FOLLOW-UP RULE ENFORCEMENT REVIEW

OF THE

CHICAGO BOARD OF TRADE

I. INTRODUCTION

The Division of Trading and Markets (“Division”) has completed a follow-up rule 

enforcement review to its June 30, 2000 rule enforcement review (“2000 Review”) of the 

Chicago Board of Trade (“CBT” or “Exchange”).1 The 2000 Review focused on the 

Exchange’s trade practice surveillance and disciplinary programs for the period of 

October 1, 1998 through September 30, 1999. Although the Division found that the 

Exchange maintained adequate trade practice and disciplinary programs, the Division’s 

2000 Review set forth several recommendations designed to further enhance the CBT’s 

self-regulatory procedures. 

With respect to the Exchange’s trade practice surveillance program, the Division 

recommended that the Exchange improve the timeliness of its investigations, expand 

investigations when serious allegations of wrongdoing are made, and take cognizance of 

the trading activity of members whose cases are referred to a disciplinary committee. 

With regard to the Exchange’s disciplinary program, the Division recommended that the 

Exchange issue meaningful penalties in instances of members improperly changing 

settlement prices or disclosing orders, refer multiple instances of violations relating to 

errors and mishandling of orders to an appropriate disciplinary committee, and take steps 

to ensure that all members and their employees understand CBT’s electronic trading 

rules.

 

1

 The 2000 Review can be found in Appendix 1.
2

The Exchange responded to the 2000 Review by letter dated September 15, 2000 

(“2000 Response”), outlining the initiatives it would take to implement the Division’s 

recommendations.2 In order to evaluate the Exchange’s progress in implementing the 

recommendations, the Division conducted this follow-up review. The target period for 

the follow-up review is January 1 through June 30, 2001. As part of the review process, 

the Division examined computer reports generated by the Exchange’s automated trade 

practice surveillance system and other documents used routinely for surveillance, trade 

practice investigation and disciplinary logs, selected trade practice investigation and 

disciplinary action files, minutes of disciplinary committee meetings, and other pertinent 

documents. 

For each 2000 Review recommendation, this report presents a brief description of 

the findings that led to the recommendation, the Exchange’s response to the 

recommendation, and the Division’s analysis of the Exchange’s progress in implementing 

the recommendation.3 The Division gave the CBT an opportunity to review and 

comment on a draft of this report on January 7, 2002. On January 15, 2002, Division 

staff conducted an exit conference with CBT compliance officials to discuss the report’s 

findings and recommendation.

 

2

 The 2000 Response can be found in Appendix 2.

3

 The Division’s 2000 Review recommendations are italicized in bold print.
3

II. TRADE PRACTICE SURVEILLANCE PROGRAM

1. Focus substantial attention on timely completion of investigations in 

order to achieve significant improvements in timeliness. Additionally, 

CBT must file a quarterly report with the Division, beginning in

October 2000, which details the timeliness of investigations closed

during the previous quarter.

In the 2000 Review, the Division found numerous investigations that were open 

for more than one year, and in some instances, in excess of two or even three years. One 

hundred and forty-four, or nearly 45 percent of the investigations closed during the target 

period, were open for more than one year, nine were open more than two years, and two 

were open more than three years. Although several of the investigations open for more 

than one year were complex in nature and, therefore, justifiably took a longer period of 

time to complete, the Division found that long periods of dormancy and undue delays in 

supervisory review were major factors in delaying the closure of the oldest investigations. 

In addition, the Exchange’s Office of Investigations and Audits (“OIA”) experienced 

unusually high rates of employee turnover prior to and during the 2000 Review target 

period, which also contributed to delays.4 

In its 2000 Response, the Exchange acknowledged that its investigation timeliness 

required improvement, described the various factors that affected timeliness, and set forth 

the latest steps it has taken to address the issue. First, in March 2000, the Exchange 

adjusted the grade levels of OIA positions. These adjustments resulted in substantive 

compensation increases for all levels of staff to bring their compensation more closely in 

line with comparable positions elsewhere. Second, the Exchange reallocated regulatory 

 

4

 OIA experienced turnover rates of approximately 25 percent during the 2000 Review target period, and 37 

percent during the 12 months preceding the target period. The CBT, as a whole, had an average staff 

turnover rate of 15 percent. OIA has reported that staff turnover levels decreased to 17 percent from June 

2000 to August 2001. 
4

resources after modifying certain programs that yielded few regulatory benefits relative 

to their costs. This allowed increased time for more productive investigative work. 

Finally, OIA streamlined its procedures for closing investigations. Under the new 

procedures, an investigation is officially closed on CBT’s logs once a manager has 

reviewed and approved an investigator’s closing memorandum. The Exchange stated that 

these steps have resulted in substantial improvement in its investigation timeliness. 

Specifically, the Exchange noted that as of the date of its 2000 Response, the Exchange 

had no cases outstanding in excess of a year and only eight cases outstanding in excess of 

10 months. 

During the follow-up target period, the Division found continued improvement in 

investigation timeliness. OIA closed 84 investigations during the target period, of which 

14, or 17 percent, had been open for more than one year. Although this represents an 

increase in the number of investigations open more than one year since CBT’s 2000 

Response, the percentage of those open more than one year compares favorably to the 

almost 45 percent identified during the 2000 Review target period.5 In addition, 59 of the 

84 investigations, or 70 percent, had been open between five months and one year, and 

the remaining 11 investigations had been open for four months or less. Thus, the number 

of investigations that were open for longer than one year decreased by 62 percent from 

2000 to 2001, while investigations that were closed between five and 12 months 

increased by 52 percent. Figure 1 below illustrates these results:

 

5

 The Division notes that timeliness could be further improved by OIA continuing to focus on hastening 

supervisory review. The Division found that the length of supervisory review ranged from 48 to 264 days 

for at least four of the 14 investigations closed during the follow-up review target period that were open for 

more than one year. See 00-TOO-07, 00-TPI-13, 99-TPI-63, and 00-TPI-25 in Appendix 3.
5

The Division reviewed 27 of the 84 investigations closed during the current target 

period, including five investigations that were referred to a disciplinary committee. The 

Division found that the Exchange continues to conduct thorough investigations, several 

of which were complex. For example, some of the investigations reviewed by the 

Division not only involved detailed analysis of outright futures trades, but also involved 

analysis of complicated option trades and spreads.6 In addition, investigations appeared 

to be well documented and investigation reports were sufficiently detailed.

2. Widen investigations appropriately when serious allegations of

 wrongdoing are made.

This recommendation stemmed from an investigation in the 2000 Review which 

the Division believed should have been expanded to other pits based on information 

obtained during an interview of the respondent.7 OIA determined that on several

occasions over a 15-day period, the Vice-Chairman of the Wheat Options Pit Committee 

settled Wheat option prices out-of-line with their fair market value. This was done in 

 

6

See 01-INV-14 and 00-TPI-39 in Appendix 4.

Figure 1: Comparison of Length of Investigations Closed during the 2000 and 

2001 Target Periods

46% 45%

13%

70%

17%

9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Closed 1 - 4 months Closed 5 - 12 months Closed Over 1 Year 

2000 2001
6

order to enhance the equity in his personal trading account with regard to several hundred 

option contracts. In doing so, the Vice-Chairman overrode the Exchange’s automated 

Option Settlement Verification Program (“OSVP”), which identifies discrepancies 

between a pit committee’s settlement recommendations and certain theoretical values. 

Discrepancies are supposed to be resolved by a pit committee representative either 

modifying the settlement price to conform to the parameters given by the OSVP or 

justifying why the option should settle outside the parameters. 

In OIA interviews, the Vice-Chairman of the Wheat Options Pit Committee 

admitted that he had marked settlement prices to benefit his position, but claimed that this 

practice had been “going on for a long time” and “occurs routinely in all pits.” 

Notwithstanding this serious allegation, OIA did not widen its investigation to include an 

examination of settlement prices in other option pits. OIA did, however, refer the Vice 

Chairman to a disciplinary committee for possible violations of the CBT’s procedures 

governing option settlement prices.8 

In its 2000 Response, the Exchange stated that it disagreed with the Division’s 

interpretation of the scope of the Vice Chairman’s statement regarding the practice of 

marking the close. Nonetheless, the Exchange agreed to initiate a study to examine a 

sampling of settlement prices in other option markets, as requested by the Division in the 

2000 Review. In its study, OIA reviewed option settlement prices for nine contracts 

during the week of November 27, 2000. These contracts included options on Corn, 

Soybeans, Wheat, Oats, Soybean Meal, Soybean Oil, Treasury Bonds, and Ten- and Five-

 

7

 99-INV-11.

8

 As discussed below in Section III.1., the Vice Chairman received only a written reprimand, which the 

Division cited in the 2000 Review as an inadequate sanction given the seriousness of the violation. 
7

Year Treasury Notes. The week of November 27 was selected based on trading volume 

and price volatility relative to other weeks during that month. 

The study found that more than 99 percent of the nearly 2800 option strikes 

settled during that week settled within OSVP parameters. OIA examined all settlements 

that fell outside of OSVP parameters and additionally did not find any modified 

settlement prices that were out-of-line with fair market value. In several instances, the 

Exchange found that modifications brought the settlements more in line with theoretical 

value. However, in reviewing the settlement modification logs, OIA found several 

instances in which the reason set forth in support of the change or justification did not 

appear to correspond to the underlying activity, or in which the member requesting the 

change was not identified.9 For example, the cited reason for adjusting the July 460 

Soybean put settlement on November 27 and 29 was to bring the conversion into line, but 

because there was no call settlement for that strike, that reason could not consequently 

apply. 

Based on these findings, and in response to the Commission’s July 2001 Report 

on Lessons Learned From the Failure of Klein & Co. Futures, Inc. (“Klein Report”), in 

which, among other things, exchanges were requested to develop and maintain programs 

to review settlement prices to determine if they are reasonable, the CBT has taken the 

following steps to ensure the integrity of its option settlement procedures and option 

settlement prices. First, OIA met with the Exchange’s option pit committees and 

appropriate staff to remind them of the importance of ensuring the accuracy, consistency, 

 

9

 The Exchange’s settlement modification procedure requires that the authorizing member of the pit 

committee record the justification for any change or modification to the settlement price, along with his or 

her member acronym, in the modification log. The requesting member’s acronym should also be 

identified.
8

and integrity of all option settlements, including those not actively traded, and that the 

OSVP program is implemented correctly in all instances. In particular, OIA reminded 

members and staff that all discrepancies outside the OSVP parameters must either be 

modified or justified in an accurate and sufficiently detailed manner on the settlement 

modification logs. 

Second, OIA has incorporated a quarterly review of option settlement prices into 

its routine surveillance program. The program is intended to ensure that OSVP 

procedures are complied with, and that patterns that may be indicative of an attempt to 

manipulate the settlements are identified and investigated. The program was 

implemented in November 2001 and generally entails reviewing each option that settles 

outside the OSVP parameters to verify that the settlement was justified and is supported 

by relevant data. In the event of a possible pattern of discrepancies or unsubstantiated 

justifications, investigators are instructed to review daily trade data and large trader data 

to assess whether the settlement price may have been marked inappropriately. As part of 

this new effort, OIA is seeking to database the relevant OSVP output to allow staff to 

query the data across trade dates.

3. Take Cognizance of Trading Activity of Members Whose Cases

 are Referred to Disciplinary Committees

In the 2000 Review, the Division identified a situation that involved a member 

engaging in apparent prearranged and noncompetitive trading during the lengthy period

of time that a case involving the same member and similar illegal trading activity was 

pending before a disciplinary committee.10 The Division, during the course of its routine 

 

10 This investigation, 97-INV-3, involved two members of the same broker group. One member was 

ultimately fined $100,000 and suspended for 30 days, while the other member was fined $20,000 and 

suspended for 20 days. 
9

oversight activity, discovered similar potential violations using the Commission’s 

Exchange Database System. Because the Division believes that the facts that led to the 

issuance of charges against the member also constitute reasonable grounds to suspect that 

the member might engage in further illegal activity, the Division recommended that CBT 

take cognizance of the trading activity of those members whose cases are referred to a 

disciplinary committee.

In its 2000 Response, the Exchange stated that OIA staff are encouraged to take 

into account the prior investigative histories of members in conducting trade practice 

oversight. In the course of conducting this follow-up review, the Division did not 

identify any similar situations. 

III. DISCIPLINARY MATTERS

1. Issue meaningful sanctions, including appropriate fines and/or suspensions

from trading, where members improperly change settlement prices or

disclose orders.

The Division found in the 2000 Review that in most cases the Exchange imposed 

adequate sanctions. However, the Division identified two cases in which it questioned 

the sufficiency of the sanctions. The first case was the matter that involved the ViceChairman of the Wheat Options Pit Committee, discussed above.11 By overriding the 

Exchange’s automated OSVP, the Vice-Chairman used his position to enhance the equity 

in his personal trading account. The settlement offer accepted by the Floor Governors 

Committee (“FGC”) included a written reprimand, but did not include a monetary penalty 

or suspension from the trading floor. Considering the nature of the violation and the 

 

11 See Section II.2.
10

Vice-Chairman’s misuse of his position, the Division believed that a monetary penalty 

and/or suspension from the trading floor was warranted. 

The second case involved a member/phone clerk who was charged with 

disclosing stop prices on two resting orders to another customer.12 The member was 

fined $2,500. The Division believed that this sanction failed to adequately address the 

seriousness of the violation, and may not serve as an effective deterrent. By disclosing 

order information, the member jeopardized the integrity of the market and disregarded his 

duty to his customers. The Division believed that a more severe sanction also was 

appropriate in this instance.

In its 2000 Response, the Exchange stated that the FGC has been apprised of the 

Division’s recommendations and that the committee will keep them in mind when 

considering future, similar cases. The Exchange also stated that the FGC believed that 

both settlements cited by the Division were reasonable when evaluated in light of the 

facts and circumstances of each case. The Exchange explained that the preliminary 

charges against the Vice-Chairman of the Wheat Options Pit Committee included the 

imposition of a $5,000 fine. However, in settling the matter, the Vice-Chairman accepted 

a formal reprimand and resigned his Pit Committee position. The Exchange further 

explained that in accepting the settlement offer, the FGC took into consideration the 

respondent’s six-year history of recommending settlements without a problem, his candor 

in his interviews with OIA, and his uncontroverted claim that he was willing to buy the 

options at the prices which he bid them at the close and at which he recommended that 

they be settled. 

 

12 98-INV-20.
11

With respect to the case involving the member who disclosed the stop orders, the

Exchange stated that the FGC took into account the context and result of the disclosure, 

the fact that the evidence indicated that the disclosure was an isolated event, and that the 

individual did not have a prior disciplinary history. The Exchange also noted that, in 

conjunction with this matter, the employing member firm was fined $10,000 for its 

failure to supervise the member/phone clerk. 

In the current target period, the Division found that none of the ten disciplinary 

cases closed raised similar concerns respecting the adequacy of sanctions. Sanctions 

were levied in six of the ten cases against a total of eight individuals.13 The sanctions 

included monetary penalties totaling $15,000 (ranging from $500 to $8,500) levied 

against four individuals for noncompetitive trading, mishandling of error trades, and 

failure to acknowledge an executed trade. Three individuals, two of whom also were 

fined, were suspended for a total of 14 business days. In addition, one individual 

received a reprimand and paid $42,875 in restitution for allocating trades in other than an 

equitable manner, and two individuals were reprimanded for mishandling error trades. In 

the four remaining disciplinary cases closed during the follow-up review target period, 

the FGC did not find sufficient evidence to warrant finding a violation of Exchange rules.

 

13 See 00-INV-11, 00-INV-07, 00-INV-15, 00-INV-16, 00-INV-18, and 00-INV-23 in Appendix 5.
12

2. Refer cases of multiple instances of violations relating to errors and 

mishandling of orders, absent mitigating circumstances, to the appropriate 

disciplinary committee for consideration of sanctions, rather than issuing 

repeated reminder letters.

The 2000 Review noted the Division’s concern regarding the Exchange’s 

enforcement of CBT Rule 350.04, which pertains to outtrades, errors and the mishandling 

of orders.14 The Division had identified numerous instances in which repeat offenders of 

the rule were not referred to a disciplinary committee, but instead were issued OIA staff 

warning letters. Specifically, during the 2000 Review target period, 43 brokers and seven 

firms received more than one warning letter concerning violations of Rule 350.04. The 

Division opined that members or member firms who violate substantive rules that address 

potential customer fraud should not be issued more than one reminder letter in a 12-

month period, absent mitigating circumstances. Rather, the Division believed that such 

members should be referred to a disciplinary committee for consideration of charges and 

appropriate penalties.

In its 2000 Response, the Exchange asserted that the majority of reminder letters 

issued during the target period for violations of Rule 350.04 were issued for technical 

violations of the rule, such as placing an error trade into a personal trading account rather 

than an error account, or for isolated, improper recordkeeping. The Exchange also 

asserted that because Rule 350.04 has different technical requirements, many of the 

reminder letters that were issued to the same members were issued for different 

 

14 Rule 350.04 provides generally that if a customer outtrade cannot be resolved, the floor broker can reexecute the order in the market and adjust the customer by check if the re-execution price is worse than the 

original execution price, or assign the opposite side of the customer’s trade to his or her error account at the 

execution price. The rule also provides that the assignment process can be used in the event a floor broker 

erroneously executes a customer order or otherwise mishandles an attempt to execute a customer order. 

However, the rule may not be used to clear unfilled or under filled orders, orders that were erroneously 

executed in the wrong contract month, strike price, put vs. call or side of the market, or price outtrades. 
13

requirements of the rule, and thus, the members were not truly repeat offenders. Further, 

CBT stated that it had referred, and would continue to refer, repeated, substantive 

violations of Rule 350.04 and all cases involving customer fraud to the FGC.15

The Division concurs with the Exchange that Rule 350.04 violations should be 

examined to determine whether the violation was procedural or substantive in nature, and 

that substantive violations should be referred to a disciplinary committee. However, a 

member who repeatedly fails to comply with the procedural requirements of an Exchange 

rule should also be referred to a disciplinary committee for consideration of further 

action. While the Division acknowledges that in certain instances reminder letters for 

procedural violations of a rule may be appropriate, the continued issuance of such letters 

may not curb the violative activity. 

3. Take appropriate steps, including issuance of notices to members, to ensure

that all members and their employees understand Exchange rules relating to 

electronic trading.

In reviewing Project A disciplinary cases closed during the 2000 Review target 

period, the Division found an apparent pattern of misunderstanding or confusion on the 

part of members and member firms concerning some of the Exchange’s electronic trading 

rules. 16 For example, the Division identified three cases involving trade entry by 

terminal operators other than the operator logged on to the system. In one of these cases, 

the member whose User ID was being improperly used by others stated that he knew that 

 

15 The Exchange explained that during the 2000 Review target period, OIA had referred four Rule 350.04 

cases that involved minor violations to the FGC. Subsequently, the FGC directed OIA to administratively 

issue reminder letters for matters involving minor infractions of Rule 350.04 that did not rise to a level 

warranting formal disciplinary action.

16 In August 2000, the Exchange replaced its Project A electronic trading platform with the a/c/e electronic 

trading platform. 
14

this was a rule violation and knew that it was occurring, but believed that this practice 

was necessary to secure the proper fill price for the customer. 

The Exchange stated in its 2000 Response that the growth in electronic trading 

creates significant transition issues on many fronts for members and member firms. The 

Exchange also explained that while it currently provides comprehensive training for new 

system users, routinely addresses regulatory issues at user group meetings, and issues 

periodic notices and bulletins regarding specific electronic trading rules, it would 

endeavor to be more proactive in educating users, particularly when its investigative 

findings indicate consistent violations of a particular rule by different parties.

In this regard, during the follow-up target period, CBT issued several notices to 

members reminding them of their obligations with respect to specific electronic trading 

rules. For example, in conjunction with the conclusion of an electronic trading 

investigation involving misuse of User IDs and passwords, the Exchange issued notices 

to all members reminding them of their obligations concerning the proper use of User 

IDs. Among other things, the notice stated that each direct user of a/c/e is required to 

utilize only his or her designated User ID, and that individual members, proprietary 

traders of member firms, and all employees and agents of member firms must be assigned 

and utilize individual User IDs. The notice also emphasized that firms were responsible 

for monitoring and verifying the accuracy of all User ID information reported to the 

Exchange, and that the audit trail for any proprietary order routing system must meet 

Exchange and Commission requirements. In addition, the Exchange issued notices 

concerning, among other things, the prohibition against the exercise of discretion by a 
15

non-member terminal operator in the placing of an order, pre-execution communications, 

and keyboard functionality in the order entry process. 

In reviewing CBT’s disciplinary cases for the follow-up target period, the 

Division identified one firm that received two warning letters within a four-month period 

regarding terminal operators placing orders using User IDs other than their own.17 The 

letters reminded the firm of its obligation to supervise its terminal operators’ compliance 

with Exchange rules and that any violation of Exchange rules by a terminal operator may 

be considered a violation by the firm. The second reminder letter concluded by stating 

that any other violation of this nature “will be referred to the Floor Governors Committee 

for disciplinary action.” The Division believes that effective enforcement of the 

Exchange’s rules would necessitate that any additional similar violations by the firm be 

referred to the FGC, as suggested in the reminder letter, for the imposition of sanctions.

IV. CONCLUSIONS AND RECOMMENDATIONS

In reviewing the Exchange’s trade practice surveillance and disciplinary 

programs, the Division finds that CBT generally has implemented the recommendations 

set forth by the Division in its 2000 Review. Most notably, CBT has improved its 

timeliness with respect to completing investigations. Of the 84 investigations closed 

during the follow-up review target period, 17 percent had been open for more than one 

year, as compared to the 2000 Review, when 45 percent of the investigations closed had 

been open for longer than one year. The Division believes that the timeliness of the 

 

17 OIA issued the first warning letter on March 16, 2001 (00-PJA-04). The second warning letter was 

issued on July 2, 2001 (00-PJA-06).
16

Exchange’s investigations could be further improved by OIA’s continued focus on 

hastening supervisory review.

The Exchange also expanded an investigation of option settlement prices at the 

request of the Division by conducting a study of settlements across certain option 

markets. Based on the study’s findings, and in response to the Commission’s Klein

Report, the Exchange reminded option pit committees and appropriate staff of the 

importance of ensuring the accuracy of all option settlements, and of their responsibility 

to document adequately the reasons for modifications to settlement prices. Additionally, 

the Exchange has incorporated a quarterly review of option settlement prices into its 

routine surveillance program.

The Exchange also issued several notices to its members reminding them of their 

responsibilities concerning specific electronic trading rules and practices. These notices 

related to, among other things, the misuse of User IDs and passwords, the prohibition 

against the exercise of discretion by a non-member terminal operator in the placing of an 

order, and pre-execution communications. 

Finally, the Division recommended in the 2000 Review that multiple instances of 

violations relating to errors and mishandling of orders, absent mitigating circumstances, 

be referred to a disciplinary committee rather than OIA issuing repeated reminder letters. 

This recommendation related specifically to the Exchange’s enforcement of Rule 350.04. 

The Exchange responded that most reminder letters that had been issued for violations of 

the rule were for procedural rather than substantive violations, and that substantive 

violations were routinely referred to a disciplinary committee. While substantive 

violations should be referred to a disciplinary committee, a member who continues to 
17

violate procedural requirements, notwithstanding the receipt of several reminder letters, 

should similarly be referred to a disciplinary committee. In this manner, the committee 

can then impose more meaningful remedial action against the member to deter future 

violations.

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

• Refer members who have received reminder letters for previous

violations of procedural requirements to a disciplinary committee for 

consideration of more meaningful remedial action.