United States General Accounting Office

GAO Report to Congressional Requesters

September 1996 FUTURES MARKETS

Heightened Audit Trail

Standards Not Met But

Progress Continues

G O A

years

1921 - 1996

GAO/GGD-96-177

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

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

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).

Page 1 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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.

Background 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.

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.

Page 2 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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

6

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

7

See page 9 for further details on the heightened standards.

Page 3 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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

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.

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

trades.

Page 4 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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 trading12 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

Results in Brief 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 exchanges14 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 199515 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

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

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

session.

13CME, however, voluntarily banned dual trading in all of its high-volume contract months about 1-1/2

years before the enactment of the FTPA.

14CFTC 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.

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

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

Page 5 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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

Page 6 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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.

Objectives, Scope,

and Methodology

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.

Page 7 GAO/GGD-96-177 Audit Trail Standards
B-261761 

CFTC Could Not

Determine CBT or

CME Compliance

With the 1-Minute

Trade Timing

Standard

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 NYMEX17

—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

17These 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.

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

19A 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.

Page 8 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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.)

CFTC Has Not Found

Any Exchange in Full

Compliance With the

Heightened

Standards, but Found

That Progress

Continued to Be Made

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.

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

21As 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.

Page 9 GAO/GGD-96-177 Audit Trail Standards
B-261761 

The Heightened Standards

Require Improved Audit

Trails

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

22CFTC 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.

23Trading 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.

Page 10 GAO/GGD-96-177 Audit Trail Standards
B-261761 

substantial compliance with the act’s audit trail standards and trade

monitoring requirements.

Electronic Trading

Terminals Were Not Fully

Operational and Have Been

Significantly Delayed

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

24In contrast to CBT, CME’s internal costs include only direct project costs.

Page 11 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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.

CFTC Gave CBT and CME

Additional Time to

Improve Their Audit Trails

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

25Clearing firms are members of an exchange clearing house. All trades of nonclearing members must

eventually be settled through a clearing member.

Page 12 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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

26Exchange 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.

Page 13 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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

27CFTC regulations require that trade execution times be captured, but do not require floor traders or

brokers to manually record them.

Page 14 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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.

CFTC Has Not Fully

Addressed the

Practicability of All of the

Act’s Provisions

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.

28CFTC 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.

Page 15 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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

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.

Page 16 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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.

Dual Trading Ban

Exemption Petitions Are

Still Pending

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

30While 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.

31An 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.

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

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

Page 17 GAO/GGD-96-177 Audit Trail Standards
B-261761 

audit trail enhancements, beginning with COMEX in September 1996, CBT

and CME in January 1997, and the remaining exchanges to follow.

Conclusions 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 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

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,

Page 18 GAO/GGD-96-177 Audit Trail Standards
B-261761 

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

Page 19 GAO/GGD-96-177 Audit Trail Standards
B-261761 

latter provides some assurance that the standards are consistently and,

therefore, fairly applied.

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

Page 20 GAO/GGD-96-177 Audit Trail Standards
Page 21 GAO/GGD-96-177 Audit Trail Standards
Contents

Letter 1

Appendix I 

CFTC

Recommendations to

Futures Exchanges

for Improving Their

Audit Trails and

Exchange Responses

24

Recommendations to CBT and CME 24

Recommendations to CSCE 27

Recommendations to NYMEX 28

Appendix II 

Comments From the

Commodity Futures

Trading Commission

29

Appendix III 

Comments From the

Chicago Board of

Trade

32

GAO Comments 42

Appendix IV 

Comments From the

Chicago Mercantile

Exchange

43

Appendix V 

Comments From the

Coffee, Sugar &

Cocoa Exchange

52

Page 22 GAO/GGD-96-177 Audit Trail Standards
Contents

Appendix VI 

Major Contributors to

This Report

54

Abbreviations

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

Page 23 GAO/GGD-96-177 Audit Trail Standards
Appendix I 

CFTC Recommendations to Futures

Exchanges for Improving Their Audit Trails

and Exchange Responses

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

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.

34CFTC’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.

35Spread 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.

Page 24 GAO/GGD-96-177 Audit Trail Standards
Appendix I 

CFTC Recommendations to Futures

Exchanges for Improving Their Audit Trails

and Exchange Responses

CFTC recommended that CBT implement the following additional

improvements:

(12) Complete efforts to capture real-time quotes in the time and sales

register36 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.

Exchange Responses 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

36The 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).

Page 25 GAO/GGD-96-177 Audit Trail Standards
Appendix I 

CFTC Recommendations to Futures

Exchanges for Improving Their Audit Trails

and Exchange Responses

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

Page 26 GAO/GGD-96-177 Audit Trail Standards
Appendix I 

CFTC Recommendations to Futures

Exchanges for Improving Their Audit Trails

and Exchange Responses

that this approach satisfied CFTC’s recommendation without incurring

excessive costs.

Recommendations to

CSCE

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.

Exchange Response 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.

37The 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.

Page 27 GAO/GGD-96-177 Audit Trail Standards
Appendix I 

CFTC Recommendations to Futures

Exchanges for Improving Their Audit Trails

and Exchange Responses

Recommendations to

NYMEX

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.

Exchange Response 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.

38It is voluntary for floor traders and brokers to manually record execution times for every fifth trade.

CFTC approved this alternative.

Page 28 GAO/GGD-96-177 Audit Trail Standards
Appendix II 

Comments From the Commodity Futures

Trading Commission

Page 29 GAO/GGD-96-177 Audit Trail Standards
Appendix II 

Comments From the Commodity Futures

Trading Commission

Page 30 GAO/GGD-96-177 Audit Trail Standards
Appendix II 

Comments From the Commodity Futures

Trading Commission

Page 31 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 32 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 33 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 34 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 35 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 36 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 37 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 38 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 39 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 40 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

Page 41 GAO/GGD-96-177 Audit Trail Standards
Appendix III 

Comments From the Chicago Board of

Trade

The following are GAO’s comments on the Chicago Board of Trade’s letter

dated July 17, 1996.

GAO Comments 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.

Page 42 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 43 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 44 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 45 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 46 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 47 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 48 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 49 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 50 GAO/GGD-96-177 Audit Trail Standards
Appendix IV 

Comments From the Chicago Mercantile

Exchange

Page 51 GAO/GGD-96-177 Audit Trail Standards
Appendix V 

Comments From the Coffee, Sugar & Cocoa

Exchange

Page 52 GAO/GGD-96-177 Audit Trail Standards
Appendix V 

Comments From the Coffee, Sugar & Cocoa

Exchange

Page 53 GAO/GGD-96-177 Audit Trail Standards
Appendix VI 

Major Contributors to This Report

Thomas J. McCool, Associate Director

Cecile O. Trop, Assistant Director

Roger E. Kolar, Evaluator-in-Charge

Cristine M. Marik, Evaluator

Daniel K. Lee, Evaluator

(233462) Page 54 GAO/GGD-96-177 Audit Trail Standards
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