[Federal Register Volume 62, Number 219 (Thursday, November 13, 1997)]
[Notices]
[Pages 60860-60865]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-29892]


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COMMODITY FUTURES TRADING COMMISSION


Chicago Mercantile Exchange 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 seven 
affected contract markets.

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SUMMARY: For the reasons set forth in the Proposed Order Granting 
Conditional Dual Trading Exemptions (``proposed Order''), the Commodity 
Futures Trading Commission (``Commission'') intends to grant, subject 
to a stated condition, the petition of the Chicago Mercantile Exchange 
(``CME'' 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 Live Cattle, Deutsche Mark, 
Japanese Yen, Swiss Franc and Eurodollar futures contracts and the 
option contracts on Eurodollar and S&P 500 futures.<SUP>1</SUP> 
Pursuant to the Act and Commission Regulation 155.5(d)(8)(C)(iii), CME 
may submit written supplemental data, views or arguments and will have 
the opportunity to make an oral presentation to the Commission before 
the Commission makes its final determination.
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    \1\ The Commission is granting CME an unconditional exemption 
from the dual trading prohibition for its S&P 500 futures contract. 
An Order granting such exemption is being submitted for publication 
together with this Notice.

DATES: If CME intends to make an oral presentation, it must submit its 
request in writing no later than ten days after receipt of this 
proposed Order. CME must submit any written supplemental data, views or 
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arguments within 30 days of receipt of this proposed Order.

ADDRESSES: CME's requests 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: 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 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.<SUP>2</SUP> Section 4j(a) of the Act and Regulation 155.5 
prohibit dual trading and establish trade monitoring standards that 
must be met in order for contract markets to be exempted from the 
prohibition.
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    \2\ The Commission has previously discussed in several 
instances, including its November 28, 1994 Report to Congress on 
Futures Exchange Audit Trails, the possible abuses attendant to dual 
trading. See also the Commission's Proposed Regulation Prohibiting 
Dual Trading by Floor Brokers, 56 FR 13025 (March 9, 1993).
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    The Commission intends to issue the following proposed Order 
granting CME 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), CME 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, CME 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 CME 
submits a request for an oral presentation, the Exchange will be 
notified by the Commission of the date and the terms under which CME 
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 20, 1993, CME submitted a Petition for Exemption from 
the Dual Trading Prohibition contained in Section 4j of the Act and 
Commission Regulation 155.5 in CME's Live Cattle, Deutsche Mark, 
Japanese Yen, Swiss Franc, British Pound, Eurodollar and S&P 500 
futures contracts and the option contracts on the Deutsche Mark, 
Eurodollar and S&P 500 futures. 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, with 
respect to eight affected contract markets.<SUP>3</SUP> Notice of the 
public availability of the CME's updated exemption petition was 
published in the Federal Register on February 20, 1997.<SUP>4</SUP>
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    \3\ Affected contract market means a contract market with an 
average daily volume equal to or in excess of 8,000 contracts for 
each of four quarters during the most recent volume year. Commission 
Regulation 155.5(a)(9). See Section 4j(a)(4) of the Act. As noted by 
the Commission in promulgating Regulation 155.5, a contract market 
trading on an exchange floor will be considered separate from a 
contract market in the same commodity trading a screen-based trading 
system. The Commission further stated that, while not excluding 
electronic trading from the dual trading prohibition, the Commission 
was retaining the flexibility to consider the matter further. See 58 
FR 40335 (July 28, 1993). The Commission is not addressing screen-
based trading in this proposed Order.
    Two contract markets included in the original petition, British 
Pound futures and options on Deutsche Mark futures, no longer are 
affected contract markets as defined in the Act and regulations. 
This proposed Order is not applicable to those two contract markets. 
As previously noted, this proposed Order also is not applicable to 
the S&P 500 futures contract market.
    \4\ 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 Commission-designed 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.
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    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

[[Page 60861]]

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;<SUP>5</SUP>
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    \5\ A list of the specific documents considered in connection 
with this proposed Order will be made available to the Exchange upon 
request. Copies of any documents not originally furnished by CME 
also will be made available upon request.
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the Exchange's existing dual trading and top step trading restrictions; 
<SUP>6</SUP>
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    \6\ Under CME Rule 552, adopted in 1991, dual trading is, with 
certain exceptions, prohibited in any contract month which is mature 
and liquid, i.e., a contract month by position in relation to the 
front month contract at any given point in time that has had during 
the prior six calendar months an average daily pit-traded volume of 
10,000 or more contracts. In any such contract months, members may 
trade only for their personal accounts until they have executed a 
customer order and then may no longer execute personal trades in 
that contract month during that trading session. Under CME Rule 555, 
effective July 1993, a member may not, with certain exceptions, 
while standing on the top step, execute a trade or place an order 
for his personal account in any contract months subject to the CME 
Rule 552 dual trading restriction which are traded in the contract 
month where the member stands.
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the Division of Trading and Markets Memorandum dated October 28, 1997;

and upon review of each element of CME's trade monitoring system and of 
CME'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 component is 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 CME conditional exemptions from the dual trading prohibition of 
Section 4j of the Act and Regulation 155.5 in the seven affected 
contract markets.
    The Commission is granting the Exchange's petition subject to the 
Exchange taking the corrective action 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.<SUP>7</SUP> Specifically, the 
Exchange has not established for the seven 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 trade timing data, an integral part of an exchange's trade 
monitoring system, is not reliably accurate in accordance with that 
standard and thus negatively impacts the Exchange's surveillance 
systems and investigatory and disciplinary action programs.
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    \7\ Commission Regulation 1.35(g) requires that ``[a]ctual times 
of execution shall be stated in increments of no more than one 
minute in length.'' Section 5a(b)(2) of the Act, among other things, 
codified that timing requirement by stating that an exchange's audit 
trail system shall, ``consistent with Commission regulation, 
accurately record the times of trades in increments of no more than 
one minute in length.'' Section II of Appendix A to Commission 
Regulation 155.5 requires that a contract market, in describing its 
audit trail system in a petition for exemption from the dual trading 
prohibition, ``[d]emonstrate the highest degree of accuracy 
practicable (but in no event less than 90% accuracy) of trade 
execution times required under regulation 1.35(g) (within one 
minute, plus or minus, of execution) * * * .'' In addition, the 
contract market must ``[d]emonstrate the effective integration of 
such trade timing data into the contract market's surveillance 
system with respect to dual trading-related abuses.'' For contract 
markets that impute trade execution times, Appendix A requires that 
the contract market provide a description of the trade imputation 
algorithm, ``including how and why it reliably establishes the 
accuracy of the imputed trade execution times.''
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    The Commission has made clear that a reliably accurate imputed 
trade execution time only can be demonstrated by a timing window that 
narrows the time assigned to the trade to a two-minute period within 
which the trade is most likely to have occurred. Even where an exchange 
can demonstrate a trade timing window of two minutes or less, it is not 
possible to determine where within that window, the trade occurred. 
This underscores the critical need for compliance with the 90 percent 
performance standard.
    CME's Regulatory Trade Timing System (``RTT'') imputes an execution 
time for every trade.<SUP>8</SUP> Trade times are imputed based upon 
entry and exit timestamps on order tickets; time and sales reports; 
times that the trades were submitted for clearing; trading card numbers 
and sequence of trades on trading cards; 15-minute bracket codes; 
manual execution times for certain types of trades; 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, RTT 
determines various time spans within which a trade is likely to have 
been executed and ultimately assigns an imputed execution time for the 
trade.
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    \8\ An imputed timing system does not capture the actual trade 
execution time but derives a time from other timing and trade data.
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    The audit trail tests designed and reviewed by the Commission and 
conducted by the Exchange in response to a November 23, 1994 Commission 
letter involved a determination of the consistency of imputed trade 
execution times with all underlying audit trail records and data. Based 
upon that process, trade timing accuracy and sequencing rates for CME's 
imputed system were computed.<SUP>9</SUP> In reviewing

[[Page 60862]]

the results of the test designed to evaluate trade timing accuracy, 
Commission staff determined that, although 90.4 percent of CME's trade 
times satisfied the standard for consistency with the underlying data, 
only 72 percent of those trade times had timing windows of two minutes 
or less and thus could be verified.<SUP>10</SUP> In March 1996, the 
Commission conducted a re-test of CME's audit trail system. Although 
94.2 percent of CME's trades times satisfied the standard for 
consistency with the underlying data, only 79.5 percent of those trade 
times had timing windows of two minutes or less and thus could be 
verified.
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    \9\ To the extent that the time imputed by a computer algorithm 
was consistent with required trade documentation, time and sequence 
data and time and sales information for the subject trade and 
surrounding trades, that time was deemed accurate. If that imputed 
time fell within a two-minute level of precision as measured by the 
size of the final time window determined by such algorithm, that 
imputed time was considered to be verifiable, reliable and precise. 
Thus, the Commission stated in its Audit Trail Report, ``[a]lthough 
90 percent of CME trade times satisfied the standards [of 
consistency with underlying data] for Test I, available data do not 
permit sufficiently precise verification of the accuracy of all of 
these trade times.'' Audit Trail Report at 11.
    Under the 90 percent performance standard, only trade times 
assigned by the Exchange's imputed timing system within timing 
windows of two minutes or less are reliably accurate. As noted 
above, Commission staff deems accurate those trades for which the 
imputed trade times are consistent with all underlying audit trail 
records and data, as determined by manual review. When comparing 
windows data for accurate trades and all trades, the Division has 
found that a higher percentage of accurate trades are assigned 
imputed times that fall within windows of two minutes or less and 
thus meet the 90 percent performance standard. However, the 
resulting percentage difference between accurate and all trades 
generally has not exceeded one percent. In addition, since the use 
of all trades data facilitates exchange submission of timing windows 
percentages because such data do not have to be generated in 
conjunction with an accuracy test, which requires an analysis of 
extensive trade documentation, the Commission finds that the use of 
all trades data provides an acceptable basis for determining windows 
performance.
    \10\ In response to recommendations made in the Audit Trail 
Report, the Exchange modified its trading card procedures such that 
only six trades can be recorded on a card, trade data can be entered 
only on one side of the card, and a new card must be used with the 
change of each time bracket. The Exchange modified its reporting and 
enforcement procedures to supply members more promptly with 
information on audit trail inconsistencies and to require 
corrections that reflect actual events, to enforce more aggressively 
data recordation and submission requirements, including spread quote 
reporting and timing data, and to enforce more aggressively 
timestamping procedures for flashed orders.
    The Exchange also made a number of improvements to its trade 
timing system. Since 1995, the CME has required a trade submission 
indicator for executions of orders flashed upon receipt, used 
seconds in the imputed timing system, including seconds from order 
ticket timestamps, added exit timestamps to the imputed timing 
system, used order type information to time trades, and used the 
clearing receipt time in its timing system. The Exchange also made a 
number of programming improvements to its timing algorithm.
    CME 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 synchronize 
timestamp clocks across the floor and upgrade the clocks to record 
times to the second.
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    Subsequent to the re-test, the Exchange provided windows data for 
all affected contract markets (including the S&P 500 futures market) in 
response to Commission requests. For December 10, 1996, the overall 
percentage of trades with timing windows of two minutes or less was 82 
percent. The percentage of trades with timing windows of two minutes or 
less computed separately for each of the seven affected contract market 
ranged from 37 percent to 89 percent. For March 12, 1997, the overall 
percentage of trades with timing windows of two minutes or less was 83 
percent and the percentages for the seven affected contract markets 
ranged from 62 percent to 87 percent.
    On June 30, 1997, the Exchange provided windows data for three 
additional trade dates selected at random by the Commission which 
showed that the overall percentage of trades with timing windows of two 
minutes or less ranged from 82 percent to 85 percent. The percentage of 
trades with timing windows of two minutes or less computed separately 
for each of the seven affected contract market ranged from 65 to 92 
percent on May 28, 1997; 66 to 86 percent on June 5, 1997; and 60 to 88 
percent on June 10, 1997. 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.<SUP>11</SUP>
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    \11\ The windows data percentages indicated for the trade dates 
December 10, 1996, through June 10, 1997, do not include windows 
data for the S&P futures contract market. As noted above, the 
Commission is issuing a separate order granting CME an unconditional 
dual trading exemption for the S&P 500 futures contract market.
    The Exchange submitted data indicating that 90 percent or more 
of the imputed trade times in its S&P 500 futures contract had 
timing windows of two minutes or less on all three dates selected by 
Commission staff using a random sampling method, as well as two 
prior dates selected by the Exchange based upon Commission 
timeframes. The Commission believes that, while timing windows data 
for all dates provided should be considered, the dates selected 
randomly by persons other than those affiliated with the Exchange 
should be accorded greater weight in determining whether an affected 
contract market attains the 90 percent performance standard. The 
windows data for the S&P 500 futures contract market demonstrates 
consistent compliance with the 90 percent performance standard. None 
of the Exchange's other affected contract markets demonstrated 
consistent compliance.
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    The negative impact on the components of the Exchange's trade 
monitoring system resulting from its failure to satisfy the 90 percent 
performance standard is exacerbated because CME does not require the 
recordation of a member's personal and customer trades in 
sequence.<SUP>12</SUP> Given the absence of such a recordation 
requirement, reliably accurate trade times are essential for effective 
determination of the sequence of trades. Where the sequence of customer 
and personal trades is not determined, possible dual trading-related 
abuses, such as trading ahead of customer orders and trading against 
customer orders, could go undetected.
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    \12\ Notably, although there are differences in various systems 
among the exchanges, the three other exchanges for which the 
Commission has granted unconditional exemptions from the dual 
trading prohibition require that customer and personal trades be 
recorded sequentially on a single trading document. Similar to CME, 
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 CME'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 14-15. Section 5a(b)(3) of the 
Act provides, among other things, that an exchange's audit trail 
system must record accurately and promptly essential data on all 
trades, including execution time, through a means that is adequately 
precise to determine the sequence of customer and personal trades, 
to the extent practicable as determined by the Commission by rule or 
order.
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Other Components of CME'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.<SUP>13</SUP> Such information also must be obtained 
in a timely manner. The Exchange requires that clearing members submit 
trade data for clearing no later than 60 minutes after the end of the 
last time bracket on the trading card or floor order ticket. CME's 
trade data, therefore, are provided periodically to the Exchange at no 
more than hourly intervals, which is continual.
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    \13\ See Audit Trail Re-Test Report at 39.
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    With regard to unalterability, as mandated by Section 
5a(b)(3)(A)(i) of the Act, the Exchange's trade records are 
unalterable, since they are recorded on trading cards and order tickets 
in nonerasable ink. Trade corrections also are not permitted to obscure 
original data.<SUP>14</SUP>
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    \14\ The Commission requires retention of a record of any 
cancellations, changes, or corrections to trades. Commission 
Regulation 1.35(d) and the Outtrade Interpretation, 54 FR 37004 
(September 6, 1989). The Commission amended Regulation 1.35(d)(7), 
effective October 21, 1996, to require that the correction of 
erroneous information on trading records be accomplished in such a 
manner that the originally recorded information must not be 
obliterated or otherwise made illegible. 61 FR 42999 (August 20, 
1996). In November 1996, CME amended its CME Rule 536 to comport 
with the Commission's amendment to Regulation 1.35(d)(7).

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[[Page 60863]]

    CME'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 practicable.<SUP>15</SUP> The Exchange's 
existing system uses, among other things, data generated by both buyers 
and sellers for personal trades, including trading card numbers and 
sequence of trades on trading cards, certain execution times required 
to be entered manually, entry and exit timestamps on order tickets, 
time and sales data and 15-minute bracket codes to impute trade 
execution times.
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    \15\ See Audit Trail Re-Test Report at 40.
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    The Exchange requires that personal trades be recorded in sequence, 
consistent with Commission regulations, by requiring that members 
record such trades in sequence on pre-numbered trading 
cards.<SUP>16</SUP> The Exchange adopted a single-sided trading card on 
which all personal buy and sell trades are required to be recorded 
sequentially in response to an Audit Trail Report recommendation. 
However, as noted elsewhere, the Exchange does not require the 
recordation of a member's personal and customer trades in sequence. 
Given the absence of such a recordation requirement, reliably accurate 
trade times are essential for effective determination of the sequence 
of trades.
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    \16\ Commission Regulation 1.35(d)(2) requires that each member 
of a contract market recording purchases and sales on trading cards 
must record such purchases and sales in exact chronological order of 
execution on sequential lines of the trading card.
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    CME 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 trade 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, CME'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 CME 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.<SUP>17</SUP>
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    \17\ 60 FR 58049 (November 24, 1995).
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Physical Observation of Trading Areas

    CME's trade monitoring system satisfies the requirements of Section 
5a(b)(1)(A) of the Act in that CME maintains and executes an adequate 
program for physical observation of Exchange trading areas and 
integrates the information obtained from such observation into its 
compliance programs. The Exchange conducts daily floor surveillance 
during the open and close on all affected contract markets and at 
random times during each trading day. CME also performs floor 
surveillance when warranted by special market conditions, such as 
exceptional volatility or contract expirations. Finally, the Exchange 
employs a video camera logging system in the interest rate quadrant on 
the upper trading floor.<SUP>18</SUP>
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    \18\ Although primarily employed for dispute resolution, the 38 
cameras run continuously throughout the trading day and may enable 
investigators to view virtually all activity in the quadrant to 
resolve irregularities detected by the Exchange's computerized 
surveillance system or to follow up on tips from members, clerks or 
floor surveillance staff.
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Recordkeeping System

    CME's recordkeeping system captures certain essential data on 
trades and uses information from the records and violations of 
recordkeeping requirements to bring appropriate disciplinary actions. 
However, the Exchange needs to improve member compliance with 
Regulation 1.35(j), in that only 83 percent of the trading cards 
selected for review by Division staff were submitted to the clearing 
member within 15 minutes following 30-minute trading intervals and 
timestamped promptly to the nearest minute following collection.
    In addition, because CME 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 CME 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.
    CME generally conducts back office audits of trading cards and 
order tickets at each clearing member firm at least once a year for a 
representative sample of customer orders and personal trades. CME 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, CME did bring 
disciplinary actions against offenders and issued meaningful penalties 
against violators. Therefore, CME 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, CME refers appropriate cases to the Commission.
    On a daily basis, CME reviews computerized surveillance reports 
generated by the Exchange's Automated Trade Surveillance system to 
detect possible instances of dual trading-related abuses and other 
trading abuses. All relevant trade data, including account numbers, are 
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, wash trading, and trading against 
a customer with a collaborator, as well as those designed to provide 
data on personal profit and loss, member dual trading and outtrade 
resolution. Once an investigation has been opened, the Exchange's 
Compliance Department can use video cameras, on a for cause basis,

[[Page 60864]]

to assist in the conduct of the investigation.<SUP>19</SUP>
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    \19\ During 1996, the CME significantly expanded its video 
surveillance capability. The two cameras on the upper trading floor 
were replaced with ten cameras, and the single camera on the lower 
trading floor was replaced with seven cameras. All 17 are state-of-
the-art ``pan, tilt and zoom'' professional grade cameras.
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    During 1996, the Exchange initiated 429 investigations and/or 
inquiries into all types of trading-related abuses. Approximately 80 
percent of the investigations opened and closed during 1996 were closed 
within the four-month standard set forth in Regulation 8.06. During 
that same period, the Exchange initiated 98 dual trading-related 
investigations and referred three of these investigations to a 
disciplinary action committee. During the period of January 1994 
through December 1996, CME assessed substantial penalties in 14 
disciplinary actions involving dual trading-related abuses.

Commitment of Resources

    The Commission finds that CME meets the requirements of Section 
5a(b)(1)(E) of the Act by committing sufficient resources for its trade 
monitoring system to be effective in detecting and deterring violations 
and by maintaining an adequate staff to investigate and to prosecute 
disciplinary actions. For fiscal year 1996, CME committed 99 personnel 
to the Exchange's Compliance, Market Surveillance and Audits 
Departments and reported its total self-regulatory costs to be 
$15,388,000. CME's reported volume for this period was 177,027,583 
contracts, and the number of trades exceeded 16,000,000.
    Accordingly, the Commission Hereby Orders that:
    The Exchange must implement the following corrective action: 
achieve compliance with the 90 percent performance standard.
    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: Live Cattle, Deutsche Mark, Japanese Yen, Swiss Franc 
and Eurodollar futures contracts and the option contracts on Eurodollar 
and S&P 500 futures.
    Accordingly, the Commission proposes to grant CME's Petition for 
Exemption, subject to the stated condition, from the dual trading 
prohibition for trading in its Live Cattle, Deutsche Mark, Japanese 
Yen, Swiss Franc and Eurodollar futures contracts and the option 
contracts on Eurodollar and S&P 500 futures.
    If, at any time, CME 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 CME 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 CME 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 CME 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) CME Rule 
552 with respect to a contract month position 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 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 
to 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 contained in 
CME Rule 552 or other 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.

Dissenting Opinion of Commissioner Barbara Pedersen Holum on the 
Disposition of the Chicago Mercantile Exchange's Dual Trading Petition

    Section 4j(a)(3) of the Commodity Exchange Act requires the 
Commission to exempt a contract market unconditionally from the dual 
trading prohibition of Section

[[Page 60865]]

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