTC's audit trail recommendations or offered alternatives.
    CBT declined to implement two of CFTC's recommendations based on
    tests it conducted.  CBT said these tests indicated that the
    recommendations disrupted trading, would increase trade processing
    costs, or would not improve audit trail accuracy.  CBT also offered
    CFTC an acceptable alternative for one recommendation.  CME declined
    to implement one recommendation but informed CFTC that it would
    continue to evaluate the recommendation.  The exchange said it based
    its decision on tests it conducted that indicated the recommendation
    disrupted trading and would increase trade processing costs.  CME
    also offered CFTC an acceptable alternative for one recommendation.
    (See app.  I for details on the exchanges' responses to CFTC's
    recommendations.)

    The CFTC recommendation that both CBT and CME declined to implement,
    based on their tests, was the requirement that floor traders manually
    record the execution time for the first and either sixth or last
    trade on every trading card.  As discussed on page 4, these two
    exchanges use computer-based algorithms to impute trade times after
    the fact, rather than requiring floor traders or brokers to record
    the times that personal or customer trades are executed.\27 CBT
    reported that its own separate tests showed that adding manual times
    to trading cards disrupted trading, increased clearing firms' trade
    processing costs, and resulted in less accurate computer-imputed
    times because traders were unable to record accurate times during
    hectic trading.  CME reported that traders involved in its separate
    test had indicated that recording these times disrupted trading.
    However, CME's tests did not show a reduction in audit trail
    accuracy.  Nonetheless, the exchange expressed concern that this
    requirement would increase trade processing costs for clearing firms
    and could result in delays in execution of customer orders or degrade
    overall market efficiency.

    In November 3, 1995, correspondence, CFTC notified CSCE and NYMEX
    that they had qualified for the statutory safe harbor.  Although CFTC
    did not indicate when the safe harbor would end, CFTC told the
    exchanges that it would retest them to evaluate whether the changes
    they made brought them into compliance with the FTPA audit trail
    standards.  CFTC reported in August 1996 that it plans to assess CSCE
    and NYMEX audit trail improvements during rule enforcement reviews in
    1997.

    CFTC also notified CBT and CME on November 3, 1995, that a decision
    on whether they qualified for the statutory safe harbor would be
    deferred until the results of another round of tests were obtained.
    CFTC tested these exchanges in March 1996 to evaluate the effect of
    the agreed-to improvements on their audit trails.  The agency
    reported in August 1996 that the test results showed improvements in
    the precision of the exchanges' audit trails but that neither
    exchange met the heightened standards.  CFTC did not determine that
    CBT and CME had demonstrated the good faith effort required to be
    granted a safe harbor under the act.  Instead, CFTC gave each
    exchange until October 28, 1996, to report on how they intended to
    improve their audit trails and until January 1997 to implement the
    improvements.

    Implementation of all CFTC recommendations will not necessarily
    result in full compliance with the heightened standards.  CFTC
    reported in June 1995 that the exchanges may need to implement
    additional improvements to their systems to achieve compliance.
    According to CFTC officials, full compliance with the heightened
    standards is an objective against which the exchanges must
    continually be tested as the quality of audit trail data also depends
    on other factors, such as the accuracy of data entry, the integrity
    of pricing data, and the handling of trade errors.  Ultimately, all
    of the exchanges covered by the FTPA heightened standards must comply
    with them or be subject to CFTC disciplinary action unless, as
    discussed next, CFTC finds compliance with a standard impracticable.

    --------------------
    \26 Exchange officials told us that they had either implemented or
    planned to implement and/or test some of the improvements prior to
    CFTC's issuance of the test results and its recommendations in June
    1995.

    \27 CFTC regulations require that trade execution times be captured,
    but do not require floor traders or brokers to manually record them.

          CFTC HAS NOT FULLY ADDRESSED
          THE PRACTICABILITY OF ALL OF
          THE ACT'S PROVISIONS
    ---------------------------------------------------------- Letter :5.4

    Several exchanges have raised concerns about CFTC's obligations under
    the FTPA for determining the practicability of the heightened audit
    trail requirements, including the need to assess the cost of
    compliance as well as to address differences between the exchanges.
    As previously discussed, the act requires CFTC to address the
    practicability of most of the heightened standards and authorizes the
    agency to promulgate standards, in some cases by either rule or
    order.  To date, CFTC has issued guidance on how orders "flashed"
    into a trading pit can satisfy the broker receipt timing requirement
    of the act,\28 but has not addressed the practicability of capturing
    broker receipt times for nonflashed orders.  According to CFTC, its
    June 1995 recommendations to the four exchanges represent guidance on
    how to demonstrate the good faith effort required by the FTPA in the
    absence of full compliance.

    In June 1996, the exchanges testified that the FTPA requirement to
    capture broker receipt time was not currently practicable.\29
    Separately, CBT and CSCE also expressed concern that due to
    differences in trading volume and in the way customer orders are
    routed, trades recorded, and execution times derived, audit trail
    features that are practicable at one exchange may be impracticable at
    another exchange without significantly disrupting trading.  CBT told
    us that the act contemplates that CFTC's practicability determination
    would result from testing its proposed enhancements to audit trails
    and conducting cost-benefit analyses of them.  Both CBT and CME said
    the act contemplates that CFTC would consider the cost of
    enhancements and the effectiveness of reasonable alternatives to
    proposed enhancements.  CSCE was concerned that CFTC make its
    practicability determination on an exchange-by-exchange basis and
    that those determinations consider the financial capability of the
    exchange.

    CFTC officials told us that the agency intends to provide further
    guidance on the practicability of the broker receipt time
    requirement.  They said that determining the practicability of this
    requirement is a dynamic process that will be affected by ongoing
    exchange initiatives to develop automated order routing systems.
    They also said that further dialogue with the exchanges and the floor
    broker community needs to occur before the agency can reach a
    conclusion on the practicability of capturing broker receipt times
    for nonflashed orders and that CFTC has scheduled an industry
    roundtable discussion for October 1996 where this topic will be
    addressed.  CFTC also reported that it plans to address the
    practicability of further integrating customer and personal trades at
    CBT and CME.

    According to CFTC, the FTPA does not require it to conduct a
    cost-benefit analysis of audit trail enhancements.  CFTC reported,
    however, that the cost of achieving a perfect audit trail may be
    prohibitive and that the costs of complying with the heightened
    standards must be taken into account.  Further, the agency reported
    that the act does not specify the method of achieving compliance but
    rather sets forth a performance standard that can be satisfied by any
    means.  CFTC has used testing to determine if exchange enhancements
    bring them into compliance with the act's audit trail standards.  As
    part of this process, CFTC has let the exchanges decide whether to
    implement electronic systems or lower-cost manual measures to meet
    the standards.  CFTC has also accepted certain lower-cost exchange
    alternatives for demonstrating a good faith effort to comply with the
    heightened audit trail standards.  CFTC reported that the agency
    accounted for exchange differences during audit trail testing at the
    four exchanges.  Our review of CFTC recommendations indicated that
    CFTC generally tailored its recommended improvements to each
    exchange.

    --------------------
    \28 CFTC has ruled that flashed orders (that is, orders rapidly
    transmitted to and reported from the trading pit verbally or by hand
    signal) can satisfy the broker receipt time requirement provided that
    certain recordkeeping and enforcement provisions are met.  Flashed
    orders account for anywhere from 60 to nearly 100 percent of CBT and
    CME customer orders in financial contracts.

    \29 "Consolidated Testimony Of The Futures Exchanges Of The United
    States Before The Senate Committee On Agriculture, Nutrition, And
    Forestry," June 5, 1996.  In addition to the four exchanges covered
    by this report, the Kansas City Board of Trade, the Minneapolis Grain
    Exchange, the NYCE, and the subsidiaries of these seven exchanges
    submitted this testimony.

          DUAL TRADING BAN EXEMPTION
          PETITIONS ARE STILL PENDING
    ---------------------------------------------------------- Letter :5.5

    The FTPA set forth conditions under which dual trading in contract
    markets in which the average daily trading volume equals or exceeds
    8,000 contracts would be banned.  The statute also requires that dual
    trading at an exchange be exempted from the ban if the exchange can
    show that it has an effective trade monitoring system that includes
    compliance with the act's audit trail standards.  The FTPA included
    the ban to limit the opportunity for trading abuses to occur.\30 It
    linked an exemption from the ban to compliance with the act's audit
    trail standards because an effective audit trail facilitates the
    detection of trading abuses and, therefore, acts as a deterrent to
    them.

    The dual trading ban was to take effect 30 days after the effective
    date of the dual trading regulations or whenever CFTC acted to deny
    an exchange's exemption petition.  On July 28, 1993, CFTC issued the
    dual trading regulations, which required that a petition for
    exemption from the dual trading ban be supported by evidence that,
    among other things, at least 90 percent of the trade times assigned
    by an exchange audit trail meet the 1-minute trade timing
    standard.\31 The regulations, as required by the FTPA, also suspended
    enforcement of the ban for all exchanges that filed timely exemption
    petitions.  According to the act and regulations, the suspension
    would remain in effect until the agency ruled on the petitions.  The
    FTPA required CFTC to act on an exemption petition within 75 days of
    receipt, or as soon as practicable.  The exchanges covered by the ban
    all filed petitions, but these petitions are still awaiting CFTC
    action.\32 As a result, the exchanges are authorized to continue dual
    trading.\33 CFTC officials told us the agency determined that given
    the relationship between the dual trading ban and compliance with the
    audit trail standards, it was essential to address the status of the
    exchanges' audit trails first.  According to CFTC, it plans to act on
    the exemption petitions, which may be updated to reflect audit trail
    enhancements, beginning with COMEX in September 1996, CBT and CME in
    January 1997, and the remaining exchanges to follow.

    --------------------
    \30 While dual trading can provide benefits, including increasing
    market liquidity, the practice makes it easier for a floor broker to
    take advantage of knowledge about customer trades by trading ahead of
    these orders.

    \31 An exemption petition must also include evidence that the
    exchange's trade monitoring system is sufficient to deter and detect
    trading abuses attributable to dual trading.

    \32 The exchanges covered by the ban are CBT, CME, COMEX, CSCE, NYCE,
    and NYMEX.

    \33 CME is the only exchange to voluntarily ban dual trading.  See
    footnote 13.

       CONCLUSIONS
    ------------------------------------------------------------ Letter :6

    CFTC has taken actions to enforce exchange compliance with the FTPA
    audit trail standards.  Also, the exchanges we reviewed have
    continued to make progress toward compliance with them.  Nonetheless,
    we are concerned that the momentum toward achieving compliance could
    be lost now that the legislatively mandated deadline has passed
    without any covered exchange being found in full compliance.  The
    audit trails of CBT and CME--the two largest futures exchanges--do
    not yet meet the heightened standards.  CFTC also concluded that they
    were insufficiently precise to verify compliance with the 1-minute
    trade timing standard that predates the FTPA.  In addition,
    implementation of electronic trading terminals that have the
    potential to bring these exchanges into compliance with the standards
    is uncertain.  Also, it is not clear when the exchanges currently
    qualifying for the statutory safe harbor will achieve compliance with
    the heightened standards through continued good faith efforts.
    Further, CFTC has not yet fully addressed the practicability of all
    the act's requirements as part of its ongoing effort to enforce the
    heightened standards.  Finally, the dual trading provisions of FTPA
    have not yet been fully implemented.  Thus, it is particularly
    important that Congress be informed of exchange progress toward
    meeting the heightened audit trail standards and other requirements
    of the act as well as steps CFTC is taking to facilitate such
    progress.  The FTPA reporting requirement achieved this result, but
    CFTC issued its report in 1994 and no further reporting requirements
    exist.

       RECOMMENDATION
    ------------------------------------------------------------ Letter :7

    We recommend that the Chairperson, CFTC, inform Congress periodically
    on exchange progress towards compliance with the FTPA heightened
    audit trail standards and on implementation of the dual trading
    ban--including any mitigating factors delaying compliance or
    implementation and the steps CFTC is taking to encourage continued
    progress.  Such information could be provided annually in a report on
    or about October 28, the anniversary of the statutory deadline for
    compliance with the heightened standards, or through periodic
    testimonies before congressional committees.

       AGENCY COMMENTS AND OUR
       EVALUATION
    ------------------------------------------------------------ Letter :8

    We requested comments on a draft of this report from CFTC, CBT, CME,
    CSCE, and NYMEX.  CFTC supported our recommendation; the exchanges
    did not address it in their written comments.  Written comments from
    CFTC, CBT, CME, and CSCE and our additional responses are contained
    in appendixes II through V; NYMEX provided oral technical comments.
    These technical comments as well as those provided by CFTC and the
    other exchanges were incorporated into the report as appropriate.

    We reported that the exchanges included in our review have continued
    to make progress towards compliance with the heightened FTPA audit
    trail standards, but no exchange has been found in full compliance
    with them.  CME indicated that, contrary to our report conclusions,
    the exchange is in substantial compliance with the FTPA audit trail
    requirements, either through direct compliance or because some
    requirements of the act are impracticable.  First, CME infers that we
    made an assessment of its compliance with the act, reflecting a
    misunderstanding of our review objectives and resulting conclusions.
    Congress delegated responsibility for ensuring compliance with the
    act's audit trail provisions to CFTC.  We were responsible for
    reporting on the status of compliance with the act, including CFTC
    actions to enforce exchange compliance with it.  Second, as stated in
    our report, CFTC plans to work with the exchanges to address the
    practicability of the act's provisions related to broker receipt time
    and with CBT and CME to address the practicability of further
    integrating customer and personal trades.

    In addition to CME, the other three exchanges indicated varying
    degrees of disagreement with CFTC's conclusions that their audit
    trail systems were not yet in compliance with the act's requirements.
    CFTC reached its initial conclusions about compliance with the act
    based on testing of exchange audit trails and exchange implementation
    of its subsequent recommendations.  CFTC has done additional testing
    and evaluation of CBT and CME audit trails and has reported that,
    although improvements were made, the test results did not show
    compliance with the heightened standards.

    CME commented that we and CFTC have focused exclusively on
    statistical measurement without reference to the underlying purpose
    of an audit trail--deterring trade practice violations.  We agree
    that the ultimate measure of the effectiveness of an audit trail is
    its ability to deter as well as detect such violations.  However, the
    effectiveness of an audit trail in these areas can be difficult to
    verify.  The use of statistical measures along with other relevant
    information, provides a baseline against which progress toward
    compliance with the audit trail standards can be measured.  It also
    provides a basis, given the differing exchange audit trail systems,
    of comparing the progress of the exchanges to each other.  The latter
    provides some assurance that the standards are consistently and,
    therefore, fairly applied.

    ---------------------------------------------------------- Letter :8.1

    We are sending copies of this report to the Chairperson, CFTC, and
    other interested parties.  We will also make copies available to
    others upon request.

    Please contact me at (202) 512-8678 or Cecile O.  Trop, Assistant
    Director, at (312) 220-7705 if you or your staff have any questions.
    Major contributors to this report are listed in appendix VI.

    James L.  Bothwell
    Director, Financial Institutions
     and Markets Issues

    CFTC RECOMMENDATIONS TO FUTURES
    EXCHANGES FOR IMPROVING THEIR
    AUDIT TRAILS AND EXCHANGE
    RESPONSES
    =========================================================== Appendix I

    The following are the audit trail improvements that CFTC recommended
    in June 1995 to the Chicago Board of Trade (CBT), Chicago Mercantile
    Exchange (CME), Coffee, Sugar & Cocoa Exchange (CSCE), and New York
    Mercantile Exchange (NYMEX) and the exchanges' individual responses.
    The exchanges indicated that they had either implemented or planned
    to implement and/or test some of the improvements prior to CFTC's
    issuance of the audit trail test results and its June 1995
    recommendations.

       RECOMMENDATIONS TO CBT AND CME
    --------------------------------------------------------- Appendix I:1

    CFTC recommended that CBT and CME implement 17 and 18 improvements,
    respectively, to their audit trail systems.  The following 11
    recommendations were common to both exchanges:

    (1) Limit the number of trades recorded on each trading card to six.
    (2) Record and use manual execution times for at least the first and
    sixth
    trades on each trading card,\34 and use more manual times in the
    lower volume markets.
    (3) Use one-sided trading cards to record personal buys and sells in
    sequence.
    (4) Use a new trading card with the change of each bracket period.
    (5) Use a special indicator to designate customer orders "flashed"
    into the
    trading pit.
    (6) Use seconds in the imputed timing system where available,
    including
    seconds from customer order ticket timestamps.
    (7) Add the time a customer trade is stamped as executed to the
    imputed
    timing system.
    (8) Promptly supply members with information on audit trail data
    inconsistencies and require corrections that reflect actual events.
    (9) Aggressively enforce audit trail data recordation and submission
    requirements, especially for spread trades,\35 and ensure that
    timing data are entered correctly.
    (10) Aggressively enforce order ticket timestamping procedures for
    orders
    flashed into the trading pit.
    (11) Reprogram the imputed timing system to use all additional data
    obtained as a result of CFTC's recommendations when assigning
    execution times to trades.

    CFTC recommended that CBT implement the following additional
    improvements:

    (12) Complete efforts to capture real-time quotes in the time and
    sales
    register\36 for trades executed during the opening of the trading
    session.
    (13) Include the identity of trade participants in the time and sales
    register
    for spread trades.
    (14) Aggressively enforce requirements to record the correct
    customer-type indicator codes.
    (15) Upgrade timestamp clocks to record times to the second.

    CBT was also required to implement two refinements to the
    computer-based algorithm used by its imputed timing system to assign
    times to trades.

    CFTC recommended that CME implement the following additional
    improvements:

    (12) Use order-type information to derive times for trades.
    (13) Use clearing receipt time in the imputed timing system.
    (14) Synchronize timestamp clocks across the floor and upgrade
    timestamp
    clocks to record times to the second.

    CME was also required to implement four refinements to the
    computer-based algorithm used by its imputed timing system to assign
    times to trades.

    --------------------
    \34 CFTC's recommendation to CME differed in that CME was to record
    and use manual execution times for at least the first and either the
    last or sixth trade on each trading card.

    \35 Spread trades involve the simultaneous buying and selling of two
    related contracts in the expectation that a profit will be made based
    on changes in the price relationship when the position is offset.

    \36 The time and sales register is a record maintained by the
    exchange of price changes during trading and the time they occur.
    The register is required as part of an exchange's audit trail by CFTC
    regulation 1.35(h).

          EXCHANGE RESPONSES
    ------------------------------------------------------- Appendix I:1.1

    CBT agreed to implement 14 of the 17 recommendations and offered an
    acceptable alternative for one recommendation.  CME agreed to
    implement 16 of the 18 recommendations and offered an acceptable
    alternative for one recommendation.  Both exchanges had planned to
    test the recordation of manual execution times for certain trades on
    each trading card (recommendation 2) and one-sided trading cards
    (recommendation 3) prior to June 1995.  CBT had also planned to test
    recommendations 1, 4, 7, and 8 prior to this time.

    Both CBT and CME declined to implement CFTC's recommendation to
    record and use manual execution times for certain trades on each
    trading card and use more manual times in the lower-volume markets
    (recommendation 2) based on tests conducted separately at both
    exchanges.  CBT said that its own separate test results indicated
    that requiring manual execution times decreased the accuracy level of
    its imputed timing system because traders were unable to record
    accurate execution times during hectic trading.  According to CBT,
    some traders commented that this requirement disrupted their trade
    recordation efficiency, and that due to being focused on executing
    trades, they frequently were unable to record execution times until
    several minutes after the actual time of execution.  CBT clearing
    firms also indicated that this requirement would increase trade
    processing costs.

    CME declined to implement this recommendation but informed CFTC that
    it would continue to evaluate the recommendation.  The exchange's
    separate tests indicated that the requirement impaired trading.
    According to CME, some higher-volume floor traders complained that
    they could not continue to trade at their accustomed pace while
    having to manually record execution times during busy periods in the
    market.  The exchange was also concerned that this requirement would
    increase trade processing costs for clearing firms and could result
    in delays in execution of customer orders or degrade overall market
    efficiency.

    CBT also declined to include the identity of trade participants in
    the time and sales register for spread trades (CBT recommendation 13)
    based on tests conducted in two of its markets.  These tests
    indicated that this recommendation did not substantially improve
    audit trail accuracy.  According to CBT, reporting this information
    to exchange price reporters also significantly reduced price
    reporting efficiency and disrupted trading.  The exchange is
    integrating synchronized timestamp clocks that record times to the
    nearest second (CBT recommendation 15) as clocks are replaced.  CBT
    indicated that it plans to use the upgraded devices on its new
    trading floor, which is currently under construction.  CBT also
    offered an alternative to one of the recommended refinements to its
    computer-based algorithm, which CFTC accepted.

    CME offered an alternative to synchronizing timestamp clocks across
    the exchange floor and upgrading timestamp clocks to record times to
    the second (CME recommendation 14), which CFTC accepted.  CME's
    alternative was to conduct more frequent audits of timeclock
    accuracy, apply more pressure on firms to ensure that timeclocks are
    accurately set, and require firms to upgrade timeclocks as they are
    replaced.  The exchange believed that this approach satisfied CFTC's
    recommendation without incurring excessive costs.

       RECOMMENDATIONS TO CSCE
    --------------------------------------------------------- Appendix I:2

    CFTC recommended that CSCE implement the following six improvements
    to its audit trail system:

    (1) Complete upgrades to its price reporting system to include entry
    of the
    selling floor trader's or floor broker's identity in the time and
    sales register.
    (2) Manually record execution times for every fifth trade on each
    trading
    card.
    (3) Aggressively enforce order ticket recordkeeping requirements.
    (4) Place customer account numbers on the trade register.\37
    (5) Use timestamp clocks that record times to the second at such time
    as
    the exchange moves to a new facility.
    (6) Ensure that the imputed timing system derives only one possible
    execution time for each trade.

    --------------------
    \37 The trade register is a comprehensive exchange record of cleared
    or matched trades and is required as part of an exchange audit trail
    by CFTC regulation 1.35(e).  Among the entries on the register are,
    for each transaction:  the date and time; quantity; underlying
    commodity; price; delivery month; and identity of the floor broker,
    trader, and clearing member.

          EXCHANGE RESPONSE
    ------------------------------------------------------- Appendix I:2.1

    CSCE agreed to implement five of the six recommendations.  CSCE
    announced its plans to upgrade its price reporting system to include
    the selling party's identity in the time and sales register
    (recommendation 1) and began testing of recording manual times for
    every fifth trade on a card (recommendation 2) prior to June 1995.
    CSCE declined to implement the recommendation to place customer
    account numbers on the trade register (recommendation 4) because it
    would interfere with the exchange's ability to quickly process and
    match trades.  CFTC said that including account numbers on the trade
    register provides a useful surveillance tool; however, it indicated
    that because customer account numbers are not related to trade timing
    accuracy, CSCE could come within the safe harbor without implementing
    the recommendation.

    According to CSCE, the recommendations related to enforcing order
    ticket recordkeeping requirements (recommendation 3) and upgrading
    timestamp clocks to record times to the second (recommendation 5)
    will not impact trade timing and sequencing at the exchange because
    its imputed timing system does not use order ticket timestamps to
    derive trade execution times.

       RECOMMENDATIONS TO NYMEX
    --------------------------------------------------------- Appendix I:3

    CFTC recommended that NYMEX implement the following nine improvements
    to its audit trail system:

    (1) Integrate pit card system times with trade sequence data on
    trading
    cards through manual or electronic means.
    (2) Manually record execution times for the first and every fifth
    trade
    thereafter on each trading card.\38
    (3) Limit the number of trades recorded on each trading card.
    (4) Collect trading cards within 15 minutes after the end of each
    30-minute
    bracket period.
    (5) Develop a time and sales register for spread trades.
    (6) Enhance the timeliness of data entry for the pit card system.
    (7) Aggressively enforce timeliness of pit card submissions and
    trading
    card sequencing requirements.
    (8) Place customer account numbers on the trade register.
    (9) Use timestamp clocks that record times to the second at such time
    as the exchange moves to a new facility.

    --------------------
    \38 It is voluntary for floor traders and brokers to manually record
    execution times for every fifth trade.  CFTC approved this
    alternative.

          EXCHANGE RESPONSE
    ------------------------------------------------------- Appendix I:3.1

    NYMEX agreed to implement eight of the nine recommendations.  The
    exchange offered an alternative to collecting trading cards within 15
    minutes after the end of each bracket period (recommendation 4),
    which CFTC accepted.  Specifically, NYMEX agreed to introduce a new
    integrated trading card that provides for concurrently recording
    trade information on both a trading card and a pit card.  The
    exchange began developing the new card prior to June 1995.  In
    addition to recording trade information on trading cards, the selling
    participant to each trade must record trade information on a separate
    card called a pit card.  The pit card is required to be thrown into a
    net in the center of the trading pit within 1 minute of trade
    execution where it is collected by an exchange employee.  The
    employee then timestamps the card, which establishes the official
    trade execution time.  Tests required by CFTC disclosed that the
    sequence of trades as determined by this time stamp was frequently
    different than the sequence as recorded on trading cards by brokers
    and traders.  According to CFTC, the new integrated card should also
    address the sequencing inconsistencies between pit cards and trading
    cards disclosed by testing.

    (See figure in printed edition.)Appendix II
    COMMENTS FROM THE COMMODITY
    FUTURES TRADING COMMISSION
    =========================================================== Appendix I

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)Appendix III
    COMMENTS FROM THE CHICAGO BOARD OF
    TRADE
    =========================================================== Appendix I

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    The following are GAO's comments on the Chicago Board of Trade's
    letter dated July 17, 1996.

       GAO COMMENTS
    --------------------------------------------------------- Appendix I:4

    1.  CBT commented that in wielding its exemptive powers under the
    FTPA, CFTC broadly exempted the over-the-counter markets from
    virtually all Commodity Exchange Act requirements, including those
    related to audit trails.  We are preparing a separate report on the
    differences in regulatory oversight of the over-the-counter
    derivatives and futures markets and possible challenges to regulatory
    policy raised by these differences.

    2.  CBT commented that the FTPA requires CFTC to conduct cost-benefit
    analyses to determine the practicability of the heightened audit
    trail standards.  CFTC has reported that the costs of complying with
    the heightened standards must be taken into account, but the agency
    has concluded, as reported on page 16 of our report, that the FTPA
    does not require a formal cost-benefit analysis.

    3.  CBT noted that, in contrast to our draft report, the exchange has
    adopted using seconds in its imputed timing system where available,
    and it is integrating synchronized timeclocks to record times to the
    nearest second.  We corrected the report.

    (See figure in printed edition.)Appendix IV
    COMMENTS FROM THE CHICAGO
    MERCANTILE EXCHANGE
    =========================================================== Appendix I

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)

    (See figure in printed edition.)Appendix V
    COMMENTS FROM THE COFFEE, SUGAR &
    COCOA EXCHANGE
    =========================================================== Appendix I

    (See figure in printed edition.)

    MAJOR CONTRIBUTORS TO THIS REPORT
    ========================================================== Appendix VI

    Thomas J.  McCool, Associate Director
    Cecile O.  Trop, Assistant Director
    Roger E.  Kolar, Evaluator-in-Charge
    Cristine M.  Marik, Evaluator
    Daniel K.  Lee, Evaluator

    *** End of document. ***