The Birmingham age-herald., 1908-05-04
LENGTHY REPORT ON
 COTTON EXCHANGES
Herbert Knox Smith, Commissioner of Corporations Makes Report of Investigations of New York and New Orleans Exchanges Showing How Cotton Is Graded and the Effect of Difference In Rules Upon Sales of
 Future Contracts
Future Contracts

New Orleans system is that the diff fernces applying on contract deliveries shall be identical with the actual diff ferenees established in the spot mar ket by the competition of buyers and sellers at the time of delivery. The New Orleans system may be referred to as the "fiuctuating- difference" or the "commeroial- difference" system.
 Difference In Rules.
 Prior to 1888 the New York cotton exchange employed substantially the same system as that now used in New Orleans. The differences applying on contract deliveries were those existing in the spot market at the time of de- livery. In that year, however the rules of the New York cotton exchange were amended so that differences be- tween middling and other grades de- liverab1e on contract should be ar rived at not from the actual selling value of the various grades in the spot market at the time of delivery but should be established or fixed" at stated periods by a committee of the exchange, officially known as the com mittee on the revision of spot quota tions, but commonly spoken of as the revision committee. At first this re-
 
 once month during the active cotton season, or nine times a year. In De- tober, 1897, however, the rules were again amended and meetings of the re- vision committee were limited to two a year, namely, on the second Wednes- day of September and the third Wednesday of November This provis ion Is still in force. The grade diff ferences established by the committee at it's September meeting hold good for settlements of deliveries on future con tract until the November meeting, while those established in November cannot be changed until the following September. This system may be re- ferred to as the fixed difference" or periodic difference" system
 The rules of the New York cotto. exchange provide no standard by which tine revision committee shall act in fixing differences. On account of the narrowness of the New York spot mar ket, the committee cannot revise diff ferences purely on the basis of local transactions. It is not, however, com pelled by any rule to fix them in ae- cordance with the commercial differences prevailing at the time in the leading spot markets. The revision committee IS, of course, supposed to take account of these commercial differences, but it Is bound by no rules whatever.
 Source of Complaint.
 This system of fixed or periodic differ- ences for settlement of deliveries on fu- ture contracts has been the source of great complaint. It is one of the prin- cipal subjects covered by this report
 It is obvious that the differences estab- lished by the New York revision com mittee may and indeed at times must, be out of line with the actual relative values Of the several grades of cotton in spot markets. In the first place, in the ab- sence of any rules to govern the action of the revision committee, it may in the first instance fix differences which do not accord with the actual commercial diff ferences at the time. This it may do either through ignorance of the commer- cial differences or because it does not con- sider the current commercial differences as proper standard, or even with the deliberate intent of making the differ ences erroneous for improper purposes In the second place. even though the diff ferences as originally fixed correspond to commercial differences, they are bound before the date of the next revision to become more or less out of line, because commercial differences fuctuate with changes in the supply and demand for specific grades. During the 10 months from November to the following September while no change can be made in the New York differences, changes in commercial differences in the spot markets are sure to occur and the same is true, to more limited extent, of the period of two months between the September and No- vember meetings. These disparities be- tween the differences established by the New York revision committee and the actual commercial differences are bound to result in injury to certain classes of dealers in future contracts. The injury may arise in either of two ways, which, however, are closely interreated:
 Probable Injuries.
 l. The buyer or less often the seller of a future contract may be injured by be- ing compelled to receive or deliver, re- spectively, certain grades of cotton at prices at variance with their actual mar ket relation to mddling; that is, the buy CT may be obliged to take certain grades above their true relative value, or the seller may be forced to deliver them at less than their true relative value.
 2. Because of the attempt of buyers to avoid this first loss, errors in grade diff ferences tend to depress the price of fu- ture contracts as compared with the spot price Of middling cotton, and this rela- tive depression causes loss to certain op- orators.
 The risk of injury falls chiefly upon the buyer of the contract rather than upon the seller. This is due to the sellers op- ton of selecting what grades he will de- liver. The possible injury to the buyer of future contract by being compelled 10 accept delivery on the basis of false, diff ferences is apparent. For the purpose of simplicity. it may be assumed that an op- orator has bought a future contract as a speculation, expecting to take up the cot ton at the time of maturity and hoping to sell it then in the spot market at an ad- vance on the price he has paid for the future If the contract called for the delivery of middling cotton only, this transaction would involve only a single element of risk, namely, the possibility that middling cotton in the spot mar ket might decline before the contract ma tured so that when the cotton was re- ceved it would have to be sold at loss. Under basis contract however, the sell CT has the option of delivering any one of a large number of grades; the buyer can not specify what grades he will accept But if the differences applying on settle ment of future contracts are Identical with the commercial differences existing in the spot market at the time of set tement, the holder of the future contract is supsantialy as well off as he would be if it called for middling cotton only | If he is compelled to accept some other grade he will get it at price correspond 1 ing to it's true relative value as compared | with middling, and he can sell 1t in the | spot market at the same relative vaiua- | tion, making the same profit or loss on his | entire transaction as he would make | under a specific contract for middling