[Federal Register: November 13, 1997 (Volume 62, Number 219)]
[Notices]
[Page 60860-60865]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13no97-44]
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COMMODITY FUTURES TRADING COMMISSION
Chicago Mercantile Exchange Petition for Exemptions From the Dual
Trading Prohibition Set Forth in Section 4j(a) of the Commodity
Exchange Act and Commission Regulation 155.5
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of intent to condition and proposed order granting
conditional exemptions from the prohibition on dual trading in seven
affected contract markets.
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SUMMARY: For the reasons set forth in the Proposed Order Granting
Conditional Dual Trading Exemptions (``proposed Order''), the Commodity
Futures Trading Commission (``Commission'') intends to grant, subject
to a stated condition, the petition of the Chicago Mercantile Exchange
(``CME'' or ``Exchange'') for exemptions from the dual trading
prohibition in Section 4j(a) of the Commodity Exchange Act (``Act'')
and Commission Regulation 155.5 for its Live Cattle, Deutsche Mark,
Japanese Yen, Swiss Franc and Eurodollar futures contracts and the
option contracts on Eurodollar and S&P 500 futures.<SUP>1</SUP>
Pursuant to the Act and Commission Regulation 155.5(d)(8)(C)(iii), CME
may submit written supplemental data, views or arguments and will have
the opportunity to make an oral presentation to the Commission before
the Commission makes its final determination.
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\1\ The Commission is granting CME an unconditional exemption
from the dual trading prohibition for its S&P 500 futures contract.
An Order granting such exemption is being submitted for publication
together with this Notice.
DATES: If CME intends to make an oral presentation, it must submit its
request in writing no later than ten days after receipt of this
proposed Order. CME must submit any written supplemental data, views or
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arguments within 30 days of receipt of this proposed Order.
ADDRESSES: CME's requests for oral presentation and submission of
written supplements are to be sent to the Office of the Secretariat,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, N.W., Washington, D.C. 20581.
FOR FURTHER INFORMATION CONTACT: Duane C. Andresen, Special Counsel, or
Rachel Fanaroff Berdansky, Special Counsel, Division of Trading and
Markets, Commodity Futures Trading Commission, Three Lafayette Centre,
1155 21st Street, N.W., Washington, D.C. 20581; telephone: (202) 418-
5490.
SUPPLEMENTARY INFORMATION: A floor broker engages in dual trading when
he or she executes a customer's order during the same trading session
in which he or she executes, directly or indirectly, a trade in the
same contract for his or her own account or an account in which he or
she has an interest. Dual trading can afford floor brokers the
opportunity to abuse customer orders if audit trail information and
surveillance are insufficient to permit the detection of such abuses.
Specifically, a dual trading floor broker can directly commit abuses of
customer orders such as trading ahead or against those orders and also
has an informational advantage for his or her personal
trading.<SUP>2</SUP> Section 4j(a) of the Act and Regulation 155.5
prohibit dual trading and establish trade monitoring standards that
must be met in order for contract markets to be exempted from the
prohibition.
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\2\ The Commission has previously discussed in several
instances, including its November 28, 1994 Report to Congress on
Futures Exchange Audit Trails, the possible abuses attendant to dual
trading. See also the Commission's Proposed Regulation Prohibiting
Dual Trading by Floor Brokers, 56 FR 13025 (March 9, 1993).
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The Commission intends to issue the following proposed Order
granting CME conditional dual trading exemptions pursuant to Section
4j(a) of the Act and Commission Regulation 155.5. In accordance with
Regulation 155.5(d)(8), CME may submit to the Commission in writing any
supplemental data, views or arguments within 30 days of receipt of this
Notice and proposed Order. In addition, CME may request, in writing
within ten days of receipt of this Notice and proposed Order, an
opportunity to make an oral presentation to the Commission. If CME
submits a request for an oral presentation, the Exchange will be
notified by the Commission of the date and the terms under which CME
may make such presentation. Public notice of such an oral presentation
also will be provided in accordance with the requirements of the
Government in the Sunshine Act, 5 U.S.C. 552b (Supp. I 1995).
Proposed Order Granting Conditional Dual Trading Exemptions
On October 20, 1993, CME submitted a Petition for Exemption from
the Dual Trading Prohibition contained in Section 4j of the Act and
Commission Regulation 155.5 in CME's Live Cattle, Deutsche Mark,
Japanese Yen, Swiss Franc, British Pound, Eurodollar and S&P 500
futures contracts and the option contracts on the Deutsche Mark,
Eurodollar and S&P 500 futures. The Exchange corrected that petition on
December 1, 1993. Subsequently, the Exchange amended its petition on
January 21, 1994. CME updated its petition on January 21, 1997, with
respect to eight affected contract markets.<SUP>3</SUP> Notice of the
public availability of the CME's updated exemption petition was
published in the Federal Register on February 20, 1997.<SUP>4</SUP>
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\3\ Affected contract market means a contract market with an
average daily volume equal to or in excess of 8,000 contracts for
each of four quarters during the most recent volume year. Commission
Regulation 155.5(a)(9). See Section 4j(a)(4) of the Act. As noted by
the Commission in promulgating Regulation 155.5, a contract market
trading on an exchange floor will be considered separate from a
contract market in the same commodity trading a screen-based trading
system. The Commission further stated that, while not excluding
electronic trading from the dual trading prohibition, the Commission
was retaining the flexibility to consider the matter further. See 58
FR 40335 (July 28, 1993). The Commission is not addressing screen-
based trading in this proposed Order.
Two contract markets included in the original petition, British
Pound futures and options on Deutsche Mark futures, no longer are
affected contract markets as defined in the Act and regulations.
This proposed Order is not applicable to those two contract markets.
As previously noted, this proposed Order also is not applicable to
the S&P 500 futures contract market.
\4\ 62 FR 7755 (February 20, 1997). The Commission did not
address the Exchange's dual trading exemption petition in 1994 in
large part because of the Exchange's prior representation that it
intended to automate the entry of trade execution times by
developing a handheld electronic trading terminal. In June 1994, the
Commission was informed that the proposed handheld terminal would
not be in place by the October 1995 deadline for compliance with the
heightened audit trail standards set forth in Section 5a(b)(3) of
the Act. Because CME had not sufficiently demonstrated that its
existing audit trail system met current and future standards, the
Commission required the Exchange to demonstrate its ability to meet
the audit trail requirements using Commission-designed tests and,
thus, deferred consideration of the Exchange's petition. Subsequent
to evaluating the results of the tests, the Commission offered CME
the opportunity to supplement its petition.
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Upon consideration of CME's petition, as supplemented, and other
data and analysis, including, but not limited to:
Exchange audit trail test results reconciling imputed times to
[[Page 60861]]
underlying trade documentation and verifying data on ``window sizes'';
actions taken in response to the Commission's November 1994 Report to
Congress on Futures Exchange Audit Trails, June 1995 Report on Audit
Trail Accuracy and Sequencing Tests (``Audit Trail Report''), and
August 12, 1996 Report on Audit Trail Status and Re-Test (``Audit Trail
Re-Test Report'');
Commission trade practice investigations and compliance reviews
conducted in conjunction with rule enforcement reviews or other
investigatory or surveillance activities;<SUP>5</SUP>
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\5\ A list of the specific documents considered in connection
with this proposed Order will be made available to the Exchange upon
request. Copies of any documents not originally furnished by CME
also will be made available upon request.
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the Exchange's existing dual trading and top step trading restrictions;
<SUP>6</SUP>
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\6\ Under CME Rule 552, adopted in 1991, dual trading is, with
certain exceptions, prohibited in any contract month which is mature
and liquid, i.e., a contract month by position in relation to the
front month contract at any given point in time that has had during
the prior six calendar months an average daily pit-traded volume of
10,000 or more contracts. In any such contract months, members may
trade only for their personal accounts until they have executed a
customer order and then may no longer execute personal trades in
that contract month during that trading session. Under CME Rule 555,
effective July 1993, a member may not, with certain exceptions,
while standing on the top step, execute a trade or place an order
for his personal account in any contract months subject to the CME
Rule 552 dual trading restriction which are traded in the contract
month where the member stands.
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the Division of Trading and Markets Memorandum dated October 28, 1997;
and upon review of each element of CME's trade monitoring system and of
CME's trade monitoring system as a whole, the Commission finds that the
Exchange's trade monitoring system does not fully satisfy the
requirements of Sections 5a(b) and 4j(a)(3) of the Act and Regulation
155.5 in that the audit trail component is deficient. The Commission
finds that corrective actions are sufficient and appropriate to meet
those standards. In addition, the Commission finds that, based on an
analysis of the composition of trading (by transaction size and volume)
of certain distant contract expirations and option markets, there is a
substantial likelihood that the broad scope of the dual trading
prohibition specified under Section 4j of the Act and Regulation 155.5,
which applies to a contract market as a whole, would harm the public
interest in hedging or price basing in less liquid months of the
affected contract markets. Therefore, the Commission has determined to
grant CME conditional exemptions from the dual trading prohibition of
Section 4j of the Act and Regulation 155.5 in the seven affected
contract markets.
The Commission is granting the Exchange's petition subject to the
Exchange taking the corrective action specified below and implementing
and enforcing the dual trading restriction described in the Appendix to
this proposed Order. The Commission has concluded that the proposed
dual trading restriction, which imposes a prohibition on dual trading
in actively traded months but has no impact on less actively traded
back months, is appropriate as a method to deter dual trading-related
abuses and other customer abuses. The Commission's limited restriction,
as opposed to the statutory dual trading ban, strikes a balance between
the need to preserve liquidity in certain low volume months and the
need to protect customers from the potential abuses that are associated
with dual trading.
The Commission Hereby finds as follows:
Components of Exchange's Trade Monitoring System
Audit Trail System
One-Minute Execution Time Accuracy
The Exchange's audit trail system fails to record ``reliably
accurate'' trade times in increments of no more than one minute in
length as required by Section 5a(b)(2) of the Act, Regulation 1.35(g),
and Appendix A to Regulation 155.5.<SUP>7</SUP> Specifically, the
Exchange has not established for the seven affected contract markets
that 90 percent or more of imputed trade times, as assigned by the
Exchange's trade timing system, are reliable, precise, and verifiable
as demonstrated by being imputed within a timing window of two minutes
or less (``90 percent performance standard''). Thus, an impermissible
amount of trade timing data, an integral part of an exchange's trade
monitoring system, is not reliably accurate in accordance with that
standard and thus negatively impacts the Exchange's surveillance
systems and investigatory and disciplinary action programs.
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\7\ Commission Regulation 1.35(g) requires that ``[a]ctual times
of execution shall be stated in increments of no more than one
minute in length.'' Section 5a(b)(2) of the Act, among other things,
codified that timing requirement by stating that an exchange's audit
trail system shall, ``consistent with Commission regulation,
accurately record the times of trades in increments of no more than
one minute in length.'' Section II of Appendix A to Commission
Regulation 155.5 requires that a contract market, in describing its
audit trail system in a petition for exemption from the dual trading
prohibition, ``[d]emonstrate the highest degree of accuracy
practicable (but in no event less than 90% accuracy) of trade
execution times required under regulation 1.35(g) (within one
minute, plus or minus, of execution) * * * .'' In addition, the
contract market must ``[d]emonstrate the effective integration of
such trade timing data into the contract market's surveillance
system with respect to dual trading-related abuses.'' For contract
markets that impute trade execution times, Appendix A requires that
the contract market provide a description of the trade imputation
algorithm, ``including how and why it reliably establishes the
accuracy of the imputed trade execution times.''
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The Commission has made clear that a reliably accurate imputed
trade execution time only can be demonstrated by a timing window that
narrows the time assigned to the trade to a two-minute period within
which the trade is most likely to have occurred. Even where an exchange
can demonstrate a trade timing window of two minutes or less, it is not
possible to determine where within that window, the trade occurred.
This underscores the critical need for compliance with the 90 percent
performance standard.
CME's Regulatory Trade Timing System (``RTT'') imputes an execution
time for every trade.<SUP>8</SUP> Trade times are imputed based upon
entry and exit timestamps on order tickets; time and sales reports;
times that the trades were submitted for clearing; trading card numbers
and sequence of trades on trading cards; 15-minute bracket codes;
manual execution times for certain types of trades; calculated
differentials for spread trades; identification of spread legs and
types of spread trades; and any available times resulting from
electronic order entry or trading systems. Based on these data, RTT
determines various time spans within which a trade is likely to have
been executed and ultimately assigns an imputed execution time for the
trade.
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\8\ An imputed timing system does not capture the actual trade
execution time but derives a time from other timing and trade data.
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The audit trail tests designed and reviewed by the Commission and
conducted by the Exchange in response to a November 23, 1994 Commission
letter 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 CME's
imputed system were computed.<SUP>9</SUP> In reviewing
[[Page 60862]]
the results of the test designed to evaluate trade timing accuracy,
Commission staff determined that, although 90.4 percent of CME's trade
times satisfied the standard for consistency with the underlying data,
only 72 percent of those trade times had timing windows of two minutes
or less and thus could be verified.<SUP>10</SUP> In March 1996, the
Commission conducted a re-test of CME's audit trail system. Although
94.2 percent of CME's trades times satisfied the standard for
consistency with the underlying data, only 79.5 percent of those trade
times had timing windows of two minutes or less and thus could be
verified.
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\9\ To the extent that the time imputed by a computer algorithm
was consistent with required trade documentation, time and sequence
data and time and sales information for the subject trade and
surrounding trades, that time was deemed accurate. If that imputed
time fell within a two-minute level of precision as measured by the
size of the final time window determined by such algorithm, that
imputed time was considered to be verifiable, reliable and precise.
Thus, the Commission stated in its Audit Trail Report, ``[a]lthough
90 percent of CME trade times satisfied the standards [of
consistency with underlying data] for Test I, available data do not
permit sufficiently precise verification of the accuracy of all of
these trade times.'' Audit Trail Report at 11.
Under the 90 percent performance standard, only trade times
assigned by the Exchange's imputed timing system within timing
windows of two minutes or less are reliably accurate. As noted
above, Commission staff deems accurate those trades for which the
imputed trade times are consistent with all underlying audit trail
records and data, as determined by manual review. When comparing
windows data for accurate trades and all trades, the Division has
found that a higher percentage of accurate trades are assigned
imputed times that fall within windows of two minutes or less and
thus meet the 90 percent performance standard. However, the
resulting percentage difference between accurate and all trades
generally has not exceeded one percent. In addition, since the use
of all trades data facilitates exchange submission of timing windows
percentages because such data do not have to be generated in
conjunction with an accuracy test, which requires an analysis of
extensive trade documentation, the Commission finds that the use of
all trades data provides an acceptable basis for determining windows
performance.
\10\ In response to recommendations made in the Audit Trail
Report, the Exchange modified its trading card procedures such that
only six trades can be recorded on a card, trade data can be entered
only on one side of the card, and a new card must be used with the
change of each time bracket. The Exchange modified its reporting and
enforcement procedures to supply members more promptly with
information on audit trail inconsistencies and to require
corrections that reflect actual events, to enforce more aggressively
data recordation and submission requirements, including spread quote
reporting and timing data, and to enforce more aggressively
timestamping procedures for flashed orders.
The Exchange also made a number of improvements to its trade
timing system. Since 1995, the CME has required a trade submission
indicator for executions of orders flashed upon receipt, used
seconds in the imputed timing system, including seconds from order
ticket timestamps, added exit timestamps to the imputed timing
system, used order type information to time trades, and used the
clearing receipt time in its timing system. The Exchange also made a
number of programming improvements to its timing algorithm.
CME declined to implement two Commission recommendations: that
members record and use manual execution times for at least the first
and sixth trades on trading cards and that the Exchange synchronize
timestamp clocks across the floor and upgrade the clocks to record
times to the second.
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Subsequent to the re-test, the Exchange provided windows data for
all affected contract markets (including the S&P 500 futures market) in
response to Commission requests. For December 10, 1996, the overall
percentage of trades with timing windows of two minutes or less was 82
percent. The percentage of trades with timing windows of two minutes or
less computed separately for each of the seven affected contract market
ranged from 37 percent to 89 percent. For March 12, 1997, the overall
percentage of trades with timing windows of two minutes or less was 83
percent and the percentages for the seven affected contract markets
ranged from 62 percent to 87 percent.
On June 30, 1997, the Exchange provided windows data for three
additional trade dates selected at random by the Commission which
showed that the overall percentage of trades with timing windows of two
minutes or less ranged from 82 percent to 85 percent. The percentage of
trades with timing windows of two minutes or less computed separately
for each of the seven affected contract market ranged from 65 to 92
percent on May 28, 1997; 66 to 86 percent on June 5, 1997; and 60 to 88
percent on June 10, 1997. Thus, the Exchange has not demonstrated that
its imputed trade execution times are sufficiently reliable, precise,
and verifiable in that it has not established that 90 percent or more
of such times are imputed within timing windows of two minutes or
less.<SUP>11</SUP>
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\11\ The windows data percentages indicated for the trade dates
December 10, 1996, through June 10, 1997, do not include windows
data for the S&P futures contract market. As noted above, the
Commission is issuing a separate order granting CME an unconditional
dual trading exemption for the S&P 500 futures contract market.
The Exchange submitted data indicating that 90 percent or more
of the imputed trade times in its S&P 500 futures contract had
timing windows of two minutes or less on all three dates selected by
Commission staff using a random sampling method, as well as two
prior dates selected by the Exchange based upon Commission
timeframes. The Commission believes that, while timing windows data
for all dates provided should be considered, the dates selected
randomly by persons other than those affiliated with the Exchange
should be accorded greater weight in determining whether an affected
contract market attains the 90 percent performance standard. The
windows data for the S&P 500 futures contract market demonstrates
consistent compliance with the 90 percent performance standard. None
of the Exchange's other affected contract markets demonstrated
consistent compliance.
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The negative impact on the components of the Exchange's trade
monitoring system resulting from its failure to satisfy the 90 percent
performance standard is exacerbated because CME does not require the
recordation of a member's personal and customer trades in
sequence.<SUP>12</SUP> Given the absence of such a recordation
requirement, reliably accurate trade times are essential for effective
determination of the sequence of trades. Where the sequence of customer
and personal trades is not determined, possible dual trading-related
abuses, such as trading ahead of customer orders and trading against
customer orders, could go undetected.
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\12\ Notably, although there are differences in various systems
among the exchanges, the three other exchanges for which the
Commission has granted unconditional exemptions from the dual
trading prohibition require that customer and personal trades be
recorded sequentially on a single trading document. Similar to CME,
one of those exchanges, the Coffee, Sugar and Cocoa Exchange, Inc.,
also uses an imputed timing system to assign trade execution times.
Such sequencing also can be achieved by recording personal and
customer trades in sequence on one set of sequentially numbered
trading documents. As the Commission noted in discussing the results
of CME's first audit trail test, ``recordation of a member's
personal and customer trades in sequence should be the Exchange's
objective.'' Audit Trail Report at 14-15. Section 5a(b)(3) of the
Act provides, among other things, that an exchange's audit trail
system must record accurately and promptly essential data on all
trades, including execution time, through a means that is adequately
precise to determine the sequence of customer and personal trades,
to the extent practicable as determined by the Commission by rule or
order.
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Other Components of CME's Audit Trail System
With regard to the requirement that trade data be provided
continually to the Exchange in accordance with Section 5a(b)(3)(A)(ii)
of the Act, exchange audit trail systems must provide trade data,
including trade timing information, on a periodic, but not necessarily
real-time, basis.<SUP>13</SUP> Such information also must be obtained
in a timely manner. The Exchange requires that clearing members submit
trade data for clearing no later than 60 minutes after the end of the
last time bracket on the trading card or floor order ticket. CME's
trade data, therefore, are provided periodically to the Exchange at no
more than hourly intervals, which is continual.
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\13\ See Audit Trail Re-Test Report at 39.
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With regard to unalterability, as mandated by Section
5a(b)(3)(A)(i) of the Act, the Exchange's trade records are
unalterable, since they are recorded on trading cards and order tickets
in nonerasable ink. Trade corrections also are not permitted to obscure
original data.<SUP>14</SUP>
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\14\ The Commission requires retention of a record of any
cancellations, changes, or corrections to trades. Commission
Regulation 1.35(d) and the Outtrade Interpretation, 54 FR 37004
(September 6, 1989). The Commission amended Regulation 1.35(d)(7),
effective October 21, 1996, to require that the correction of
erroneous information on trading records be accomplished in such a
manner that the originally recorded information must not be
obliterated or otherwise made illegible. 61 FR 42999 (August 20,
1996). In November 1996, CME amended its CME Rule 536 to comport
with the Commission's amendment to Regulation 1.35(d)(7).
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[[Page 60863]]
CME's imputed timing system, which uses data from sources other
than the trader, as well as data provided by the trader, to derive
times, also meets the Section 5a(b)(3)(A)(iii) standards for
independence, to the extent practicable.<SUP>15</SUP> The Exchange's
existing system uses, among other things, data generated by both buyers
and sellers for personal trades, including trading card numbers and
sequence of trades on trading cards, certain execution times required
to be entered manually, entry and exit timestamps on order tickets,
time and sales data and 15-minute bracket codes to impute trade
execution times.
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\15\ See Audit Trail Re-Test Report at 40.
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The Exchange requires that personal trades be recorded in sequence,
consistent with Commission regulations, by requiring that members
record such trades in sequence on pre-numbered trading
cards.<SUP>16</SUP> The Exchange adopted a single-sided trading card on
which all personal buy and sell trades are required to be recorded
sequentially in response to an Audit Trail Report recommendation.
However, as noted elsewhere, the Exchange does not require the
recordation of a member's personal and customer trades in sequence.
Given the absence of such a recordation requirement, reliably accurate
trade times are essential for effective determination of the sequence
of trades.
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\16\ Commission Regulation 1.35(d)(2) requires that each member
of a contract market recording purchases and sales on trading cards
must record such purchases and sales in exact chronological order of
execution on sequential lines of the trading card.
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CME enforces its audit trail requirements and integrates audit
trail data into its surveillance system for dual trading-related
abuses. However, because the Exchange's trade surveillance system
incorporates into its data, including exception reports, an
impermissible amount of imputed trade execution times that are not
reliably accurate, the effectiveness of the Exchange's integration of
audit trail data is diminished.
As required by Section 5a(b)(1)(B) of the Act, CME's trade entry
and outtrade resolution programs capture certain essential data on
cleared trades, unmatched trades, and outtrades.
Finally, with regard to broker receipt times, the Commission finds
that it is not practicable at this time for CME to record the time that
each order is received by a floor broker for execution. Immediately
executable flashed orders, however, are in substantial compliance with
the objectives of Section 5a(b)(3)(B) of the Act, as stated previously
by the Commission in its Order on flashed orders and broker receipt
times.<SUP>17</SUP>
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\17\ 60 FR 58049 (November 24, 1995).
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Physical Observation of Trading Areas
CME's trade monitoring system satisfies the requirements of Section
5a(b)(1)(A) of the Act in that CME 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 conducts daily floor surveillance
during the open and close on all affected contract markets and at
random times during each trading day. CME also performs floor
surveillance when warranted by special market conditions, such as
exceptional volatility or contract expirations. Finally, the Exchange
employs a video camera logging system in the interest rate quadrant on
the upper trading floor.<SUP>18</SUP>
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\18\ Although primarily employed for dispute resolution, the 38
cameras run continuously throughout the trading day and may enable
investigators to view virtually all activity in the quadrant to
resolve irregularities detected by the Exchange's computerized
surveillance system or to follow up on tips from members, clerks or
floor surveillance staff.
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Recordkeeping System
CME's recordkeeping system captures certain essential data on
trades and uses information from the records and violations of
recordkeeping requirements to bring appropriate disciplinary actions.
However, the Exchange needs to improve member compliance with
Regulation 1.35(j), in that only 83 percent of the trading cards
selected for review by Division staff were submitted to the clearing
member within 15 minutes following 30-minute trading intervals and
timestamped promptly to the nearest minute following collection.
In addition, because CME does not meet the 90 percent performance
standard, the system captures an impermissible amount of trade timing
data that is not reliably accurate. This circumstance is compounded by
the fact that CME does not require the recordation of personal and
customer trades in sequence. As a result, the Exchange's recordkeeping
system is limited in its capability to capture essential data on the
sequence of customer trades.
CME generally conducts back office audits of trading cards and
order tickets at each clearing member firm at least once a year for a
representative sample of customer orders and personal trades. CME also
uses a computerized tracking system to monitor member compliance daily
with certain trade timing and sequencing requirements, regularly
examines trading records during the course of investigations for
possible recordkeeping violations, and uses information from these
audits to generate investigations. The Exchange requires that the
account identifier reflected on the floor order ticket relate back to
the ultimate customer account.
Surveillance Systems and Disciplinary Actions
The inclusion of an impermissible amount of trade timing data that
is not reliably accurate in the Exchange's trade monitoring system
diminishes the capability of the Exchange's trade surveillance system
to review trade data effectively, and as a result, possible dual
trading-related abuses could go undetected. Further, the lack of
reliably accurate trade timing data diminishes the capability of the
Exchange's disciplinary program to bring appropriate disciplinary
actions against violators. In other respects, the Exchange's trade
surveillance system may be capable of reviewing and is used to review
trading data on a regular basis to detect possible dual trading-related
abuses and other customer order abuses. In addition, CME did bring
disciplinary actions against offenders and issued meaningful penalties
against violators. Therefore, CME has demonstrated the capability to
use 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 as required by Sections 5a(b)(1)(C), (D) and (F) of the
Act. Further, CME refers appropriate cases to the Commission.
On a daily basis, CME reviews computerized surveillance reports
generated by the Exchange's Automated Trade Surveillance system to
detect possible instances of dual trading-related abuses and other
trading abuses. All relevant trade data, including account numbers, are
included in these reviews. Among the computerized exception reports
generated by the Exchange and reviewed daily are those designed to
identify such suspicious trading activity as trading ahead of a
customer, trading against a customer, wash trading, and trading against
a customer with a collaborator, as well as those designed to provide
data on personal profit and loss, member dual trading and outtrade
resolution. Once an investigation has been opened, the Exchange's
Compliance Department can use video cameras, on a for cause basis,
[[Page 60864]]
to assist in the conduct of the investigation.<SUP>19</SUP>
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\19\ During 1996, the CME significantly expanded its video
surveillance capability. The two cameras on the upper trading floor
were replaced with ten cameras, and the single camera on the lower
trading floor was replaced with seven cameras. All 17 are state-of-
the-art ``pan, tilt and zoom'' professional grade cameras.
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During 1996, the Exchange initiated 429 investigations and/or
inquiries into all types of trading-related abuses. Approximately 80
percent of the investigations opened and closed during 1996 were closed
within the four-month standard set forth in Regulation 8.06. During
that same period, the Exchange initiated 98 dual trading-related
investigations and referred three of these investigations to a
disciplinary action committee. During the period of January 1994
through December 1996, CME assessed substantial penalties in 14
disciplinary actions involving dual trading-related abuses.
Commitment of Resources
The Commission finds that CME meets the requirements of Section
5a(b)(1)(E) of the Act by committing sufficient resources for its trade
monitoring 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, CME committed 99 personnel
to the Exchange's Compliance, Market Surveillance and Audits
Departments and reported its total self-regulatory costs to be
$15,388,000. CME's reported volume for this period was 177,027,583
contracts, and the number of trades exceeded 16,000,000.
Accordingly, the Commission Hereby Orders that:
The Exchange must implement the following corrective action:
achieve compliance with the 90 percent performance standard.
The Commission further orders that:
Until such time as the Exchange demonstrates that its trade
monitoring system satisfies the relevant standards, the Exchange shall
be subject to the following condition: Within 60 days from the
effective date of a final Order, the Exchange must implement and
enforce the limited dual trading restriction described in the Appendix
to this proposed Order, which is less restrictive than the dual trading
prohibition of Section 4j of the Act and Regulation 155.5. Such dual
trading restriction currently would apply to the following affected
contract markets: Live Cattle, Deutsche Mark, Japanese Yen, Swiss Franc
and Eurodollar futures contracts and the option contracts on Eurodollar
and S&P 500 futures.
Accordingly, the Commission proposes to grant CME's Petition for
Exemption, subject to the stated condition, from the dual trading
prohibition for trading in its Live Cattle, Deutsche Mark, Japanese
Yen, Swiss Franc and Eurodollar futures contracts and the option
contracts on Eurodollar and S&P 500 futures.
If, at any time, CME believes that it can demonstrate to the
Commission's satisfaction that it meets, for an affected contract
market subject to this Order, all of the standards set forth in this
Order, including, but not limited to, those in Section 5a(b) and
Regulation 155.5, the Exchange may petition for an unconditional
exemption to the dual trading prohibition for that affected contract
market.
Unless otherwise specified, the provisions of this proposed Order
shall be effective on the date on which it is issued as a final Order
by the Commission, and the condition shall become effective as stated
herein and shall remain in effect unless and until removed, as provided
above, or revoked in accordance with Section 8e(b)(3)(B) of the
Commodity Exchange Act, 7 U.S.C. 12e(b)(3)(B). Failure of CME to abide
by the condition of a limited dual trading restriction will
automatically cause the dual trading prohibition set forth in Section
4j of the Act and Regulation 155.5 to go into effect.
If other CME contract markets become affected contract markets
after the date this Order becomes final, the Exchange would be
required, absent submission of a dual trading exemption petition, to
restrict dual trading in those affected contract markets in accordance
with the dual trading prohibition set forth in Section 4j of the Act
and Regulation 155.5. Further, if CME demonstrates to the Commission's
satisfaction that an affected contract market subject to this Order has
ceased to meet the Regulation 155.5(a)(9) affected contract market
threshold, that contract market no longer would be subject to this
Order.
Dated: November 7, 1997.
By the Commission.
Edward W. Colbert,
Deputy Secretary.
Appendix--Dual Trading Restriction
a. Restriction
A floor broker is prohibited from executing customer orders in
an affected contract market month, as defined below, during the same
pit trading session in which the floor broker executes directly, or
initiates and passes to another member for execution, a transaction
in any such affected contract market month for (1) the floor
broker's own account, (2) any account in which the floor broker's
ownership interest or share of trading profits is ten percent or
more, (3) any account for which the floor broker has trading
discretion, or (4) any other account controlled by a person with
whom such floor broker is subject to trading restrictions under
Section 4j(d) of the Act to the extent such section is applied by
Commission regulation or order.
b. Affected Contract Market Month (Volume)
Affected contract market month means: (1) For each affected non-
agricultural contract market, any contract market month with an
average daily trading volume of 10,000 contracts or more as
determined by, at the election of the Exchange, either (i) CME Rule
552 with respect to a contract month position or (ii) trading in the
previous calendar month; and (2) For each affected agricultural
contract market, any contract market month with an average daily
trading volume of 10,000 contracts or more as determined by trading
in the previous calendar month. For this purpose, daily trading
volume means the total number of contracts sold (or bought) in any
contract month of an affected contract market during a trading day,
with the average computed as set forth above and excluding ex-pit
transactions as permitted under contract market rules that have been
made effective under the Act. There will be a two business day
allowance at the beginning of each calendar month for computation
and member notification purposes.
c. Affected Contract Market Month (Front Month)
Front month means, for each affected contract market, the month
which is either the expiration or delivery month which is nearest to
expiration or, at the Exchange's discretion, the expiration or
delivery month which is next nearest to expiration when the contract
month nearest to expiration is five business days or less from the
first notice day or last trading day for cash settled contracts for
futures contracts or the expiration date for futures options
contracts. If a front month is not subject to a prohibition pursuant
to paragraph b. above, then it shall, nonetheless, be an affected
contract market month and be subject to a prohibition unless, on the
basis of historical data, that front month reasonably can be
expected to have an average daily trading volume of less than 500
contracts.
d. Exceptions
Dual trading shall be permitted under exceptions contained in
CME Rule 552 or other exceptions consistent with Commission
Regulation 155.5(c)(4) in accordance with Exchange rules which the
Commission has permitted to go into effect pursuant to Section
5a(a)(12)(A) of the Act and Regulation 1.41.
Dissenting Opinion of Commissioner Barbara Pedersen Holum on the
Disposition of the Chicago Mercantile Exchange's Dual Trading Petition
Section 4j(a)(3) of the Commodity Exchange Act requires the
Commission to exempt a contract market unconditionally from the dual
trading prohibition of Section
[[Page 60865]]
4j(a) of the Act upon finding that the trade monitoring system
satisfies the requirements of Section 5a(b) of the Act by
effectively detecting and deterring dual trading-related abuses. I
dissent from the Commission's proposed Order granting the CME a
conditional exemption in seven affected markets.
Based on information provided to the Commission, I find that the
CME's trade monitoring system as a whole effectively detects and
deters dual trading abuses and therefore accomplishes the intended
objectives of the Act. Additionally, in 1991 the CME implemented a
dual trading restriction as part of its trade monitoring system
which the Commission approved. The Commission has reviewed the CME's
enforcement of that restriction over the past six years and found it
to be effective.
Therefore, I find that CME's trade monitoring system, including
its dual trading restriction, meets the standards for an
unconditional exemption from the dual trading prohibition.
[FR Doc. 97-29892 Filed 11-12-97; 8:45 am]
BILLING CODE 6351-01-P
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