Federal Register / Vol. 62, No. 219 / Thursday, November 13, 1997 / Notices 60865

1The Commission has previously discussed in

several instances, including its November 28, 1994

Report to Congress on Futures Exchange Audit

Trails, the possible abuses attendant to dual trading.

See also the Commission’s Proposed Regulation

Prohibiting Dual Trading by Floor Brokers, 56 FR

13025 (March 9, 1993).

2Affected contract market means a contract

market with an average daily volume equal to or in

excess of 8,000 contracts for each of four quarters

during the most recent volume year. Commission

Regulation 155.5(a)(9). See Section 4j(a)(4) of the

Act. As noted by the Commission in promulgating

Regulation 155.5, a contract market trading on an

exchange floor will be considered separate from a

contract market in the same commodity trading a

screen-based trading system. The Commission

further stated that, while not excluding electronic

trading from the dual trading prohibition, the

Commission was retaining the flexibility to

consider the matter further. See 58 FR 40335 (July

28, 1993). The Commission is not addressing

screen-based trading in this proposed Order.

3 62 FR 7754 (February 20, 1997). The

Commission did not address the Exchange’s dual

trading exemption petition in 1994 in large part

because of the Exchange’s prior representation that

it intended to automate the entry of trade execution

times by developing a handheld electronic trading

terminal. By letter dated June 22, 1994, CBT

informed the Commission that the proposed

handheld terminal would not be in place by the

October 1995 deadline for compliance with the

heightened audit trail standards set forth in Section

5a(b)(3) of the Act. Because CBT had not

sufficiently demonstrated that its existing audit trail

system met current and future standards, the

Commission required the Exchange to demonstrate

Continued

4j(a) of the Act upon finding that the trade

monitoring system satisfies the requirements

of Section 5a(b) of the Act by effectively

detecting and deterring dual trading-related

abuses. I dissent from the Commission’s

proposed Order granting the CME a

conditional exemption in seven affected

markets.

Based on information provided to the

Commission, I find that the CME’s trade

monitoring system as a whole effectively

detects and deters dual trading abuses and

therefore accomplishes the intended

objectives of the Act. Additionally, in 1991

the CME implemented a dual trading

restriction as part of its trade monitoring

system which the Commission approved. The

Commission has reviewed the CME’s

enforcement of that restriction over the past

six years and found it to be effective.

Therefore, I find that CME’s trade

monitoring system, including its dual trading

restriction, meets the standards for an

unconditional exemption from the dual

trading prohibition.

[FR Doc. 97–29892 Filed 11–12–97; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

Chicago Board of Trade Petition for

Exemptions From the Dual Trading

Prohibition Set Forth in Section 4j(a) of

the Commodity Exchange Act and

Commission Regulation 155.5

AGENCY: Commodity Futures Trading

Commission.

ACTION: Notice of intent to condition

and proposed order granting conditional

exemptions from the prohibition on

dual trading in 13 affected contract

markets.

SUMMARY: For the reasons set forth in

the Proposed Order Granting

Conditional Dual Trading Exemptions

(‘‘proposed Order’’), the Commodity

Futures Trading Commission

(‘‘Commission’’) intends to grant,

subject to the stated conditions, the

petition of the Chicago Board of Trade

(‘‘CBT’’ or ‘‘Exchange’’) for exemptions

from the dual trading prohibition in

Section 4j(a) of the Commodity

Exchange Act (‘‘Act’’) and Commission

Regulation 155.5 for its Wheat, Corn,

Soybean, Soybean Meal, Soybean Oil,

U.S. Treasury Bond, 10-Year Treasury

Note, and 5-Year Treasury Note futures

contracts and the option contracts on

the Corn, Soybean, U.S. Treasury Bond,

10-Year Treasury Note, and 5-Year

Treasury Note futures. Pursuant to the

Act and Commission Regulation

155.5(d)(8)(C)(iii), CBT may submit

written supplemental data, views or

arguments and will have an opportunity

to make an oral presentation to the

Commission before the Commission

makes its final determination.

DATES: If CBT intends to make an oral

presentation, it must submit its request

in writing no later than ten days after

receipt of this proposed Order. CBT

must submit any written supplemental

data, views or arguments within 30 days

of receipt of this proposed Order.

ADDRESSES: CBT’s request for oral

presentation and submission of written

supplements are to be sent to the Office

of the Secretariat, Commodity Futures

Trading Commission, Three Lafayette

Centre, 1155 21st Street, N.W.,

Washington, D.C. 20581.

FOR FURTHER INFORMATION CONTACT:

Rachel Fanaroff Berdansky, Special

Counsel, or Duane C. Andresen, Special

Counsel, Division of Trading and

Markets, Commodity Futures Trading

Commission, Three Lafayette Centre,

1155 21st Street, N.W., Washington,

D.C. 20581; telephone: (202) 418–5490.

SUPPLEMENTARY INFORMATION: A floor

broker engages in dual trading when he

or she executes a customer’s order

during the same trading session in

which he or she executes, directly or

indirectly, a trade in the same contract

for his or her own account or an account

in which he or she has an interest. Dual

trading can afford floor brokers the

opportunity to abuse customer orders if

audit trail information and surveillance

are insufficient to permit the detection

of such abuses. Specifically, a dual

trading floor broker can directly commit

abuses of customer orders such as

trading ahead or against those orders

and also has an informational advantage

for his or her personal trading.1 Section

4j(a) of the Act and Regulation 155.5

prohibit dual trading and establish trade

monitoring standards that must be met

in order for contract markets to be

exempted from the prohibition.

The Commission intends to issue the

following proposed Order granting CBT

conditional dual trading exemptions

pursuant to Section 4j(a) of the Act and

Commission Regulation 155.5. In

accordance with Regulation 155.5(d)(8),

CBT may submit to the Commission in

writing any supplemental data, views or

arguments within 30 days of receipt of

this Notice and proposed Order. In

addition, CBT may request, in writing

within ten days of receipt of this Notice

and proposed Order, an opportunity to

make an oral presentation to the

Commission. If CBT submits a request

for an oral presentation, the Exchange

will be notified by the Commission of

the date and the terms under which CBT

may make such presentation. Public

notice of such an oral presentation also

will be provided in accordance with the

requirements of the Government in the

Sunshine Act, 5 U.S.C. 552b (Supp. I

1995).

Proposed Order Granting Conditional

Dual Trading Exemptions

On October 25, 1993, CBT submitted

a Petition for Exemption from the Dual

Trading Prohibition contained in

Section 4j of the Act and Commission

Regulation 155.5 for its Wheat, Corn,

Soybean, Soybean Meal, Soybean Oil,

U.S. Treasury Bond, 10-Year Treasury

Note, and 5-Year Treasury Note futures

contracts and the option contracts on

the U.S. Treasury Bond and 10-Year

Treasury Note futures. The Exchange

corrected that petition on December 2,

1993. Subsequently, by letters dated

March 25 and May 14, 1994, CBT

supplemented its petition to include the

option contracts on its Corn, Soybean

and 5-Year Treasury Note futures since

such contract markets had reached

average daily volumes of 8,000 contracts

and, thus, had become affected contract

markets (‘‘affected contract markets’’) as

defined in the Act and regulations

thereunder.2 CBT updated its petition

on January 17, 1997, with respect to all

13 of its affected contract markets.

Notice of the public availability of the

CBT’s updated exemption petition was

published in the Federal Register on

February 20, 1997.3
60866 Federal Register / Vol. 62, No. 219 / Thursday, November 13, 1997 / Notices

its ability to meet the audit trail requirements using

Commission-designed tests and, thus, deferred

consideration of the Exchange’s petition.

Subsequent to evaluating the results of the tests, the

Commission offered CBT the opportunity to

supplement its petition.

4A list of the specific documents considered in

connection with this proposed Order will be made

available to the Exchange upon request. Copies of

any documents not originally furnished by CBT also

will be made available upon request.

5Commission Regulation 1.35(g) requires that

‘‘[a]ctual times of execution shall be stated in

increments of no more than one minute in length.’’

Section 5a(b)(2) of the Act, among other things,

codified that timing requirement by stating that an

exchange’s audit trail system shall, ‘‘consistent with

Commission regulation, accurately record the times

of trades in increments of no more than one minute

in length.’’ Section II of Appendix A to Commission

Regulation 155.5 requires that a contract market, in

describing its audit trail system in a petition for

exemption from the dual trading prohibition,

‘‘[d]emonstrate the highest degree of accuracy

practicable (but in no event less than 90% accuracy)

of trade execution times required under regulation

1.35(g) (within one minute, plus or minus, of

execution) * * *.’’ In addition, the contract market

must ‘‘[d]emonstrate the effective integration of

such trade timing data into the contract market’s

surveillance system with respect to dual tradingrelated abuses.’’ For contract markets that impute

trade execution times, Appendix A requires that the

contract market provide a description of the trade

imputation algorithm, ‘‘including how and why it

reliably establishes the accuracy of the imputed

trade execution times.’’

6An imputed timing system does not capture the

actual trade execution time but derives a time from

other timing and trade data.

7To the extent that the time imputed by a

computer algorithm was consistent with required

trade documentation, time and sequence data and

time and sales information for the subject trade and

surrounding trades, that time was deemed accurate.

If that imputed time fell within a two-minute level

of precision as measured by the size of the final

time window determined by such algorithm, that

imputed time was considered to be verifiable,

reliable and precise. Thus, the Commission stated

in its Audit Trail Report, ‘‘90 percent of CBT trade

times satisfied the standards [of consistency with

underlying data] for Test I. However, for 59 percent

of the trade times deemed accurate, available data

are not sufficiently precise to verify that the oneminute audit trail time chosen was actually within

the minute of execution.’’ Audit Trail Report at 17.

Under the 90 percent performance standard, only

trade times assigned by the Exchange’s imputed

timing system within timing windows of two

Upon consideration of CBT’s petition,

as supplemented, and other data and

analysis, including, but not limited to:

Exchange audit trail test results

reconciling imputed times to

underlying trade documentation and

verifying data on ‘‘window sizes’’;

actions taken in response to the

Commission’s November 1994 Report

to Congress on Futures Exchange

Audit Trails, June 1995 Report on

Audit Trail Accuracy and Sequencing

Tests (‘‘Audit Trail Report’’), and

August 12, 1996 Report on Audit Trail

Status and Re-Test (‘‘Audit Trail ReTest Report’’);

Commission trade practice

investigations and compliance

reviews conducted in conjunction

with rule enforcement reviews or

other investigatory or surveillance

activities; 4

the Division of Trading and Markets

Memorandum dated October 28, 1997;

and upon review of each element of

CBT’s trade monitoring system and of

CBT’s trade monitoring system as a

whole, the Commission finds that the

Exchange’s trade monitoring system

does not fully satisfy the requirements

of Sections 5a(b) and 4j(a)(3) of the Act

and Regulation 155.5 in that the audit

trail, recordkeeping, and physical

observation of trading areas components

are deficient. The Commission finds

that corrective actions are sufficient and

appropriate to meet those standards. In

addition, the Commission finds that,

based on an analysis of the composition

of trading (by transaction size and

volume) of certain distant contract

expirations and option markets, there is

a substantial likelihood that the broad

scope of the dual trading prohibition

specified under Section 4j of the Act

and Regulation 155.5, which applies to

a contract market as a whole, would

harm the public interest in hedging or

price basing in less liquid months of the

affected contract markets. Therefore, the

Commission has determined to grant

CBT conditional exemptions from the

dual trading prohibition of Section 4j of

the Act and Regulation 155.5 in its 13

affected contract markets.

The Commission is granting the

Exchange’s petition subject to the

Exchange taking the corrective actions

specified below and implementing and

enforcing the dual trading restriction

described in the Appendix to this

proposed Order. The Commission has

concluded that the proposed dual

trading restriction, which imposes a

prohibition on dual trading in actively

traded months but has no impact on less

actively traded back months, is

appropriate as a method to deter dual

trading-related abuses and other

customer abuses. The Commission’s

limited restriction, as opposed to the

statutory dual trading ban, strikes a

balance between the need to preserve

liquidity in certain low volume months

and the need to protect customers from

the potential abuses that are associated

with dual trading.

The Commission Hereby Finds as

follows:

Components of Exchange’s Trade

Monitoring System

Audit Trail System

One-Minute Execution Time Accuracy

The Exchange’s audit trail system fails

to record ‘‘reliably accurate’’ trade times

in increments of no more than one

minute in length as required by Section

5a(b)(2) of the Act, Regulation 1.35(g),

and Appendix A to Regulation 155.5. 5

Specifically, the Exchange has not

established for any of its 13 affected

contract markets that 90 percent or more

of imputed trade times, as assigned by

the Exchange’s trade timing system, are

reliable, precise, and verifiable as

demonstrated by being imputed within

a timing window of two minutes or less

(‘‘90 percent performance standard’’).

Thus, an impermissible amount of the

trade timing data, an integral part of an

exchange’s trade monitoring system, is

not reliably accurate in accordance with

that standard and thus negatively

impacts the Exchange’s surveillance

systems and investigatory and

disciplinary action programs.

The Commission has made clear that

a reliably accurate imputed trade

execution time only can be

demonstrated by a timing window that

narrows the time assigned to the trade

to a two-minute period within which

the trade is most likely to have

occurred. Even where an exchange can

demonstrate a trade timing window of

two minutes or less, it is not possible to

determine where within that window

the trade occurred. This underscores the

critical need for compliance with the 90

percent performance standard.

CBT’s Advanced Computerized Trade

Reconstruction (‘‘Advanced CTR’’)

system imputes an execution time for

every trade. 6 Trade times are imputed

based upon entry and exit timestamps

on order tickets; time and sales reports;

trading card numbers and sequence of

trades on trading cards; certain

handwritten execution times; times that

trades were submitted for clearing; 15-

minute bracket codes; calculated

differentials for spread trades;

identification of spread legs and types of

spread trades; and any available times

resulting from electronic order entry or

trading systems. Based on these data,

Advanced CTR determines various time

spans within which a trade is likely to

have been executed and ultimately

assigns an imputed execution time for

the trade.

The audit trail tests designed and

reviewed by the Commission and

conducted by the Exchange in response

to a November 23, 1994 Commission

letter involved a determination of the

consistency of imputed trade execution

times with all underlying audit trail

records and data. Based upon that

process, trade timing accuracy and

sequencing rates for CBT’s imputed

system were computed. 7 In reviewing
Federal Register / Vol. 62, No. 219 / Thursday, November 13, 1997 / Notices 60867

minutes or less are reliably accurate. As noted

above, Commission staff deems accurate those

trades for which the imputed trade times are

consistent with all underlying audit trail records

and data, as determined by manual review. When

comparing windows data for accurate trades and all

trades, the Division has found that a higher

percentage of accurate trades are assigned imputed

times that fall within windows of two minutes or

less and thus meet the 90 percent performance

standard. However, the resulting percentage

difference between accurate and all trades generally

has not exceeded one percent. In addition, since the

use of all trades data facilitates exchange

submission of timing windows percentages because

such data do not have to be generated in

conjunction with an accuracy test, which requires

an analysis of extensive trade documentation, the

Commission finds that the use of all trades data

provides an acceptable basis for determining

windows performance.

8 In response to recommendations made in the

Audit Trail Report, the Exchange modified its

trading card procedures such that a member can

record only one time bracket per trading card,

record no more than six trades per trading card, and

use only one-sided trading cards to record for each

trader all personal buy and sell trades in sequence.

Additionally, the Exchange implemented

recommendations that it enforce certain data

recordation and submission requirements,

requirements to record correct customer type

indicator codes, and timestamping procedures for

flashed orders.

The Exchange also made a number of

improvements to its trade timing system. CBT now

requires a trade submission indicator for flashed

orders, uses seconds in the imputed timing system,

when available, including seconds from order ticket

timestamps, requires member firms to input the

seconds from order entry and order confirmation

timestamps into the trade entry system,

reprogrammed CTR to impute proper execution

times for trades executed during the close, and

upgraded synchronized timestamp clocks to record

times to the nearest second. The Exchange also

made programming improvements to its timing

algorithm.

CBT declined to implement two Commission

recommendations: that members record and use

manual execution times for at least the first and

sixth trades on trading cards, and that the Exchange

include the identity of traders in the spread time

and sales.

9May 28, 1997; June 5, 1997; and June 10, 1997

were selected by Commission staff using a random

sampling method. The Exchange also provided

similar percentage data for three days of its own

choosing. The overall percentage of trades with

timing windows of two minutes or less was 87

percent on May 13 and May 20, 1997 and 88

percent on May 15, 1997. For those same dates, the

percentage of trades with timing windows of two

minutes or less computed separately for each

affected contract market ranged from 74 to 90

percent on May 13, 1997; 72 to 91 percent on May

15, 1997; and 68 to 90 percent on May 20, 1997.

The Exchange submitted data indicating that 90

percent or more of the imputed trade times in its

Soybean futures contract had timing windows of

two minutes or less on one of the three dates

selected at random by Commission staff and on all

three dates selected by the Exchange. Although the

Commission considers timing windows data for all

dates provided, the dates selected by persons other

those affiliated with the Exchange are accorded

greater weight in determining whether an affected

contract market attains the 90 percent performance

standard. Overall, the windows data for the

Soybean futures contract market does not

demonstrate consistent compliance with the 90

percent performance standard.

10Notably, although there are differences in

various systems among the exchanges, the three

other exchanges for which the Commission has

granted unconditional exemptions from the dual

trading prohibition require that customer and

personal trades be recorded sequentially on a single

trading document. Similar to CBT, one of those

exchanges, the Coffee, Sugar and Cocoa Exchange,

Inc., also uses an imputed timing system to assign

trade execution times. Such sequencing also can be

achieved by recording personal and customer trades

in sequence on one set of sequentially numbered

trading documents. As the Commission noted in

discussing the results of CBT’s first audit trail test,

‘‘recordation of a member’s personal and customer

trades in sequence should be the Exchange’s

objective.’’ Audit Trail Report at 20. Section 5a(b)(3)

of the Act provides, among other things, that an

exchange’s audit trail system must record

accurately and promptly essential data on all trades,

including execution time, through a means that is

adequately precise to determine the sequence of

customer and personal trades, to the extent

practicable as determined by the Commission by

rule or order.

11See Audit Trail Re-Test Report at 39.

12The Commission requires retention of a record

of any cancellations, changes, or corrections to

trades. Commission Regulation 1.35(d) and the

Outtrade Interpretation, 54 FR 37004 (September 6,

1989). The Commission amended Regulation

1.35(d)(7), effective October 21, 1996, to require that

the correction of erroneous information on trading

records be accomplished in such a manner that the

originally recorded information must not be

obliterated or otherwise made illegible. 61 FR 42999

(August 20, 1996). In December 1996, CBT amended

its Floor Practices Rule 332.05 and 332.07 to

comport with the Commission’s amendment to

Regulation 1.35(d)(7).

the results of the test designed to

evaluate trade timing accuracy,

Commission staff determined that,

although 91 percent of CBT’s trade

times satisfied the standard for

consistency with the underlying data,

only 41 percent of those trade times had

timing windows of two minutes or less

and thus could be verified. 8 In March

1996, the Commission conducted a retest of CBT’s audit trail system.

Although 92.7 percent of CBT’s trade

times satisfied the standard for

consistency with the underlying data,

only 69.2 percent of the trade times had

timing windows of two minutes or less

and thus could be verified.

Subsequent to the re-test, the

Exchange provided windows data for all

affected contract markets in response to

Commission requests. For December 19,

1996, the overall percentage of trades

with timing windows of two minutes or

less was 67 percent. For subsequent

dates, the Exchange computed windows

data separately for each affected

contract market in addition to

computing overall windows data. The

overall percentage of trades with timing

windows of two minutes or less was 84

percent on March 26, 1997, and 85

percent on May 28, 1997; June 5, 1997;

and June 10, 1997. For those same dates,

the percentage of trades with timing

windows of two minutes or less

computed separately for each affected

contract market ranged from 58 to 89

percent on March 26, 1997; 74 to 89

percent on May 28, 1997; 69 to 91

percent on June 5, 1997; and 70 to 90

percent on June 10, 1997. 9 Thus, the

Exchange has not demonstrated that its

imputed trade execution times are

sufficiently reliable, precise, and

verifiable in that it has not established

that 90 percent or more of such times

are imputed within timing windows of

two minutes or less.

The negative impact on the

components of the Exchange’s trade

monitoring system resulting from its

failure to satisfy the 90 percent

performance standard is exacerbated

because CBT does not require the

recordation of a member’s personal and

customer trades in sequence.10 Given

the absence of such a recordation

requirement, reliably accurate trade

times are essential for effective

determination of the sequence of trades.

Where the sequence of customer and

personal trades is not determined,

possible dual trading-related abuses,

such as trading ahead of customer

orders and trading against customer

orders, could go undetected.

Other Components of CBT’s Audit Trail

System

With regard to the requirement that

trade data be provided continually to

the Exchange in accordance with

Section 5a(b)(3)(A)(ii) of the Act,

exchange audit trail systems must

provide trade data, including trade

timing information, on a periodic, but

not necessarily real-time, basis.11 Such

information also must be obtained in a

timely manner. The Exchange requires

that clearing members submit trade data

for clearing within one hour after the

end of each hour on the half-hour.

However, as explained below, the

Exchange fails to enforce the

requirement that trading cards be

collected and timestamped in a timely

manner. This failure calls into question

the Exchange’s ability to assure that

trade data are provided continually to

clearing.

With regard to unalterability, as

mandated by Section 5a(b)(3)(A)(i) of

the Act, the Exchange’s trade records are

unalterable, since they are recorded on

trading cards and order tickets in

nonerasable ink. Trade corrections also

are not permitted to obscure original

data. 12

CBT’s imputed timing system, which

uses data from sources other than the

trader, as well as data provided by the

trader, to derive times, also meets the

Section 5a(b)(3)(A)(iii) standards for

independence, to the extent
60868 Federal Register / Vol. 62, No. 219 / Thursday, November 13, 1997 / Notices

13See Audit Trail Re-Test Report at 40.

14Commission Regulation 1.35(d)(2) requires that

each member of a contract market recording

purchases and sales on trading cards must record

such purchases and sales in exact chronological

order of execution on sequential lines of the trading

card.

15 60 FR 58049 (November 24, 1995).

16This proposed Order does not address certain

disciplinary actions taken by the Exchange

regarding the March 1996 Wheat futures contract

expiration. Those matters are before the

Commission in a separate proceeding.

practicable.13 The Exchange’s existing

system uses, among other things, data

generated by both buyers and sellers for

personal trades, including trading card

numbers and sequence of trades on

trading cards, certain execution times

required to be entered manually, entry

and exit timestamps on order tickets,

time and sales data and 15-minute

bracket codes to impute trade execution

times.

The Exchange requires that personal

trades be recorded in sequence,

consistent with Commission

regulations, by requiring that members

record such trades in sequence on prenumbered trading cards.14 The

Exchange adopted a single-sided trading

card on which all personal buy and sell

trades are required to be recorded

sequentially in response to an Audit

Trail Report recommendation. However,

as noted elsewhere, the Exchange does

not require the recordation of a

member’s personal and customer trades

in sequence. Given the absence of such

a recordation requirement, reliably

accurate trade times are essential for

effective determination of the sequence

of trades.

CBT enforces its audit trail

requirements and integrates audit trail

data into its surveillance system for dual

trading-related abuses. However,

because the Exchange’s trade

surveillance system incorporates into its

data, including exception reports, an

impermissible amount of imputed

execution times that are not reliably

accurate, the effectiveness of the

Exchange’s integration of audit trail data

is diminished.

As required by Section 5a(b)(1)(B) of

the Act, CBT’s trade entry and outtrade

resolution programs capture certain

essential data on cleared trades,

unmatched trades, and outtrades.

Finally, with regard to broker receipt

times, the Commission finds that it is

not practicable at this time for CBT to

record the time that each order is

received by a floor broker for execution.

Immediately executable flashed orders,

however, are in substantial compliance

with the objectives of Section 5a(b)(3)(B)

of the Act, as stated previously by the

Commission in its Order on flashed

orders and broker receipt times.15

Physical Observation of Trading Areas

CBT’s trade monitoring system does

not provide for physical observation of

trading areas in accordance with Section

5a(b)(1)(A) of the Act in that the

Exchange does not conduct daily floor

surveillance on the open and close to

the extent practicable in each affected

contract market as required by

Appendix A to Regulation 155.5. As

part of the Exchange’s Market Open/

Close Floor Surveillance Program, CBT

currently conducts floor surveillance on

the open for only half of the affected

contract markets and on the close for the

remaining half. The Exchange conducts

some additional open/close floor

surveillance as part of other specialized

surveillance programs. The Exchange

does conduct floor surveillance at

random times and when special market

conditions warrant. Information

obtained during floor surveillance is

integrated into the Exchange’s other

compliance activities. During 1996, the

Exchange initiated two investigations

based upon floor surveillance

observations.

Recordkeeping System

The recordkeeping component of

CBT’s trade monitoring system fails to

comply with Section 5a(b)(1)(B) of the

Act because it does not satisfy the

trading record collection and

timestamping requirements of

Regulation 1.35(j). These requirements

are essential to maintaining the basic

integrity of trading records used in the

Exchange’s system to capture essential

data on the sequence of transactions in

that they ensure the removal of such

records from the member’s possession

in a timely manner and thereby limit the

opportunity to alter records, to fabricate

trades, or otherwise to use trading

records to disadvantage customer

accounts. Only approximately 67

percent of the trading cards selected for

review by Commission staff were

submitted to the clearing member

within 15 minutes of the 30-minute

trading interval and timestamped

promptly to the nearest minute

following collection as required by

Regulation 1.35(j). The Exchange,

however, does use information from the

records and violations of recordkeeping

requirements to bring disciplinary

actions.

In addition, because CBT does not

meet the 90 percent performance

standard, the system captures an

impermissible amount of trade timing

data that is not reliably accurate. This

circumstance is compounded by the fact

that CBT does not require the

recordation of personal and customer

trades in sequence. As a result, the

Exchange’s recordkeeping system is

limited in its capability to capture

essential data on the sequence of

customer trades.

CBT generally conducts back office

audits of trading cards and order tickets

at each clearing member firm twice a

year for a representative sample of

customer orders and personal trades.

CBT also uses a computerized tracking

system to monitor member compliance

daily with certain trade timing and

sequencing requirements, regularly

examines trading records during the

course of investigations for possible

recordkeeping violations, and uses

information from these audits to

generate investigations. The Exchange

requires that the account identifier

reflected on the floor order ticket relate

back to the ultimate customer account.

Surveillance Systems and Disciplinary

Actions

The inclusion of an impermissible

amount of trade timing data that is not

reliably accurate in the Exchange’s trade

monitoring system diminishes the

capability of the Exchange’s trade

surveillance system to review trade data

effectively, and as a result, possible dual

trading-related abuses could go

undetected. Further, the lack of reliably

accurate trade timing data diminishes

the capability of the Exchange’s

disciplinary program to bring

appropriate disciplinary actions against

violators. In other respects, the

Exchange’s trade surveillance system

may be capable of reviewing and is used

to review trading data on a regular basis

to detect possible dual trading-related

abuses and other customer order abuses.

In addition, CBT did bring disciplinary

actions against offenders and issued

meaningful penalties against violators.16

Therefore, CBT has demonstrated the

capability to use information generated

by its trade monitoring and audit trail

systems on a consistent basis to bring

appropriate disciplinary action for

violations relating to the making of

trades and execution of customer orders

as required by Sections 5a(b)(1)(C), (D)

and (F) of the Act. Further, CBT refers

appropriate cases to the Commission.

On a daily basis, CBT reviews Trade

Practice Investigation Reports and uses

its Sophisticated Market Analysis

Research Technology system, a

framework for reviewing such data, to

detect possible instances of dual

trading-related abuses and other trading

abuses. All relevant trade data,

including account numbers, are
Federal Register / Vol. 62, No. 219 / Thursday, November 13, 1997 / Notices 60869

17Broker association members trading on the top

step of the U.S. Treasury Bond pit are subject to

trading restrictions. These restrictions limit the

amount of customer and personal trades members

can execute opposite each other in the most active

contract month. Members cannot trade more than

20% of their monthly volume (brokerage and

personal trades) opposite members of their broker

association. The members also cannot trade more

than 20% of their monthly volume against members

of a contiguous broker association. In total, the

members cannot trade more than 30% of their

monthly volume against members of their own and

a contiguous broker association.

included in these reviews. Among the

computerized exception reports

generated by the Exchange and

reviewed daily are those designed to

identify such suspicious trading activity

as trading ahead of a customer, trading

against a customer, preferential trading

and wash trading and to review outtrade

resolution and U.S. Treasury Bond

futures contract broker association top

step trading.17

During 1996, CBT initiated 309

investigations into all types of trading

related abuses. Of the 86 investigations

opened and closed during this period,

34 percent were closed within the fourmonth objective set forth in Commission

Regulation 8.06, and an additional 28

percent were closed within four to six

months. Thus, approximately 62 percent

of the investigations opened and closed

during 1996 were closed in six months

or less. CBT should improve the

timeliness of its investigations or

provide the reasons that such

investigations require more than four

months to complete. During that same

period, the Exchange opened and closed

45 dual trading-related investigations,

and referred nine of those investigations

to a disciplinary committee. CBT

assessed substantial penalties in 13

disciplinary actions involving dual

trading-related abuses.

Commitment of Resources

The Commission finds that CBT

commits sufficient monetary resources

to its trade monitoring system to be

effective in detecting and deterring

violations attributable to dual trading.

The Exchange maintains an adequate

staff to conduct investigations and to

develop and prosecute disciplinary

actions. For calendar year 1996, the

Exchange reported that it committed

141 personnel to the Exchange’s various

self-regulatory activities and reported its

total self-regulatory costs to be

$15,456,317. CBT’s reported volume for

this period was 222,438,505 contracts,

and the number of trades was

17,675,749. However, CBT should

allocate its resources as appropriate to

improve its trade monitoring system, as

discussed above.

Accordingly, the Commission Hereby

orders that:

The Exchange must implement the

following corrective actions:

(1) achieve compliance with the 90

percent performance standard,

(2) significantly improve compliance

with the requirement that trading

records be collected and

timestamped in accordance with

Commission regulations, and

(3) conduct floor surveillance daily on

the open and close for each affected

contract market.

The Commission Further orders that:

Until such time as the Exchange

demonstrates that its trade monitoring

system satisfies the relevant standards,

the Exchange shall be subject to the

following condition: Within 60 days

from the effective date of a final Order,

the Exchange must implement and

enforce the limited dual trading

restriction described in the Appendix to

this proposed Order, which is less

restrictive than the dual trading

prohibition of Section 4j of the Act and

Regulation 155.5. Such dual trading

restriction currently would apply to the

following affected contract markets:

Wheat, Corn, Soybean, Soybean Meal,

Soybean Oil, U.S. Treasury Bond, 10-

Year Treasury Note, and 5-Year

Treasury Note futures contracts and the

option contracts on the Corn, Soybean,

U.S. Treasury Bond, 10-Year Treasury

Note, and 5-Year Treasury Note futures.

Accordingly, the Commission

proposes to grant CBT’S Petition for

Exemption, subject to the stated

conditions, from the dual trading

prohibition for trading in its Wheat,

Corn, Soybean, Soybean Meal, Soybean

Oil, U.S. Treasury Bond, 10-Year

Treasury Note, and 5-Year Treasury

Note futures contracts and the option

contracts on the Corn, Soybean, U.S.

Treasury Bond, 10-Year Treasury Note,

and 5-Year Treasury Note futures.

If, at any time, CBT believes that it

can demonstrate to the Commission’s

satisfaction that it meets, for an affected

contract market subject to this Order, all

of the standards set forth in this Order,

including, but not limited to, those in

Section 5a(b) and Regulation 155.5, the

Exchange may petition for an

unconditional exemption to the dual

trading prohibition for that affected

contract market.

Unless otherwise specified, the

provisions of this proposed Order shall

be effective on the date on which it is

issued as a final Order by the

Commission, and the condition shall

become effective as stated herein and

shall remain in effect unless and until

removed, as provided above, or revoked

in accordance with Section 8e(b)(3)(B)

of the Commodity Exchange Act, 7

U.S.C. 12e(b)(3)(B). Failure of CBT to

abide by the condition of a limited dual

trading restriction will automatically

cause the dual trading prohibition set

forth in Section 4j of the Act and

Regulation 155.5 to go into effect.

If other CBT contract markets become

affected contract markets after the date

this Order becomes final, the Exchange

would be required, absent submission of

a dual trading exemption petition, to

restrict dual trading in those affected

contract markets in accordance with the

dual trading prohibition set forth in

Section 4j of the Act and Regulation

155.5. Further, if CBT demonstrates to

the Commission’s satisfaction that an

affected contract market subject to this

Order has ceased to meet the Regulation

155.5(a)(9) affected contract market

threshold, that contract market no

longer would be subject to this Order.

Dated: November 7, 1997.

By the Commission:

Edward W. Colbert,

Deputy Secretary.

Appendix—Dual Trading Restriction

a. Restriction

A floor broker is prohibited from executing

customer orders in an affected contract

market month, as defined below, during the

same pit trading session in which the floor

broker executes directly, or initiates and

passes to another member for execution, a

transaction in any such affected contract

market month for (1) the floor broker’s own

account, (2) any account in which the floor

broker’s ownership interest or share of

trading profits is ten percent or more, (3) any

account for which the floor broker has

trading discretion, or (4) any other account

controlled by a person with whom such floor

broker is subject to trading restrictions under

Section 4j(d) of the Act to the extent such

section is applied by Commission regulation

or order.

b. Affected Contract Market Month (Volume)

Affected contract market month means: (1)

For each affected non-agricultural contract

market, any contract market month with an

average daily trading volume of 10,000

contracts or more as determined by, at the

election of the Exchange, either (i) trading in

a contract month by position in relation to

the front month contract, as defined below,

during the prior six calendar months or (ii)

trading in the previous calendar month; and

(2) For each affected agricultural contract

market, any contract market month with an

average daily trading volume of 10,000

contracts or more as determined by trading

in the previous calendar month. For this

purpose, daily trading volume means the

total number of contracts sold (or bought) in

any contract month of an affected contract

market during a trading day, with the average

computed as set forth above and excluding

ex-pit transactions as permitted under
60870 Federal Register / Vol. 62, No. 219 / Thursday, November 13, 1997 / Notices

1Affected contract market means a contract

market with an average daily volume equal to or in

excess of 8,000 contracts for each of four quarters

during the most recent volume year. Commission

Regulation 155.5(a)(9). See Section 4j(a)(4). The

Commission is granting CME conditional

exemptions from the dual trading prohibition for its

remaining seven affected contract markets. A Notice

of Intent to Condition and proposed Order granting

such conditional exemptions is being submitted for

publication together with this Order.

2 62 FR 7755 (February 20, 1997). The

Commission did not address the Exchange’s dual

trading exemption petition in 1994 in large part

because of the Exchange’s prior representation that

it intended to automate the entry of trade execution

times by developing a handheld electronic trading

terminal. In June 1994, the Commission was

informed that the proposed handheld terminal

would not be in place by the October 1995 deadline

for compliance with the heightened audit trail

standards set forth in Section 5a(b)(3) of the Act.

Because CME had not sufficiently demonstrated

that its existing audit trail system met current and

future standards, the Commission required the

Exchange to demonstrate its ability to meet the

audit trail requirements using Commissiondesigned tests and, thus, deferred consideration of

the Exchange’s petition. Subsequent to evaluating

the results of the tests, the Commission offered CME

the opportunity to supplement its petition.

3Under CME Rule 541 (S&P 500 Top Step rule),

a member cannot trade an S&P futures contract for

his or her own account while on the top step of the

S&P 500 futures pit, except to liquidate a position

that resulted from an error. Further, a member who

has executed a customer order for an S&P 500

futures contract while on the top step of the S&P

500 futures pit may not on the same day trade such

contracts for his or her own account.

contract market rules that have been made

effective under the Act. There will be a two

business day allowance at the beginning of

each calendar month for computation and

member notification purposes.

c. Affected Contract Market Month (Front

Month)

Front month means, for each affected

contract market, the month which is either

the expiration or delivery month which is

nearest to expiration or at the Exchange’s

discretion the expiration or delivery month

which is next nearest to expiration when the

contract month nearest to expiration is five

business days or less from the first notice day

or last trading day for cash settled contracts

for futures contracts or the expiration date for

futures options contracts. If a front month is

not subject to a prohibition pursuant

paragraph b. above, then it shall, nonetheless,

be an affected contract market month and be

subject to a prohibition unless, on the basis

of historical data, that front month

reasonably can be expected to have an

average daily trading volume of less than 500

contracts.

d. Exceptions

Dual trading shall be permitted under

exceptions consistent with Commission

Regulation 155.5(c)(4) in accordance with

Exchange rules which the Commission has

permitted to go into effect pursuant to

Section 5a(a)(12)(A) of the Act and

Regulation 1.41.

Notice of Intent To Condition and Proposed

Order Granting Conditional Dual Trading

Exemptions to the Chicago Board of Trade,

Supplemental Statement of Commissioner

John E. Tull, Jr.

I am happy to support the Commission’s

action proposing to grant the CBOT

conditional dual trading exemptions for its

affected markets. I am troubled, however, by

that part of the Commission’s Proposed Order

which orders the CBOT to conduct floor

surveillance daily on the open and close for

each affected market when such surveillance

is not required by the Act or the

Commission’s Regulations. Appendix A to

Regulation 155.5 states that such surveillance

should be conducted to the extent

practicable. In my opinion, the Commission

should not attempt to instruct an exchange

regarding the allocation of its resources with

such specificity. Such management decisions

are better left to the exchange leadership,

which has hands-on, daily contact with the

markets at issue. Management should have

the discretion to assign exchange personnel

as needed to monitor ‘‘hot’’ markets or pits

with trading activity of concern.

Opinion of Commissioner Barbara Pedersen

Holum, Concurring in Part and Dissenting in

Part, on the Disposition of the Chicago Board

of Trade’s Dual Trading Petition

For the reasons set out below, I concur

with the findings of the proposed Order but

I dissent from the proposed Order’s

imposition of a Commission-designed dual

trading restriction.

Section 4j(a)(3) of the Commodity

Exchange Act requires the Commission to

exempt a contract market conditionally from

the dual trading prohibition of Section 4j(a)

of the Act upon finding that: (1) There is a

substantial likelihood that a dual trading

suspension would harm the public interest in

hedging or price basing at the contract

market, and (2) other corrective actions are

sufficient and appropriate to bring the

contract market into compliance with the

standards of Section 5a(b) of the Act by

effectively detecting and deterring dual

trading-related abuses. The Commission has

determined that the Chicago Board of Trade’s

trade monitoring system fails to satisfy the

standards necessary for an unconditional

exemption, but that it meets the criteria for

granting a conditional exemption. In

addition, the Commission has determined to

impose a dual trading restriction on the CBT

a as condition to the exemption. Given these

findings, I agree with the majority’s view that

the CBT should be granted a conditional

exemption. However, I dissent from the

proposed Order because it would impose a

Commission-designed dual trading

restriction on the CBT as a condition to the

exemption.

Consistent with the statutory framework of

self-regulation, I believe that the CBT should

adopt its own rules to detect and deter dual

trading abuses. When the CBT’s trade

monitoring system as a whole is determined

by the Commission to meet the objectives of

the Act by detecting and deterring dual

trading abuses, the CBT would be granted an

unconditional exemption.

[FR Doc. 97–29893 Filed 11–12–97; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

Chicago Mercantile Exchange Petition

for Exemption From the Dual Trading

Prohibition Set Forth in Section 4j(a) of

the Commodity Exchange Act and

Commission Regulation 155.5

AGENCY: Commodity Futures Trading

Commission.

ACTION: Order.

SUMMARY: The Commodity Futures

Trading Commission (‘‘Commission’’) is

granting the petition of the Chicago

Mercantile Exchange (‘‘CME’’ or

‘‘Exchange’’) for exemption from the

prohibition against dual trading in its

S&P 500 futures contract.

DATES: This Order is to be effective

November 7, 1997.

FOR FURTHER INFORMATION CONTACT:

Duane C. Andresen, Special Counsel, or

Rachel Fanaroff Berdansky, Special

Counsel, Division of Trading and

Markets, Commodity Futures Trading

Commission, Three Lafayette Centre,

1155 21st St., N.W., Washington, DC

20581; telephone (202) 418–5490.

SUPPLEMENTARY INFORMATION: On

October 20, 1993, CME submitted a

Petition for Exemption from the Dual

Trading Prohibition contained in

Section 4j of the Commodity Exchange

Act (‘‘Act’’) and Regulation 155.5 for its

affected contract markets, including the

S&P 500 futures contract market.1 The

Exchange corrected that petition on

December 1, 1993. Subsequently, the

Exchange amended its petition on

January 21, 1994. CME updated its

petition on January 21, 1997. Notice of

the public availability of the CME’s

updated exemption petition was

published in the Federal Register on

February 20, 1997.2

Upon consideration of CME’s petition,

as supplemented, and other data and

analysis, including, but not limited to:

Exchange audit trail test results

reconciling imputed times to underlying

trade documentation and verifying data

on ‘‘window sizes’’; actions taken in

response to the Commission’s November

1994 Report to Congress on Futures

Exchange Audit Trails, June 1995

Report on Audit Trail Accuracy and

Sequencing Tests (‘‘Audit Trail

Report’’), and August 12, 1996 Report

on Audit Trail Status and Re-Test

(‘‘Audit Trail Re-Test Report’’);

Commission trade practice

investigations and compliance reviews

conducted in conjunction with rule

enforcement reviews or other

investigatory or surveillance activities.

The Exchange’s S&P 500 futures

contract trading restrictions.3