[Federal Register: July 14, 1997 (Volume 62, Number 134)] [Notices] [Page 37563-37566] From the Federal Register Online via GPO Access [wais.access.gpo.gov] [DOCID:fr14jy97-36] ======================================================================= ----------------------------------------------------------------------- COMMODITY FUTURES TRADING COMMISSION Coffee, Sugar & Cocoa Exchange, Inc. Petition for Exemption From the Dual Trading Prohibition in Affected Contract Markets AGENCY: Commodity Futures Trading Commission. ACTION: Order. ----------------------------------------------------------------------- SUMMARY: The Commodity Futures Trading Commission (``Commission'') is granting the petition of the Coffee, Sugar & Cocoa Exchange, Inc. (``CSCE'' or ``Exchange'') for exemption from the prohibition against dual trading in its Sugar #11 futures contracts. DATES: This Order is effective July 8, 1997. FOR FURTHER INFORMATION CONTACT: Duane C. Andresen, Special Counsel, Division of Trading and Markets, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st St., N.W., Washington, DC 20581; telephone (202) 418-5490. SUPPLEMENTARY INFORMATION: On October 19, 1993, the Coffee, Sugar & Cocoa Exchange, Inc., (``CSCE'' or ``Exchange'') submitted a Petition for Exemption from the Dual Trading Prohibition for its Sugar #11 and Coffee ``C'' futures contracts. Subsequently, the Exchange submitted an amended petition on March 21, 1997.<SUP>1</SUP> Upon consideration of these petitions and other matters of record, including Exchange submissions and undertakings [[Page 37564]] in response to the November 1994 audit trail tests designed and reviewed by the Commission and conducted by the Exchange, compliance with the order ticket customer identification requirement of Commission Regulation 1.35, dual trading surveillance data required under the Commission's August 12, 1996 Audit Trail Report, and disciplinary and investigatory actions undertaken by the Exchange between September 1995 and December 1996, the Commission hereby finds that CSCE meets the standards for granting a dual trading exemption contained in Section 4j(a) of the Commodity Exchange Act (``Act'') as interpreted in Commission Regulation 155.5. <SUP>2</SUP> --------------------------------------------------------------------------- \1\ In its amended petition, the Exchange petitioned for the dual trading exemption for six contract markets: Coffee ``C'', Sugar #11 and Cocoa futures and futures option contracts. This Order is applicable to the Sugar #11 futures contract market, which currently is the only affected contract market at the Exchange. \2\ The record consists of the CSCE's petition and amendment thereto and supporting and supplemental documents, the November 1994 audit trail accuracy and sequencing tests conducted by the Exchange that were designed and reviewed by the Commission, dual trading surveillance, windows data and customer identification information, and documents submitted by the Exchange in support of a rule enforcement review of the Exchange presented to the Commission on September 30, 1996. --------------------------------------------------------------------------- Subject to CSCE's continuing ability to demonstrate that it meets applicable requirements, in particular, appropriately investigating potential trading to disadvantage a customer order and passing a Commission re-test of the performance of the Exchange's audit trail system in January 1998, <SUP>3</SUP> the Commission specifically finds that CSCE maintains a trade monitoring system which is capable of detecting and deterring, and is used on a regular basis to detect and to deter, all types of violations attributable to dual trading and, to the full extent feasible, all other violations involving the making of trades and execution of customer orders, as required by Section 5a(b) and Commission Regulation 155.5. The Commission further finds that CSCE's trade monitoring system includes audit trail and recordkeeping systems that satisfy the Act and regulations. <SUP>4</SUP> In assessing the Exchange system, the Commission has considered that system as a whole. --------------------------------------------------------------------------- \3\ In this connection, the Commission will review the CSCE's implementation of the upgrade to its electronic Ring Reporter System to include entry of the selling broker's identity to enhance matching of time and sales prints to specific trades. Subsequent to the CSCE committing to undertake this audit trail improvement, it became one of the changes offered by the Exchange in order to be found by the Commission to be within a safe harbor with respect to the enhanced independence and sequencing requirements of Section 5a(b)(3) of the Act, which became effective in October 1995. Among other things, such an upgrade can provide improved calibration of the Exchange's imputed timing system based on independent observations of trades verifying attributed times. At the time that the Commission informed the Exchange that it qualified for a safe harbor, the Exchange had represented that it would implement the upgrade in the second quarter of 1996. The Exchange has represented in connection with updating its petition that it will commence a test pilot in July 1997. \4\ Sections 4j(a)(3) and 5a(b) of the Commodity Exchange Act and Commission Regulations 1.35 and 155.5, 17 CFR Secs. 1.35, 155.5. Section 4j(a)(3) requires the Commission to exempt a contract market from the prohibition against dual trading, either unconditionally or on stated conditions, upon finding that the trade monitoring system in place at the contract market satisfies the requirements of Section 5a(b), governing audit trails and trade monitoring systems, with regard to violations attributable to dual trading at such contract market. Commission Regulation 155.5 requires a contract market to demonstrate that its trade monitoring system is capable of and is used to detect and to deter dual trading abuses and to demonstrate that it meets each element required of the components of such a system. --------------------------------------------------------------------------- With respect to each required component of the trade monitoring system, the Commission finds as follows: 1(a) Physical Observation of Trading Areas CSCE's trade monitoring system satisfies the requirements of Section 5a(b)(1)(A) in that CSCE maintains and executes an adequate program for physical observation of Exchange trading areas and integrates the information obtained from such observation into its compliance programs. The Exchange physically observes trading areas by conducting daily floor surveillance during the open, close, and at random times during each trading day. CSCE also performs floor surveillance when warranted by special market conditions, such as exceptional volatility or contract expirations. The Exchange uses information obtained from such surveillance in evaluating audit trail data and otherwise in executing its compliance programs. (b) Audit Trail System The Exchange's trade monitoring system satisfies the audit trail standards of Section 5a(b)(1) in that it is capable of capturing essential data on the terms, participants and sequence of transactions. The system obtains relevant data on unmatched trades, errors and outtrades as required by Section 5a(b)(1) of the Act. The Commission further finds that CSCE accurately and promptly records the essential data on terms, participants, times (in increments of no more than one minute in length) and sequence through a means that is unalterable, continual, independent, reliable and precise, as required by Section 5a(b)(3) of the Act. Consistent with the guidelines to Regulation 155.5, the Commission finds that CSCE also demonstrated the use of trade timing data in its surveillance systems for dual trading-related and other abuses. (1) One-Minute Execution Time Accuracy and Sequencing CSCE's trade timing system imputes a one-minute execution time for every trade.<SUP>5</SUP> Trade times are imputed based upon time and sequencing data entered by both buyers and sellers for customer and proprietary trades, including trading card and line order entry sequence numbers, certain execution times required to be manually entered, time and sales data and 30-minute bracket codes.<SUP>6</SUP> The manually-recorded time for the first trade on the card provides a starting reference point for each subsequent trade on that card. The ending reference point is derived from the next verified manually- recorded time following the trade, either on the same card or the first time on the next trading card. --------------------------------------------------------------------------- \5\ An imputed timing system does not capture the actual trade execution time but derives a time from other timing and trade data. As the Commission previously has noted with respect to audit trail generally, its tests have focused on assessing the consistency of the underlying trade data with execution times submitted according to Commission Regulation 1.35(g) ``because there is no benchmark for determining actual execution times and sequence.'' Commission Report on Audit Trail Accuracy and Sequencing Tests at 5 (June 1995). \6\ CSCE does not use order ticket timestamp data in the processing logic for imputing times. Instead, the system attempts to obtain and use a time and sales print for all trades, extensive sequencing data (such as line numbers) and the various required manually entered times to impute trade execution times. Order ticket entry and exit times have been verified in the course of tests of the CSCE audit trail as being consistent with imputed times. CSCE's planned enhanced system would add third party confirmation of the selling broker's identity in a majority of cases, thereby further ratifying sequence information. --------------------------------------------------------------------------- The November 1994 audit trail tests designed and reviewed by the Commission and conducted by the Exchange involved a determination of the consistency of imputed trade execution times with all underlying audit trail records and data. Based upon that process, trade timing accuracy and sequencing rates for CSCE's imputed system were computed. The level of consistency and verifiability of imputed times with underlying documentation sorted by the computer algorithm exceeded 90 percent. Additionally, the time imputed by the system was within a window length of two minutes or less for more than 90 percent of the trades deemed accurate.<SUP>7</SUP> More recently, data [[Page 37565]] for April 1997 reflect window lengths of two minutes or less for more than 90 percent of all trades in the affected contract market. Separately, the Exchange provided the Commission with the results of four Audit Trail System reviews conducted during the period of September 1995 through December 1996 demonstrating that more than 90 percent of trade times in three different futures contracts were consistent with time and sales data during this time period.<SUP>8</SUP> --------------------------------------------------------------------------- \7\ To the extent that the time imputed by a computer algorithm is consistent with required trade documentation, time and sequence data and time and sales information for the subject trade and surrounding trades, and the imputed time falls within a two-minute level of precision as measured by the size of the final time window assigned by such algorithm, that imputed time will be considered to be reliable and precise under Commission test procedures. \8\ This is a less stringent measure than the full reconciliation with underlying manual information and records that will be accomplished by Commission staff during the course of the audit trail re-test. --------------------------------------------------------------------------- (2) Unalterable, Continual, Independent, Reliable, and Precise Times The Commission finds that trade records generated by CSCE, including order tickets and trading cards, are recorded in nonerasable ink and that alterations are completely recorded. Trading card collections occur within 15 minutes after each half-hour time bracket, and members must submit trade data by one-half hour after the end of the bracket period in which the trade was executed. Trade data, therefore, are provided periodically to the Exchange at no more than hourly intervals, which is continual. Trade times are independently obtained through a reliable means, to the extent practicable. Specifically, trade time and sequence data, which include separate entries by buying and selling brokers or traders, are entered into an electronic data base which then sorts all relevant data pursuant to a computer algorithm.<SUP>9</SUP> --------------------------------------------------------------------------- \9\ The enhanced Ring Reporter System will further improve the Exchange's level of compliance with the Act's standards of independence, continual provision of timing data and precise sequencing. --------------------------------------------------------------------------- (3) Broker Receipt Time The Commission finds that it is not practicable at this time for CSCE to record the time that each order is received by a floor broker for execution at CSCE. (c) Recordkeeping System CSCE satisfies the requirements of Section 5a(b)(1)(B) by maintaining an adequate recordkeeping system that is capable of capturing essential data on the terms, participants, and sequence of transactions. The Exchange uses such information and information on violations of such requirements on a consistent basis to bring appropriate disciplinary actions. CSCE conducts trading card and order ticket reviews three times a year for a representative sample of customer orders and personal trades and uses information from these reviews to generate investigations. The Commission's review of a sample of order ticket account identifiers demonstrated in excess of 95 percent compliance with the requirement that the account identifier relate back to the ultimate customer account. (d) Surveillance Systems and Disciplinary Actions As required by Sections 5a(b)(1) (C), (D) and (F), in general CSCE uses information generated by its trade monitoring and audit trail systems on a consistent basis to bring appropriate disciplinary action for violations relating to the making of trades and execution of customer orders. In addition, CSCE assesses meaningful penalties against violators and refers appropriate cases to the Commission. On a daily basis, CSCE's different management information system programs analyze trade data to detect possible instances of dual trading-related and other trading abuses. Systems are designed to permit subjection of all relevant trade data to these reviews. The computerized exception reports generated by the Exchange are designed to identify such suspicious trading activity as accommodation trading, including direct and indirect trading against, direct and indirect trading ahead, and improper cross trading.<SUP>10</SUP> Investigators can design customized exception reports to identify certain specific trading activity to isolate suspicious trading patterns, to filter and to sort data within reports and to expand review activities. --------------------------------------------------------------------------- \10\ On a recent date, for example, CSCE's trading ahead reviews, which isolate brokers receiving better prices than customers fairly contemporaneously, identified .493 percent of trades in all futures and futures option contracts for further review. --------------------------------------------------------------------------- During the period of September 1995 through December 1996, the Exchange initiated 181 investigations and/or reviews into all types of possible abuses. Based on examination of its computerized surveillance reports, CSCE initiated 87 dual trading-related investigations during that period, of which seven resulted in referrals to the BCC. With regard to disciplinary actions, CSCE assessed $65,175 in fines and ordered $1,926.40 in restitution in eleven dual trading-related cases involving 14 members. (e) Commitment of Resources The Commission finds that CSCE meets the requirements of Section 5a(b)(1)(E) by committing sufficient resources for its trade monitoring system, including automating elements of such trade surveillance system, to be effective in detecting and deterring violations and by maintaining an adequate staff to investigate and to prosecute disciplinary actions. For fiscal year 1996, CSCE committed 25 personnel to Compliance and Market Surveillance and reported its total self- regulatory costs to be $4,113,400. CSCE reported volume for this period as 11,315,979 contracts and number of trades as 2,084,916. Accordingly, on this date, the Commission hereby grants CSCE's Petition for Exemption from the dual trading prohibition for trading in its Sugar #11 futures contract, subject to the Exchange passing a Commission re-test of its audit trail system. For this exemption to remain in effect, CSCE must demonstrate on a continuing basis that it meets the relevant statutory and regulatory requirements. The Commission will monitor continued compliance through review of specific investigations and through its rule enforcement review program and any other information it may obtain about CSCE's program. It is the Commission's understanding that CSCE intends to complete its upgrade to its Ring Reporter System to include the entry of the selling broker's identity to enhance matching of time and sales prints to specific trades. Although the Commission has found that CSCE can meet the standards of continual provision of data, and independence to the extent practicable, and has found that it is not practicable at this time to capture a broker receipt time, the Commission reserves the ability to reconsider what is practicable as technology for order routing becomes more widely available. The provisions of this Opinion and Order shall be effective on the date on which it is issued and shall remain in effect unless and until it is revoked in accordance with Section 8e(b)(3)(B) of the Commodity Exchange Act, 7 U.S.C. Sec. 12e(b)(3)(B). If other CSCE contracts become affected contracts after the date of this Order, the Commission may expand this Order in response to an updated petition that includes those contracts. It is so Ordered. [[Page 37566]] Dated: July 8, 1997. Jean A. Webb, Secretary to the Commission. [FR Doc. 97-18370 Filed 7-11-97; 8:45 am] BILLING CODE 6351-01-P
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