RULE ENFORCEMENT REVIEW 

OF THE 

NEW YORK BOARD OF TRADE

Division of Market Oversight 

October 26, 2005 
Table of Contents 

I. INTRODUCTION...............................................................................................1 

II. SUMMARY OF FINDINGS AND RECOMMENDATIONS...........................3 

III. SURVEILLANCE OF MARKET ACTIVITY ..................................................5 

 A. Market Surveillance Staff and Overview of Routine Surveillance.............6 

 B. Surveillance of Expiring Contracts..............................................................8 

 C. Large Trader Reporting System.................................................................11 

 D. Enforcement of Speculative Position Limits, Hedge Exemptions, and 

 Position Accountability .............................................................................13 

 1. Exemptions from Speculative Position Limits ...................................13 

 2. Monitoring Position Limits and Hedge Exemptions ..........................17 

 3. Position Accountability.......................................................................18 

 E. Exchange of Futures for Physicals and Exchange of Futures for Swap 

 Transactions................................................................................................19 

 1. Routine EFP Reviews ..........................................................................20 

 2. EFP Investigations ...............................................................................21 

IV. CONCLUSIONS AND RECOMMENDATIONS ...........................................23 
RULE ENFORCEMENT REVIEW 

OF THE MARKET SURVEILLANCE PROGRAM 

AT THE NEW YORK BOARD OF TRADE 

I. INTRODUCTION 

 

 The Division of Market Oversight (“DMO”) has completed a rule enforcement review of 

the market surveillance program of the New York Board of Trade (“NYBOT” or “Exchange”) 

for compliance with applicable core principles under Section 5(d) of the Commodity Exchange 

Act (“Act”), as amended by the Commodity Futures Modernization Act of 2000 (“CFMA”), and 

Part 38 of the Commission’s regulations. The review covers the target period of January 1, 2004 

to December 31, 2004 (“target period”).1

In June 1998, the New York Cotton Exchange (“NYCE”) and its subsidiaries, the New 

York Futures Exchange and the Citrus Associates of NYCE, merged with the Coffee, Sugar, & 

Cocoa Exchange (“CSCE”) to form the New York Board of Trade (“NYBOT”). Prior to June 

10, 2004, NYBOT was composed of two subsidiaries, the CSCE (referred to as “Division A”) 

and NYCE and its subsidiary exchanges (referred to as “Division B”). As of June 10, 2004, the 

exchanges officially became one exchange and NYBOT was designated as a contract market for 

all of its exchanges. However, the Exchange continues to maintain the Division A and Division 

B distinction for the purpose of conducting market surveillance. 

 

1

 Rule enforcement reviews prepared by DMO are intended to present an analysis of an exchange’s overall 

compliance capabilities for the period under review. Such reviews deal only with programs directly addressed in the 

review and do not assess all programs. DMO’s analyses, conclusions, and recommendations are based, in large part, 

upon DMO’s evaluation of a sample of investigation and disciplinary case files, and other exchange documents. 

This evaluation process, in some instances, identifies specific deficiencies in particular exchange investigations or 

methods but is not designed to uncover all instances in which an exchange does not address effectively all exchange 

rule violations or other deficiencies. Neither is such a review intended to go beyond the quality of the exchange’s 

self-regulatory systems to include direct surveillance of the market, although some direct testing is performed as a 

measure of quality control. 
2

The review focuses on the two core principles that relate to an exchange’s market 

surveillance program. Core Principle 4, Monitoring of Trading, relates to an exchange’s 

program to prevent manipulation, price distortion, and disruptions of the delivery or cash 

settlement process, and Core Principle 5, Position Limitations or Accountability, relates to an 

exchange’s program for enforcing its speculative position limits and position accountability 

rules. Appendix B to Part 38 provides acceptable practices for demonstrating compliance with 

Core Principles 4 and 5. 

 For purposes of this review, DMO staff interviewed officials and staff from the 

Exchange’s Market Surveillance Department (“MSD”).2

 DMO also reviewed numerous 

documents used by MSD in carrying out the Exchange’s routine market surveillance 

responsibilities. These documents included, among other things, the following: 

• computer reports generated by the Exchange’s automated surveillance systems and other 

documents used in market surveillance and speculative limit and position accountability 

enforcement; 

• files and records concerning contract expirations, speculative limit and position 

accountability enforcement, and speculative limit exemptions; 

• market surveillance inquiry, investigation, and disciplinary action files for cases closed or 

conducted during the target period; 

• the Exchange’s Market Surveillance Procedures Manuals and guidelines; and 

• minutes of all Control Committee meetings and all other meetings of committees 

responsible for market surveillance matters held during the target period. 

 DMO provided the Exchange an opportunity to review and comment on a draft of this 

report on September 30, 2005. On October 11, 2005, DMO staff conducted an exit conference 

with Exchange officials to discuss the report’s findings and recommendations. 

 

2

 A copy of the March 9, 2005 transcript of those interviews can be found in Appendix 1. 
3

II. SUMMARY OF FINDINGS AND RECOMMENDATIONS 

Findings

 Market Surveillance Staff and Routine Surveillance 

• The MSD’s market surveillance activities are divided between NYBOT’s former 

Division A and Division B exchanges. The Managing Director has primary 

responsibility for surveillance of the Division A markets and the Surveillance Manager 

has primary responsibility for surveillance of the Division B markets. They are assisted 

by six other MSD staff members. MSD staffing levels are adequate given the number of 

active NYBOT markets. 

• Daily market surveillance activities include monitoring of prices, volume, open interest, 

spread relationships, market news, deliveries, physical supplies, and other factors that 

could affect NYBOT’s markets. 

Surveillance of Expiring Contracts 

• Surveillance of expiring contracts is heightened well in advance of last trading day, 

focusing on position concentrations, large trader positions, deliverable supplies, and the 

relationship between open interest and deliverable supplies. Files maintained for contract 

expirations were well documented and reflective of the surveillance activities conducted.

• The December 2004 cotton contract was the only non-routine expiration during the target 

period. A major long position holder in the market indicated that he intended to take 

delivery on his large position during a tight supply situation. The Exchange’s Control 

Committee and the MSD maintained close observation of the market and the MSD was in 

daily contact with the major long position holder. At expiration, the contract liquidated 

in an orderly manner. 

Large Trader Reporting and Speculative Limit Enforcement 

• The MSD uses two different computerized large trader reporting systems, one for its 

former Division A markets and one for its former Division B markets, to monitor 

compliance with speculative and hedge exemption position limits. Although both 

systems produce similar large trader reports, the Division B system has query capabilities 

that allow staff to sort data by a number of variables for both futures and options. The 

Exchange is working to merge the systems and have an integrated large trader reporting 

system incorporating the positive features of each system. The Exchange plans to have 

the new system operating by December 2005. 
4

• Exemptions from speculative limits may be granted for bona fide hedging, arbitrage and 

straddle positions, and for independently controlled positions. DMO randomly reviewed 

32 out of 93 position limit exemption requests filed during the target period and 22 letters 

confirming the renewal of overall and/or single month exemptions. The files examined 

were well documented, and indicated that exemption requests were thoroughly reviewed 

by the MSD and appear to be granted at appropriate levels. 

• During the target period, eight investigations involving speculative limit violations were 

opened and closed. The investigations were thorough and completed in a timely manner. 

Violations were found in seven of the eight investigations, which resulted in five warning 

letters and three informational letters being issued to first time offenders. 

Exchanges of Futures for Physicals and Exchanges of Futures for Swaps 

• The Exchange conducts routine reviews of selected exchanges of futures for physicals 

(“EFPs”) and exchanges of futures for swaps (“EFSs”) monthly to ensure that they are 

transacted in accordance with Exchange rules. During the target period, the Exchange 

completed 12 reviews that examined 72 EFPs and two EFSs. In each review, the 

Exchange issued a document request letter that asked for, among other things, 

documentation that would verify the cash-side of the transaction. The Exchange’s 

routine reviews were generally thorough and well-documented, and included appropriate 

analysis to determine whether the transactions satisfied the Exchange’s EFP/EFS 

requirements.

• The Exchange opened 10 EFP investigations during the target period, nine resulting from 

DMO referrals and one from a routine review. The referrals identified EFPs which DMO 

believed involved either the same entity or affiliated entities under common control on 

both sides of the transaction. 

• DMO’s review of the investigations revealed that several of the investigations were not 

conducted in a thorough manner. DMO identified four EFP investigations where the 

Exchange did not issue document request letters to determine whether the EFPs were 

bona fide transactions satisfying all of the Exchange’s requirements. Rather, the MSD 

only inquired as to whether the buyer and seller were under separate control. 

• The Exchange’s EFP investigations also revealed that NYBOT’s requirement of separate 

control for affiliated entities may not be fully understood by members and their 

customers. Three of the five warning letters and both informational letters issued for EFP 

violations during the target period related to non-compliance with the Exchange’s 

requirement that affiliated parties to an EFP be under separate control. In each case, it 

appeared that the subjects of the investigation were unaware of, or did not understand, the 

Exchange’s rule in that regard.

 
5

Recommendations

• The MSD should request underlying cash-side documentation for all EFPs under 

review, regardless of whether they emanate from a routine review or a Commission 

referral, to evaluate fully compliance with all provisions of the Exchange’s EFP 

rule. 

• The Exchange should issue a notice reminding members of the separate control 

requirement of NYBOT’s EFP rule and how it can be satisfied, and request that 

members share this information with their customers who engage in EFPs.

 

III. SURVEILLANCE OF MARKET ACTIVITY 

Core Principle 4 – Monitoring of Trading: 

 

The board of trade shall monitor trading to prevent manipulation, price distortion, 

and disruptions of the delivery or cash-settlement process. 

Core Principle 5 – Position Limitations or Accountability: 

To reduce the potential threat of market manipulation or congestion, especially 

during trading in the delivery month, the board of trade shall adopt position 

limitations or position accountability for speculators, where necessary and 

appropriate. 

 Pursuant to the acceptable practices set forth in Appendix B to Part 38 of the 

Commission’s regulations, an acceptable market surveillance program should regularly collect 

and evaluate market data to determine whether markets are responding to the forces of supply 

and demand. An exchange also should have routine access to the positions and trading of its 

market participants. To diminish potential expiration problems that may arise from excessively 

large speculative positions, an exchange may need to establish speculative limits for some 

commodities. Such position limit rules may provide for hedge or other exemptions and the limits 

may be set differently by markets, delivery months, or time periods. Spot month limits should be 

adopted for markets based on commodities having more limited deliverable supplies or where 

necessary to minimize a market’s susceptibility to manipulation or price distortion. 
6

 Position limits are not necessary for markets where the threat of excessive speculation or 

manipulation is very low. For some contracts, such as financial instruments, an exchange may 

provide for position accountability in lieu of position limits. An exchange which trades several 

products with a large number of traders should have an automated large trader reporting system 

that is used daily to enforce compliance with position limit rules.

A. Market Surveillance Staff and Overview of Routine Surveillance 

The MSD, which is part of the Exchange’s Market Regulation Department (“Market 

Regulation”), is responsible for administering the Exchange’s market surveillance program.3 

MSD is led by the Managing Director, who reports to the Vice President of Market Regulation. 

MSD’s staff includes a Surveillance Manager, a Senior Database Clerk, a Senior Database 

Clerk/Surveillance Assistant, an Exchange of Futures for Physicals (“EFP”)/Operations 

Manager, an EFP/Operations Assistant, a Statistics Coordinator, and a Database Analyst.4

 MSD’s surveillance of NYBOT’s markets is divided between the former Division A and 

Division B exchanges. The Managing Director has primary responsibility for surveillance of the 

Division A markets and the Surveillance Manager has primary responsibility for surveillance of 

the Division B markets.5

 Both conduct routine market surveillance activities, such as monitoring 

 

3

 Market Regulation, which includes the MSD and the Compliance Department, reports to the Senior Vice President 

for Legal and Regulatory Affairs. The Senior Vice President for Legal and Regulatory Affairs also serves as 

NYBOT’s General Counsel and Corporate Secretary. 

4

 A copy of an organizational chart for MSD can be found in Appendix 2. The Vice President of Market Regulation 

has 24 years of experience in commodity regulation, including both market surveillance and trade practice 

surveillance. The Managing Director has 10 years of market surveillance experience and an additional seven years 

of commodities research experience. The Surveillance Manager has 30 years of market surveillance and compliance 

experience, which includes over 25 years at NYBOT and several years at the Commission and its predecessor, the 

Commodity Exchange Authority. The EFP/Operations Manager has worked for the Exchange for 17 years in 

research and economic functions, and has more than six years of experience with EFP reviews. The remaining MSD 

staff has combined market surveillance and compliance experience totaling more than 40 years. 

5

 Active markets on the former Division A, the CSCE, include coffee C, sugar #11, and cocoa. Less active markets 

include sugar #14 and ethanol. On the former Division B, the NYCE and its subsidiaries, active markets include 

cotton #2 and frozen concentrated orange juice (“FCOJ”), while less active markets include cash settled financial 
7

large traders and contract expirations, in their respective markets on a daily basis. In addition, 

both manage the processing of position limit exemption requests for their assigned markets and 

oversee any market surveillance related investigations. With respect to the Division A markets, 

the Managing Director is assisted by the Senior Database Clerk, the EFP/Operations Manager, 

and the Operations/EFP Assistant. The Senior Database Clerk assists the Managing Director 

with routine surveillance activities, while the EFP/Operations Manager and Operations/EFP 

Assistant conduct monthly EFP reviews, and have other responsibilities related to the 

Exchange’s Statistics Department. With respect to the Division B markets, the Database Analyst 

assists the Surveillance Manager in performing routine surveillance and the Senior Database 

Clerk/Surveillance Assistant conducts monthly EFP reviews and other surveillance tasks, as 

assigned. 

 MSD’s routine surveillance activities include daily monitoring of prices, volume, and 

open interest to detect potential price distortions and market congestion. Staff also monitors 

daily price movements and spread relationships, market news, deliveries, physical supplies, and 

other factors that could affect NYBOT’s markets. Clearing member and large trader positions 

also are monitored daily to ensure compliance with speculative and hedge exemption position 

limits. Further, MSD regularly contacts trade sources and large market participants to keep 

informed of cash market developments and delivery intentions. In addition, weekly summaries 

of long and short position holders in the nearby contract are prepared for review by the Vice 

President of Market Regulation. 

 The MSD’s staffing levels are adequate given the number of active markets at NYBOT. 

 instruments and index contracts, as well as several cross currencies that are traded after hours on NYBOT’s Dublin 

FINEX floor. 
8

B. Surveillance of Expiring Contracts 

 To ensure orderly liquidations, MSD intensifies surveillance during contract expirations. 

MSD typically begins its enhanced surveillance approximately three weeks prior to the first 

notice day for coffee and cocoa and three weeks prior to the spot month limit taking effect for 

sugar #11.6

 Surveillance of the cotton and FCOJ contracts is intensified approximately 40 

business days before the last trading day in those commodities. 

 With the exception of the Exchange’s financial contracts, surveillance of expiring 

contracts is conducted in the same manner for all contracts.7

 MSD focuses on position 

concentrations, large trader positions, deliverable supplies, and the relationship between open 

interest and deliverable supplies. MSD also gathers information about cash market prices and 

supplies, and any other factors that may affect an orderly liquidation. It also contacts holders of 

large positions to ascertain their intentions with respect to making or taking delivery as contract 

expiration approaches. Prior to first notice day, and spot month position limits taking effect, 

MSD sends reminder letters to traders whose current positions are approaching speculative 

position limits and who might be eligible for a hedge exemption. Exchange rules require that 

such exemption requests be submitted at least five business days before the reduced position 

limit takes effect.8

 

 The Exchange’s Control Committee is responsible for directing the Exchange’s market 

surveillance activities and works closely with MSD to ensure orderly contract expirations. 

 

6

 First notice day typically occurs four weeks before the last trading day in coffee and cocoa, and the spot month 

limit for sugar #11 typically takes effect 12 business days before expiration. 

7

 Since availability of deliverable supply is not relevant for cash settled index contracts and generally is not of 

significant concern for financial instruments that are in plentiful supply, MSD staff focus their attention on clearing 

member and large trader position information in these markets. 

8 See pp. 13-17 below for further discussion of hedge exemptions. 
9

Currently, there are five standing Control Committee subcommittees, one for coffee, cocoa, 

sugar #11, cotton, and FCOJ.9 The subcommittees have the authority to obtain position 

information, compel testimony by members and the production of books and records, and to 

investigate and take action in any situation that may jeopardize the Exchange.10

 MSD is responsible for keeping the Control Committee subcommittees informed 

regarding market conditions prior to and during delivery periods. The coffee and cocoa 

subcommittees meet at least one week prior to first notice day. The sugar #11 subcommittee 

meets at least one week before the spot month limit takes effect. Cotton and FCOJ 

subcommittee meetings are scheduled on an as needed basis. Prior to a Control Committee 

meeting, MSD provides the respective subcommittee with, among other things, a report that 

includes: (1) the largest position holders (with identities coded) that shows whether the trader is a 

commercial or non-commercial, (2) clearing member positions and charts, (3) data on open 

interest and spread relationships, and (4) information on deliverable supplies. Also included are 

minutes from the last subcommittee meeting. During the target period, there were a total of 18 

subcommittee meetings. The subcommittee meetings for coffee (five), cocoa (five), and sugar 

#11 (four) were the routine meetings convened prior to expiration.11 The Control Committee’s 

cotton and FCOJ subcommittees each held two meetings. 

 

9

 If any issues arose with respect to the expiration of a financial instrument, index contract, or cross currency 

contract, the Chairman of the Control Committee would convene a subcommittee. 

10 NYBOT Rule 3.12. Control Committee members may not be Board members. Each subcommittee must include 

at least three Control Committee members. A committee member may not serve on a subcommittee if that person is 

identified with the contract for which the subcommittee has jurisdiction. 

11 Although the coffee, cocoa, and sugar #11 subcommittees meet at least once in connection with each contract’s 

expiration, they may meet more frequently if market conditions so require. 
10

 MSD maintains expiration files for the coffee, cocoa, sugar #11, cotton, FCOJ, and index 

and financial contracts.12 DMO reviewed expiration files for two agricultural contracts (May 

2004 sugar #11 and December 2004 cotton) and two financial index contracts (September 2004 

U.S. Dollar and June 2004 Russell 1000). DMO found that the files were well documented and 

reflective of the surveillance activities conducted. The files examined typically included coded 

weekly large trader reports, open interest charts, spot month exemptions, notes and memoranda 

concerning discussions with large market participants, trader intentions, and deliverable supply 

data. The sugar #11 and cotton files also included minutes of the respective Control Committee 

subcommittee meetings.13 

 In addition, the December 2004 cotton file thoroughly documented staff’s and the 

subcommittee’s heightened surveillance of that expiration. Surveillance was heightened when a 

major long position holder in the market indicated to MSD staff that the trader was going to take 

delivery on a large position during a tight deliverable supply situation. The tight supply situation 

developed because growers were placing their cotton into the U.S. Department of Agriculture’s 

“loan” program due to low cotton prices.14 A cotton subcommittee was convened on November 

16, 2004 to discuss the situation. The subcommittee Chairman instructed MSD staff to closely 

monitor deliverable supply, market composition and price, and to contact the large trader daily to 

get the terms of any liquidating orders he was placing. The subcommittee Chairman and MSD 

 

12 The MSD also monitors low-volume contracts daily, such as sugar #14, but generally does not maintain expiration 

files for those contracts. However, if there was an unusual or problematic expiration, an expiration file would be 

maintained. 

13 The minutes for Control Committee meetings held during the target period can be found in Appendix 3. 

14 The Non-recourse Marketing Assistance Loan and Loan Deficiency Payment Program are administered by the 

U.S. Department of Agriculture. The program provides producers with the financing to store harvested crop 

production rather than immediately selling the crop. Producers can have funds to pay bills without having to sell the 

harvested crop if prices are low. When the adjusted world price (“AWP”) for upland cotton falls below the loan 

rate, producers can repay loans at the AWP level. Alternatively, an eligible producer may choose to receive a loan 

deficiency payment (“LDP”) in return for forgoing the loan. When market conditions allow an LDP, the payment is 

based on the difference between the loan rate and the AWP. 
11

staff maintained close observation of the market as a gradual decline in open interest reduced any 

potential delivery problems. In the end, the December 2004 cotton contract expired in an orderly 

fashion without disruption. There were no other problematic expirations during the target 

period. 

C. Large Trader Reporting System 

 NYBOT clearing members transmit daily computerized large trader reports, including all 

reportable futures and options positions to the Exchange. Exchange rules specify that once a 

trader reaches the reportable level in one contract, then all of that trader’s positions in that 

particular commodity must be provided to the Exchange.15 Non-member futures commission 

merchants (“FCMs”) and foreign brokers are required to provide daily large trader reports, 

including reportable futures and options positions to the Exchange by e-mail or fax. 

 Reportable positions are processed into the Exchange’s large trader reporting systems 

daily. In order to calculate futures-equivalent positions, an account’s daily futures positions are 

combined with its options on a delta-adjusted basis.16 In addition, related and/or commonlycontrolled accounts are aggregated. Once position data have been entered into the Exchange’s 

large trader reporting systems, reports are generated to detect speculative position limit 

violations and for general market surveillance purposes. MSD staff view these reports daily on 

screens and in hard copy form. 

 MSD uses two different computerized larger trader reporting systems. The Speculative 

Limits Information Management (“SLIMS”) system is used for NYBOT’s former Division A 

 

15 NYBOT Rule 6.15. 

16 “Delta” is the measure of the sensitivity of an option’s value to a change in the price of the underlying futures 

contract, and is also referred to as an options futures-equivalent position. Deltas are positive for calls, and negative 

for puts. 
12

markets, and a database system coupled with FoxPro query software (“FoxPro System”) is used 

for the former Division B markets.17 Both SLIMS and the FoxPro System, though independent 

systems, are capable of performing similar monitoring of trading data for their respective 

contract markets and produce similar reports. However, the FoxPro System has query 

capabilities that allow staff to sort data by a number of variables for both futures and options. 

For example, while both systems can generate a report identifying large trader positions for a 

selected market by contract month, the FoxPro System can sort data by size, type of trader 

(commercial/non-commercial), etc. The analogous SLIMS report will simply list the positions 

by account holder, and any further sorting must be done manually. 

 In addition, both SLIMS and the FoxPro System produce a “Speculative Limits 

Violations Selection Report.” This report is used to view every reportable position or to review 

position holders maintaining a selected percentage of the speculative position limit. The SLIMS 

version can be set to display reportable positions at any selected percentage of the speculative 

position limit, while the FoxPro System’s version only displays those positions at 75 percent or 

more of the speculative limit. SLIMS and the FoxPro System also produce similar reports that 

show all omnibus account positions for a particular date. Identified customers are listed with the 

omnibus account. Staff reviews these reports to determine if there are omnibus accounts that 

may have reportable positions which are not providing the Exchange with a large trader report. 

When this occurs, MSD contacts the omnibus accounts directly to determine if they have 

reportable positions. If so, the omnibus accounts are directed to report such positions to the 

Exchange daily by fax or e-mail. 

 

17 The Speculative Limits Options Positions (“SLOPS”) system is used in conjunction with SLIMS for the Division 

A markets. SLIMS/SLOPS and the FoxPro System are essentially the systems that were in place at CSCE and 

NYCE, respectively, prior to the merger of the two exchanges. 
13

 Other reports and screens generated by the Exchange’s large trader reporting systems 

show reportable positions by account or in the aggregate; compare cleared long and short 

positions to reported positions for each clearing member (which allows staff to ensure that there 

are no reporting discrepancies); list all unidentified reportable accounts by clearing member;18

display a specified account’s identifying information, including the name of the aggregate to 

which the account may belong; list all reportable accounts held by traders who use more than one 

clearing member; list aggregated accounts and accounts included within each aggregation, as 

well as the clearing member where each account is carried; and display position information for 

all reportable accounts or selected accounts, and for clearing members. 

 The Exchange is working to merge its large trader reporting systems and have an 

integrated system incorporating the positive features of each system. The Exchange plans to 

have the new system operating by December 2005. 

 D. Enforcement of Speculative Position Limits, Hedge Exemptions, and 

 Position Accountability 

 1. Exemptions from Speculative Position Limits 

 The Exchange’s speculative limit rules set forth the maximum number of net futuresequivalent contracts (futures and options) which any one person may own or control on the same 

side of the market without an exemption approved by the Exchange. Pursuant to NYBOT Rules 

6.26, 6.27, and 6.28, the Exchange may grant speculative position limit exemptions for bona fide 

hedging, arbitrage and straddle positions, and independently controlled positions.19 Exemptions 

 

18 The MSD requests a CFTC Form 102 to identify reportable accounts. In addition to identifying a particular 

account, the form provides account control and contact information. If an unidentified account has a large position, 

account identification is immediately requested by telephone, to be followed by a Form 102. If a large position is 

not involved, the account is given five business days to file a Form 102. Upon receipt of the Form 102, MSD staff 

determines if an aggregation code must be assigned to the account, if one doesn’t already exist. 

19 NYBOT Rule 6.28 defines an “Independent Account Controller” as a person who (1) is registered with the 

Commission as either an FCM, introducing broker, commodity trading advisor, or as an associated person of any 
14

may be granted for non-spot single month and net all months combined limits (sugar #14 and 

FCOJ), notice period limits (coffee, cocoa, and FCOJ), and spot month limits (sugar #11 and 

ethanol).20 With respect to NYBOT’s former Division B markets, DMO’s Market Surveillance 

section is notified when spot month exemptions are granted and is periodically provided with a 

listing of exemptions in any single month and all months combined. Similar information is 

provided for NYBOT’s former Division A markets upon request by DMO. 

 To apply for a single month and/or a net all months combined position limit exemption, 

an exemption request form must be filed with the Exchange. The form must be signed by a 

NYBOT member or an officer or partner of a NYBOT member firm. When reviewing the 

request, MSD considers the size of the requested position with respect to open interest, the 

principal business and occupation of the requestor, the requestor’s historical level of futures and 

options positions, the requestor’s inventories and uncovered purchases and sales in the physical 

market, and any other information staff may consider relevant to the request. Within five days of 

the submission of a completed request, the applicant is informed in writing whether the 

exemption has been granted, partially granted, or denied.21 Approved exemption quantities are 

 such registrant; (2) is authorized by an eligible entity (such as a commodity pool operator or a commodity trading 

advisor which authorizes a person to independently control trading decisions for its positions, or any other person or 

entity deemed exempt by Commission regulations or guidelines, including Regulation 150.3) to control 

independently trading by, and on behalf of, but without the day-to-day direction of the eligible entity; (3) trades 

independently of the eligible entity and of any other Independent Account Controller trading for the eligible entity; 

(4) is supervised by the eligible entity only to the degree necessary to fulfill its fiduciary responsibilities and duty to 

supervise diligently the trading done on its behalf; and (5) has no knowledge of trading decisions by any other 

Independent Account Controller. 

20 During the target period, NYBOT’s cotton #2 contract was subject only to the speculative position limits set forth 

in Part 150 of the Commission’s regulations and all exemption requests were filed with the Commission. In June 

2005, NYBOT adopted its own speculative position limits for the cotton #2 contract. Exemption requests for cotton 

#2 must now be filed with the Exchange, as well as with the Commission. 

In addition to speculative limits, as discussed below on p. 18, position accountability levels apply to net overall 

positions in cocoa, coffee, sugar #11, and seven cross currency contracts. 

21 A copy of this letter must be signed by a NYBOT member or an officer or partner of a NYBOT member firm and 

returned to the Exchange. 
15

entered into either SLIMS or the FoxPro System, depending on the contract, along with the date 

the exemption was granted. 

 All single month and net all months combined exemptions are reviewed annually to 

ensure that outstanding exemption levels continue to reflect the nature and scope of the 

exemption holder’s business. The Exchange sends a letter to each exemption holder asking it to 

resubmit an exemption request if any material change has occurred in its business. The holder 

may maintain its current exemption by signing, dating, and returning the letter. MSD revokes 

the exemptions of holders who do not respond. The date that an exemption is updated is entered 

into SLIMS or FoxPro. The Exchange reviewed all single month and all months combined 

exemptions in the fourth quarter of 2004. 

The exemption process for notice period and spot month exemptions is similar to that for 

single month and net overall month exemptions, except that exemption requests are due no later 

than five business days before the notice period or spot month position limit takes effect. 

Approximately five business days before such requests are due, MSD sends a reminder letter to 

traders whose current positions exceed position limits. Notice period and spot month exemptions 

expire on the last trading day for the contract for which the exemption was granted. 

 A trader whose position is approaching or exceeds any of the Exchange’s current limits 

may also request an exemption or expansion of a current exemption level by verbally providing 

MSD with the information needed to process the request. If the exemption is granted, the 

applicant must file a completed exemption request form with MSD within 24 hours. 

 During the target period, all of the arbitrage and straddle exemptions granted were of the 

“cash-and-carry” variety. The Exchange granted a total of 34 cash-and-carry exemptions. A 

cash and carry exemption allows a trader to take delivery in the near month and redeliver the 
16

same product in a deferred month at a profit.22 With respect to cash-and-carry exemption 

requests, the applicant must provide its cost of carry and the minimum spread at which the trader 

will enter into a straddle position which would result in an economic profit. The applicant also 

must provide the quantity of stocks in Exchange licensed warehouses that it already owns and 

the applicant’s entire long position carried into the notice period must have been put on at a 

differential that covers the applicant’s cost of carry. Further, the applicant must agree to 

liquidate any long positions in excess of the notice period position limit before the nearby month 

rises to a premium to the second futures month. Cash-and-carry exemptions are typically 

granted in stages and are expanded if requested and if appropriate to market conditions. 

 MSD’s Managing Director and Surveillance Manager have the authority to grant 

exemptions. In the event that an exemption request is deemed large or unusual, the Vice 

President of Market Regulation and, if need be, the Control Committee are consulted before a 

final determination is made regarding approval. As stated earlier, when reviewing any request, 

MSD staff considers the size of the requested position with respect to open interest, the principal 

business and occupation of the requestor, the requestor’s historical level of futures and options 

positions, the requestor’s inventories and uncovered purchases or sales in the physical market, 

and any other information staff considers relevant to the request. Particular emphasis is placed 

on current cash and futures commitments, delivery intentions and deliverable supplies. The 

applicant must justify the entire position requested, not only the amount in excess of speculative 

position limit. 

 

22 In carrying-charge markets, current deliverable stocks are usually adequate and prices are higher for deferred 

expiration months. Traders may request cash and carry exemptions when the spread between the expiring contract 

and next delivery month exceeds carrying charges. Thus, a trader who has purchased the near month and sold the 

deferred month may profit by taking delivery and redelivering the next month. 
17

 DMO randomly reviewed 32 out of 93 position limit exemption requests filed during the 

target period and 22 letters confirming the renewal of overall and/or single month exemptions.23 

In some cases, the Exchange granted only part of a requested hedge exemption or denied an 

exemption based on information provided by the applicant or the lack of such information. The 

exemption files examined by DMO were well documented. The files indicated that the 

Exchange thoroughly reviewed exemption requests, and appeared to grant exemptions at 

appropriate levels. 

 2. Monitoring Position Limits and Hedge Exemptions 

MSD staff reviews large trader positions daily for compliance with speculative position 

limits and/or position limits granted by exemptions. The Exchange’s large trader reports identify 

Division A traders that are at or above 80 percent of their position limits and Division B traders 

that are at or above 75 percent of their position limits. MSD either telephones or faxes a letter to 

such traders reminding them that they are approaching their position limit and they may need to 

apply for an exemption or an expansion of a current exemption, if appropriate. When a member 

exceeds a position limit, staff contacts the member by telephone. If the account belongs to a 

non-member customer and the position is carried by one clearing member, the Exchange contacts 

the carrying clearing member, who in turn contacts its customer. When a position limit has been 

exceeded due to unforeseen bona fide hedging needs, MSD allows the trader to file an exemption 

request that must be received by MSD within five business days (10 business days for FCOJ). If 

the exemption request is approved by MSD, there is no violation. 

 

23 The selected files reviewed included exemption requests for FCOJ, coffee, sugar #11, and cocoa futures, and 

renewal letters for FCOJ and sugar #14 exemptions. No exemption requests were received during the target period 

for any financial or index contracts. 
18

 DMO found that the Exchange addresses potential speculative limit position violations in 

a timely manner and that MSD’s files adequately document staff’s efforts in this regard. During 

the target period, the MSD opened and closed eight investigations involving potential position 

limit violations.24 Violations were found in seven of the eight investigations, which resulted in 

five warning letters and three informational letters being issued to first time offenders.25 

Although warning letters are not typically issued to non-members, during the target period one of 

the warning letters was sent to a non-member for violating FCOJ position limits. The same nonmember again violated FCOJ’s position limits on various dates beginning in December 2004, 

continuing through February 2005 (after the target period). This resulted in the Exchange 

sending another warning letter on March 19, 2005. Because the Exchange lacks disciplinary 

authority over non-members, the Exchange referred the apparent speculative limit violations to 

the Commission for further investigation. 

 3. Position Accountability 

 MSD staff also monitors for violations of the Exchange’s position accountability rules 

using the same large trader reports that it uses to monitor speculative limits. Position 

accountability levels apply to net overall positions in cocoa, coffee, sugar #11, and to seven cross 

currency contracts.26 When a position accountability level is initially reached, MSD staff 

contacts the account holder. If the account holder cannot be reached, clearing members or FCMs 

 

24 Five of these matters were referred to the Exchange by DMO’s Market Surveillance section. According to the 

Exchange, MSD staff had been aware of the violations and had been in contact with DMO’s surveillance staff 

regarding the violations prior to receiving formal Commission referral letters. 

25 An “informational letter” reminds a non-member of rule provisions that apply to a non-member’s conduct and 

serves to put non-members on notice that the Exchange views certain actions as potential rule violations. Warning 

letters are typically sent to Exchange members and become part of a member’s disciplinary history. 

26 The seven currency contracts are: Australian Dollar/New Zealand Dollar; Euro/Czech Koruna; Euro/Hungarian 

Forint; U.S. Dollar/Hungarian Forint; U.S. Dollar/Czech Koruna; U.S. Dollar/African Rand; and New Zealand 

Dollar/U.S Dollar. 
19

carrying the position are contacted. Information is collected and documented regarding the 

nature of the position (e.g., hedging, speculative, arbitrage), trading strategy, how large the 

account holder anticipates the position may become and any other information staff considers 

relevant. If the account that has breached the position accountability level is familiar to staff due 

to past exemption requests, it may not be necessary to contact the account at the time the position 

level is breached. NYBOT’s position accountability rules grant the Exchange the authority to 

instruct an account not to increase its position any further.27 This authority can be invoked due 

to liquidity concerns or for other reasons that the Exchange feels might negatively impact the 

market. 

 During the target period, NYBOT opened one position accountability inquiry. DMO 

found that this inquiry, which involved the sugar #11 contract, was thorough and completed in a 

timely manner. After analyzing the size and nature of the trader’s positions, and taking into 

account the trader’s trading strategy, MSD increased the trader’s position accountability level. 

E. Exchange of Futures for Physicals and Exchange of Futures for Swap 

 Transactions 

NYBOT Rule 4.12 permits EFPs by means of related and simultaneous cash and futures 

transactions in which the buyer and seller of the futures are, respectively, the seller and buyer of 

an approximately equivalent quantity of the physical commodity. EFP transactions may be 

effected in all futures contracts offered for trading on the Exchange. Rule 4.12 also permits 

EFSs by means of related futures and swap transactions in which the buyer and seller of the 

futures are, respectively, the seller and buyer of a swap involving an approximately equivalent 

quantity of the commodity underlying the futures contract (or a derivative, by-product or related 

product of such commodity). For both EFPs and EFSs, the Exchange also requires that the buyer 

 

27 NYBOT Rules 6.17, 6.18, 6.22, 6.24. 
20

and seller be separate parties, or, if they are related or affiliated entities, that they be under 

separate control.28 

 1. Routine EFP Reviews 

 Each month, MSD selects six EFP/EFS transactions (four agricultural and two financial 

transactions) for review to ensure the bona fides of the transactions. During the target period, the 

exchange completed 12 EFP/EFS reviews that examined 72 EFP and two EFS transactions.29 

The Exchange’s selection criteria include, among other things, EFPs/EFSs that involve an 

unusually large size, have the same customer account on both the buy and sell side of the 

transaction, or have the appearance of a new clearing member or trader who does not typically 

engage in EFPs/EFSs. The Managing Director also may recommend that particular EFPs/EFSs 

be reviewed. If a sufficient number of transactions meeting the above criteria are not found, then 

transactions are randomly selected. Once a transaction is selected for review, the Exchange 

requests that the clearing members produce trade confirmation statements indicating the account 

into which the EFP/EFS cleared. For EFPs, the Exchange also requests documentation 

supporting the cash side of the transaction, such as a commercial contract, warehouse receipt, or 

price-fixation letter. For EFSs, the Exchange requests copies of a master swap agreement. 

 The elements of each EFP/EFS reviewed by MSD include ascertaining that the buyer and 

seller of the futures are, respectively, the seller and buyer of the physical commodity/swap as 

evidenced by the names on the trade confirmation statements and cash or swap documents, and 

that there was an actual transference of the physical commodity/swap; that the buyer and seller 

 

28 See NYBOT Rule 4.12 and Questions and Answers (“Q&As”) explaining the Exchange’s February 2002 

amendments to its EFP and EFS rules and the appropriate procedures. The Q&As can be found in Appendix 4. 

29 During the target period, the number of contracts executed via an EFP far outweighed the number of contracts 

executed via an EFS. Specifically, 2,343,285 contracts were executed through EFP transactions and 121,544 

contracts were executed through EFS transactions. This represented approximately 10 percent of the Exchange’s 

2004 total volume. 
21

are different entities, or, if they are related or affiliated, that they are under separate control; and 

that the quantity covered by the cash or swap transaction is approximately equivalent to the 

quantity of the futures transaction. Upon completion of an EFP/EFS review, a summary is 

prepared that includes a listing of the clearing members examined, an EFP/EFS trade report that 

lists all of the EFPs/EFSs executed for the selected clearing members for a selected date, the 

supporting documentation submitted by members and/or customers, and a description of each 

EFP/EFS transaction. 

 DMO examined all of the Exchange’s EFP/EFS reviews for adequacy. The reviews 

were generally thorough and well-documented, and included appropriate analysis to determine 

whether the transactions satisfied the Exchange’s EFP or EFS requirements. The documentation 

for each transaction examined indicated that: (1) the accounts involved had different beneficial 

owners or were under separate control, (2) a change in ownership of a physical commodity for an 

EFP or a swap for an EFS occurred, and (3) that the quantity covered by the cash or swap 

transaction was approximately equivalent to the quantity of the futures transaction. One of the 

EFP transactions reviewed was expanded into a separate investigation that resulted in warning 

letters being issued to two clearing members for failing to submit documents demonstrating that 

the EFP was a bona fide transaction. 

 2. EFP Investigations 

In addition to the one investigation that resulted from a routine EFP review, the Exchange 

opened nine EFP investigations that resulted from referrals from DMO’s Market Surveillance 

staff. DMO’s referrals identified several EFPs which it believed involved either the same entity 
22

or entities under common control on both sides of the transaction.30 Currently, the Exchange’s 

EFP/EFS Report lists for each trading day the EFPs/EFSs cleared by each clearing member. The 

data provided includes, among other things, the commodity, contract, opposite clearing member, 

and the customer account number. To ascertain whether the parties to an EFP are related entities 

is a cumbersome process that requires MSD staff to examine several EFP/EFS reports and then 

access the Exchange’s large trader reporting systems to identify the names associated with 

account numbers. The Exchange has informed DMO that its new integrated large trader 

reporting system will produce an EFP/EFS report that will contain identities of reportable 

accounts. This will allow MSD to more readily identify EFPs/EFSs that may involve related 

entities and to review those transactions for which there is a question with respect to separate 

control of the involved accounts. 

 DMO reviewed all of the Exchange’s EFP/EFS investigations and found that several 

were not conducted in a thorough manner. In five instances, MSD sent either the clearing firm 

or the customer a standard document request similar to that which it uses for its monthly EFP 

reviews. This request asks for specific documentation underlying the cash exchange which 

assists MSD in determining whether an EFP is a bona fide transaction that satisfies all of the 

Exchange’s EFP requirements.31 However, DMO identified four other EFP investigations 

where, rather than issuing a standard document request, MSD only inquired as to whether the 

buyer and seller were under separate control. MSD did not request the documentation necessary 

to determine the existence of a related cash transaction or to verify the transference of the actual 

physical commodity. Although separate control was the central issue in DMO’s referrals, the 

 

30 The MSD’s summary close-out memorandum for four of DMO’s referrals notes that documents had already been 

requested for one of the referred matters prior to DMO’s referral. A copy of the April 1, 2005 memorandum can be 

found in Appendix 5. 

31 A copy of a sample standard EFP document request can be found in Appendix 6. 
23

Exchange should have requested underlying cash-side documentation to evaluate fully the bona 

fides of the EFPs. 

 The Exchange’s EFP investigations also revealed that the requirement of separate control 

for affiliated entities may not be fully understood by members and their customers. In this 

regard, three of the five warning letters and both informational letters issued for EFP violations 

related to non-compliance with the Exchange’s requirement that affiliated parties to an EFP be 

under separate control. In each case, it appeared that the subjects of the investigation were 

unaware of, or did not understand, the Exchange’s rule in this regard. Therefore, the Exchange 

should issue a notice reminding members of the separate control requirement of NYBOT’s EFP 

rule and how it can be satisfied, and request that members share this information with their 

customers who engage in EFPs. 

IV. CONCLUSIONS AND RECOMMENDATIONS 

 DMO found that the Exchange maintains an adequate market surveillance program that 

includes daily monitoring of prices, volume, open interest, spread relationships, large trader 

positions and market news. In addition, MSD staff keeps informed of cash market developments 

and delivery intentions. Surveillance of expiring contracts typically includes focusing on 

position concentrations, deliverable supplies, and the relationship between open interest and 

deliverable supplies. Staff also works closely with the Control Committee and its 

subcommittees, which are responsible for directing the Exchange’s market surveillance 

activities. Staff keeps the committees informed of market conditions prior to and during delivery 

periods. During the target period, there was one non-routine expiration that involved the 

December 2004 Cotton contract. MSD heightened its surveillance of that contract and was in 
24

frequent contact with the subcommittee Chairman. The contract expired in an orderly manner 

without disruption. 

 The Exchange maintains two large trader reporting systems that produce similar large 

trader reports and provide staff with the capability of performing similar monitoring of trade data 

for their respective markets. These two systems will be integrated into a single system in 

December 2005. DMO also found that the Exchange has adequate procedures to review hedge 

exemption applications and to monitor for speculative limit violations and accounts that exceed 

position accountability thresholds. 

 In addition, each month, the Exchange opens a routine EFP/EFS review to examine six 

EFP/EFS transactions for compliance with Exchange rules. DMO found that the 12 reviews 

completed during the target period were through and well documented, and included appropriate 

analysis to determine whether the EFPs/EFSs were bona fide transactions that satisfied the 

Exchange’s requirements. The Exchange also opened 10 EFP investigations during the target 

period, one which resulted from a routine EFP review and nine which resulted from referrals 

from the DMO’s Market Surveillance staff. The referrals questioned whether particular EFPs 

involved the same entity or entities under common control, a violation of NYBOT Rule 4.12. 

The Exchange’s new integrated large trader reporting system will provide MSD with the ability 

to more readily identify EFPs involving related entities. 

 DMO reviewed each of the EFP investigations and found that several were not conducted 

in a thorough manner. Specifically, DMO identified four investigations where rather than 

seeking documentation to determine the existence of an underlying cash transaction and to verify 

the transference of the physical commodity, MSD only inquired as to whether the affiliated 

buyer and seller were under separate control. Although separate control was a key issue in the 
25

investigations, DMO believes that any EFP subject to review should be fully examined to 

properly evaluate the bona fides of the transaction. DMO also found that the requirement that 

affiliated accounts engaging in EFPs be under separate control may not be fully understood by 

members and their customers. In this connection, DMO notes that three of the five warning 

letters and both informational letters issued for EFP violations related to non-compliance with 

this requirement. In each case, it appeared that the persons involved were unaware of, or did not 

understand, the Exchange’s rule in this regard. 

 Based on the foregoing, DMO recommends that the Exchange: 

• Request underlying cash-side documentation for all EFPs under review, regardless 

of whether they emanate from a routine review or a Commission referral, to 

evaluate fully compliance with all provisions of the Exchange’s EFP rule. 

• Issue a notice reminding members of the separate control requirement of NYBOT’s 

EFP rule and how it can be satisfied, and request that members share this 

information with their customers who engage in EFPs.