RULE ENFORCEMENT REVIEW

OF THE

KANSAS CITY BOARD OF TRADE

Division of Market Oversight

February 26, 2003
Table of Contents

Page

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

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

A. Audit Trail Program............................................................................................................ 3

B. Trade Practice Surveillance Program.................................................................................. 3

C. Disciplinary Program.......................................................................................................... 4

D. Dispute Resolution.............................................................................................................. 4

E. Exchange Governance ........................................................................................................ 5

III. AUDIT TRAIL PROGRAM .............................................................................................. 6

A. Trade Recordation Requirements ....................................................................................... 7

B. Audit Trail Reviews............................................................................................................ 9

C. Trade Timing .................................................................................................................... 11

D. Safe Storage Capability .................................................................................................... 13

E. Conclusions and Recommendations................................................................................. 13

IV. TRADE PRACTICE SURVEILLANCE PROGRAM..................................................... 15

A. Compliance Staff .............................................................................................................. 16

B. Automated Surveillance System....................................................................................... 16

C. Floor Surveillance............................................................................................................. 18

D. Routine TPIs and Special Investigations.......................................................................... 19

E. Adequacy of Investigations .............................................................................................. 21

F. Conclusions and Recommendations................................................................................. 23

V. DISCIPLINARY PROGRAM.............................................................................................. 25

A. Disciplinary Committees and Procedures......................................................................... 25

B. Sanctions Imposed ............................................................................................................ 27

C. Timeliness of Disciplinary Procedures............................................................................. 29

D. Conclusion ........................................................................................................................ 29

VI. DISPUTE RESOLUTION................................................................................................ 31

A. Customer Arbitration ........................................................................................................ 31

B. Member-to-Member Arbitration....................................................................................... 33

C. Conclusion ........................................................................................................................ 33

VII. GOVERNANCE............................................................................................................... 35

A. Fitness Standards .............................................................................................................. 35

B. Conflicts of Interest .......................................................................................................... 37

C. Board Composition ........................................................................................................... 39

D. Conclusion ........................................................................................................................ 39
RULE ENFORCEMENT REVIEW

OF THE

KANSAS CITY BOARD OF TRADE

I. INTRODUCTION

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

of the self-regulatory programs at the Kansas City Board of Trade (“KCBT” or “Exchange”) for 

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

(“Act”) and Part 38 of the Commission’s regulations. 1 The Division’s review covered core 

principles that relate to the Exchange’s audit trail, trade practice surveillance, disciplinary, and 

dispute resolution programs. The Division also reviewed KCBT’s compliance with core 

principles relating to exchange governance. The review covers the period of June 1, 2001 

through June 1, 2002 (“target period”).2

Specifically, the Division evaluated Exchange compliance with eight core principles. 

Core Principle 10– Trade Information and Core Principle 17- Recordkeeping, relate to the 

maintenance of an audit trail that can be used to assist a contract market in the identification and 

prosecution of customer and market abuses and the maintenance of trade-related records. Core 

Principle 2- Compliance with Rules and Core Principle 12- Protection of Market Participants, 

relate to surveillance, enforcement, and disciplinary procedures used by a contract market to 

 

1

 Rule enforcement reviews prepared by the Division 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. The Division’s analyses, conclusions, and recommendations are based, in 

large part, upon the Division’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 Division last rule enforcement review of the Exchange was presented to the Commission on September 15, 

2000 (“2000 Review”).
2

protect market participants from abusive trading practices. Core Principle 13- Dispute 

Resolution, relates to fair and equitable dispute resolution procedures for customers and 

member-to-member disputes. The Division also focused on Core Principle 14- Governance 

Fitness Standards; Core Principle 15- Conflicts of Interest; and Core Principle 16- Composition 

of Boards of Mutually Owned Contract Markets, which relate to exchange governance.3

To assess KCBT compliance with these core principles, Division staff reviewed 

Exchange rules and numerous documents used by the Exchange’s Department of Audits and 

Investigations (“A&I”) in performing its routine oversight responsibilities. These documents 

included, among other things, computer reports and other documentation used routinely for audit 

trail enforcement and trade practice surveillance; audit trail recordkeeping and trade practice 

investigation files; trading cards and order tickets from selected firms for selected dates; trade 

practice investigation, floor surveillance, and disciplinary logs; disciplinary case files; minutes of 

disciplinary committee and Board of Directors (“Board”) meetings held during the target period; 

and compliance manuals and guidelines. The Division also interviewed A&I officials with 

respect to the operation of the Exchange’s self-regulatory programs.4

The Division provided the Exchange an opportunity to review and comment on a draft of 

this report on February 10, 2003. On February 12, 2003, Division staff conducted an exit 

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

 

3

 Appendix B to Part 38 of the Commission’s regulations provides guidance concerning the core principles with 

which a designated contract market must comply to maintain its designation. In addition, Appendix B provides 

acceptable practices for several of the core principles. Although the acceptable practices establish non-exclusive 

safe harbors, they do not establish a mandatory means of compliance with the core principles. Appendix B provides 

acceptable practices for Core Principles 2, 10, 13, and 17. However, acceptable practices are not set forth for Core 

Principles 12, 14, 15, or 16. In promulgating Part 38, the Commission reserved the authority to adopt acceptable 

practices for Core Principles 12, 14, 15, and 16 at a later date.

4

 A copy of the July 24, 2002 transcript of the interview can be found in Appendix 1.
3

II. SUMMARY OF FINDINGS AND RECOMMENDATIONS

A. Audit Trail Program

Findings

• The Exchange maintains an adequate audit trail program that provides for the 

recording and safe storage of trade information in a manner that allows staff to use 

the information to assist in the prevention of customer and market abuses and to 

provide evidence of rule violations.

• Members manually record the time of execution for each trade to the minute on 

trading cards and order tickets. The Exchange maintained a high trade timing 

accuracy rate of approximately 93 percent during the target period.

• A&I staff reviews daily trade timing errors identified on computer reports and 

compiles monthly statistics of each member’s trade timing errors. Members with a 

high monthly trade timing error rate are scheduled for an investigation.

• The Exchange’s audit trail enforcement program also includes quarterly audit trail 

reviews of clearing firms and floor members to assess compliance with order ticket 

and trading card recordkeeping requirements. Reviews conducted during the target 

period indicate a high level of compliance with KCBT’s trade recordation 

requirements.

The Division has no recommendations in this area.

B. Trade Practice Surveillance Program

Findings

• The Exchange maintains an adequate trade practice surveillance program. Potential 

trade practice violations are identified through the use of computerized surveillance, 

daily review of computer reports, floor surveillance, and routine TPIs.

• The Exchange’s investigations were completed in a timely manner and most 

investigations were thorough and well documented. Since the 2000 Review, the 

Exchange has improved the quality of its investigation reports by providing a 

complete and clear explanation to support its findings.

• The Division identified two investigations that it believes should have been expanded 

to include a more thorough analysis. In one investigation, in view of the member’s 

previous involvement in noncompetitive trading, the Exchange should have looked 

beyond the recordkeeping aspect of the investigation to examine whether substantive 

violations may have occurred. In the second investigation, the Exchange should have 

expanded the scope of its investigation to include additional trade dates given the 

subject members’ disciplinary histories.
4

Recommendations

• The Exchange should examine audit trail violations detected during the course 

of an investigation to determine whether such violations may have facilitated 

substantive trading abuses, especially in those instances in which the number of 

audit trail violations is large and/or the subject member has previously engaged 

in illegal trading activity.

• The Exchange should consider a member’s prior disciplinary history when 

developing the scope of an investigation and increase the amount of trading 

activity examined beyond that reviewed in routine trade practice investigations.

C. Disciplinary Program

Findings

• The Exchange maintains an adequate disciplinary program. During the target period, 

five cases were referred for disciplinary action. The cases were all resolved in a 

timely manner pursuant to settlement agreements.

• The Exchange levied fines against five individuals totaling $4,375. Two individuals 

were fined a total of $2,500 for engaging in noncompetitive trading and one 

individual was fined $500 for taking the opposite side of a customer’s order. Neither 

case involved customer harm. The remaining $1,375 in fines were imposed for 

recordkeeping violations.

• A&I issued 24 reminder and eight warning letters, principally for trading card 

recordkeeping violations.

The Division has no recommendations in this area.

D. Dispute Resolution

Findings

• Customers are afforded voluntary dispute resolution through Exchange customer 

arbitration rules that are fair and equitable. A customer may elect to have his or her 

claim or grievance against a member or its employees heard by either a panel of the 

Arbitration Committee or by a specially constituted panel which has at least a 

majority of panel members who are not Exchange members or associated with any 

member of any designated contract market or employee thereof. 

• Each party has the right to counsel and each party receives adequate notice of claims 

presented against them and an opportunity to be heard on all claims, defenses, and 

counterclaims. The Exchange’s arbitration procedures require a prompt hearing and 

authorize prompt, written, final settlement awards that are not subject to appeal within 

the Exchange.
5

• Arbitration procedures also are provided for member-to-member disputes. Any 

member who commences any legal action against another member for any dispute 

must first attempt to arbitrate under Exchange rules or be subject to disciplinary 

action. In addition, member-to-member arbitration is separate from and independent 

of customer claims or grievances submitted for resolution.

• There were no customer or member-to-member arbitrations during the target period.

The Division has no recommendations in this area.

E. Exchange Governance

Findings

• A person with a significant history of disciplinary violations within the past three 

years, or a person who is currently suspended from trading on a contract market or is 

suspended or expelled from membership in any self-regulatory organization, is 

prohibited from serving on the Board or a disciplinary committee.

• The Exchange has adopted and enforces appropriate rules and procedures to identify 

and resolve the presence of conflicts of interest in any Board or disciplinary 

committee decision-making process.

• Prior to considering or hearing a matter that may involve a possible conflict of 

interest, Board members and members of disciplinary committees must disclose the 

possibility of such conflict. If A&I determines that a conflict exists, the person may 

not participate in deliberations, unless the person has unique expertise or is needed for 

a quorum, and may not vote on the matter.

• KCBT’s Board fairly represents the diversity of interests of market users. During the 

target period, the Board included three futures commission merchants (“FCMs”), 

three commercials, three Wheat floor traders, one Wheat floor broker, one Wheat 

option floor trader, and one Value Line floor trader.

The Division has no recommendations in this area.
6

III. AUDIT TRAIL PROGRAM

Core Principle 10 – Trade Information:

The board of trade shall maintain rules and procedures to provide for the recording 

and safe storage of all identifying trade information in a manner that enables the 

contract market to use the information for purposes of assisting in the prevention of 

customer and market abuses and providing evidence of any violations of the rules of 

the contract market.

Core Principle 17 – Recordkeeping

The board of trade shall maintain records of all activities related to the business of 

the contract market in a form and manner acceptable to the Commission for a 

period of five years.

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

Commission’s regulations, an effective contract market audit trail should capture and retain 

sufficient trade-related information to permit contract market staff to detect trading abuses and 

reconstruct transactions within a reasonable period of time. In addition, the contract market must 

create and maintain an electronic transaction history database that contains information with 

respect to transactions executed on the designated contract market. An acceptable audit trail also 

must be able to track a customer order from time of receipt through fill allocation or other 

disposition. Further, an acceptable audit trail should include original source documents, 

transaction history, electronic analysis capability and safe storage capability.

Original source documents include unalterable, sequentially identified records on which 

trade execution information is originally recorded, whether recorded manually or electronically. 

A transaction history consists of an electronic history of each transaction, including all data that 

are input into the trade entry or matching system for the transaction to match and clear. These 

data should include the categories of participants for whom such trades are executed; timing and 

sequencing data adequate to reconstruct trading; and the identification of each account to which 

fills are allocated. An electronic analysis capability permits sorting and presenting data included 
7

in the transaction history so as to reconstruct trading and to identify possible trading violations, 

while safe storage capability provides for a method of storing the data included in the transaction 

history in a manner that protects the data from unauthorized alteration, accidental erasure or 

other loss.

Commission Regulation 1.31 governs the manner in which an exchange is required to 

maintain trade-related records. The regulation mandates that all records required to be kept 

under the Act or Commission regulations be maintained for five years and be readily accessible 

during the first two years. Most categories of required records may be stored on either 

micrographic or electronic storage media for the full five-year maintenance period. However, 

trading cards, documents on which trade information is originally recorded in writing, and order 

tickets must be retained in hard copy for five years.

A. Trade Recordation Requirements

AT KCBT, orders are either written-up on floor order tickets by clearing firm staff or 

electronically received at firm trading floor desks via the Trade Order Processing System 

(“TOPS”), an industry-wide order routing system.

5

 Order tickets are then physically handed to 

floor brokers or order instructions are “flashed into the pit. Upon execution, a floor broker either 

records fill information on the order ticket or flashes fill information back to the firm’s desk. 

The Exchange requires that an order ticket include an account identifier, an order number, an 

entry timestamp indicating when the order was received on the floor, and an exit timestamp 

indicating when the filled order was returned or reported back to a firm’s desk.6

 

5

 Nine of the Exchange’s 19 clearing firms receive orders via TOPS. Each of these firms has a TOPS machine at its 

trading floor desk that prints orders received from various office locations in the form of an order ticket. 

6

 KCBT Resolution 11-1130.00-1.
8

KCBT also requires each member to record all trade executions for customer and 

personal accounts on trading cards promptly upon the purchase or sale of any contract.7 Floor 

members record trades on double-sided cards, with buys on one side and sells on the other. The 

card must contain the member’s trading initials, clearing firm code, date, time of trade execution 

to the nearest minute, quantity, commodity, month, price, opposite member and clearing firm 

initials, and for option contracts, premium, strike price, and put or call indicator. Members must 

record their trades in non-erasable ink, in sequential order, and without skipping lines between 

trades. In addition, a line must be drawn to separate trades executed during the opening and 

closing periods from other trades.

Three different types of trading cards are used at the Exchange: (1) personal trading 

cards; (2) brokerage cards; and (3) master cards. Personal trading cards, which are used by 

Exchange members to record personal trades, are pre-printed with the respective member’s 

trading initials and card sequence numbers. Members must mark through any remaining unused 

lines on a personal trading card before starting a new card. Brokerage cards, which do not 

contain pre-printed sequence numbers, are used to record executions for house and customer 

accounts. A broker uses a separate brokerage card for each clearing member for which he or she 

fills customer orders. Finally, a broker also may record all house and customer fills together on a 

master card and then have the required trade information transcribed onto separate brokerage 

cards, one per clearing member. Master cards are used by brokers who fill orders for numerous 

clearing members and prefer not to carry or hold separate cards for each firm. Only two brokers 

used master cards during the target period.

 

7

 KCBT Rule 1115.00.
9

Personal trading cards and brokerage cards must be submitted to clearing firms no later 

than 15 minutes after each 30-minute trading interval and promptly timestamped upon 

collection.8 Clearing firms must submit trades to the Kansas City Board of Trade Clearing 

Corporation (“Clearing Corporation”) within 60 minutes after each 30-minute interval. The 

clearing system matches trades that agree on quantity, brokers, month, price, and clearing firms 

as soon as both sides are entered. Clearing firms can enter trades and correct errors until the first 

reconciliation report listing all matched trades is distributed, approximately 45 minutes after the 

close of each contract. In addition to the reconciliation report, clearing firms are given a list of 

trades that cannot be matched due to a data inconsistency (“cutout trades”). The Clearing 

Corporation busts all cutout trades that are not resolved by 4:00 p.m., the end of the final 

reconciliation process. However, cutout trades that are busted may be resolved prior to the 

opening on the following business day “as of” the original trade date.

The Clearing Corporation provides A&I with a “Daily Out-Trade Audit Report” 

(“Outtrade Report”) that contains a record of all cutout trades, corrections, and busted trades 

from the previous trading day. A&I reviews this report daily to ensure that trade corrections 

were not made to facilitate a trading abuse.9 A&I also reviews all as-of trades by comparing the 

trade price to the previous day’s Time and Sales Report (“Time and Sales”).

B. Audit Trail Reviews 

The Exchange conducts quarterly reviews of order tickets and trading cards (“audit trail 

reviews”) to enforce its trade recordation requirements. Audit trail reviews alternate between 

 

8

 KCBT Rule 1115.02. Master cards are not subject to Exchange collection requirements because only data 

recorded on personal trading cards and brokerage cards are entered into the clearing system. However, pursuant to 

Commission Regulation 1.31, members who use master cards must save the cards for five years and produce the 

cards upon request.

9

 During the target period, one investigation, SP0110, arose from A&I’s review of the Outtrade Report. See pp. 21-

22 for a discussion of this investigation.
10

full-scope and limited-scope reviews. Full scope reviews are intended to encompass all 

Exchange clearing firms and floor members.10 Limited-scope reviews primarily focus on 

clearing firms and floor members who received a reminder or warning letter, or were referred to 

the Complaint Committee in the previous full-scope audit trail review.

For both full scope and limited scope reviews, A&I randomly selects a three-day period 

and examines all trading cards and order tickets prepared by the firms and floor members under 

review. If A&I finds that a clearing firm’s or floor member’s noncompliance rate exceeds five 

percent of the transactions examined, A&I will issue a reminder letter or a warning letter, or refer 

the matter to the Complaint Committee for possible disciplinary action.11

During the target period, A&I conducted two full-scope audit trail reviews in which it 

examined a total of 2,705 order tickets prepared by 13 clearing firms and 3,061 trading cards 

(1,732 brokerage cards and 1,329 personal trading cards) prepared by 68 floor members.12 

Overall, the reviews indicated a high level of compliance with KCBT’s trade recordation 

requirements. A&I found that all of the order tickets examined contained order numbers and 

account identifiers; 2,652 of the order tickets (98 percent) included both entry and exit 

timestamps; and 2,999 of the trading cards (98 percent) were promptly timestamped upon 

collection.

With respect to floor members’ brokerage and personal trading cards, the reviews 

indicated that all of the 3,061 trading cards were written in non-erasable ink. Further, 99 percent 

 

10 When the Exchange initiates an audit trail review, one review is opened to examine clearing firms and a separate 

review is opened to examine floor members.

11 The Exchange’s program for enforcing its order ticket and trading card rules (as well as its trade timing rules) 

permits A&I to exercise discretion in determining whether to issue a reminder letter or a warning letter, or to refer a 

member to the Complaint Committee. For a first offense, A&I generally issues a reminder letter if a member’s 

deficiency level is between five and ten percent, or a warning letter if the member’s deficiency level exceeds ten 

percent. A second offense for the same violation(s) within one year generally results in a warning letter. A&I will 

refer members who repeatedly violate the Exchange’s audit trail rules to the Complaint Committee. 

12 Copies of the investigation reports for the two audit trail reviews can be found in Appendix 2.
11

of the cards had all trades recorded in sequence, had no skipped lines, properly identified the 

opening and closing periods, and included the date, commodity, price, quantity, and put or call 

indicator for option trades. Additionally, 98 percent of the cards indicated the executing and 

opposite clearing firms, and 97 percent of the cards were collected by the clearing member 

within 15 minutes of each 30-minute trading interval. With respect to the additional 

requirements for personal trading cards, 99 percent of the 1,329 personal trading cards reviewed 

were preprinted with members’ trading initials and trading card sequence numbers, and had 

unused lines properly marked through. In addition, 98 percent of the personal trading cards were 

properly started after each 30-minute trading interval.

The Division’s examination of the Exchange’s audit trail reviews found that the reviews 

were thorough, well documented, and completed in a timely manner. The Exchange’s files 

included copies of all original floor orders and personal trading cards examined during the 

respective review, worksheets, and copies of all resulting reminder and warning letters. Each 

audit trail review file also included a form that showed the start date, completion date, final 

report date, and the dates of any resulting disciplinary actions, as well as the dates of any further 

action taken by a disciplinary committee.

C. Trade Timing

As stated above, KCBT requires that the buying and selling members manually record the 

time of each trade to the nearest minute on his or her trading card. The Exchange enforces this 

requirement by reviewing its daily trade register, the Time Audit Report (“TAR”), which 

contains various codes indicating possible trade timing errors.13 The Exchange’s one-minute 

 

13 A sample copy of the TAR can be found in Appendix 3.
12

trade timing accuracy rate, as computed for all contracts on two representative trade dates for 

each month of the target period, was a high 93 percent.

The TAR identifies seven types of timing errors that may be indicative of a trade timing 

violation. The first error is “Bought Side-No Trade” (“B-NT”). The TAR compares the time 

recorded by the buyer to the Time and Sales listing. If no trade is indicated on Time and Sales at 

the time recorded by the buyer, or within one minute preceding or one minute following that 

time, the trade is coded B-NT. The second error is “Sold Side-No Trade” (“S-NT”). The 

computer program follows the same procedure as for a B-NT, but compares the seller’s recorded 

time to the prices recorded on Time and Sales. The third error, “No Quotes at This Price” (“No 

Quote”), is a combination of a B-NT and a S-NT. Thus, a trade is coded as a No Quote if the 

trade does not appear on Time and Sales within a minute of the time recorded by either the buyer 

or the seller.

The fourth type of timing error identified on the TAR is “Time Out of Limits” (“TOL”). 

A trade is coded TOL if the times recorded by both the buyer and the seller are marked as 

accurate by the system but there is more than two minutes between the two times. The fifth error 

noted on the TAR is “Bought Side-Untimed Trade” (“B-UT”). A trade is coded B-UT if the 

buyer fails to record a time for the trade on his or her trading card. Similarly, a trade is coded as 

“Sold Side-Untimed Trade” (“S-UT”) if the seller fails to record a time for a trade on his or her 

trading card. The final timing error, “Invalid Spread,” refers to a spread differential that does not 

appear on Time and Sales within the minute or minute preceding or following the trade time 

recorded by either the buyer or seller.

A&I reviews the TAR daily and compiles monthly statistics of each member’s timing 

errors. Although members are not summarily disciplined based on these statistics, members with 
13

a high error rate are scheduled for a routine trade practice investigation (“TPI”).14 As part of the 

routine TPI, A&I collects the member’s trading records for the time period under review and 

examines all trade timing errors (and potential trade practice violations) identified on the TAR 

for the particular member. If A&I finds that the member’s trade timing deficiency level 

exceeded five percent of his or her transactions, A&I will issue either a reminder or a warning 

letter, or refer the member to the Complaint Committee for possible disciplinary action.

D. Safe Storage Capability

KCBT trade data and historical files are stored and maintained in an AS 400 computer 

system. Trade data also are periodically backed-up throughout each trading day and saved to 

tape. These data are then restored to a back-up AS 400 computer system periodically throughout 

the day. Therefore, at the end of each trading day, all trade data and historical files are 

maintained in two different AS 400 computer systems, as well as on tapes. The tapes are 

removed from the Exchange’s premises nightly. The Exchange retains trade information for a 

time period that exceeds the five years required by Commission Regulation 1.31.

E. Conclusions and Recommendations

The Division found that the Exchange maintains an adequate audit trail program. 

Pursuant to Core Principle 10, the Exchange maintains rules and procedures that provide for the 

recording and safe storage of trade data, time and sales data, and historical transactions in a 

manner that enables A&I to use the information to assist in the prevention of customer and 

market abuses and to provide evidence of any rule violations. The Exchange’s program for 

enforcing its audit trail rules allows staff to reconstruct the path of a customer order from the 

 

14 A routine TPI is a review of a member’s trading activity for potential trade violations over a three-to five-day time 

period. See pp. 19-20 for a discussion of the Exchange’s routine TPI program. 
14

time of receipt to fill allocation or other disposition. In addition, the Exchange retains audit trail 

data for at least five years in compliance with Core Principle 17.

The Division’s review of one-minute trade execution times recorded by members during 

the target period found that the Exchange’s overall accuracy rate was a high 93 percent. A&I 

daily reviews trade timing errors identified on the TAR and compiles monthly statistics of each 

member’s timing errors. Those members with a high trade timing error rate typically are 

scheduled for a routine TPI.

The Exchange’s audit trail enforcement program also includes quarterly audit trail 

reviews of clearing firms and floor members to assess compliance with order ticket and trading 

card trade recordation requirements. The Division’s review of the Exchange’s full-scope audit 

trail reviews found that clearing firms and floor members demonstrated a high level of 

compliance with pertinent Exchange rules. In addition, the Exchange’s audit trail reviews were 

thorough, well documented, and completed in a timely manner. 

Based on the foregoing, the Division has no recommendations in this area.
15

IV. TRADE PRACTICE SURVEILLANCE PROGRAM

Core Principle 2 – Compliance with Rules:

The board of trade shall monitor and enforce compliance with rules of the contract 

market, including the terms and conditions of any contracts to be traded and any 

limitations on access to the contract market.

Core Principle 12 – Protection of Market Participants:

The board of trade shall establish and enforce rules to protect market participants 

from abusive practices committed by any party acting as an agent for the 

participants.

Pursuant to Appendix B to Part 38 of the Commission’s regulations, a contract market’s 

trade practice surveillance program should have the arrangements, resources, and authority 

necessary to perform effective rule enforcement. The arrangements and resources attendant to 

the program should facilitate the direct supervision of the contract market, including analysis of 

relevant data. An acceptable program should have systems that maintain all data reflecting the 

details of each transaction executed on the contract market. In this regard, the program should 

include routine electronic analysis of these data to detect potential trading violations. The 

program also should provide for appropriate and thorough investigation of all potential trading 

violations brought to the contract market’s attention, including member and Commission 

referrals and customer complaints. In addition, the program should have the authority to 

discipline, suspend, or terminate the activities of members or market participants pursuant to 

clear and fair standards.15

 

15 That aspect of Core Principle 2 which relates to the disciplining of members who violate Exchange rules is 

discussed below in Section V, Disciplinary Program. This section of the report addresses the Exchange’s program 

for monitoring its markets for possible trading abuses and the investigation of any abuses identified.
16

A. Compliance Staff

A&I is responsible for administering the Exchange’s trade practice surveillance and audit 

trail programs.16 A&I’s staff is comprised of two individuals who monitor and review all aspects 

of Exchange trading activity. They also conduct trade practice investigations and audit trail 

reviews. These two individuals, each of whom has served in his current position for the past five 

years, are the Vice President and Assistant Vice President for Compliance. The Vice President 

has 15 years of Exchange experience and the Assistant Vice President has 12 years of Exchange 

experience. The Assistant Vice President is primarily responsible for monitoring the Wheat 

futures contract and the Vice President is primarily responsible for monitoring the Wheat options 

contract and the Value Line futures and options contracts. Although A&I staff is small, the 

Division believes staffing levels are sufficient to monitor the limited number of markets 

currently trading at the Exchange.17 In addition, staff has not encountered problems with 

completing investigations in a timely manner.

B. Automated Surveillance System

The TAR also serves as the Exchange’s automated trade practice surveillance system.18 

The system identifies possible trade practice violations by performing edit functions based on 

predetermined parameters designed for specific types of trading abuses. All trades meeting the 

criteria for one or more parameters are flagged as exceptions on the TAR with a violation code. 

The codes relate to violations such as trading ahead of customer orders, accommodation trading, 

 

16 A&I also administers the Exchange’s market and financial surveillance programs.

17 The Exchange lists contracts in Wheat and Value Line futures and options. Internet Stock Index futures and 

options were delisted as of January 28, 2003. In 2002, KCBT volume was 3,326,836 contacts, with virtually all of 

the volume in Wheat futures and options.

18 A separate TAR is generated for each Exchange-traded contract. As discussed earlier at pp. 11-13, the TAR also 

identifies possible trade timing errors.
17

wash trading, and money passing. The system identifies all cross trades, which are referred to as 

“ring trades” at KCBT.19

A&I reviews the TAR daily for each contract and conducts an initial inquiry into each 

trade identified as a possible violation in order to determine whether to open a formal 

investigation. A formal investigation is typically opened if further information and more detailed 

analyses are needed to determine whether a rule violation occurred, or if a particular member has 

an unusually high number of exceptions on a given day or during a given month. For example, 

with respect to possible wash trades and accommodation trades, A&I’s initial inquiry considers 

factors such as the price difference between the trades, the amount of time between the trades, 

the price movement during that time, and the number of contracts traded. When necessary, A&I 

also requests trading cards and order tickets and/or discusses the questionable trade(s) with the 

member(s) involved.

The Division selected six days over the course of the target period to examine A&I’s 

daily TAR reviews with respect to trade practice violations. The Division found that A&I 

adequately reviewed all flagged trades and that pertinent information reflecting staff’s initial 

analysis regarding such trades was recorded on the respective TAR. During the target period, 

two investigations arose from A&I’s daily TAR reviews. Both involved improper ring trades 

and resulted in two members being issued reminder letters. In addition, an investigation 

involving taking the opposite side of a customer order that was opened prior to the target period 

and completed during the target period resulted in a $500 fine against one member.20

 

19 A&I manually reviews all ring trades to ensure that they were executed in accordance with Exchange rules.

20 Investigations SP0203 and SP0205 involved improper ring trades, and Investigation SP0104 involved taking the 

other side of a customer order. 
18

C. Floor Surveillance

A&I conducts daily floor surveillance on the open and close in each market, and 

randomly during the day for a 15- to 20-minute time period.21 If a market is exceptionally active 

or volatile, A&I staff will stay on the floor longer, typically until the activity abates. 

Observations made during daily floor surveillance may result in a more targeted analysis of a 

member’s trading activity during A&I’s daily TAR review and can result in the opening of an 

investigation. Similarly, if A&I has reason to believe that a member is engaging in prohibited 

trading activity, it will closely monitor the member’s trading activity while on the floor to 

enhance an ongoing investigation.

The Exchange maintains a daily floor surveillance log for each contract.22 The log 

reflects the observer’s initials, data and time of surveillance, and any material observations. If a 

possible trading violation is observed, the observing staff member prepares a “Floor Surveillance 

Report” and notes this on the floor surveillance log. Floor Surveillance Reports list the 

following information: (1) the date and time of the observation; (2) the staff member who 

observed the incident; (3) the member or firm observed; (4) the possible violation; (5) any prior 

instances of similar conduct; (6) the action taken, including summaries of any conversations 

between A&I staff and members related to the incident; and (7) an investigation number if the 

matter is examined further.

During the target period, A&I prepared two Floor Surveillance Reports, one of which 

resulted in an investigation after staff observed a noncompetitive trade between two members 

after the close of the Wheat futures contract. Based upon the investigation’s findings, the two 

 

21 Due to the higher trading volume in Wheat futures and options, both A&I staff members observe the opening and 

closing periods for these contracts.

22 A copy of the floor surveillance log can be found in Appendix 4.
19

members were referred for disciplinary action and pursuant to settlement agreements, were fined 

$2,000 and $500, respectively. A&I prepared the second Floor Surveillance Report after 

observing a floor clerk, who also is an Exchange member, trade opposite his firm’s primary floor 

broker while on the telephone. A&I verbally reminded the floor clerk of the relevant rules 

regarding taking the other side of an order and the use of telephones in the trading pit.23

D. Routine TPIs and Special Investigations

The Exchange also conducts routine TPIs and Special Investigations to monitor trading 

activity for possible abuses. A routine TPI is a comprehensive examination of a member’s 

trading activity for possible rule violations, typically over a three- to five-day period. A&I 

generally examines 300 trades for members trading Wheat futures and options, and 100 trades 

for members trading Value Line futures and options. The Exchange strives to perform one 

routine TPI on each active member during the calendar year.

During a routine TPI, A&I reviews all of a member’s trades executed during the 

designated review period. In this connection, A&I runs a report from the TAR to isolate the 

member’s possible timing errors and trade practice violations and requests relevant trading cards 

and order tickets. A&I then analyzes all of the possible errors and violations and reviews the 

order tickets and trading cards for recordkeeping compliance. Finally, A&I meets with the 

member under review to discuss possible violations that remain unresolved after staff have 

completed their analyses. If A&I concludes that a reasonable basis exists, it will issue a 

reminder or warning letter, or refer the matter to the Complaint Committee for consideration of 

charges, depending upon the severity of the violation.

 

23 KCBT Rules 1133.00 (Taking Other Side) and 1177.00 (Prohibition On Use Of Telephones). KCBT Rule 

1177.00 prohibits brokers from being in a pit with a telephone in hand or from executing trades in the pit with a 

telephone in hand. 
20

In addition to routine TPIs, the Exchange conducts Special Investigations when evidence 

indicates that a violation of Exchange rules may have occurred. Special Investigations generally 

are initiated from observations of unusual trading activity arising from floor surveillance, daily 

TAR reviews, Commission or National Futures Association (“NFA”) referrals, or investigation 

of member, customer, or anonymous complaints. The Exchange’s quarterly audit trail reviews 

also are classified as Special Investigations.24

During the target period, the Exchange opened a total of 41 investigations that included 

29 routine TPIs and 12 Special Investigations. Of the 12 Special Investigations, two were 

initiated from A&I’s daily TAR review, one was initiated from A&I’s review of its Outtrade 

Report, one was initiated from floor surveillance, and the remaining eight were audit trail 

reviews.

The Division found that the Exchange’s investigations were completed in a timely 

manner. During the target period, the Exchange closed a total of 41 investigations, which 

included five investigations opened prior to the target period. Of the 41 investigations closed 

during the target period, 39 were completed within four months and two were completed within 

six months.25

 

24 A&I records information relating to each routine TPI or Special Investigation on the Exchange’s investigation log. 

The information recorded includes the investigation number, name(s) of the member(s) under investigation, the date 

the investigation was opened and closed, the name of the staff member conducting the investigation, the source of 

the investigation, and findings. If an investigation is referred for disciplinary action, the log will reflect the actions 

taken and the dates of such actions. A copy of the investigation log can be found in Appendix 5.

25 The five investigations opened during the target period that remained open at the close of the target period have 

since been closed. All five investigations were completed within four months of their respective open date. 
21

E. Adequacy of Investigations

The Division conducted an in-depth review of 24 investigations (15 routine TPIs and nine 

Special Investigations) for adequacy and thoroughness.26 The Division found that most of the 

Exchange’s investigations were thorough and well documented. Each file included an index of 

its contents, a summary of the investigative steps taken (with the date each step was completed), 

spreadsheets, work papers, summaries of interviews, letters notifying the subject member of the 

investigation and its results, and a copy of the investigation report. The Division also found that 

the Exchange has improved the quality of its investigation reports by providing a clear and 

complete explanation to support its findings. Specifically, in those instances when A&I 

concluded that there was not a reasonable basis to conclude that a rule violation occurred, 

investigation reports stated why the facts not supportive of finding a rule violation outweighed 

facts supportive of such a finding.27

However, the Division found two investigations that it believes should have been 

expanded to include a more thorough analysis given the existence of audit trail violations that 

may have facilitated substantive trading abuses, and the subject members’ previous disciplinary 

histories. The first investigation, Investigation SP0110, was opened after A&I identified a large 

number of outtrades on four consecutive days involving one member.28 The subject floor 

member was previously the subject of a Commission enforcement action relating to wash sales, 

fictitious sales, and noncompetitive trading at the Chicago Board of Trade.29 KCBT’s 

 

26 The Division also reviewed the investigation reports for the remaining 17 investigations closed during the target 

period.

27 In the previous rule enforcement review of the KCBT, dated September 15, 2000, the Division found that 

investigation reports did not always clearly explain how A&I concluded that there was no basis for finding a rule 

violation. 

28 A copy of the investigation report for Investigation SP0110 can be found in Appendix 6.

29 In March 2001, the Commission denied the member’s motion to reduce sanctions. The member was fined $5,000 

and his trading privileges were suspended for six months.
22

investigation revealed that the member failed to record a time for 29 trades and the opposite 

clearing member for 20 trades. Further, of the 53 trading cards A&I examined, eight cards 

reflected more than one trade on a line, giving the appearance that trades possibly were not 

recorded in chronological order of execution. In addition, four of the cards reflected trades that 

occurred on the open or close but were not identified as such, and unused lines were not properly 

marked through on any of the 53 trading cards. Finally, none of the cards included preprinted 

trading initials. The member was issued a warning letter for his recordkeeping violations.

The Division notes that the Exchange’s investigation focused solely on the number of 

audit trail violations committed by the member and included no analysis regarding whether the 

audit trail violations or the outtrades may have been associated with noncompetitive trading. 

Trading card violations, such as those uncovered in this investigation, and missing trade times, 

can be indicative of substantive trading violations. The Division believes that the Exchange 

should have looked beyond the recordkeeping aspect of this investigation to examine whether 

substantive violations may have occurred, especially in view of the member’s previous 

involvement in noncompetitive trading,

The second investigation, Investigation W0118, involves possible accommodation 

trading identified during the course of a routine TPI.30 The TPI covered four days of trading for 

the subject member and found a possible accommodation trade between that member and 

another member, both of whom were previously sanctioned by the Exchange for noncompetitive 

trading and other substantive trading violations. A&I concluded that the evidence did not 

support a finding of a rule violation. Toward that end, the investigation report noted that A&I’s 

floor surveillance experience and daily TAR reviews did not reveal “any pattern of 

 

30 A copy of the investigation report for Investigation W0118 can be found in Appendix 7.
23

accommodation trading between the members.” The member who was the subject of the TPI 

was fined $250 for trading card violations.

Based on the members’ previous disciplinary histories, the Division believes that the 

Exchange should have expanded its review of trading between the two members beyond four 

days. In this connection, in 1999, the Exchange fined both members $250 for engaging together 

in noncompetitive trading.31 In May 2000, Division staff observed what it believed to be another 

occurrence of noncompetitive trading between the two members and referred the matter to the 

Exchange. Upon investigation, the Exchange fined one of the members $2,500 for disclosing 

orders and taking the opposite side of a customer’s order.32 In addition, during the target period, 

the other member was fined $2,000 for noncompetitive trading and for taking the other side of a 

customer order, and $1,000 for failing to report trades and failing to time trades to the nearest 

minute.33

F. Conclusions and Recommendations

The Division found that the Exchange maintains an adequate trade practice surveillance 

program. Although A&I only has a staff of two, these individuals have extensive Exchange 

experience and are able to monitor adequately the limited number of markets traded at the 

 

31 Investigation SP9907. Both members were charged with violating KCBT Rule 1110.00 (Trades Executed Openly 

and Competitively), KCBT Rule 1132.00 Disclosure of Orders), KCBT Rule 1133.00 (Taking Other Side), and 

KCBT Rule 1134.00 (Prearranged Sale). The Division reviewed this case in the 2000 Review and found that the 

imposed penalty was insufficient in light of the activity involved. 

32 Investigation SP0002. Division staff observed one of the members receive a verbal customer order from a firm 

floor clerk to buy 30 July Wheat futures at the market. The member waved off the order and tapped the other 

member on the shoulder and directed his attention to the floor clerk. The floor clerk then verbally gave the order to 

the other member. Both members then turned to face each other and recorded the trade without it first being offered 

to the pit. As a result, the first member took the opposite side of his customer’s order. A&I obtained the relevant 

trading records and interviewed both members and the floor clerk. The first member was referred for disciplinary 

action and was charged with violating KCBT Rule 1132.00 (Disclosure of Orders) and KCBT Rule 1133.00 (Taking 

Other Side). A&I concluded, however, that there was insufficient evidence to refer the second member for 

disciplinary action.

33 Investigation SP0204 (noncompetitive trading and trading ahead of customer orders) and Investigation W0120 

(audit trail violations). Prior to Investigation W0120, the member had been issued two reminder letters, two 

warning letters, and had been fined a total of $1,000 in two separate matters for audit trail violations.
24

Exchange. The Exchange’s investigations were completed in a timely manner and were well 

documented. In addition, the Exchange’s investigations were generally conducted in a thorough 

manner. The Exchange also improved the quality of its investigation reports by providing a clear 

and complete explanation to support its findings.

The Division, however, found two investigations that it believes should have been 

expanded to include a more thorough analysis given the existence of audit trail violations that 

may have facilitated substantive trading abuses, and the subject members’ previous disciplinary 

histories. In one investigation, the Exchange should have analyzed whether audit trail violations 

were associated with substantive trading abuses. In the second investigation, the Exchange 

should have expanded the scope of its investigation to include additional trade dates.34

Based on the foregoing, the Division recommends that the Exchange:

• Examine audit trail violations detected during the course of an investigation to 

determine whether such violations may have facilitated noncompetitive trading, 

especially in those instances in which the number of audit trail violations is large 

and/or the subject member has previously engaged in illegal trading activity.

• Consider a member’s prior disciplinary history when developing the scope of an 

investigation and increase the amount of trading activity examined beyond that 

reviewed in routine trade practice investigations.

 

34 At the exit conference held with Exchange staff to discuss the Division’s findings and recommendations, the 

Division requested that the Exchange reopen the investigations and advise the Division of its findings upon 

completion.
25

V. DISCIPLINARY PROGRAM

Core Principle 2 – Compliance with Rules:

The board of trade shall monitor and enforce compliance with rules of the contract 

market, including the terms and conditions of any contracts to be traded and any 

limitations on access to the contract market.

As noted earlier, Core Principle 2 requires, among other things, that an exchange have the 

authority to discipline, suspend, or terminate the activities of members or market participants 

pursuant to clear and fair standards. Consequently, an acceptable compliance program should 

provide for prompt and effective disciplinary action for any violation that is found to have been 

committed.

A. Disciplinary Committees and Procedures

The Complaint Committee and the Business Conduct Committee (“BCC”) serve as the 

Exchange’s two primary disciplinary committees. The Complaint Committee consists of ten 

members representing various Exchange interests who are appointed each year by the Chairman 

of the Exchange and approved by the Board of Directors.35 The BCC consists of five members, 

three of whom are elected, the First Vice Chairman of the Exchange and the President of the 

Clearing Corporation. 36 The elected members serve for a three-year staggered term so that each 

year one new member is elected to replace the elected member who has served three years.

The Complaint Committee is a grand jury-type committee that reviews investigation 

reports referred by A&I to determine whether a Notice of Charges should be issued.37 In this 

regard, the Complaint Committee must meet within ten business days of receipt of an 

 

35 KCBT Rule 247.00.

36 KCBT Rule 244.00.

37 KCBT Rules 1410.00 and 1414.00.
26

investigation report to consider the matter.38 Exchange policy requires that the Complaint 

Committee determine one of the following: (1) additional investigation or evidence is necessary, 

(2) no reasonable basis exists for finding a violation, (3) a reasonable basis exists for finding a 

violation, but prosecution is not warranted,39 or (4) a reasonable basis exists for finding a 

violation and the matter should proceed for adjudication to the BCC for hearing.

If the Complaint Committee determines that formal charges should be issued, A&I staff 

will prepare a Notice of Charges.40 A Notice of Charges must include a summary of the possible 

violations, the possible rules that have been violated, and the options available to the charged 

party. Those options include filing a written answer within ten business days either admitting or 

denying the charges, or filing a “nolo contendere” plea. A failure by the charged party to file a 

written answer within the prescribed time period will be deemed as a not guilty plea and a 

hearing will be scheduled.41 Upon being served with a Notice of Charges, the charged party has 

the right to be represented by counsel in all succeeding stages of the disciplinary proceeding.42

The Complaint Committee receives and considers all settlement offers. If the Complaint 

Committee accepts a settlement offer, the offer is then forwarded to the BCC for final acceptance 

and approval. 43 The BCC must consider a settlement offer within ten business days of receipt 

from the Complaint Committee.44 If the BCC rejects a settlement offer, a full hearing on the 

 

38 KCBT Rule 1412.00.

39 If the Complaint Committee finds that there was a violation but prosecution is not warranted, it generally will 

issue a warning letter. The Complaint Committee did not issue any warning letters during the target period. All 

such letters sent during the target period were issued by A&I staff.

40 KCBT Rule 1414.00.

41 KCBT Rule 1414.02. A nolo contendere plea is neither an admission nor denial of guilt, but has the effect of a 

member waiving all proceedings except a hearing, if necessary, to set appropriate penalties. KCBT Rule 1414.02(f).

42 KCBT Rule 1425.00(a).

43 KCBT Rule 1416.00.

44 KCBT Rule 1417.00.
27

matter will be scheduled either before the entire BCC or a panel of the BCC.45 The BCC is 

required under most circumstances to issue a written decision within 15 business days.46 A 

decision of the BCC may be appealed to the Board within ten business days. The Board or a 

panel of the Board is required to hear the appeal within 20 business days and to issue a written 

decision within 30 calendar days of the hearing.47

B. Sanctions Imposed

Five cases were referred to the Complaint Committee for disciplinary action and 

subsequently settled during the target period.48 Three of the cases involved audit trail violations 

and the remaining two cases involved trade practice violations that included indirectly taking the 

opposite side of customer orders and failure to openly and competitively execute trades. The 

Exchange levied sanctions totaling $4,375 against five members. Although $4,375 is a small 

amount of fines for a 12-month period, the Division has identified no systemic deficiencies in the 

Exchange’s trade practice program that would suggest that the Exchange should have brought 

additional cases during the target period.

One member was the subject of two disciplinary actions as a result of two separate 

investigations, Investigations W0120 and SP0204.49 In Investigation W0120, the member was 

charged with failing to report trades and to accurately and legibly time trades to the nearest 

minute. The member was fined $1,000.50 In Investigation SP0204, the same member was 

 

45 KCBT Rules 1417.01 and 1421.00. No hearings were held during the target period.

46 KCBT Rule 1432.01.

47 KCBT Rules 1437.00 and 1442.00.

48 One case involved two members and one member was a subject in two different cases.

49 Although separate matters, these two cases were referred to the Complaint Committee together on March 28, 

2002. A copy of the investigation reports for Investigations W0120 and SP0204 can be found in Appendix 8.

50 In connection with this matter, the member also received an A&I staff warning letter regarding 15 brokerage 

cards for which he failed to record the clearing member code, three personal trading cards for which he failed to 
28

charged with failing to trade openly and competitively and taking the opposite side of a 

customer’s order. A second member was also charged with noncompetitive trading in this 

matter. The matter emanated from floor surveillance after A&I staff observed the members 

record two Wheat trades on their trading cards after the close, resulting in one member taking the 

opposite side of two lots of his customer’s three-lot order. A&I did not observe the trades take 

place in the pit.51 Based on the fill received, which was within the closing range, there did not 

appear to be customer harm. The members were fined $2,000 and $500, respectively.

The other substantive violation that resulted in a sanction involved a member who took 

the opposite side of two lots of his customer’s 55-lot Wheat options order. There was no 

customer harm, as the customer received his limit price. The member was fined $500. The 

remaining sanctions levied during the target period included $175 and $200 fines against two 

members for various trading card recordkeeping violations.52 A&I also issued 24 reminder 

letters and eight warning letters regarding trade timing and recordkeeping violations, and one 

reminder letter concerning the Exchange’s rule requiring that all orders be executed openly and 

competitively.53

 

mark through remaining blank lines, and two brokerage and two personal trading cards that were not submitted to 

the clearing member within 15 minutes following the end of a 30-minute interval.

51 A&I noted that one member was in the July area of the Wheat pit and the other was in the May area with his back 

to the July area during the entire closing period. After the 1:15 closing bell, one member approached the other and 

both members turned their backs to A&I staff. The members engaged in brief discussion and then both proceeded to 

record trade information on their trading cards. The Wheat TAR for that date showed that two trades timed at 1:14 

cleared between the two members.

52 Investigations SP0104, W0116, and W0118, respectively. Copies of the investigation reports for Investigations 

SP0104 and W0116 can be found in Appendix 9. A copy of the investigation report for Investigation W0118 can be 

found in Appendix 7.

53 With respect to the reminder letter for open and competitive execution of orders, A&I had received an anonymous 

complaint regarding Wheat options trading. A&I investigated whether a particular member had violated KCBT 

Rules 1136.00 (Withholding or Withdrawal of Orders) and 1110.00 (Trades Executed Openly and Competitively). 

After reviewing trading records and interviewing several members present in the pit when the alleged 

noncompetitive trades were executed, A&I did not find sufficient evidence to support a rule violation. Investigation 

SP0105.
29

C. Timeliness of Disciplinary Procedures

The Division found that the Complaint Committee reviewed investigation reports 

promptly after receiving them. Exchange rules require that the Complaint Committee meet 

within ten business days of receiving an investigation report to consider the report, and 

determine whether to issue a notice of charges within ten business days of the respective 

meeting.54

The Complaint Committee met four times during the target period to review five 

investigation reports. In each instance, the Complaint Committee met within ten business days 

of receiving an investigation report to consider the report, reached its decision on the day of the 

meeting, decided to issue a Notice of Charges, and issued such notice within ten business days 

following the meeting. All of the respondents submitted settlement offers within 14 days, and 

those offers were reviewed and accepted by both the Complaint Committee and the BCC within 

20 days of their submission

D. Conclusion

Based upon its review, the Division found that the Exchange maintains an adequate 

disciplinary program. During the target period, a total of five cases involving audit trail and 

trade practice rule violations were reviewed by the Complaint Committee. All five cases were 

settled and resulted in fines totaling $4,375 against five individuals. In addition, A&I issued 24 

reminder letters and eight warning letters, principally for trading card recordkeeping violations. 

All disciplinary matters referred to the Complaint Committee during the target period were 

 

54 KCBT Rules 1412.00 and 1413.00.
30

considered in a timely manner. In addition, all settlement offers were timely accepted and 

approved by the Complaint Committee and the BCC.

Based on the foregoing, the Division has no recommendations in this area.
31

VI. DISPUTE RESOLUTION 

Core Principle 13 – Dispute Resolution

The board of trade shall establish and enforce rules regarding and provide facilities 

for alternative dispute resolution as appropriate for market participants and any 

market intermediaries.

Pursuant to the acceptable practices set forth in Appendix B to Part 38, an exchange is 

required to provide a customer dispute resolution mechanism that is fundamentally fair and 

equitable, and available on a voluntary basis. In this regard, customers should have the 

opportunity to have their claims heard and decided by an objective and impartial decision maker. 

Each party should have the right to counsel and be provided with adequate notice of claims 

presented against him or her and an opportunity to be heard on all claims, defenses, and 

counterclaims. The process also should provide for the opportunity of a prompt hearing. An 

exchange’s dispute resolution mechanism should authorize prompt, written, final settlement 

awards that are not subject to appeal within the exchange. The parties also should be notified of 

the fees and costs that may be assessed. If an exchange provides procedures for the resolution of 

member-to-member disputes (not involving customers), the procedures for resolving such 

disputes must be independent of and not interfere with the resolution of customers’ claims or 

grievances.

A. Customer Arbitration

KCBT customers are afforded voluntary dispute resolution through the Exchange’s 

customer arbitration rules and procedures. A customer may elect to have his or her claim or 

grievance against a member or its employees heard by either a panel of the Exchange’s 

Arbitration Committee or by a specially constituted panel which has at least a majority of panel 
32

members who are not Exchange members or associated with any member of any designated 

contract market or employee thereof.55

Any customer desiring to submit a matter in dispute for arbitration must file a written 

sworn complaint alleging the nature of the dispute, the basic facts, the damages sought, and the 

name of the member within one year after the date of the transaction from which the dispute 

arose. If the member fails to answer the complaint in writing within ten days, or fails to sign an 

agreement to arbitrate, the member will be deemed as refusing to arbitrate and incurs the 

possibility of disciplinary action by the BCC, including an award for the customer.56 A member 

also has the right to file counterclaims that arise out of the transaction or occurrence that is the 

subject of the customer’s claim or grievance. The customer must reply to the counterclaim 

within ten days.57

Arbitration proceedings are held at the KCBT, unless otherwise agreed to by the parties, 

and are required to take place in a timely manner. Each party has the right to be represented by 

counsel at its own expense. Each party also is entitled to appear in person or by telephone 

conference at the arbitration hearing unless the claims submitted are less than $2,500, in which 

case the claim may be resolved without a hearing on the basis of submitted written documents.58

The hearing body must meet to discuss the case within two business days after the 

hearing and make its decision within ten business days after receipt of the transcript. The 

hearing body must render its award(s) or finding(s) within five business days after its decision. 

There is no right of appeal to any entity within the KCBT to overturn the arbitration decision. 

 

55 KCBT Rules 1500.00, 1503.00, 1503.01 and 1503.02. A customer also may elect to have his or her claim or 

grievance heard by a single arbitrator who meets the requirements of former Commission Regulation 180.2(a). 

KCBT Rule 1503.03.

56 KCBT Rules 1510.00, 1510.01, 1514.00, and 1517.00.

57 KCBT Rules 1524.00 and 1524.01.

58 KCBT Rules 1528.00, 1528.01, 1528.02, 1528.03, 1529.00 and 1531.00.
33

The only right of appeal is under applicable law. A member’s refusal to comply with an award 

within 30 calendar days of its issuance is a violation of KCBT Rules.59

Arbitration fees are initially paid by the party bringing the case. Those fees, and any 

additional incurred costs, are ultimately assessed against either of the parties in the case, as may 

be decided by the hearing body and included in its award or finding.60 There were no customer 

arbitrations during the target period.

B. Member-to-Member Arbitration

The Exchange’s member-to-member arbitration rules and procedures generally are 

similar to the customer arbitration rules. However, any member who commences legal action 

against another member for any dispute must first attempt to arbitrate under Exchange rules or be 

subject to Exchange disciplinary action. If arbitration has been attempted and rejected, then a 

legal action may be commenced and the member failing or refusing to arbitrate also may be 

subject to Exchange disciplinary action. Exchange rules also provide that member-to-member 

disputes involving futures contract transactions are independent of and separate from any 

customer claims or grievances submitted for dispute resolution.61 There were no member-tomember arbitrations during the target period.

C. Conclusion

Based upon its review, the Division found that the Exchange maintains adequate dispute 

resolution procedures. KCBT rules provide customers with voluntary procedures for arbitration 

that are fundamentally fair and equitable. In this connection, customers have the opportunity to 

have their claims heard and decided by an objective and impartial decision maker. Each party 

 

59 KCBT Rules 1541.00 through 1541.06.

60 KCBT Rules 1548.00 and 1551.00.

61 KCBT Rules 1600.00, 1603.00 and 1604.00.
34

has the right to counsel and each party receives adequate notice of claims presented against them 

and an opportunity to be heard on all claims, defenses, and counterclaims. The Exchange’s 

arbitration procedures require a prompt hearing and authorize prompt, written, final settlement 

awards that are not subject to appeal within the Exchange. The Exchange also provides adequate 

arbitration procedures for member-to-member disputes. Any member who commences legal 

action against another member for any dispute must first attempt to arbitrate under Exchange 

rules or be subject to Exchange disciplinary action. In addition, member-to-member arbitration 

is separate from and independent of customer claims or grievances submitted for resolution. 

There were no customer or member-to-member arbitrations during the target period.

Based on the foregoing, the Division has no recommendations in this area.
35

VII. GOVERNANCE

Core Principle 14 – Governance Fitness Standards

The board of trade shall establish and enforce appropriate fitness standards for 

directors, members of any disciplinary committee, members of the contract market, 

and any other persons with direct access to the facility (including any persons 

affiliated with any of the persons in this paragraph).

Core Principle 15 – Conflicts of Interest:

The board of trade shall establish and enforce rules to minimize conflicts of interest 

in the decision making process of the contract market and establish a process for 

resolving such conflicts of interest. 

Core Principle 16 – Composition of Board of Mutually Owned Contract Markets:

In the case of a mutually owned contract market, the board of trade shall ensure 

that the composition of the governing board reflects market participants.

A. Fitness Standards

The Division believes that KCBT has established and enforces appropriate fitness 

standards for Exchange members, Board members, and members of the Exchange’s disciplinary 

committees.62 Any person or entity that wishes to become an Exchange member must submit a 

membership application.63 Among other things, an applicant must submit a sworn statement 

answering questions regarding fitness standards.64 For example, an applicant must provide 

information regarding his or her membership or denial of membership at any futures or securities 

exchange, his or her disciplinary history at any futures or securities exchange, and any judgments 

other than minor traffic violations. An applicant also must answer questions regarding finances.

A&I reviews membership applications to ensure that applicants meet minimum financial 

requirements. The Membership Committee is responsible for reviewing each membership 

 

62

 See pp. 25-27 for a description of the Exchange’s disciplinary committees.

63

 See KCBT Rule 106.00.

64 These fitness standards are the same as those enumerated under Section 8a(2) of the Act that would serve as a 

basis for refusal to register a person.
36

application and for recommending whether the Board should approve or disapprove an applicant. 

At least eight Board members must vote in the affirmative to approve an applicant as qualified 

for membership.65 During the target period, no membership applications were disapproved. 

With respect to the ongoing fitness of Exchange members, NFA will notify the Exchange of any 

members whose registration has been suspended or revoked.

The Exchange prohibits a person with a significant history of disciplinary violations 

within the past three years, or a person who is currently suspended from trading on a contract 

market or is suspended or expelled from membership in any self-regulatory organization, from 

serving on the Board, Complaint Committee, BCC, or an Arbitration Panel.66 For example, a 

person would be barred from service, if, among other things, he or she was found pursuant to a 

final decision to have committed a “disciplinary offense” or entered into a settlement agreement 

in which the findings or acts charged included a disciplinary offense. A disciplinary offense 

includes any violation of the rules of a self-regulatory organization, except those rules relating to 

decorum or attire, financial requirements, or reporting or recordkeeping requirements (provided 

that the resulting reporting or recordkeeping fines do not total more that $5,000 within any 

calendar year), unless violation of such rules involved fraud, deceit, conversion, or resulted in a 

suspension or expulsion. The Exchange also deems any violation of the Act or the 

Commission’s regulations as a disciplinary offense.67

A&I monitors the fitness of persons with governing authority or who serve on a 

disciplinary committee to ensure that the individuals have not committed a disciplinary offense 

within the past three years. Prior to the Nominating Committee meeting each November to 

 

65 KCBT Rules 130.00 and 131.00. All KCBT members have voting privileges.

66 KCBT Rule 260.00.

67 KCBT Rule 260.00(1).
37

prepare a list of candidates for elected positions and the Chairman appointing members to the 

standing committees the following January, A&I staff presents a list to the Assistant Secretary 

which reflects members who are ineligible to serve on the Board or a disciplinary committee. 

A&I also reviews fitness information on an ongoing basis throughout the year. During the target 

period, no member of the Board, the Complaint Committee, or the BCC was removed for failure 

to comply with KCBT’s fitness requirements.

B. Conflicts of Interest

The Division’s found that KCBT has adopted and enforces appropriate rules and 

procedures to identify and resolve the presence of conflicts of interest in any Board or 

disciplinary committee decision-making process. In addition, KCBT has adopted and enforces 

rules that limit the use or disclosure of material non-public information gained through the 

performance of official duties by Board members, committee members, and KCBT employees.

Specifically, the Exchange’s rules describe what relationships will be considered a 

conflict of interest in matters involving named parties in interest and Board members or 

disciplinary committee members hearing such matters. The rules also provide procedures for 

resolving conflicts of interest.68 In this regard, a member of the Board, Complaint Committee, or 

BCC must abstain from such body’s deliberations and from voting on any matter where such 

member is: (1) a named party in interest or an employer, employee, or fellow employee of a 

named party in interest; (2) associated with a named party in interest through a broker 

association; (3) has any other significant, ongoing business relationship with a named party in 

 

68 KCBT Rules 261.00, 1421.01 and 1438.01.
38

interest; (4) has a family relationship with a named party in interest; or (5) has a direct and 

substantial financial interest in the result of the vote.69

Determinations as to the nature of a relationship between a member of the Board or 

member of a disciplinary committee and a named party in interest are largely determined by, but 

are not limited to, the member’s disclosure of such a relationship.70 Similarly, determinations as 

to whether a Board member or member of the Complaint Committee or BCC has a direct and 

substantial financial interest are made based upon, but are not limited to, such member’s 

disclosure of positions held in the member’s personal accounts, proprietary accounts, and 

customer accounts.71 In both instances, A&I will review such disclosures in addition to any 

other information reasonably available to determine if a conflict exists. During the target period, 

A&I was not asked to consider any potential conflicts of interest regarding any member of the 

Board or a disciplinary committee.

Board members, members of Exchange committees, and Exchange employees also are 

prohibited from disclosing material, non-public information obtained from the person’s 

respective service in such position.72 During the target period, there were no matters that 

involved the Exchange’s non-disclosure rules.

 

69 In the event that a Board or committee member’s participation in deliberations is necessary for achieving a 

quorum or the member has unique or special expertise, knowledge, or experience in a matter under consideration, 

the member may participate in deliberations prior to a vote, provided that such participation is consistent with the 

public interest and the member abstains from voting on such action. KCBT Rule 261.00(d).

70 KCBT Rule 261.00(b)(2) requires that prior to the consideration of any matter involving a named party in interest, 

each member of the Board or disciplinary committee must disclose to A&I whether he or she has one of the abovementioned relationships with a named party in interest.

71 KCBT Rule 261.00(c)(3) and (4).

72 KCBT Rules 232.031, 232.06, and 251.01.
39

C. Board Composition

Finally, as described below, the Division believes that the composition of KCBT’s Board 

adequately reflects a broad array of market participants to ensure that various interests are fairly 

represented. The Exchange’s governing body includes the Chairman, First Vice Chairman, 

Second Vice Chairman, President, and Treasurer. These individuals also serve on the 

Exchange’s Board, along with 12 Exchange members, four outside directors, the President of the 

KCBT Investment Company, the President of the Clearing Corporation, and the Secretary.73

The Exchange, which is a mutually owned Delaware for-profit corporation, requires that 

ten percent or more of the Board include persons representing farmers, producers, merchants or 

exporters of the principal commodities underlying a commodity futures or commodity option 

contract traded on the Exchange. In addition, the Board must represent a diversity of 

membership interests including floor brokers, floor traders, FCMs, producers, consumers, 

processors, distributors, and merchandisers of commodities traded on the Exchange, as well as 

participants in a variety of pits or principal groups of commodities traded on the Exchange.74 

During the target period, the Board’s members included three FCMs, three commercials, three 

Wheat floor traders, one Wheat floor broker, one Wheat option floor trader, and one Value Line 

floor trader.

D. Conclusion

The Division found that the Exchange has adopted and enforces appropriate rules and 

procedures that relate to Exchange governance. The Exchange has established membership 

procedures to ensure that members satisfy enumerated fitness standards. With respect to the 

 

73 KCBT Rule 200.00. Under KCBT Rule 230.05, outside directors may not be Exchange members or employees, 

or officers, principals, or employees of a firm that holds an Exchange membership. In addition, outside directors 

must have knowledge of futures trading or financial regulation.

74 KCBT Rules 210.01 and 210.02.
40

ongoing fitness of members, NFA notifies the Exchange of any members whose registration has 

been suspended or revoked. The Exchange also prohibits a person with a significant history of 

disciplinary violations within the past three years, or a person who is currently suspended from 

trading on a contract market or is suspended or expelled from membership in any self-regulatory 

organization, from serving on the Board or a disciplinary committee. A&I monitors the fitness 

of members of the Board, Complaint Committee, and BCC to enforce these standards.

With respect to conflicts of interest, prior to considering or hearing a matter that may 

involve a possible conflict of interest, members of the Board, Complaint Committee, and BCC 

are required to disclose the possibility of such conflict. If A&I determines that a conflict does 

exist, the person may not participate in deliberations, unless the person has a unique expertise or 

is needed for a quorum, and may not vote on the matter. Board members, members of Exchange 

committees, and Exchange employees also are prohibited from disclosing material, non-public 

information obtained from the person’s respective service in such position. Lastly, the 

Exchange’s Board fairly represents the diversity of interests of market users.

Based on the foregoing, the Division has no recommendations in this area.