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COMMODITY FUTURES TRADING COMMISSION 

MEETING OF THE 

TECHNOLOGY ADVISORY COMMITTEE 

Wednesday, October 13, 2004 

1:15 p.m. 

Commodity Futures Trading Commission 

Hearing Room 1012 

1155 21st Street, N.W. 

Washington, D.C. 
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C O N T E N T S 

AGENDA ITEM PAGE

Welcoming Remarks 

 Acting Chairman Sharon Brown-Hruska 

 Committee Chairman 3 

Remarks - Commissioner Walter Lukken 7 

Introduction of TAC Meeting Participants 12 

Surveillance of Electronic Trading - 

Presentation by CFTC - Steve Braverman 17 

How Exchanges Deal with Disruptions to 

Market Operations 

Presentations by: 

 Chicago Mercantile Exchange 

 Donald Serpico 67 

 New York Board of Trade 

 Pat Gambaro 91 

Report on Industry-Wide Disaster Recovery 

Test - Presentation by Morgan Stanley - 

John Davidson 107 
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P R O C E E D I N G S 

 ACTING CHAIRMAN BROWN-HRUSKA: I'd like to welcome 

everyone here today in what is our inaugural meeting of the 

Technology Advisory Committee. 

 When former Chairman Jim Newsome asked me to serve 

as Chairman of this Committee, I saw it as a great 

opportunity for the Commission and for myself to explore how 

technology has influenced market structure and the quality 

of markets. 

 As an economist, these are not only interesting 

concepts, but also very important concepts. And they are 

also very timely, in that over the past several years the 

structure of the futures markets and markets, in general, 

has and still is going under a great deal of change. And 

technology has played a large role in this, and I certainly 

don't have to tell you that. 

 We've seen advances in computer and communication 

technologies that have fundamentally changed the way we use 

markets compared to 50, or even 20 years ago. The ability 

to manipulate vast amounts of data has led to a far better 

understanding of how to price options, for example. They 
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have given risk managers far greater ability to comprehend 

the risk exposure and to control risk. 

 Computers and communication technology have also 

expanded the pits. Orders once phoned in to a broker and 

routed through paper and oral communication are now 

conducted through electrons on a global basis. The 

Commission has designated 11 entirely electronic exchanges, 

and the Chicago Board of Trade and the CME now execute most 

of their trades electronically. 

 As Chairman of the Committee, I'm also looking 

forward to exploring the issues that are raised by changes 

in opportunities made possible by advances in technology, 

and I'm especially interested in the policy implications of 

those changes. 

 As you can see from the agenda before you, today I 

would like to explore three issues that are impacted by 

technology. The first deals with the issue of how to 

conduct surveillance of electronic trading. We've heard 

diverging views. Some suggest that electronic trading makes 

surveillance easier. Some suggest that it actually creates 

situations where we're unable to see market activity, and 

therefore somehow we're at a disadvantage. 
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 So I thought what would be useful is to have our 

very experienced and knowledgeable Steve Braverman, of the 

Division of Market Oversight, give us some perspective on 

the topic and give us a presentation especially on a review 

that they have been engaged in recently on this issue. 

 The second presentation will look at how exchanges 

have prepared to deal with disruptions in market operations. 

Don Serpico, of the CME, and Pat Gambaro, of NYBOT, will 

each bring us up to date with the preparations their 

exchanges have taken to deal with such events. These are 

vitally important. They are important to us as a Commission 

in our role as regulators and important to our government, 

to the President, as a whole, that we know that we're 

prepared to deal with these difficult issues. 

 Finally, John Davidson, of Morgan Stanley, will 

give us a report on an industry-wide disaster recovery test 

that was run just this weekend to see how the industry as a 

whole is prepared to deal with such events. 

 I anticipate and encourage each of you to take an 

active part in the discussion of these topics. It was my 

plan when I put this group together to create a diverse 
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group of participants on the Committee so that we can bring 

a wide range of viewpoints to the table. 

 And so I think just as with the Global Markets 

Advisory Committee and the Ag Advisory Committee, I think we 

really see this as a--and I'm going to speak for you, Walt-- 

but I think we see this as an important way for us to bring 

together and learn, bring together divergent views and 

knowledge and expertise, and for us to learn as an agency 

where we best should go in the future and how we can best 

prepare for the future and the change that is occurring. 

 I also anticipate that we'll have more frequent 

advisory committee meetings, whether it be this Committee or 

others, to flesh out these important issues and anticipate 

them. 

 Before we get into the presentations, I would like 

to take the opportunity to recognize Walt, my colleague at 

the Commission, Commissioner Walt Lukken. Walt and I joined 

the Commission on the same day and it has been a real 

pleasure to have had the opportunity to work with him and I 

look forward to continuing to work with him in the future. 

 Commissioner Lukken, if you have any comments 

you'd like to share with the group, I'll give you an 
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opportunity to make them, and then follow with an 

introduction of the Committee members, followed by the 

presentations. 

 COMMISSIONER LUKKEN: Thank you, Sharon. I echo 

those comments. It has been a pleasure while we’ve come 

together, I have to admit it's a little lonely on the ninth 

floor, just the two of us, but hopefully we'll have some 

additions on the ninth floor soon. We'll see. It's good to 

see some old friends around the table and to meet some new 

friends. 

 Obviously, technology is a big issue that impacts 

the industry, and also the regulators of that industry. 

We're always trying to spot trends in the industry. 

Technology on its own has been a major impact on the 

business over the last 10 to 15 years. We’ve seen 

productivity in our economy double over the last eight 

years, causing standards of living to increase 

exponentially, if those trends continue. 

 That, in combination with the Commodity Futures 

Modernization Act, which opened up competition for our 

industry, has really led to some interesting issues that we 

are now having to look at. Some of them are on the list 
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today. Others, including intellectual property, are things 

that the Commission is going to have to deal with, where 

technology and competition intersect. 

 That's something--I'll plug my own panel at FIA 

Expo--that's something we're going to talk about in Chicago, 

and I look forward to exploring how regulators will take 

more of a role in that issue. 

 As an agency, we're now spending close to 10 

percent of our budget on technology; and that is growing 

every year. These are for reasons that Steve will talk 

about momentarily. We're having better surveillance at less 

of a cost to the industry. We're able to do our job and 

impact you less, which is always a good thing. 

 We're also able to do enforcement issues better. 

We have web-crawling technology that is able to look at 

100,000 websites a month. Using technology, we're able to 

do things better as an agency, and that's good. 

 We just recently launched our e-law initiative. 

This enables our litigation team to now go paperless, 

including from hearing real-time transcripts in courts of 

law. We're trying to catch up to what the legal community 

is doing already and that's definitely a positive trend. 
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 Of course, technology is a double-edge sword. I 

remember five years ago when I was in the Senate, we had a 

hearing on electronic trading and technology. David Battan, 

who was working for Timber Hill--David Downey before him-- 

was talking about some of the problems that could happen 

with electronic trading. 

 I think we as the oversight committee of the CFTC 

were a little starry-eyed about electronic trading, that it 

was the silver bullet. If we can only get there, then all 

our problems would be solved. And obviously we were wrong. 

Electronic trading has helped this industry. It is better 

with audit trails and other advantages it brings. However, 

there are other issues that arise because of electronic 

trading, and we will explore some of those in Steve's 

presentation today. 

 But I just want to conclude that I'm very happy 

that Sharon has taken on a lot of these interesting issues. 

I look forward to all the presentations today, and hopefully 

as an agency we'll learn from your insights. 

 Thank you. 

 ACTING CHAIRMAN BROWN-HRUSKA: Thank you, 

Commissioner Lukken. I think that you raise a lot of 
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important issues that we do want to go forward and look at. 

I know that I ran into Ed Rosen just before this meeting and 

we were talking about of putting our heads together as 

experts and individuals here and thinking about some of 

these IT issues and some of these issues that are created by 

technology and the advancement of different changes in 

trading mechanisms. 

 Well, what I'd really like to do--and I, you know, 

kind of went back and forth on whether I wanted to give a 

personal introduction of all of you. I would say that I'm 

just delighted that you have agreed to participate in this 

Committee. You were hand-picked and we're just so happy 

that each one of you brings something important to the 

table, and we really want to encourage you to raise up your 

expertise and your knowledge. 

 What I've decided to do is have you make a brief 

introduction of yourself and say who you are and who your 

affiliation is. Before we do, I need to remind everyone 

that you need to push the button on your microphone to get 

it to operate. There are microphones in between folks, so 

you might want to pass it down a little bit. But you don't 
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have to get right on top of the microphone for it to pick up 

your voice. 

 And after you've stated your piece, I need to 

remind you to turn off the microphone. If we get too many 

mikes turned on at once, we'll overload the system and 

generate feedback. And while I'm interested in feedback, 

that's not the kind that I want. 

 So let's begin the introductions. I'll lead off--

let's see--let's start right here. 

 Pat. 

 MR. GAMBARO: Pat Gambaro, Executive Vice 

President, New York Board of Trade, Operations. 

 MR. DAVIDSON: John P. Davidson. I'm global head 

of institutional operations for Morgan Stanley. 

 MS. FERBER: Laurie Ferber, Goldman Sachs, 

commodities and economic derivatives. 

 MS. GABLE: Wayne Gable with Koch Industries, head 

of the Washington office, but economist by training. So I'm 

happy to be here. 

 MR. ROSEN: Ed Rosen, Cleary Gotlieb. 

 MR. DURKIN: Bryan Durkin, Executive Vice 

President, COO, Board of Trade. 
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 MR. LEITNER: I'm Tony Leitner. I'm a regulatory 

consultant, after 24 years at Goldman Sachs. 

 MR. BAGAN: I'm Mark Bagan with the Minneapolis 

Grain Exchange, responsible for operations in the regulatory 

systems. 

 MR. OTT: Joe Ott, Vice President of Compliance 

with the Kansas City Board of Trade. I'm actually sitting 

in today for our president, Jeff Borchardt. 

 MR. TELLEFSEN: Hi. Jerry Tellefsen, Tellefsen 

Consulting Group Chairman. 

 MR. McPARTLAND: I'm John McPartland. I'm an 

independent clearing and settlement consultant often 

mistaken as an employee of the Federal Reserve Bank of 

Chicago. 

 [Laughter.] 

 MS. DOWNS: Yvonne Downs, National Futures 

Association. 

 MR. FOYLE: John Foyle, Deputy Chief Executive, 

Euronext.liffe, in London. 

 MR. GAER: Sam Gaer, Chief Information Officer, 

New York Mercantile Exchange. 
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 MR. BATTAN: David Battan, General Counsel, 

Interactive Brokers, Timber Hill Group. 

 MR. MANNION: Marty Mannion, with Citadel, in our 

Execution Services Group, and I'm substituting for Matt 

Andresen. 

 MR. HEINZ: Jim Heinz, Managing Partner of 

Marquette Partners. 

 MR. PAULSON: Brett Paulson, Executive Vice 

President, CIO, at the Clearing Corporation. 

 MR. PIRRONG: Craig Pirrong, Professor of Finance, 

University of Houston, and Director of the Global Energy 

Management Institute. 

 MR. FALVEY: Jim Falvey, General Counsel with 

Eurex US. 

 MR. RAISLER: Ken Raisler, with Sullivan and 

Cromwell. 

 MR. MELAMED: Leo Melamed, sometimes with the 

Chicago Mercantile Exchange. 

 MR. GAINE: Jack Gaine, with Managed Funds 

Association. 

 MR. HERSCH: Ron Hersch, with Bear Stearns. 
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 MR. SERPICO: Don Serpico, Chicago Mercantile 

Exchange, Operations. I'm substituting for Phupinder Gill. 

 MR. BRAVERMAN: Steve Braverman, Deputy Director 

for Market Compliance, CFTC. 

 ACTING CHAIRMAN BROWN-HRUSKA: Thank you very 

much. Thank you. I just wanted to say at some point I know 

that Peter Borish, from OneChicago, will also be joining us. 

 I should say that we will--just to give you the 

lay of the land here, we have an agenda here. You can take 

a look at that in your packet. We also have copies of all 

the slides. Did the FIA slides make it in time? I think 

yes, pushing it to the last minute. 

 But I wanted to ask you, Walt. You've mentioned 

you're on a panel at the FIA Expo. What day is that? Do 

you know? 

 COMMISSIONER LUKKEN: Tuesday. 

 ACTING CHAIRMAN BROWN-HRUSKA: Tuesday, okay. 

 COMMISSIONER LUKKEN: Tuesday at 2:30. 

 ACTING CHAIRMAN BROWN-HRUSKA: All right, just to 

make sure I have my proper flight schedule. I think I'm on 

a panel, too, on Thursday. So, you know, put in a plug for 

John, make it easier for him to sell tickets. 
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 I think that we also have a plan to deliberate for 

a while. Steve Braverman will make his presentation and 

then we'll talk about market disruptions by Pat and Don, and 

then we'll take a coffee break, and we'll finish off with 

John Davidson, who will talk about the disaster recovery 

test. And hopefully we'll be able to wrap it up around 

four, and we'll have an opportunity for a brief reception 

for those participating today here until five. So we'll 

have some refreshments then. 

 So without further ado, I'll hand it over to Steve 

Braverman, and thank you very much. 

 MR. BRAVERMAN: Good afternoon to everyone. I 

guess the first thing I would like to say is I guess it's 

obvious that I'm the staff member at the table. Obviously, 

I forgot to put on my dark suit, but I like to be 

conspicuous. 

 What I'd like to do today is present some of the 

salient findings of a review that the Division of Market 

Oversight conducted to determine the implications of the 

recent dramatic growth in electronic trading in the U.S. for 

the division's own trade practice surveillance program and 

the manner in which that surveillance is conducted. 
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 Among other things, DMO is responsible for 

ensuring that exchanges have effective compliance programs 

for enforcing their rules, including those prohibiting 

certain trading practices, and for monitoring daily trading 

activity in order to identify potential trading violations 

for further investigation. 

 It is within the context of this latter program, 

our own trade practice surveillance program, that our review 

of electronic trading was conducted. So with that brief bit 

of background, I'll begin the presentation. 

 As we all know, there's been a dramatic growth in 

electronic trading in the U.S. particularly over the last 

four to five years. Electronic trading in CFTC-regulated 

markets has grown significantly since 1999. Electronic 

trading as a percent of total volume at U.S. futures 

exchanges was 5 percent in 1999, and it grew to 42 percent 

in 2003. And as we all know, that number has even grown 

thus far in 2004. 

 This was one of the reasons that we felt we had to 

take a fresh look at how we should surveil these markets, 

and if there are any differences in these markets vis-a-vis 

pit trading. 
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 The most dramatic increases, of course, have been 

at the largest U.S. exchanges. The CME, for example, in 

1999 traded only 8 percent of their volume electronically. 

By 2003, it was up to 44 percent. The CBT traded 5 percent 

electronically in 1999, and that grew to 52 percent in 2003. 

Currently, approximately 60 percent of volume at those 

exchanges is now traded electronically. So we've had 

tremendous growth in this area. 

 Another reason that we decided to look at this 

area was because of the recent trend in designations by the 

Commission of all-electronic exchanges. We've designated 

over the last two years the CBOE Futures Exchange, 

HedgeStreet, NQLX, One-Chicago and the U.S. Futures 

Exchange. These exchanges have, and probably will continue 

to contribute to volume, and there will probably be many 

more coming along. 

 Again, the purpose of our review was to determine 

the implications of growth in electronic trading for DMO's 

trade practice surveillance program. We want to know what 

we can learn from exchanges and other regulators that have 

experience with monitoring electronic markets. And, 

foremost, we wanted to know where should we focus our 
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surveillance of electronic markets in order to be most 

effective. 

 In doing so, we interviewed compliance staffs at 

several SROs here that have electronic platforms, including 

the CME, the CBT, NYMEX, and we also interviewed NFA, which 

monitors electronic trading systems on behalf of several 

exchanges. 

 We also went overseas to talk to Eurex and LIFFE 

because, of course, they have been trading electronically 

for a long time. And we met with regulators overseas, 

including BAFIN, in Germany, CONSOB, in Italy, and the FSA 

in the UK, to elicit their insights and perspectives on 

surveillance of electronic markets. As you can see, it was 

not a real unpleasant assignment. 

 We gained a lot of insights from our interviews. 

In particular, we came away with several recommended focuses 

of surveillance for electronic trading, and we also came 

away with some very useful observations regarding other 

aspects of electronic trading which I'll get to in a moment. 

 The four recommended points of surveillance focus 

were the point of order entry, illiquid markets, side-byside trading, and inter-market trading. These were all 
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raised by the interviewees, the exchanges and the 

regulators, as points which they felt should be the focus of 

attention. 

 First, I'll address order entry. With respect to 

order entry, the surveillance focus necessarily shifts from 

order execution by the floor broker in the pit to order 

entry by the terminal operator on an electronic system. The 

focus shifts because the algorithm now controls the 

execution. It's not the broker in the pit. 

 Order entry is the point at which human 

intervention occurs for those orders that aren't entered 

directly by customers into their own front-end systems, and 

this is where abuses can possibly occur. In particular, in 

the electronic environment a terminal operator controls the 

time of entry for orders not submitted by customers directly 

into the trading house by their front-end systems. 

 This presents an opportunity to trade ahead of a 

customer order. And, importantly, we found that there is no 

evidence of the time of receipt for telephone customer 

orders, which is the manner in which most orders are 

communicated when they're not entered directly by a customer 

into the front-end system. And it's important to note that 
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that time of receipt by the firm or the terminal operator is 

really critical to proving an abuse like trading ahead. 

 The second area-- 

 MR. HERSCH: Excuse me one second. 

 MR. BRAVERMAN: Yes. 

 MR. HERSCH: How does that differ from--I'm trying 

to understand the distinction of how it differs from--sorry. 

I just want to understand how that differs from the 

distinction to the way business is handled in the 

traditional manner when a customer calls up on the 

telephone. Why is it different when a customer calls up and 

the terminal operator places the order on a terminal? Are 

you saying that you don't have a time stamp-- 

 MR. BRAVERMAN: As distinguished from the pit. 

 MR. HERSCH: As distinguished from the pit, okay. 

 MR. BRAVERMAN: Yes. If an order goes down to the 

floor, the present requirement is that order be written up 

on an order ticket and time-stamped with the time of 

receipt, so that you have that as a piece of evidence when 

you're trying to prove trading ahead. 

 With respect to orders that are phoned in to a 

firm or a terminal operator, the rules right now--most 
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exchanges require that if an order is immediately 

executable, you don't have to write up an order ticket. If 

it's not immediately executable and you want to hold it, 

then you would have to write up an order ticket and you 

would have a time stamp. But the case is that most orders 

that are received by terminal operators are immediately 

entered into the system. 

 MR. HERSCH: Thank you. 

 MR. BRAVERMAN: Sure. 

 The second area of focus that was recommended by 

the interviewees was illiquid markets, which makes a lot of 

sense--increased likelihood of successful violations such as 

pre-arranged trading, trading against customer orders and 

wash trading. The reason for this: in illiquid markets, 

there's obviously a decreased probability that other orders 

are going to interfere with the illegal activity. So there 

should be a focus on illiquid markets. 

 The third area identified was side-by-side 

trading. Traders now have simultaneous access to open 

outcry and electronic trading in the same markets. This 

offers opportunities for abuses such as front-running an 

open outcry order on an electronic market, or vice versa, 
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and manipulating a price in one market to take advantage in 

the other. 

 Finally, the last area that was brought to our 

attention by the interviewees is inter-market transactions. 

Traders can now access multiple exchanges on a single screen 

simultaneously around the world, as we all know. Intermarket trading is increasing. The speed at which it takes 

places is ever-increasing--inter-market spreads, basis 

trades, over-the-counter versus futures. We have parallel 

products now trading on different exchanges--Treasuries. 

The latest one would be metals. And these offer 

opportunities for trading abuses. 

 One case that was brought to our attention in our 

review, I think, illustrates the importance of these four 

focus points. In this case, a firm receives a large 

customer order to buy CME Eurodollars and sells CBT Fed 

Funds. The firm traded ahead of the sell lag in the pit, 

going short Fed Funds in their house account. The firm then 

entered legs of the customer spread order, buying the 

Eurodollars on GLOBEX and selling Fed Funds on then a/c/e 

system at the CBT. 
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 And the firm took the other side of the sell order 

on a/c/e, effectively offsetting its short position in the 

pit. The result of the transaction was that the firm 

profited by trading ahead of the customer and trading 

against the customer. The customer was injured because it 

received an inferior price on electronic system at the time 

that it could have gotten in the pit, so that, in sum, this 

type of activity involved all four focus points. It 

involved an inter-market transaction. Markets were trading 

side-by-side. It was a relatively illiquid market, and it 

involved trading ahead at the order entry point. 

 In addition to the four focus points, the 

interviewees also pointed out some very useful observations 

regarding other aspects of surveillance of electronic 

markets. These involved the effects of trade anonymity on 

surveillance capabilities, the need for vigilance regarding 

novel violations which may occur in the electronic 

environment and perhaps not in the pit environment, the 

impact of electronic trading on customer abuses. Are there 

fewer customer abuses? 

 First, effects of trader anonymity. Trader 

anonymity may affect trader complaints of possible 
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wrongdoing by other traders. It was observed that fewer 

complaints are being received by exchanges with respect to 

electronic trading, possibly due to the fact that traders 

are not visible to each other. 

 It's also more difficult to identify relationships 

between traders, making it harder to direct data-mining to 

detect correlations among traders because of the 

dispersement of traders. These are both very important 

components to a successful surveillance program. 

 Secondly, we need to remain vigilant with regard 

to novel electronic trading violations. Traders and 

exchanges still face a steep learning curve. As more 

traders become more familiar, new types of violations will 

most likely be attempted. 

 We've heard about some new potential violations. 

I'm sure we've all read about flipping or spoofing several 

months ago which took place overseas on Eurex. And taking 

the improper advantage of an allocation algorithm is 

something that we saw at one of the exchanges that we 

interviewed, and I'd just like to go through those just very 

quickly to give you a sense as to what those involve because 

I think it's important to understand that. 
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 In flipping and spoofing, as I said, it occurred 

on Eurex in early 2004. A trader entered a large size offer 

below the current market, a very large size offer below the 

current market. That offer attracted smaller offers from 

other traders. The trader then canceled his large order, 

reversed to the bid side when the market went lower, and hit 

the offers that he attracted by his initial large offer. 

And he profited as the market went higher and then 

liquidated. Some traders argue that this practice caused a 

disorderly market and should be banned. This is something 

that certainly is unique to electronic trading. 

 In a case described to us which involved really 

taking improper advantage of the allocation algorithm, in 

this case a firm knows that the spreader algorithm uses 

price and quantity priority, but not time priority in its 

matching algorithm. The result of that is that large orders 

at the best price get the larger share of the fills. 

 So what happens is that the firm receives several 

large customer spread orders. The firm entered an unusually 

large proprietary spread trade on the opposite of the market 

before entering the customer order. The intention there was 

to lock out other sellers at the same price because of the 
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algorithm so that the firm could trade against its customer 

order and then covering the remainder of its large sell 

order, which was initially put in so that it could, in 

effect, take the other side of the customer's order. 

 And, thirdly, there were observations, interesting 

observations on the impact of electronic trading on customer 

abuses. All the U.S. SROs that we interviewed stated that 

electronic trading appears to have reduced customer abuses, 

that they were getting fewer hits in their electronic 

surveillance systems. 

 The reasons for this: the anonymous automated 

nature of the order execution process in electronic trading, 

less human intervention, and the comprehensive, unalterable 

electronic audit trail which perhaps is a deterrent to 

trading abuses on electronic platforms. 

 As a result of the review, the Commission, the DMO 

in particular, is going to focus its surveillance on the 

four points identified where electronic trading is most 

vulnerable to trading abuses, ensure that the new CFTC trade 

practice surveillance system which is currently under 

development--we're reengineering and developing hopefully a 

state-of-the-art system that we will use in our own trade 
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practice surveillance, an automated system, and we want to 

make sure that that system has robust capabilities for 

detecting the types of violations that can occur in the 

electronic environment, as well as pit violations. 

 And we want to explore approaches to addressing 

order entry vulnerability and the capturing of the time of 

receipt for telephone orders which I mentioned before with 

respect to trading ahead. 

 One possible approach to that issue is the 

recording, time-indexing and retention of telephone calls in 

which customers place orders. This was something that was 

mentioned and recommended by all the U.S. SROs that we 

talked to. I think it offers substantial benefits, and that 

technology over the years has reduced the burden. 

 The benefits of recording: It would close the gap 

in an otherwise comprehensive electronic audit trail. 

Without an automated record of when a telephone order is 

received, as I said before, the order is vulnerable to 

abuse, particularly trading ahead, before it's entered into 

the system and captured by the audit trail. Time-indexing 

would capture the exact time that the order was received. 

And this, of course, would provide very useful support for 
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effective investigation and prosecution of customer abuses 

of trading ahead, and SRO and the CFTC experience has showed 

that recording evidence has proved highly valuable. 

 It would also reduce the burden of recording. 

Today's digital recording time-index process is less costly 

and onerous than the old analog system of recording. 

Computer storage of recordings is easier, cheaper than 

analog tape storage, and most FCMs already record phone 

calls for dispute resolution purposes. 

 In conclusion, I'd point out that this review is 

necessarily preliminary in nature. As we all know, 

electronic trading is still evolving. Exchanges and traders 

still face a steep learning curve with respect to 

surveilling these markets, and as traders' knowledge 

increases, some will seek new ways to game the system. 

 As a result, we're going to continue our dialogue 

with the SROs regarding new developments in electronic 

trading, so that we will continue to have an aggressive and 

effective trade practice surveillance program here at the 

Commission. 

 That concludes my presentation. I'd be glad to 

answer any questions. 
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 MR. TELLEFSEN: Steve, could you tell us a little 

bit more about how this new surveillance system is going to 

work generally, where the data comes from, what it does and 

how it does it? 

 MR. BRAVERMAN: Right. Well, we are really in the 

very, very early stages of developing it, but we anticipate 

that we will continue to receive trade data from the 

exchanges, as we have been doing for many years with our 

current system. And we receive right now daily trade data, 

time and sales data, and we combine the two into our current 

system and anticipate that we would be doing the same with 

our new system. 

 Our new system is--my understanding is that it's 

going to take a couple of years to develop, but we are going 

to be rolling it out incrementally so that we will be 

getting some use out of that in the near future, hopefully. 

 MR. TELLEFSEN: Thank you. 

 ACTING CHAIRMAN BROWN-HRUSKA: Ken, you and I had 

talked about this some time ago--the question of whether 

there are any kind of factors that we should consider 

especially from a legal perspective of the recording of 
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transactions, of any kind of order discussions between 

customers and the clerks. 

 And I don't know if you've thought about any of 

these issues, but I just thought that you might want to 

share your thoughts. 

 MR. RAISLER: I guess I had one sort of general 

observations in terms of Steve's presentation, and that is 

that a lot of the comments obviously focused on electronic 

trading, which is what this Committee is about, apply 

equally to the existing trading environment. And issues 

about recording certainly would be relevant to that market 

as well. 

 I think this is an area that the Commission has 

been reluctant to go to for a long period of time. And, you 

know, I think the issue of document retention across a lot 

of areas of activity in the marketplace is a very 

considerable expense and burden to doing business in a whole 

variety of regulated and even unregulated, or what people 

think to be unregulated markets. 

 So I think it does require some pretty careful 

examination before going down that road, and also I would be 

concerned to impose requirements that might bias people's 
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decisions as to where they would trade, and whether that's 

an OTC-regulated market or pit versus electronic market, 

because I think these are all material decisions. 

 I don't dispute the value of that information in 

the abstract, but every piece of information that you 

collect does have a cost and I would just want to be mindful 

of that cost in trying to evaluate what the benefits are. 

 MR. BRAVERMAN: Yes, I agree. I think that those 

are, you know, very interesting observations and certainly 

not lost on us here, and we will have to consider very 

carefully your comments. 

 MR. HEINZ: Steve, I have a question, Steve. By 

the way, nice job on this because this touches on a lot of 

things we've witnessed in the markets that we trade. But I 

have one question for you 

 The flipper, who by the way is still alive and 

well--as much as he has hurt and harmed a number of people, 

can you tell me why that activity is illegal? What is it 

that he is doing that is illegal? 

 MR. BRAVERMAN: Well, hopefully I didn't say it 

was illegal. The issue at the time, as I recall, was that 

it was potentially illegal, that there were locals, I 
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believe, in London who were trading Eurex markets who 

noticed this on their screens and complained to the 

authorities. 

 The outcome of--I believe Eurex was investigating 

that circumstance. The outcome of that investigation I'm 

not certain of. To my knowledge, there were no findings of 

illegal activity, but quite frankly I'm not certain if Eurex 

has completed--or if BAFIN is looking into that and has 

completed their inquiry into it. 

 One could imagine a circumstance where if it was 

determined that that type of activity was disruptive to the 

market that one could charge that trader with something 

like, you know, conduct detrimental to the interest of the 

exchange or something like that, not a specific, per se, 

trading violation. But to my knowledge, I'm not aware of 

any charges in that regard. So if I implied it was a 

violation, that was incorrect. 

 MR. DAVIDSON: I'm having a real hard time with 

seeing any violative behavior here whatsoever, and I'm also 

having a hard time seeing the point that someone was harmed. 

Someone lost money. That doesn't necessarily mean that they 

were harmed. Markets go up, markets go down. It's an open, 
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transparent market. A person took risk in putting his order 

in. The people that followed on put their orders in, knew 

their orders can be canceled, and they happened to be a 

little slower on the trigger than this individual and/or 

computer was. 

 I fail to see violative behavior. I fail to see 

the conclusion that the market was disorderly. Disorderly 

is a result; it's not something that necessarily occurs by 

intent. And a certain amount of disorder is necessary in 

markets. 

 I also completely fail to understand the 

conclusion that it's unique to the electronic trading 

environment. Absolutely no reason you couldn't do it in a 

telephone market, or conceivably even in a trading pit. 

 ACTING CHAIRMAN BROWN-HRUSKA: I'll go ahead and 

call on you, David. 

 MR. BATTAN: This is also an issue that's very 

lively on the securities side. 

 ACTING CHAIRMAN BROWN-HRUSKA: I was just going to 

say-- 

 MR. BATTAN: Unfortunately, I'm intimately 

familiar with it because we have a lot of active traders 
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that we euphemistically call active traders who are sort of 

day traders who have figured out that on the options 

markets, the specialists guarantee to fill a certain number 

of contracts. So they put in a one-lot order on one 

exchange and they improve the bid or the offer. Then they 

hit their own bid or offer for a ten-lot on another 

exchange, and the specialist on the first exchange has 

committed himself to honor the prices on the exchanges. 

 So therefore the customer gets a better fill and 

they can repeatedly--especially using the electronic system, 

they can do it repeatedly both going in and coming out and 

make quick profits. People might want to know that we have 

taken the position that--at one point, we took the position 

that it was not market manipulation because the exchanges 

are very aggressively pursuing broker/dealers who have these 

customers. 

 Even if you have no knowledge of what they're 

doing, even if it's done entirely electronically, they have 

been extremely aggressive and have taken enforcement actions 

against firms-- not only against the customers, but against 

the firms. And there's at least one SEC settled case where 

spoofing or small updating was considered to be, you know, 
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10(b)(5) fraud. But it was a settled case. Anyway, it's a 

very tricky issue. 

 ACTING CHAIRMAN BROWN-HRUSKA: I did pick up on 

that. I mean, I remember the stories of stepping in front, 

and whenever you put a large order up that people will step 

in front. And in some sense, it does seem to be--I mean, 

the reason that they would put in those small orders right 

behind that offer is to make money, to begin with. 

 Leo, did you have a comment? 

 MR. MELAMED: Well, I do have a comment, maybe a 

lot of comments, and I mainly want to loan support to the 

comments by John Davidson and Ken Raisler. And I grant you 

that an electronic trade will create opportunities for 

violative abuses. there's no question it'll be an evolving 

learned process by people who want to violate the rules and 

they'll find ways to do so, and that will be a role for the 

CFTC. 

 I also clearly think that your example of running 

ahead of a placed order the way it did is a violation, and 

it's clear, and so forth. But there is this danger that by 

assuming that every tactic by a trader, be it in the pit or 

be it on electronic, is automatically a disruptive or 
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potentially violative action is highly dangerous because the 

ultimate result--and I'm sure Sharon and Walt understand 

this that in the perfect world where there are no violations 

or opportunities to violate anything, there is also no 

market. 

 The example that spoofing--as James Heinz 

indicated, what is wrong with that? When I first learned to 

trade, maybe before some of you, it was at the New York 

Mercantile Exchange that I was trading potatoes. And there 

was a fabulous trader there who was known around the world 

as a hugely successful trader. He was, and he taught me 

once that he attracted a great deal of attention, no matter 

what he was doing. 

 When he walked into the pit, the entire New York 

Mercantile Exchange stopped to look, what is he going to do 

in Maine potatoes. And he took advantage of that. He 

showed me how he walked into the pit and began to buy 

furiously. The pit prices rose dramatically. He had 

sellers everywhere selling to the pit, to every trader that 

was buying who had assumed that this grand trader was 

buying. In fact, he had sold most of his position out 

because everyone around him had orders to sell. 
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 Now, that was a tactic and it was used in the pit. 

It's something like this spoofing or flipping, or whatever 

it is. It's not very much different. I doubt if it's a 

violation of any kind. As John Davidson indicated, it is a 

tactic. But be careful if you go down the road where 

tactics that are clever are considered violative. It's not 

a road a free market wants to go to. 

 MR. ROSEN: To my mind--and I haven't reached a 

conclusion about the conduct and I would wonder--I would 

also want to know is this sort of sub-human reaction time in 

which the offer is placed and retracted? I think what I 

would want to think about is whether you could conclude that 

the individual was manipulating the market by creating a 

misimpression of what the real trading interest was. 

 I think that would be the analysis, and I think on 

the SEC side the 10(b)(5) is also, you know, sort of a 

market manipulation provision. And what I think is a 

potentially distinguishing factor, though, that both John 

and I think--and I think it's also probably true in Leo's 

example, although there are some permutations on it where it 

may not be the case. 
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 This person is potentially at least subjecting his 

order to the market and taking the risk of getting hit. If 

that's true, I think that would affect the analysis. If he 

was sort of doing this electronically where it was, you 

know, put in and then withdrawn in sub-human response time 

and then the other orders were generated because they were 

sort of electronically programmed to happen, you know, I 

think I'd be a little bit less sympathetic to the argument. 

 On the securities law side, you know, obviously, 

if you're buying at the market and at the same time selling, 

so you have no market risk, even through surrogates, and 

your orders are meeting up, that could create a misleading 

impression of trading interest as well. On the other hand, 

if they're not timed to coincide so there's some market risk 

and slippage in the executions of the buys and the sells, 

that would change the analysis. But I do think that would 

probably be the lens through which you could look at 

activity like that. 

 ACTING CHAIRMAN BROWN-HRUSKA: Whether putting the 

position on creates a risk or there is a risk that it won't 

succeed. 
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 MR. ROSEN: Or it will be lifted, in which case 

it's no longer a misimpression of the trading interest. 

 ACTING CHAIRMAN BROWN-HRUSKA: Pat, I know you-- 

 MR. GAMBARO: On the open outcry markets, this 

happens everyday, except that it's surveilled by the floor 

broker and it's an ethical thing. So if they see somebody 

trying to play games, if you will, as opposed to an 

electronic marketplace, there will be things done on the 

floor itself to correct itself. They won't allow this type 

of activity to continue because it touches off stops; it 

does a bunch of things that gets the brokers in dismay with 

their customers. So it's kind of surveilled on the floor, 

as opposed to not being surveilled instantaneously in this 

electronic world. 

 ACTING CHAIRMAN BROWN-HRUSKA: Sam. 

 MR. GAER: More to Pat's point, and also to 

Edward's point, yes, it is surveilled on the floor, but it's 

really surveilled in a free market sense, in that if you're 

going to offer and a market plays down, you are placing 

yourself--or that order for that customer is in the 

marketplace; you are at risk. If somebody takes out that 
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offer and bids the market up on you, you're going to lose 

money. 

 So this is done naturally, and whether it's done 

by a human being putting his head down and offering through 

bids or whether it's done by an algorithm which simulates 

that by basically saying, okay, you know, create a big offer 

because I know that there are participants in the 

marketplace who follow me and then pull that offer and grab 

everybody who follows me, I fail to see the difference, 

except for the fact that the person who is creating the 

strategy is devising a strategy. He's putting himself at 

risk and he's going into the marketplace with it. And I 

think to regulate the creation of strategies, you're 

stepping into an area that we might not want to be in as a 

free market. 

 ACTING CHAIRMAN BROWN-HRUSKA: Tony. 

 MR. LEITNER: These meetings are great, but I 

think what we take away from them often is buzz words. So 

I'm going to give you three to consider as a Commission in 

guiding how you react to a report like this and developments 

in the electronic marketplace, keeping in mind that among 

the evolutions taking place are not only in the marketplace 
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itself and the electronic trading there, but how orders get 

to the market essentially untouched by human hands and 

without for the most part now somebody talking to a 

salesman. 

 The issues with respect to potentially people who 

do talk to a salesman while electronic orders are being 

delivered, you have, I think, quite adequately said. 

 But with regard to this manipulation issue, I 

would give you three buzz words--clarity, consistency and 

responsibility. By clarity, I mean that just as this 

discussion indicates, people's views of what is good or bad 

tend to evolve over time. And what constitutes manipulation 

or bad conduct, while there are some legal definitions of 

intent, capacity, the intent to create a false and 

misleading price--those kinds of things have always been out 

there. Finding it and recognizing it is in the eye of the 

beholder. 

 By consistency, I mean that exchanges set their 

own rules, and they potentially can set different rules 

about access and what is fair, you know, in the marketplace. 

In an electronic marketplace, it's difficult for an order 

entry firm that may be members of those different markets to 
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have tools, electronic tools that allow them to distinguish 

among exchanges with regard to some of the rules the 

exchanges set. Again, we've met that in the options 

markets, in particular, where the CBOE may have a different 

rule for electronic order entry than the AMEX. And as an 

order entry firm, you try to figure out which one is which. 

 So the Commission's role here is potentially to 

police the exchanges and make sure that where there are 

disparities that could be, you know, potentially difficult 

inconsistencies that they be dealt with. 

 And the third buzz word is responsibility, and 

that is, you know, when misconduct is detected, whose 

misconduct is it? Often, you know, in this environment it's 

the customer's misconduct and the exchange doesn't 

necessarily have a hook into the customer. It has a hook 

into its member or the order entry firm. 

 That's an issue that this vicarious liability 

issue where the firm is then held responsible after the fact 

for "knew or should have known" that the customer was 

committing the violation is, again, a standard that often 

bites us after the deed is done and without the ability to 

detect and surveil in advance for what that's going to be. 
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 So those are three buzz words I would leave you. 

 ACTING CHAIRMAN BROWN-HRUSKA: Yes, Ron. 

 MR. HERSCH: First of all, I still don't see, 

Steve--and maybe we could talk about it after--the 

distinction that you tried to point out to me with respect 

to the audit trail and the telephone order versus electronic 

order with respect to time-stamping and things like that. 

We can talk about it later, but I don't see the distinction. 

 But in sort of carrying on that argument for one 

moment, and some of the comments made by my colleagues here, 

the one sort of red flag I would put up is that customers 

and intermediaries are finally beginning to enjoy what I 

call the technology premium that is coming back to us 

because of the change from open outcry to electronic 

trading. 

 And what I hope doesn't happen is that in an 

effort to make sure that the business is surveilled properly 

that we don't end up heaping more extra costs on 

intermediaries, which ultimately get passed on to customers, 

than exists right now, so we end up losing the premium that, 

you know, took us so long to earn. 
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 Secondly, I'm sure that the Commission is working 

on a variety of different areas. I would say if I had a 

list of priorities where I would make my first hit, it goes 

back to what Tony just said. One of the things that 

intermediaries and customers are beginning to suffer from 

and will suffer more from is the inconsistencies that exist 

between the policies on the electronic exchanges. 

 It's very difficult to maneuver through that mine 

field right now. There's different error policies, there's 

different limit policies, different margin policies, 

different order entry policies, different surveillance 

policies. And that's something where it would be good for 

the Commission to take more of a leading role because at the 

end of the day that will protect customers more and it will 

save the customers money. 

 ACTING CHAIRMAN BROWN-HRUSKA: Laurie, do you 

still want to throw in? 

 MS. FERBER: Thanks, Sharon. Yes, I think this is 

a very good study and a very good attempt to get ahead of 

difficult issues. You know, echoing most of the earlier 

points, but tying a few things together, I just look back to 

the beginning and the notation of the dramatic increase in 
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electronic trading, but really just on the largest 

exchanges. And I think that obviously many of the exchanges 

have a tremendous, long way and a difficult way to go yet in 

beginning to break into electronic trading. 

 And I also note what, to me, was a very important 

fact here and one that I don't think there was a lot of 

attention paid to that all of the U.S. SROs that were 

interviewed stated that electronic trading has reduced 

customer abuses. And I tie that together with, I think, 

Ken's very important point that there are significant 

additional costs, and sometimes hidden costs to increased 

regulation, increased requirements, and taping and things 

like that, and those costs can be friction in decisions 

about where people trade or difficult decisions about 

adopting electronic trading and things like that. 

 So I think--and obviously many of us around the 

table are struggling with whether some of these things 

really are violations or whether they're just smart trading 

and our own problems with how to analyze smart trading when 

you take it to an electronic trading environment. 

 So I think this is an important study, but I think 

it's early days, and I would really just echo the caution 
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that I think many of my colleagues here have noted to not go 

too far in either imposing regulation, and to Tony's point 

about clarity, but, you know, clarity should not come at the 

cost of collecting so much information about the trading 

that we scare people away from developing the electronic 

markets. 

 ACTING CHAIRMAN BROWN-HRUSKA: John. 

 MR. FOYLE: Chairman, I'd like to echo Laurie's 

comment just now. We at LIFFE feel that the scope for abuse 

of customers has been significantly reduced by automated 

markets, partly because of the quality of the audit trail, 

which is a disincentive for people who might be minded to do 

it. 

 But I'd like to say I can prove that that's the 

case, and that wouldn't really be true because we at LIFFE 

don't have the same quality of audit trail now with regard 

to the time of order receipt, for example, as we had when we 

ran a floor. For many years, while we still had a floor, 

all phone lines to the trading floor were audio log-tape 

recorded, and with members' consent in the first place. And 

also with their consent, we had access to that record for 

surveillance purposes. 
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 No good browsing; awfully boring, and you've got 

to know what you're looking for and be put on notice by some 

other event, a pattern of trading or by information 

supplied. But if you know what you're looking for and can 

pinpoint when things occurred, that telephone record was 

awfully powerful in providing evidence to the disciplinary 

and investigative process. 

 And we don't have that now. Most large orders 

came through the floor directly, so we did capture the time 

of the order being placed by the customer for the large-size 

business. A lot of other orders came through members' 

offices, and Ron Hersch's point there is a hundred percent 

valid. We didn't have a requirement for audio logging of 

all those in members' offices. 

 Having moved off the floor, we haven't required 

that all our members audio-log every phone line on which 

they get a live order. It would be absurd for one exchange-

-no matter how high a proportion of a broker, FCM's business 

is done on LIFFE, he's dealing on umpteen other markets and 

this is not something which can be tackled by one market as 

a requirement, or even in terms of reviewing the 

thoroughness of a member's procedures because risk 
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management, risk assessment is going to be a major part of 

the approach here, not just looking at individual incidents. 

No one exchange can do that. 

 So one question I'd like to put forward for Steve 

and his team to look at in the future is now that the focus 

needs to be on what happens in members' offices--it won't be 

the guy on the terminal, by the way, who gets a chance to do 

the malpractice, but now that the focus is on FCMs' offices, 

who does that? Do you really look to individual exchanges 

or can it only be done through a collective effort, or does 

the regulator have to take on the work of assessing how 

sound members' procedures are and investigating general 

compliance as opposed to specific incidents? 

 And the second comment I'd like to make is that 

you're going to need an awful big system to handle all the 

data that's going to be thrown at it when you automate your 

review of trading data. You need all the bids and offers, 

of course, as well as the trade data. And we're now seeing 

the development of indicative pricing systems. 

 Not that I think that's an excuse for trying to 

patent them, but where a process just outside the exchange 

trading mechanism where people can offer indicative prices 
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as a first step toward getting business done may become, may 

become, a significant pass-off the way contracts get made in 

certain contracts. And that indicative pricing mechanism 

outside of an exchange will be the area where you've got the 

possibility for abusive behavior through offers or bids 

which can't be hit being put forward into the marketplace to 

mislead other people. 

 ACTING CHAIRMAN BROWN-HRUSKA: I've broken it. 

Okay, now I've fixed it. 

 I wanted to give the market where the flipper 

lived an opportunity to kind of give us some of your 

impressions as to, you know, how we can best deal with this 

kind of tactical activity. 

 MR. FALVEY: Actually, despite appearances to the 

contrary, I actually work for Eurex US and not Eurex. So 

that is not a Eurex US issue. And anticipating that this 

question would possibly come up at this forum, I spoke with 

the folks back in Frankfurt about the matter and they have 

addressed it with the BAFIN and other appropriate regulators 

locally and it has been taken care of. 

 I'm not at liberty to say beyond that what the 

resolution is, but they would be delighted--again, they 
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would be delighted, I'm sure, again the compliance folks 

from Eurex, to come in and brief the staff in a confidential 

manner as to the resolution. 

 But that actually wasn't why I was raising my hand 

a second ago. If I can make a quick comment and then a 

question for Steve, the comment is just echoing what Ken 

said relating to essentially what amounts to electronic 

discovery, phone records and other electronic data. 

 Having previously been a litigator, and thankfully 

no more, I can tell you that while technology has gotten 

better, it is still very painful to sort through lots of 

electronic data. And in some cases, it's much more 

expensive than the traditional paper data to go through 

these days. The systems just aren't quite as perfected as 

we would like and there's still a lot of sorting and manual 

going through the data. So from a firsthand account, I can 

tell you it's very expensive and not a simple process. 

 That said, I understand where you're coming from, 

Steve, and I do think it's important. But again just to 

sort of echo what everyone else has said, it is a balancing 

act that I think you need to take into account. 
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 The question for you I had quickly is on direct 

access from market participants and customers, which seems 

to be a growing trend at a number of the exchanges, and 

whether your study took into account that phenomenon and how 

that will possibly affect some of your surveillance. 

 MR. BRAVERMAN: The short answer is, no, it 

didn't. But, you know, this review is, as I said, 

preliminary in nature, and I think we're going to have to 

delve into that aspect more, you know. 

 We know that many customers now have front-end 

systems that are being offered by the various exchanges, and 

many of those orders go directly in by the customer. There 

are other exchanges where they don't have that access and 

orders are communicated in other ways. So we're going to 

have to continue to look at that aspect and how that impacts 

surveillance because it does present a lot of unique issues 

when you're talking about a customer entering the order 

directly and he becomes part of the audit trail, and what 

information does an exchange or an SRO have access to with 

respect to the audit trail when the order is being put in 

directly. So, yes, there are certainly a lot of issues that 

we're going to have to look into there. 
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 ACTING CHAIRMAN BROWN-HRUSKA: I see a lot of 

hands here. 

 Yvonne. 

 MS. DOWNS: Just very quickly, the question of 

consistency, I think, is so key. Looking at the way trading 

occurs across so many markets and being that I've been at a 

couple of different exchanges, even though you think the 

audit trails may be generally consistent, you do find enough 

anomaly in them that it's very difficult to do surveillance 

equitably across the different markets without having some 

consistency in that. And I'd just encourage some 

consistency across all the different markets on audit trail 

issues. 

 MR. TELLEFSEN: Press the button. I had your 

problem, Sharon. I pressed the button and it didn't go on. 

I'm getting old or something. 

 I agree with John when he talked about the system 

that you guys are building and it's going to take a couple 

of years. Chances are that if it takes that long to build, 

by the time you get it ready, the requirements have changed 

and what you got in is going to be something that's going to 
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be good for two years ago, but not so good for where he is 

then. 

 Number two, an observation is something that I 

have from working in Chicago and New York. I agree with 

Pat. One of the reasons I think that identification of 

surveillance violations have gone down with electronic 

trading is because the pit used to report a lot of these 

things. Surveillance departments on the exchanges in 

Chicago and New York would come and tattle on guys on the 

floor and let them know that this kind of stuff is going on 

because they see it. Hard to see with electronic trading 

systems. 

 And electronic trading systems have been thrust 

upon us. All of a sudden, after so much resistance for so 

many years, all of a sudden it's being embraced and half the 

volume in Chicago is being done electronically. Who would 

have thought that ten years ago? I mean, you'd be thrown 

out of the board room in Chicago if you volunteered that 

that was going to be the case. It wouldn't happen. 

 And just as we used 135(g) as a tool to learn how 

to better control and surveil our marketplaces under open 

outcry, we're going to have to learn how to surveil 
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electronic trading systems with new technological tools and 

with some other kinds of policies and procedures, or it's 

going to potentially run amok. 

 So I think that those are--the kind of study that 

you've done at the Commission, Steve, I think, is very, very 

good. Some of the findings, I thought, were just terrific. 

It's right on, but how do you handle that? 

 Thank you. 

 ACTING CHAIRMAN BROWN-HRUSKA: You know, I just 

wanted to ask you Bryan. You know, Jerry raises a good 

point about developing this surveillance system or this 

data. When I went to your exchange, you showed me your 

system for surveillance and the exception reports, and we 

were salivating. We just thought we were so impressed with 

the mechanisms and the ability to generate exception reports 

and the like. 

 You know, is it feasible for us to pursue this 

path, to develop our own system here at the CFTC, or is 

there any way that we can hook into--I know this question 

has been asked before, but I'm going to ask it again. Is 

there any way for the CFTC to hook into the systems that 
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exist, the SRO systems, to try to keep up with the 

developments and move more quickly? 

 MR. DURKIN: Well, thank you for your compliment, 

by the way. You know, first of all, I don't agree that we 

can't have systems in place and don't have systems in place 

to monitor our markets. We do, and I think that we, a 

number of us, have been ahead of that curve. So I think, 

you know, nobody should be walking out of here thinking we 

don't know how to protect our marketplace as we deal with 

this evolution, because we do. But you've got to be 

balanced in your approach and you have to be realistic in 

your approach. 

 And so I compliment, you know, what I've heard 

here today, Steve, but I also worry very much about what is 

being suggested in terms of the requirements on the 

recordation of the phone lines. And so being the former 

regulator and head of regulation for the exchange, it's a 

little bit of a concern to me in terms of how far afield you 

might want to go with some of those recommendations. 

 The technology is evolving. The system that you 

saw continues to be embellished. We're going into our 

second phase of that system. We're very proud of it, and I 
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do think that, you know, from the Board of Trade's 

perspective, as we've demonstrated before, we're always open 

and happy to share our experiences, our knowledge, what 

we've been able to innovate, how we've learned along the 

way, but do so on a very balanced, pragmatic basis. And so, 

you know, from the Board of Trade's perspective, I do think 

the exchange would be more than happy to work with the CFTC 

in that regard. 

 MR. ROSEN: The one other thing that I would add 

to this mix of balancing costs and benefits is there are 

frequently more than one way to skin a cat, and trading 

ahead is something that can also be gleaned from observing 

patterns of executions where you have, just for an example, 

an FCM on one side of the market that is constantly two 

seconds ahead of and on the opposite side of the market 

from, you know, a customer--or on the same side of the 

market as a customer, rather. You can discern patterns of 

trading ahead and other abuses retrospectively, as well. 

And, you know, that might be a more cost-effective way of 

going about it. 

 ACTING CHAIRMAN BROWN-HRUSKA: The birthday boy, 

Jack Gaine. 
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 MR. GAINE: Thank you. I'll be very brief. 

 Steve, thank you and your staff for a good 

presentation. Your initial statistics on ICC change into 

electronic trading--and I guess I'm a trend follower. 

Hypothetically, if a team is ahead eight-nothing and they 

hang on to win ten-seven, that's a trend, okay; it's a 

favorable trend. 

 Let me ask you what cooperation, if any, what 

information have you gotten from the SEC and the securities 

side on where they're going on electronic trading, because 

apropos of Yvonne's statements about cross-markets and 

things, I think it's important that the government act as a 

whole, particularly the federal financial regulators. 

 Have they come into the process or are they 

involved at all? I mean, many of the issues are similar, 

some are not. Some are relevant and some are not. 

 MR. BRAVERMAN: Yes, Jack. No, in this phase we 

didn't include the SEC and the equity side. We wanted to 

start with the futures side. We recognize that the equity 

side is very active in trading electronically, and has been 

for the last several years. So that's on our agenda and 
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we're certainly going to get information from them to put 

into the mix. 

 MR. GAINE: Thanks. 

 ACTING CHAIRMAN BROWN-HRUSKA: Professor, do you 

have anything to add? 

 MR. PIRRONG: Just one comment going back to the 

spoofing, is you have to be concerned about sort of the 

adverse impacts on incentives of people to supply liquidity 

to the marketplace. That sort of activity is more likely to 

occur when spreads are relatively wide, and if somebody puts 

in a spread that improves the market and then for another 

reason cancels it and they face some risk of being falsely 

accused of some sort of violation, that might temper their 

incentives to improve liquidity. So there can be some sort 

of indirect costs that can be important here as well. 

 ACTING CHAIRMAN BROWN-HRUSKA: Well, on that note 

I think I'll go ahead and shift topics, but I really 

appreciate your remarks, and please feel free to give us 

more feedback as you think on these things. 

 What we are going to turn to now is how exchanges 

deal with disruptions to market operations. Don Serpico 
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from the Chicago Mercantile will start out, and he will 

slide over here and we'll get him set up and get started. 

 I should also add while that is happening that I 

did mention that it is Jack Gaine's birthday. 

 Jack, 62 going on 70, right? 

 MR. GAINE: I can vote in the next election. 

 MR. SERPICO: Thank you, Sharon. For those of you 

don't know me, I was with the exchange for 20 years, left 

for 2 years and returned, very happy to return. Before I 

left, when somebody asked me what I did, I said I have to 

turn the lights on; I'm responsible to turn the lights on 

and make sure that when things break, we fix them. When I 

came back, the lights were on 24 hours a day and we make 

sure that now things are as seamless as can be so that you 

don't know that anything is broke. 

 So that's the lead-in for this topic, a very 

important topic as it relates to how secure we are with our 

operations, and when something does happen, how you can 

react, although we try to make it as seamless as possible. 

 So let me start. Let's see, excuse me. I'd like 

to handle three topics here. First of all, the response to 

the agenda item, but in addition to that, I'd like to get 
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into a little bit of risk mitigation because we're doing 

something in Chicago, inside the exchange and outside the 

exchange, that I think is a little unique, especially as it 

relates to an organization that we belong to that has been 

in existence for a year, and also some communication 

channels. We've got some communication channels that I 

think are really important as it relates to both our 

exchange and our industry. 

 So with that in mind, let me start with the 

environment that can cause a disruption. We're all familiar 

with the typical types of problems you can have with fire, 

flood, power, and unfortunately just recently, terrorism. 

 If you can remember 1992, who would have ever 

thought we'd have a flood that could cripple Chicago? But 

we had one. So from that standpoint, we had an operational 

disruption that was quite a unique and a very severe 

disruption from that standpoint. Now, we worry more about 

the fourth topic, unfortunately. 

 The infrastructure that all of us have put in 

place as a result of the last few years--we never had these 

in the past. Most of us had one operation in one building, 

or in our case two towers with an infrastructure. But just 
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most recently, within the last two, three years, we've all 

had to put capital in place for multiple power feeds, 

generators, working on a third facility in our case. 

 We have the ability to run in multiple sites, and 

have had for over two years now. With that in mind, we're 

building a third site that is out of the loop, but it gives 

us the opportunity to put another production environment in 

that gives us an even more fail-safe environment. So that's 

going on at the exchange. 

 I may go a little bit fast to keep us on schedule. 

If you need to slow me down, just raise your hand. 

 The CME's response as it relates to the direct 

topic in the given areas--the first one is open outcry. A 

number of you had asked, well, gee, it makes a lot of sense 

from an electronic trading standpoint that you could go to 

your backup site, you could make it as seamless as possible 

and you continue with your electronic trading. But the big 

challenge is really open outcry as it relates to 

transitioning futures and options to another medium. 

 So in our case, what we do is we've opted to go to 

electronic trading. Three of four years ago, that was very 

difficult, and with the statistic we saw today, the 2003 
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statistic from the CFTC, you saw at the end of 2003 about 50 

percent was electronic. We've over 60 percent, moving 

towards 65 percent, depending upon what quadrant you're 

talking about. So it's becoming a little easier to take 

this mode. 

 If you had a problem in Chicago on the trading 

floor, a serious problem that required us to evacuate and 

move to the GLOBEX platform, it is made easier because there 

are so many products now that are on GLOBEX, many more 

products, in addition to that for our more complex products. 

 We're developing the trading, if you will, 

strategies that are more in tune with what is done in open 

outcry--the butterflies and the straddles and the strangles 

and the packs and the bundles. So in our Eurodollar 

products, what you put into GLOBEX has to be almost the same 

as open outcry or you have a problem going to GLOBEX. 

 In addition to that, the number of contracts. 

We've got about 60,000 contracts right now. By no means 

would we transfer 60,000 contracts over to GLOBEX, but we 

would certainly take our active contracts, both from an 

options and a futures standpoint. 
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 I can remember in 1987 when we had the crash, the 

CBOE, the OCC, had 30,000 strikes, 30,000 contracts that 

they had in their system. Well, we're up to 60,000 now. I 

would perish to think what they have at the OCC now with all 

of the options that are in place. So with that in mind, you 

have to look at what is practical to put onto open outcry in 

an emergency. So we've got that in place. 

 We've got a hand-held on the trading floor now 

that has allowed people to become far more familiar with 

electronic trading. We call it our Galaxy product. And we 

also have a training program in place through our GLC, our 

GLOBEX Learning Center, which we put in place about a year 

ago that allows us to train people en masse. So we've got 

in this year alone 1,000 people that we've trained that can 

move to electronic training if they needed to. So open 

outcry is doable. We don't have a pit that we've opted to 

go to, but we certainly have this environment that we 

believe will work very nicely. 

 GLOBEX itself is fully recoverable at either site. 

We have that in place now, so from the standpoint of being 

able to process at our main site or backup site, we have 
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done that. The FIA test demonstrated that and you'll hear 

more about that later. 

 From a clearing standpoint, both for us and the 

Board of Trade, we've got the clearing system that runs at 

both sites. And I might add for both clearing and for 

GLOBEX, we've got one that runs at the backup site and one 

that runs in Chicago, and we alternate those. So from the 

standpoint of both testing, clearing runs primarily at the 

main and GLOBEX runs at the backup. So that's in place if 

we need it from an instruction standpoint. 

 As far as our internal processes, now, the 

internal processes that make up the systems, this is where 

things really have to be seamless. If you lose a building, 

everybody is going to know you lose a building and you've 

got to go somewhere else if you have to evacuate. But it's 

these internal processes, and what has really impressed me 

over the last two years is how distributed they have become, 

because just by sheer need, what you've had to do is you 

have had to distribute the workload, whether it be from the 

order entry, what we call our i-link side, our output side, 

our MDAPI, as we call it, and also from the standpoint of 

the trading engine. 
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 You have to have a main process and a backup and 

backup to the backup, and they have to run automatically to 

the other. So from that standpoint, we have a primary to a 

backup. We have tools and systems that help us to do this. 

 And I marvel at the boxes, literally the boxes, we 

call them, the Unix boxes and the Linux boxes. We literally 

have in place hundreds and hundreds of boxes that back each 

other up, so that what used to be--I can tell you honestly, 

from turning the lights on and making sure nothing breaks, 

what used to be a page to me all night where you literally 

had to talk to somebody verbally, you've got a little page 

now that's all talking from an operator that is in inside a 

computer that is telling you that box 486 broke and 487 just 

took over, and that's the end of the problem. 

 So there's a lot of that seamlessness that we've 

had to put in place that you don't see that's very important 

from an exchange standpoint, for two reasons, number one 

because we've got far stiffer competition. And, number two, 

in our case we're now public, so you've got the investors 

and the analysts looking at you very closely. So you have 

to have it as seamless as possible, not that we didn't in 
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the past, but it's far more complex and you have to have 

these infrastructures in place. 

 Now, the clearing firms, and I might add that this 

was a big part of our FIA test. We look for three means for 

the clearing firms to ensure that they can back themselves 

up, the first of which is a backup facility. And I'm really 

happy and proud to report that for the industry, there were 

a number of you that had your backups in place so that you 

could talk to our backups this last Saturday. 

 To have you talk from your main system to our main 

system really was not our objective. So from that 

standpoint, we accomplished what we wanted to accomplish. 

And what you've done is you've put in place, a lot of you, 

the backup facilities. But if you don't have one, the 

second alternative comes into play, which is a third-party 

disaster recovery outsourcing, a Sun Guard, if you will, or 

an organization like that that can run it for you. 

 And your third alternative is a give-up 

arrangement. If all else fails, you can have a give-up 

arrangement with another firm where you can at least keep 

your business in place and not have to shut your doors. And 

I'm sure a number of you have those. So we make sure that 
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all three of those are in place. That's part of what we do 

both from an FIA standpoint and an exchange standpoint. 

 Now, the worst case which is highlighted on the 

top of this page is what happens if you lose it all, if you 

lose your main processing center and you lose your backup 

processing center. Now, a lot of that has to do with a hell 

of a lot more than a guy named Murphy. There's really cases 

where that could happen, but you have to design for it. 

 So in our case, we've had conversations with Bryan 

where we have a reciprocal arrangement we're putting 

together with the CBOT where literally we can exchange each 

other's facilities to help us to get through the day if it's 

a narrow problem. By narrow, I mean just one exchange. 

Although it's a serious problem, it's not the whole Chicago 

land area. 

 If it goes beyond that, like it did in New York, 

what you literally have to do is you have to look at 

alternatives outside the city. And in the case of what 

happened in New York, unfortunately, there were some 

exchanges that actually came to Chicago looking for some 

possibility of support in Chicago, if that needed to be put 
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in place. Fortunately, we didn't have to do that as an 

industry, but you have to think about those things. 

 And as an exchange, we have those reciprocal 

agreements in place so that we at least know that whether 

we're competitive enemies on the product base, we're not as 

it relates to disasters. We all have to help each other, 

regardless of what the product competition result is. 

 Now, from a staffing standpoint, I keep talking 

about systems and infrastructure, but your staffing is 

equally as important as it relates to outages. And from our 

standpoint, and I think the industry's standpoint, what 

we're modeling is something that we think is a little bit 

unique. Everybody does scheduled evacuation and fire 

drills. I know as a result of how to get out of a building, 

it's critical how to get out of a building. We all learn 

that, and we exercise those on a routine basis with the 

Chicago Fire Department. Those are mandatory for our office 

towers. 

 We have something that, as I said, is a little 

unique. We have what is called a distributive staff exit 

holding process in place. What I mean by that is we used to 

say let's send everybody over to the train station. It's 
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convenient, it's right across the river in Chicago. If you 

can get back into the building within a reasonable period of 

time, you go back in the building from the train station. 

 Well, after what happened in Spain, the last thing 

you want to do is put everybody in a train station. So 

you've got to be a little creative. So what we have is 

every division head at the Chicago Mercantile Exchange has a 

particular location that's not exactly close to the next 

guy's location and they go to these locations. 

 And on our pass that we all use to get into the 

facility, there's a phone number. You call that number and 

there's a division voice mail that keeps you up to date on 

what's going on with the emergency and where you should go 

next. If all fails--and before that, there's a new thing 

that is in place if all fails and you have to go home. 

 There's something that is put in place just this 

year. It's called shelter in place. Shelter in place is 

for the chemical problems where you have an issue where you 

have to keep people in the building. That's something that 

we're working out right now with the federal agencies, the 

state agencies, the city and the fire department as to how 
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to keep people in the building, because there's no such 

thing as mandatory. 

 When you say you have to stay in the building, you 

know certain people will want to get out, and obviously they 

have to take that risk. But that's something that we're 

working on right now and we're making a lot of progress on 

how to make that happen. 

 What we're doing is we're taking our critical 

staff and we're distributing them between Chicago and our 

remote site, meaning that the site that does our GLOBEX 

processing--we're having people work there both from a 

regulatory--and I add regulatory as being critical; we think 

that's very critical because you do have to monitor the 

markets in an emergency. We can't let that down. So from a 

regulatory standpoint, from an operations standpoint, from a 

GLOBEX control center standpoint so you can have a help 

desk, from the standpoint of IT and the clearinghouse, as 

well, all of these groups are working in the backup site at 

all times, so that if you had lost an entire site, that site 

could literally run with the people that you need to make it 

happen. So that's a big part of it. 
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 And then you've got, unfortunately, for some that 

would like to be there, the non-critical staff--you can't 

house everybody there, so you would take your other groups, 

and I won't mention those, but there are other departments 

that are not quite as critical where you have a short-term 

work at home program that we put in place. 

 That can't last too long; it can't be too 

effective for too long. But what we've done is we've also 

looked at staff deployment to an outsourced facility in the 

event that we have an extended outage. So that's something 

that you have to consider as well, and we have. 

 And then, of course, you have your executive 

staff. I can remember during the flood, the Board of Trade 

had to evacuate their building and I think they used the 

CBOE's board room for a while. And we knew how to get a 

hold of that group, and they operated there for a day or two 

or however long that needed to be. 

 But you have to think about those kinds of things. 

They do happen, so we have again a cooperative arrangement 

with the Board of Trade. We have--I won't say where, but a 

hotel south of the Loop that we'll operate out of. And we 

also have that group that can move to our remote site. So 
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your key executives are very important, as well. Obviously, 

they run the company in this kind of a situation, so you get 

them to a safe place where they can function. 

 Now, risk mitigation real quick, coordinated test. 

I won't say much about that, other than that we were very 

pleased, and John is going to report on that. There was a 

full industry test, there was network connectivity. And 

we're also planning--it's called "what if" exercise. It's 

tabletops, in addition to this annual test that we'll have. 

 The Chicago futures industry--this is the one that 

I wanted to tell you about that is brand new for Chicago; I 

want to say a year old. And the rest of the United States 

is looking at this very closely through the Treasury 

Department. This is a very important step that we've taken. 

 We didn't initiate this. It was initiated by a 

few of us, and what it is is it's 16 organizations in the 

Chicago land area that are made up of banks and exchanges 

and other entities that are all part of the financial 

system, if you will, that have formed a group called 

ChicagoFIRST. 

 We hired a person to run this. This person has a 

number of different responsibilities, the biggest of which 
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are just noted right here. We work on ongoing fail-safe and 

reactive coordination with the city of Chicago. This is 

police, fire, transportation and water. 

 We have major telecommunication carriers that 

report in to us--the AT&Ts, the Sprints, the MCIs and the 

other carriers. We have all the major utilities connected 

into this organization, the state police and federal 

agencies, all the way up to Homeland Security. It's a 

regular forum that meets on a religious basis. 

 We did a tabletop exercise back in July, I want to 

say with a hundred people across these organizations. We 

simulated two terrible events through these tabletops and 

went through the whole exercise of how do you recover from 

something like that. And we found some things that we 

really didn't have in place that we need to put in place as 

a result of this very important exercise. 

 The Treasury Department actually paid for it and 

it was a two-day exercise. So that's a real important 

element of what we do, and that as far as the rest of--I 

know that Philadelphia is looking at it. I know the West 

Coast is looking at it. It's an easy organization to form. 

You just have to be religious about it. 
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 The Financial Services Sector Coordinating 

Council. That's a long title. Its abbreviation is FSSCC 

and it's a federal organization that deals with the security 

industry and it has primarily been put in place to do the 

same kinds of things that some of the federal agencies do 

for the futures industry. 

 They are a little surprised that the futures 

industry has not joined this. It's a free organization to 

join. What they focus on is knowledge-sharing, best 

practices in telecommunications, electric power and IT 

problems, whether they be sabotage or what have you. 

 We joined this organization, first of all, because 

it's free. You can always say that there's too much 

information out there, but not in this area. There never 

can be enough information. So we joined with this 

organization, and we would ask that others join it as well. 

I'm not their spokesman, but I just want to say that it was 

easy for the Merc and it is very beneficial for us. It has 

been in place for I don't know how long. They came to visit 

us, and they also deal with the--I want to mention the Fed. 

They have a daily conference call with them. 
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 Now, everybody knows about full business 

continuity plans. I won't talk about these, but there's the 

four Rs. Response is respond to the problem. Resumption is 

how to get your business up in less than three days. 

Recovery is recovering, getting back to your normal 

operation to some extent, and restoration is all the way 

back. 

 The title of my report, "Business Continuity 

Planning"--every exchange is treating this seriously. We 

all have departments to deal with this and that's a big part 

of making sure that the industry can be protected when we do 

have a problem. 

 Communication channels, the emergency joint 

operation. There are just two more topics here. One has to 

do with an organization called the JOC, which is a Chicago 

organization. It is literally a room full of people, the 

ones that I mentioned, all of the utilities, all of the 

telecommunication companies. When there is a problem in 

Chicago, there will be one representative from every single 

organization, all the way up to the federal government and 

Homeland Security, sitting in one room. And their 
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particular job is to assess the problem and give direction 

and literally talk about how to solve the problem. 

 Our responsibility is to be part of that process. 

We're not allowed in the room, because you can't have too 

many people in a room like this. It is the pulse of how to 

respond to a problem, but the important thing is the 

ChicagoFIRST representative is in there. We have our 

representative in there who gives us all the updates that we 

need if we have a chemical problem, if we have a system 

problem of some type that affects multiple exchanges or the 

banking industry or what have you. 

 So with that in mind, we learn about the exit 

strategies if you have to get out of the city, the shelter 

in place program specific to the problem related to what 

kind of chemical spill is it and do you have to close your 

intake valves and things like that for your building; lots 

of issues they deal with. 

 And the financial services industry's part of that 

is what are we doing. In other words, are we taking the 

step to close our exchange? They want to know that. They 

want to know are you evacuating, are you letting your people 
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go home. In some cases, they will tell us that we should 

let our people go home and give us the exit strategy. 

 So I really would like to suggest again as a--and 

this is what I want to be a spokesman for--this is very 

important in the city of Chicago. It has been in place and 

it works. It's a very, very good process. It's a place you 

know you can get to if you have a problem. 

 Major cooperative efforts with the city of 

Chicago, state of Illinois and federal agencies. We have 

surveillance of our financial district, including the CME, 

LaSalle Street, Wacker and other critical areas. We have 

real-time monitoring. We have surveillance cameras that are 

tied into us from the city standpoint, and we have alternate 

communications channels beyond the JOC. 

 One of the things we learned in our sit-down in 

July when we had these hundred people was we lost 

communication. Somebody hit your communication hub. So 

what do you have to do? We have to look at satellite 

phones. You have to look at--the worst case is pony 

express; you have somebody run it to wherever they got to 

run it. 
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 We have in Chicago an alarm that goes off every 

Tuesday at 10:30 in the morning. Since I was born, they've 

had this alarm. One time, it went off and it made me feel 

good. It was when the White Sox went to the World Series in 

1959. It's the last time I ever got to enjoy something 

related to baseball. But the bottom line is that alarm went 

off in 1959. The city caught a lot of heat because they 

turned the alarm on when the White Sox went to the World 

Series, but a lot of us felt good. We can use that alarm 

literally as a way to signal each other. So there's ways 

you can deal with communication. We're looking at all of 

them. 

 So this is where we're moving, and we're trying to 

make the industry safer. We've got the fail-safes in place. 

I would say the one that's the most critical is if we lose 

everything. If we lose everything, then we all have to bend 

over and you know what, or do whatever we got to do to 

recover. 

 So that's our system. 

 ACTING CHAIRMAN BROWN-HRUSKA: Well, thank you so 

much. Thank you so much for going so quickly, too. You 

covered a boatload of information and we do very much 
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appreciate it. Again, it gives us great comfort to know 

that we're looking ahead and we're keeping these important 

markets alive and working. 

 I'm happy to introduce Pat Gambaro, whom many of 

you all know, at the New York Board of Trade. He was most 

responsible for enabling a backup site for the New York 

Board of Trade when it was destroyed during the World Trade 

Center disaster. 

 So, Pat, I think all of us are very grateful to 

you for your hard work and your foresight, and so we're 

delighted to have you come today and talk about your work in 

the future. 

 MR. GAMBARO: Thank you very much. 

 Don, take a breath, guy. 

 [Laughter.] 

 MR. GAMBARO: I'm not going to go into any detail 

close to what Don has done. What I'm going to talk about 

the finite stuff that really happens on the floor. 

 The thing you have to consider first is that you 

have a comprehensive disaster recovery business continuity 

plan that covers all the disruptions. If you have it in 
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writing and everybody is aware of what you're doing, no 

problem. You can cover it. 

 Redundancy is the key. As Don pointed out, if you 

have a pyramiding effect where something is backing up 

something, not just the disaster recovery site, but internal 

to your primary site, your secondary site, you recover. 

And, of course, we did learn from the '93 event. That's why 

we survived the 9/11 event. 

 I'd just make a comment. As we all know, 

electronic trading is quite different than the organized 

chaos that occurs on open outcry trading floors. I put 

together, along with Jerry Tellefsen, a chart depicting what 

we believe are the various outages that could occur on our 

floors. 

 We've addressed both the very minor to the 

catastrophic, all of which do have implications of delay or 

stoppage on the floors within the daily work environment. 

So if you just look at the chart, I'll not go through it 

completely. We have only five minutes. Don took all my 

time. 

 [Laughter.] 
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 ACTING CHAIRMAN BROWN-HRUSKA: No. Take your 

time. 

 MR. GAMBARO: The smallest thing on the floor, a 

time clock, in our open outcry markets can stop us for a 

minute or two to try and get it back. Everybody is tuned 

into the atomic clock. If you can't clock your orders on 

the floor, the CFTC is going to have a major problem. You 

need all the timings, which is approximately five timings on 

every order that comes down between when it gets to the 

floor, it gets to the trading area, it gets back to you, you 

call your customer, and so forth. 

 On our floor, about 90 percent of our business is 

non-electronic. It's done through the phone systems. We do 

have an electronic order routing process and we are looking 

at an ETS environment, but right now, on our floor, the New 

York Board of Trade, 90 percent phones. 

 We pride ourselves on the amount of business that 

we can do utilizing the phones and how error-free it is, and 

how we go home at night with one-tenth of 1 percent in 

outages. However, in order to get there, you have to have 

systems in place and the mind set in place that will keep 

the trading going throughout the day. 
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 So small things like time clocks. You have to 

have a backup plan. Small things like the hand-held units 

that we use to do price reporting; if they fail, what do you 

do? What's the backup to it? If a display goes down in a 

trading pit--I'm trading coffee and I can't display the 

coffee prices in the trading pit, which is internal, not 

external. Do I keep trading? 

 If the markets are not displaying price discovery 

and sent down to the vendors because there's a sub-station 

failure, I mean we have a problem there. Do we keep 

trading, no communications to the outside world? 

 All these type of things have to be handled as 

best you can, such as with the phone system. We have a 

brand new phone system which we just put in based on the 

move that we made to the New York Mercantile Exchange a year 

ago September. It has multiple vendors. As Don pointed 

out. If AT&T fails, we can go to Sprint, we can go to 

Verizon, we can move on to whoever to keep the service 

flowing. 

 The problem that the exchanges have especially on 

the open outcry end of it is that we don't have any control 

on the electricity. I don't have control of what Reuters 
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does as far as their subsets and what not. I have no 

control on anything that's external to my building that is 

not part of my daily environment. 

 So we had a problem on 9/11 because of that. Even 

though we had built for an instantaneous type recovery 

process which, in fact, by eight o'clock that night on 9/11, 

we were up and ready to trade, the outside world couldn't 

communicate to us. All the T1, T3 lines that were under 

Building 7 were down, so nothing could come into us. All 

the vendors were down. We had, naturally, problems with all 

the phones. You couldn't communicate on the phones. So all 

of that will cause us to stop trading, call trading, close. 

 The things that we tried to look at as far as the 

loss of a hand-held, the loss of a display, the loss of an 

internal process, is to make it as redundant and pyramid as 

much as possible. The things that you could lose that would 

not interrupt your trading is our electronic order routing 

process. Even though it's an electronic process, this goes 

down to the floor. The phones are still there, so you can 

still get down to the floor. The loss of the clearing 

system. It's redundant upon redundant, so the only thing 
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that's going to really take us out is really catastrophic 

events. 

 We are in two separate areas; we're about ten 

miles apart. You might think that's not good enough. 

They're on different power grids, different water, different 

everything. It's across the river. It's easy for us to get 

to from the standpoint of continuance of trading. If I had 

my trading floor in Chicago, I'd have to move all my floor 

brokers, approximately 1,000 of them, to Chicago to trade, 

or I would have to invest in an electronic trading system, 

which again we're looking at. 

 There are so many things that happened--loss of 

wall boards, the loss of the displays--that occur everyday 

that is transparent to everyone because of the redundancies. 

All the little butterflies, the hiccups that happen all 

throughout the day just pass right through all our networks 

because that's all redundant. We have one site over it. 

 We have a triangulated effect at the New York 

Board of Trade. When we were at 4 World Trade Center, the 

primary data center was in 4 World Trade and the secondary 

site was in Long Island City, which is that ten-mile 

difference. When we lost 4 World Trade Center, it took out 
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the primary site. So now I only have one site. I have no 

backup. 

 What we've done now since the 9/11 disaster--I've 

put my primary site in a lower Manhattan area and I kept my 

Long Island City site. I'm running both sites. God forbid 

we should lose the building and have to do what you said 

before, that technical term you were using. 

 [Laughter.] 

 MR. GAMBARO: We won't lose the data centers. 

I'll have backup, unless something happens in the entire 

lower Manhattan area, and in that case nobody is going to be 

looking at trading anyway. 

 So we've taken all the possibilities that could 

happen on a small to minor event each day and made it as 

redundant as possible, or put some kind of manual process 

back in. We've tried to make everything as automated as 

possible outside of the open outcry environment to keep us 

going. 

 The problem with it is that something is always 

going to happen where you're going to have to stop trading. 

If I lost all the phone systems, I'd have to stop trading. 

If the phone company couldn't get to me, I could keep 
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switching over to another phone company until I ran out of 

phone companies. 

 If I lose the electric in the building, which 

happened to us a year ago because we had that blackout on 

the East Coast--we were lit. I mean, you wouldn't have 

known anything, except that the rest of the world was black. 

So we had to stop trading anyway. 

 Long Island City, New York Merc Building, total 

redundancy as far as everything is concerned, but the 

problem with it is if somebody can't get to you, you're 

still closed. And then depending upon who is the person who 

can't get to you, how big is that FCM who will close you 

down if the FCM has a problem. 

 The biggest concern we all have, naturally, is the 

terrorism. I can tell you what we've been doing at the New 

York Merc, first, to control the event has been phenomenal, 

and also to control the outside environment, you know, just 

based what you see on TV and you hear about what's going on. 

 We, too, have a major concern with New York City. 

We do meet with the people from the police and the FBI and 

all the other agencies--New York City, the mayor's office 
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and what not, to keep in touch. We don't have it as 

sophisticated as Chicago, which sounds great. 

 I think we ought to look into it, Sam, and see how 

we can develop that kind of an agency. I think that's 

fantastic. 

 But we do keep in touch with the Coast Guard, with 

the Army, everyone. There are helicopters flying outside 

our building all day long. It sounds like you're in an 

airport sometimes. You got sniffing dogs, special force 

tactical staff downstairs walking around with body armor and 

machine guns. It's not a pretty sight, but it's there. 

 In the building, we have all sorts of security. 

It's like going through an airport. You have to go through 

the x-rayed machines, have everything x-rays; the metal 

detectors and what not we have there. We have armed guards 

inside the building to protect the environment. 

 So the people kind of feel secure. I know a lot 

of them are a little hesitant, especially when you hear 

little things like some guy was--I was telling Sharon at 

lunch that we had one gentleman who sat outside our building 

for about three hours, four hours one day and he was taking 

down the schedules of the ferries coming from the other 
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parts of the building. I guess he wasn't smart enough to 

know there's a ferry schedule someplace. 

 [Laughter.] 

 MR. GAMBARO: But this guy is taking down the 

times the ferries are coming in. So the FBI came over and 

arrested him and whatever. So you have those problems. And 

little things like that will scare people, especially after 

what they went through on 9/11. 

 Coming and getting our staffs back from 9/11 at 4 

World Trade Center back two years later wasn't exactly the 

easiest thing to do because of the mental state of some 

people, especially since we are right on the water and we do 

trade crude. So there are situations there. So, mentally, 

we have to be very careful with that type of activity. 

 But as far as the disruptions are concerned, I 

think we got it all covered. You very rarely hear of an 

open outcry exchange going down because a video display 

failed, or a phone system. Occasionally, but not often. 

Everything is basically covered. 

 But the biggest thing you have to do--and Jerry 

told me this one a while ago--is the luck aspect, you know. 

Luck is only as good as the preparation and planning that 
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you put into it, and I've said that time and again at all 

sorts of interviews and what not. It's not luck. You have 

to be prepared, you have to plan; disaster recover planning, 

business continuity planning, cover all the disruptions. 

You're there. Everything looks like it never happened if 

you have the right systems in place and the right people 

monitoring them. 

 That's it. 

 ACTING CHAIRMAN BROWN-HRUSKA: What I think I'll 

do--did you want to throw something in Brett? I'm sorry. 

 MR. PAULSON: Yes. My compliments to your 

presentations, and I echo Don's comments on ChicagoFIRST. 

They're doing great work. 

 There's been a lot of discussion about having a 

site to recover to several hundred miles away, and I was 

wondering if there's any plans in place or you've actually 

recovered to a site of that nature. 

 MR. GAMBARO: No. We have talked about it. We've 

talked about things like Don has talked about, which we've 

talked a few times about sharing a regional type process. 

What we wanted to do is to share our disaster recovery site 
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with, say, Philadelphia, or with Chicago. I know they're a 

lot bigger than we are, but maybe we can help. 

 I was really proud and pleased, and I'll tell you 

that Don was one of the first people who called me on 9/11, 

first, to see if I was okay, and, second, to tell me 

whatever I needed, they were there to help. There was one 

overseas exchange who called and said I'd be glad to list 

your products until you get back on your feet. Well, you 

know what we told him. It was another technical term. 

 [Laughter.] 

 MR. GAMBARO: So we do have things in place where 

we will, in fact, try and work out other activities. The 

biggest key for us with regard to that is the electronic 

trading process, where we can have something in Kansas City 

or in Montreal, or whatever, Bermuda, set up where we can 

trade and the systems will be in. We are looking very 

heavily at that right now, but there is the process in 

place. 

 COMMISSIONER LUKKEN: A lot of what you've talked 

about in your presentations has been about physical 

disruptions. I was wondering, as part of terrorism we hear 
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a lot about cyber attacks and coordinated efforts to attack 

electronic trading sites. 

 Has that been a part of disaster recovery and is 

that something you're proactively looking at? 

 MR. SERPICO: Well, I can tell you from the Merc 

we've got a group that focuses on that type of security and 

they belong to the same kind of agencies that I described 

from the physical standpoint. And one of our key people who 

just came back from one of these conferences, he came back 

with a whole myriad of new processes that groups can follow 

and the support that they can get from the agencies, because 

you do need some help. You need some help so that these 

kinds of things can be monitored more at a very high level. 

 And it's now starting to reach the forefront, 

where it wasn't before, and they're now starting to report 

back to the Merc, our folks, that it's starting to get a lot 

of attention up at the top, where it wasn't before, because 

everything is centered around a bomb or what have you. 

 But I was amazed at what they came back with. 

They're starting to look at some granularity that really, 

really focuses on how to put these firewalls in place much 

better than they have in the past, and that's real 
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encouraging. I can't say it's going to happen overnight, 

but at least they're focusing on it. 

 MR. GAMBARO: Yes, we're doing the same thing on 

our side. We have a security office who has three employees 

who just work on security, cyber security, to make sure we 

have everything in place for the spam and everything else 

that's going on, to make sure we have enough firewalls up. 

 And, you know, even yourself, when you sit down at 

your PC right now, you get the messages from Joe and Mary 

and Dick and Harry and everybody else. And you don't want 

to open them up because they're all viruses, and there's no 

blocking techniques unless you don't want to get any e-mail. 

So you have a problem. 

 So we are looking at and keeping in touch with--

and certainly with Sam and being in the same building 

together and we share a lot of information. And it's a lot 

of work; it's a lot of apprehensive work because you don't 

want to shut the systems down. But you’ve got to be careful 

where you open the portals. You have to be careful who has 

access to your systems. 

 You have to make sure there's all the blocking 

techniques, all the firewalls, all the encryptions that are 
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all there, without impeding the process of the exchange. So 

it's very difficult, but we keep up on it. You have to. 

 ACTING CHAIRMAN BROWN-HRUSKA: I wonder if we 

might-- 

 MR. HERSCH: I had a question. 

 ACTING CHAIRMAN BROWN-HRUSKA: Okay. Well, we've 

got a lot of questions. I was wondering if we should break 

and come back and pick this up, because the other topic that 

we're going to take up in the next session dove-tails nicely 

with this. 

 Is that okay with you, Ron? 

 MR. HERSCH: Yes. 

 ACTING CHAIRMAN BROWN-HRUSKA: And, Leo, I know 

you have some good points that you want to make. So hold 

those thoughts and we'll come back and we'll grab a cup of 

coffee or something to drink and we'll take a--I guess we're 

scheduled for a 15-minute, but we'll take about a 10-minute 

break and get started again. 

 [Recess.] 

 ACTING CHAIRMAN BROWN-HRUSKA: What I think we'll 

do is go ahead and let John do his presentation and then 
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we'll kind of open it up for questions and comments on this 

and the previous discussion topic. 

 John, if you're ready, take it away. 

 MR. DAVIDSON: Great. Thank you very much, Madam 

Chairman, Commissioner Lukken, ladies and gentlemen. I'd 

like to walk you through a presentation on the industrywide--that is to say the Futures Industry-wide Disaster 

Recovery Test that was executed just this weekend. And I'm 

happy to say it was not a disaster. It was a quite 

successful test and we'll go through a little about how it 

works. 

 The notion of having an industry-wide test started 

at an FIA Information Technology Division meeting in April, 

and from that point on they held a number of meetings with 

exchanges, clearing organizations and firms to sort of set 

the scope, pick a date and establish the various parameters 

for the test. 

 They talked about what the benefits were of 

conducting an industry-wide test--you can really think of 

those benefits as setting a common denominator for 

understanding how prepared the industry is for some 

unfortunate set of events; established a common date for the 
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test; wanted, in particular, to test the firm, the 

individual clearing member-FCM backup sites of the exchanges 

and clearing organizations, and then to make it a realistic 

test; actually, a small number of orders in sort of a frontto-back manner. 

 This actually was the first industry-wide disaster 

recovery test in the United States financial services 

sector. I think we in the futures industry were able to do 

that primarily because of the longstanding good 

relationships between exchanges, clearing organizations and 

FCMs. 

 Of course, a lot of us do individual testing. 

This was the first time that a number of firms had the 

opportunity to test their specific backup sites to the 

backup sites of the exchanges. The FIA committee that was 

responsible for oversight for this initiative held biweekly, and as we got closer to the day weekly tests 

throughout this period of time with all of the involved 

parties, including a number of the vendor providers to the 

industry, both service providers and software providers. 

And then in July, August and one more time in September, 
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there were test briefings for FCM, exchange and clearing 

organization staff held both in Chicago and New York. 

 The specific test was held on this past Saturday, 

October 9th, between the hours of 8:00 and 4:30, although 

not everybody was up and ready to go instantaneously at 

eight. Participation in the test was not mandatory. It's 

an industry initiative. It was done on a voluntary basis, 

but as you'll see, participation was quite widespread. Some 

might argue more widespread than it would have been had it 

been mandatory. 

 [Laughter.] 

 MR. DAVIDSON: Each exchange developed its own 

test script and recruited the member firms that were 

important to it with respect to its own tests. The FIA has 

agreed not to release any firm names, and consistent with 

that agreement I'm not going to talk about any specifics of 

disaster recovery procedures at member firms, exchanges or 

clearing organization, just give you some general 

information. And then we did a number of--particularly 

Marianne Burns and her staff did some post-test interviews 

with firms and a number of surveys to get the sense of how 

things went. 
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 So here's a list of who participated, and we'll 

talk a little bit about what each of these organizations 

did. Obviously, we don't have a hundred-percent universal 

coverage, and one thing to aim for in the future is to 

perhaps increase these participants somewhat. 

 The CBOE futures exchange tested its connectivity 

to CBOEdirect, its trading platform. It had some scripted 

trade entry for the VIX, which is its primary futures 

contract. That information was then transmitted to the 

Clearing Corporation's backup systems and the Clearing 

Corporation produced end-of-day files and transmitted them 

to the backup location of the Options Clearing Corporation, 

which, in fact, is several thousand miles from the primary 

location of the Options Clearing Corporation. 

 The Board of Trade tested connectivity to its 

eCBOT platform. It did not actually test order entry. 

Connectivity was confirmed by your ability to successfully 

log into their backup system. The CME, which provides 

clearing for them, generated a subset of their production 

reports from October 8th. Trade confirmation messages were 

sent from the CME clearing facility and certain reasonably 
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esoteric types of records were also accepted, in addition to 

regular trades. 

 The CME did test connectivity to the GLOBEX 

production trading system through its backup site. They did 

scripted order entry for a host of their important contracts 

across a mix of different products that they transact in. 

Again, they used some distributed technology for entry of 

some of the more esoteric information that's required. They 

put out SPAN files, which obviously member firms would need 

to use if they had to be in production for a full overnight 

batch cycle. And they provided file transfer facilities for 

trade register and other types of files. 

 The Clearing Corporation tested connectivity 

between member firms and its backup clearing system. It did 

not do scripted entry, but it did confirm connectivity to 

its systems through the log-in message. It provided certain 

previous business day clearing reports which are listed 

here, and again some of the more esoteric information in 

this case was not processed by the Clearing Corporation. 

 Eurex US Exchange did also test connectivity to 

their production trading platform, but again not by the 

entry of orders. It then utilized the facilities of the 
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Clearing Corporation for transmitting prior day's orders, 

establishing electronic connectivity to the various backup 

sites in the industry. 

 The New York Board of Trade tested connectivity to 

its backup trading floor, as well as to its backup 

electronic order routing system for getting orders to that 

backup trading floor. They did scripted order entry for 

cotton and sugar futures. They did order entry through 

their backup phone lines, as well as through the members' 

order routing systems. They forwarded phones from their 

primary location to their backup location, entered trades 

through the TIPS system, test trades and the various 

clearing esoteria, and produced a set of end-of-day files 

for member firms to receive. 

 The New York Mercantile Exchange tested 

connectivity to the eACCESS backup trading platform. They 

did scripted trade entry in a number of their major 

contracts, did reporting of fills back to firms and produced 

end-of-day clearing firms and some of the other important 

end-of-day reporting. 

 So that's a sort of a summary on a participant-byparticipant level, 7 exchanges and designated clearing 
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organizations, 80 member firms, in total. You can see the 

breakdown here across the different exchanges or clearing 

organizations, how many of their participants participated. 

And then the far right column is the percentage of their 

average daily trading volume that that number of firms 

represents. 

 That's not to say that we did in the case of the 

CME, for example, 98 percent of a day's volume during the 

test. That's to say that if you took the volume of those 52 

participating firms, you'd have 98 percent of the volume on 

that exchange represented. So when you do that aggregate 

across the market share, 96 percent of the U.S. trading 

volume was represented by the intermediaries participating 

in this particular test. 

 What were the lessons learned? And, obviously, 

this is the preliminary. We're four days after the test and 

at least one late night from a ball game. So there will be 

more lessons to be reviewed as time goes by, and I'm sure 

the IT Division will have a couple of meetings to talk about 

these. 

 In general, the test objectives were met. There 

are always improvements to be made for the next time an 
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exercise is done. We think we've identified a number of 

those. There was strong support within the FIA IT Division 

for this sort of a firm-wide disaster recovery testing. 

 Generally, the feedback from all of the 

participants was that it was a valuable and worthwhile 

exercise and the industry should do more common testing in 

the future. There's a little caveat to those conclusions at 

the end which I'll talk briefly about. 

 There were some testing design issues, as one 

might expect the first time through. Fundamentally, we 

needed more time for testing. We needed more time for 

preparation for testing, probably needed a more rigorous 

rejection rate for people that weren't ready, needed to see 

faster turn-around time on reports coming back, more pretesting and set-up, more support from some of the front-end 

non-clearing-related vendors, more personnel in certain 

instances, and more coordination among the different 

exchange scripts, and a might fewer changes late in the 

process to those scripts. 

 As always, there were some glitches. That's why 

you test. If everything was going to be perfect, there 

would never be any need to do the tests. In different 
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cases, with different combinations of organizations and 

member firms, there were MQ, FTP and RJE. Those are all 

technical terms not quite of the nature previously used-- 

 [Laughter.] 

 MR. DAVIDSON: --for means of electronically 

communicating among the various parties. And those were not 

all properly set up exactly correctly the first time around. 

There were some network router addressing issues. There 

were some invalid IP addresses at various places. There 

were some invalid or outdated passwords at backup 

facilities, and there were a couple of issues where the 

phone center response system was not as optimal as one might 

have liked. 

 In general, talking to the disaster recovery 

professionals in the industry--and this is all work that FIA 

staff has done--they felt that it was valuable in that it 

helped them document more of the business continuity 

procedures that they need to have fully documented and ready 

in the event of a real disaster. 

 It allowed them to connect to the backup sites of 

the exchanges and test that connectivity. It heightened 

their awareness about internal issues and covered in some 
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cases single points of failure and underscored the need for 

cross-training. 

 Now, just to put a slight damper on all of this 

enthusiasm that I've exhibited so far, there is somewhat of 

a minority view with respect to this particular exercise and 

it comes from the very largest participants; that is to say 

the large globally-integrated broker/dealers, of which 

Morgan Stanley is one, but by no means the only one. 

 In the case of a firm that is primarily in the 

futures business that runs their bookkeeping system on a 

vendor package that sits on a single or a couple of servers 

and that's the end of the business, this is a relatively 

straightforward exercise. 

 In the case of a large global broker/dealer that 

has data centers in multiple locations on multiple 

continents around the globe and has, because of the 

proliferation of futures contracts as a liquid and deep 

means of hedging, risk exposure, it's extraordinarily 

difficult to have a single part of your business do a quote, 

unquote, "industry-wide, full front-to-back disaster 

recovery drill" on a single day. 
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 The four Rs that Don talked about--the most 

important of those four Rs, particularly with a drill, is 

getting back to your normal everyday working situation by 

the time the markets open in Asia; actually, by the time the 

markets open in Sydney. 

 And so in the case of the large broker/dealers, 

they tested connectivity from their disaster recovery sites. 

They did not bring their entire systems up in their disaster 

recovery sites and run from front to back. That's just far 

too risky to do for this sort of a test. 

 There is a question about the need for an 

industry-wide test as opposed to a regional test, 

particularly since there weren't any clearing cycles run. 

So you need to have everybody involved if you're actually 

going to match trades and simulate what goes on in the 

everyday running of the environment. 

 Whether you need to have absolutely everybody in 

full backup mode all at the same time--and there's an 

incremental benefit from that as opposed to a large regional 

test--is a little hard to say, I think. 

 One thing that's very important to this group of 

participants is these exchanges and clearing organizations 
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making multiple weekend dates available so that they can 

coordinate both internal and external disaster recovery 

tests. 

 So all of these firms--first of all, the notion of 

disaster recovery sites for firms of this scale really isn't 

the way they run disaster recovery. They have multiple data 

centers. They distribute their data processing load over 

those multiple data centers, and two or more of those data 

centers are capable of running the entire load for the 

entire organization in the event that one or more of those 

constituent data centers goes down. 

 So it's not like they're idle processors waiting 

to be utilized. There is disk-mirroring across the 

different data centers, but there's a huge operation 

involved in going fully to one of your centers away from 

another center that has failed. 

 But notwithstanding that, three or four times a 

year, people do that. They just don't do it all on the same 

day, and also assume simultaneously that all of their 

industry interactions go down. So having some coordinated 

dates, sort of one a month or something like that, would be 

a desirable thing leading up to another test of this type. 
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 The number of staff required if every industry 

which we're in every location decided that it was going to 

do a single industry-wide test would be reasonably costprohibitive. How many industries is a giant broker/dealer 

in? Well, sort of count the number of trade associations by 

location and then multiply by four or five continents and, 

you know, you get a number that's a couple of hundred. 

That's going to use up all the available weekends that don't 

have other conflicts pretty quickly. So we need to do some 

more coordination before we decide we can take this all the 

way to the ultimate level, which is to simulate full frontto-back production. 

 But with that small caveat, I think you can reach 

the following conclusions. We do need to finalize these 

results to make sure we get back to all of the participants 

and understand what they learned and what they thought could 

be done better. 

 We need to get inputs into the future tests, form 

early a disaster recovery test steering committee and 

determine what we're going to do for 2005. Based on the 

selection criteria for the 9th of October, the sort of 

analogous date in 2005 looks like October 15th. So stay 
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tuned for the next iteration of an industry-wide test at 

that time. 

 ACTING CHAIRMAN BROWN-HRUSKA: Thank you, John. 

 Leo, I know you had a question before and I'm 

giving you the floor, giving you the first shot. Your 

remarks? 

 MR. MELAMED: Well, actually not a question, but 

first I want to compliment John and the FIA IT Division for 

spearheading and conducting this industry-wide test. It's a 

first, and obviously we all can be very pleased with the 

results. And it really is a most responsible thing to do 

for our industry and we've done it among ourselves, as it 

were, and that, too, is to be applauded because I think it's 

the finest example of the kind of responsibility that the 

industry feels it has in this area. 

 It's a brand new area. It all came upon us rather 

quickly on 9/11, but since 9/11 I'm very proud of the 

futures industry reactions and what each exchange has done 

and how each exchange has taken these things seriously. And 

as I say, most of it is private sector initiatives. So 

that, too, is very, very encouraging; this one, in 
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particular. So all the plaudits for John and the team of 

people that were involved in this. 

 A corollary to all of that was actually the 

subject I wanted to bring up, and I don't have an answer and 

I don't even know if it belongs with the CFTC, per se. But, 

certainly, this is the kind of forum that perhaps we can 

bring it up and then decide how you might want to go about 

it. 

 And the best way I can explain it is to tell you 

that on 9/11, when that occurred, because of the shock 

nature of the event, we all reacted differently than we 

will, God forbid, it happens, or a similar event happens 

again. That experience has given us so much knowledge and 

the things we've done in between have made us much more 

prepared. 

 But at that point in time, there was an immediate 

conversation by telephone between the New York Stock 

Exchange, in the presence of Dick Grasso, and some of us 

officials both at the Chicago Mercantile Exchange and the 

Chicago Board of Trade who were on that conference call. I 

don't recall whether NYMEX had a representative on that 

call. Probably, it did, but I'm not sure. 
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 And the subject was a request from Dick Grasso 

primarily that the exchanges, the other exchanges not open 

until the New York Stock Exchange is ready to be in business 

again, and he wasn't sure when that would be. We discussed 

it at great length because the ramifications of that 

decision, you can all understand, are enormous. There are 

both pluses and minuses in that decision. It's anything but 

simple. 

 The competitive consideration was actually not 

even undertaken. That was not the consideration that was at 

all involved. What was involved is the consideration of 

positions of customers, how they can react to a closed 

market where they can't do anything, or whether it's better 

to have some markets open so that they can act and do 

something versus a blanket closing which would, in fact, 

assist in many ways some other issues involved. Very 

complex. 

 The ultimate decision at that time, and mainly 

because of the shock, I must say, because all of us were so-

-you know, it never happened, never considered, never 

thought perhaps possible, and here was the request by what 

is viewed as the major market in the United States, 
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certainly, in securities, in the world perhaps, was asking 

that we all hold still, and we all agreed. And you all know 

that ultimately the markets opened sort of together, 

eventually, for better or for worse. 

 That issue is probably a private sector issue. I 

don't know, but I do know it has not been discussed, as far 

as I know, since then in terms of what happens when it 

happens again, if it does. There are, of course, all kinds 

of subsets to that issue. Does the securities market act 

separately to the derivatives/futures markets? Are we all 

in the same boat, so to speak? Would NASDAQ keep going if 

the New York Stock Exchange can't? 

 In many cases, some of these answers are already 

answered. For instance, we have an arrangement--the CME has 

an arrangement with the Board of Trade. Like Don Serpico 

provided, we can exchange our needs and continue going. So 

in some areas, that could be the answer. 

 But what I am asking is if there is a national 

disaster that affects one major market like, say, the New 

York Stock Exchange, or say securities generally, or say 

derivatives generally, is this an issue that shouldn't be 

brought somewhere on the table for discussion? I don't know 
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what the answer is and I don't know that we'll ever come to 

an answer, but discussion is healthy anyway. 

 ACTING CHAIRMAN BROWN-HRUSKA: Thank you. I would 

just say I could give you my impressions based on--and, Sam, 

I'm glad you're raising your hand because when the blackout 

occurred, I know that, you know, we were very involved here 

at the CFTC interacting with the administration, with the 

White House and the Treasury, to make sure that markets were 

able to perform and send that vital price discovery 

information, and that in some sense there was at least my 

sense--again, this is not--this is my sense, and also 

somewhat my opinion, so I'm not speaking on behalf of anyone 

here or elsewhere. 

 But it seemed to me that it's better to have 

markets open and running rather than--to the extent that 

they're linked, I know that there are some concerns there, 

especially with the information flows. But sometimes, where 

some markets are disabled, other markets can pick up the 

slack and continue that important price discovery and that 

important trading activity. 

 Sam, I don't know what your comments were going to 

be, but I know you were involved in that blackout and you 
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all did some good things and found out some weaknesses, as 

well. 

 MR. GAER: Absolutely. First, to address some of 

the comments from Leo, I mean he's, as usual, spot-on. But 

the representative from NYMEX on that phone call was Vinnie 

Viola, if you remember. 

 MR. MELAMED: I do remember. 

 MR. GAER: He is our ex-chairman, as many of you 

know. 

 And most recently, I was at a--as I mentioned to 

you before in passing, I was at a House Financial Services 

hearing where I sat with Bob Ritz, who's the President and 

COO, I think is his title, at the New York Stock Exchange. 

And it was very interesting, in that both the New York Stock 

Exchange and NASDAQ--and I think this actually goes more to 

the competitive nature that was really not at issue last 

time, but I think, you know, now it is. Both NASDAQ and the 

New York Stock Exchange are prepared and have made 

modifications to their systems to list each other's 

products, should another event occur. 

 But I think the most interesting part of what Leo 

just said is, well, how does this whole market start-up get 
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coordinated, because you have CFTC overseeing the 

futures/derivatives side of the marketplace and the SEC 

overseeing the securities end of it? And is there a plan 

for the twain to meet, or is it going to be more kind of at 

a high-level decision, you know, policymaking effort? 

 COMMISSIONER LUKKEN: If I could just chime in on 

that, we do have Bob Wasserman sitting behind you. We have 

FBIIC in place, which is the coordinated efforts of all the 

financial regulators to talk during disasters. I think it's 

more on an operational level versus big policy issues that 

you talk about, Leo. 

 But the President's working group, I think, was 

made for just that type of a decision. Even though we 

might have, as Sharon points out rightfully, an obligation 

according to the statute to have price discovery mechanisms 

in place, there may be an overriding public policy reason 

not to open our markets. And I think it would have to be a 

coordinated effort between the Treasury Department, the 

White House, the Fed, the SEC and the other financial 

services, in close coordination with the industry, about 

what to do in that type of a situation. 
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 You're exactly right. It's unique, but I think 

what 9/11 has taught us is how to keep those lines of 

communication open, and certainly the PWG was meant for that 

type of a situation. 

 ACTING CHAIRMAN BROWN-HRUSKA: Pat. 

 MR. GAMBARO: The problem that you have is some of 

us aren't electronic. The New York Stock Exchange is not 

electronic; from an order routing standpoint, yes, but they 

don't have an electronic ETS process. 

 MR. GAER: Well, they're actually moving in that 

direction. 

 MR. GAMBARO: Well, I know they're moving there, 

but they're not there. So I don't know how they can swap 

with NASDAQ. 

 But the other problem that remains is you have to 

understand what the situation is. I mean, 9/11 was unique, 

and where are the phones, where is the electric, what about 

the staffs? I mean, who is what? 

 It's very easy to move a product to another 

market, but then you have the opinions of the FCM community, 

the brokerage concerns, as far as where you're going to 

trade that. Are they hooked up? Are they ready to go? 
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There are so many relationships that really have to be 

solidified in order to do the whole process as far as, okay, 

if "x" happens, we all shut down for a day and then we 

reopen. 

 It's not that simple. I mean, it wasn't that 

simple on 9/11. I don't believe any situation is going to 

be that simple. You have to look at the situation, you have 

to assess it, you have to see what's right. Certainly, all 

markets should be open as quickly as possible. Maybe we 

delayed too many days. Instead of opening up on Monday, 

maybe we should have opened up on Friday. 

 I know you guys were ready to go at the Merc and 

you traded, didn't you, on Thursday and Friday? 

 MR. GAER: Yes, we actually opened up on the 14th. 

 MR. GAMBARO: So that was terrific, and I think 

that if we had a market such as an ETS process, I think we 

would have opened as well. But it's not as simple to say 

it's this, that or this; you know, here's the potpourri, 

this is the menu, select one and this is what we're doing. 

You can't do it that way. It requires the phone calls, it 

requires the public, it requires the CFTC and the government 

to know what's going on. 
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 I mean, you can certainly address it. I think 

Leo's point is very well taken. Let's address it and get a 

best practices document out, like we spent two-and-a-half 

years doing in ETS for the NFA. And nothing can be as 

simple as what happened on 9/11, or God forbid, something 

worse than that. 

 ACTING CHAIRMAN BROWN-HRUSKA: Wayne Gable, I know 

you're with Koch Industries. What's your view from an end 

user perspective? I mean, I know that, you know, you--when 

trading shut down, how does that affect your perspective and 

how you go forward? 

 MR. GABLE: Boy, I mean I don't have detailed 

knowledge of what we did on 9/11. In fact, Ken, you may 

know more. You've, I know, worked with our guys more than I 

have, so that's probably one I would throw to Ken. 

 MR. RAISLER: I mean, I think the bias of most end 

users, and Koch would be no exception, is along the lines of 

what you said, Sharon, which is keep markets open. I think 

that opportunities for liquidity at times of stress are even 

greater than they are in normal times. 

 But I think the situation at, you know, 9/11 

obviously--you know, we've gone over this before, but 
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obviously from the perspective of companies like Koch that 

trade the physical markets, the work of NYBOT and NYMEX in 

getting their market back up and going was obviously very 

critical and deserving of broad-based applause and credit. 

 So I think that obviously we would expect that, 

you know, if something like this were to happen again, we'd 

be even more able to move more quickly, although certainly 

even a completely unexpected even was responded to in a very 

efficient way. So I think broad praise is appropriate. 

 MR. DAVIDSON: You know, at the risk of sounding a 

little like Senator Kerry, this is an appropriate topic for 

a multilateral conference. No matter how good you are at 

making decisions on the fly, you need to have considered all 

the different ramifications in advance and thought them out. 

 It doesn't have to be the sort of catastrophic 

national tragedy that 9/11 was, which might lead you to a 

different set of conclusions. It can be a lot of snow, 

right. So if you accept this notion that New York is the 

center of a financial universe, should a huge snow storm 

that shuts down New York impact the operation of the 

financial markets? 
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 Well, those people that have chosen to operate 

their markets in such a way that people have to ride their 

sleds into the exchange hall in order to transact have made 

a set of choices which I don't think necessarily should set 

public policy all by themselves. 

 What are the connections? If you say, well, if 

the stock exchange is closed, you should reasonably stop 

trading the options that are related to those stocks that 

are closed, that's one level of connectivity. What does 

that say for indexed futures? What does that say for 

interest rate products? I don't think those necessarily 

have to be linked, but until you go through those in a 

couple of scenarios in an organized give-and-take fashion, 

you're not really going to have the right mix of information 

to make that decision when the chips are down. 

 MR. HERSCH: If that's an endorsement, I want 

equal time, by the way. 

 MR. DAVIDSON: Of course, it's an endorsement. 

 MR. HERSCH: That's okay. 

 ACTING CHAIRMAN BROWN-HRUSKA: Leo. 

 MR. MELAMED: I just want to kind of add this to 

my statement, in that I didn't expect that discussion to 
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lead to any kind of answer now. I really believe, though, 

what John Davidson said. You can't just leave this to sort 

of react on the fly. I do think it can't be scripted. It 

probably will always have some different consequence, will 

create a different decision at the time. 

 But if you don't talk it out, if the community 

doesn't have an opportunity to explain itself so that 

everybody hears the various considerations, then it can lead 

to confusion. I, too, am very much in the camp as Sharon 

would be that as soon as possible, open the markets. 

 I was part of a conversation in--it was October 

20th, 1987, with the White House on that very subject. 

There were people in the White House who wanted to close. I 

won't name those names. And there were those of us who 

didn't want to and we won out. But there are considerations 

of this kind that should be discussed and it should be a 

forum for it. 

 That's all I wanted to bring it up that it's 

something that deserves attention, and it's a global issue, 

too. Mind you, there are considerations that are 

competitive and we do compete globally, so that if a 

disaster were to happen, God forbid, in London and shut 
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London down, does that mean that we in Chicago would also 

shut down or not? And these are issues we ought to discuss. 

That's all I'm saying. 

 ACTING CHAIRMAN BROWN-HRUSKA: I agree. I mean, 

that's why we're having this meeting. So I would second 

that. I think it's very important, and I don't think we 

need John Kerry to give us guidance on how we conduct our 

conferences. 

 So, Patrick, did you have something you wanted to 

say? 

 MR. GAMBARO: Yes. I know how difficult it was to 

get the testing done, and John did a great job presenting 

the findings. And Leo is right and we should be looking 

into a discussion of this type, a full conference, to 

understand what the problematic conditions are and let 

everybody have their say, the banking community included. 

 But there were a lot of people--and this was a 

major, major effort that took a long time to put together 

across basically the entire U.S., but mainly through Chicago 

and New York. And there were a few people that I'd like to 

personally thank who were involved and who manned it. 
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 From the CFTC was Bob Wasserman, who was there 

giving me hell all the time. 

 ACTING CHAIRMAN BROWN-HRUSKA: Take a bow, Bob. 

 MR. GAMBARO: And he did a great job helping us 

out. Marianne Burns was extremely instrumental in getting 

this done. John Rapper, of TCG, Tellefsen Consulting, was 

our outside consultant who coordinated, did the minutes. He 

did a fantastic job. 

 The FIA IT Division, headed by my own Steve Bass, 

did one heck of a job coordinating it through--the FCMs, the 

clearinghouses, the exchanges all were very cooperative. 

There wasn't a person who said that they wouldn't help, they 

wouldn't want to get involved. 

 And John's point is well taken. It should be done 

more often. I think a year from now is too long. God knows 

what's going to happen tomorrow. But we should be looking 

at more testing, more interaction, which will answer maybe 

some of the questions that Leo might have through this whole 

process. But it was a great, cooperative effort from the 

Board of Trade and certainly from the New York Merc. I 

think I can speak for Sam that we thank you very much for 

helping us and we want to continue. 
MILLER REPORTING CO., INC. 

735 8th STREET, S.E. 

WASHINGTON, D.C. 20003-2802 

(202) 546-6666 

122

 ACTING CHAIRMAN BROWN-HRUSKA: Well, we're quickly 

running out of time. I want to thank everyone so much for 

participating. I think we've all learned a lot, and I think 

we've also discovered some new topics that we want to take 

up in the future, whether it be in a multilateral conference 

or through this very type of forum in the advisory committee 

structure. I think it's a really excellent structure for us 

to get feedback and to deliberate and think about what the 

issues are. 

 We have a brief reception and we invite you to 

participate. Again, thank you very much for coming. 

 [Whereupon, at 4:11 p.m., the meeting of the 

Advisory Committee was concluded.]