By letters dated January 7, 2000, through June 6, 2000, the Merchants� Exchange of St. Louis, L.L.C. (�MESL� or �Exchange�), a Missouri for-profit limited liability company, applied to the Commodity Futures Trading Commission (�Commission�) for designation as a contract market for the automated trading of deliverable Illinois Waterway and St. Louis Harbor barge freight futures contracts. The Exchange�s application also included various proposed rules necessary to the establishment of a contract market.

MESL has contracted with the Board of Trade Clearing Corporation (�BOTCC�) to provide all clearing and settlement services for its contracts. MESL also has contracted with the National Futures Association (�NFA�) to perform several of the Exchange�s self-regulatory duties, including investigating and prosecuting trade practice violations and conducting market surveillance in conjunction with an Exchange employee. Exchange Cubed, LLC (�Exchange Cubed�) would act as MESL�s technology service provider. International Business Machines Corp. ("IBM") has licensed an existing automated trading system that would be modified to serve MESL�s purposes, the �MESL System,� to Exchange Cubed. Exchange Cubed, in turn, has contracted to provide the MESL System to the Exchange. IBM also would act as a facility operator for the host equipment and would provide user support.

The Commission has not previously approved MESL as a contract market in any commodity futures contract or option.1 Accordingly, in addition to the terms and conditions of the two proposed futures contracts, the Exchange has submitted to the Commission a proposed trade-matching algorithm, procedures and rules pertaining to MESL governance, disciplinary and arbitration procedures, trading standards, recordkeeping requirements, and various other materials to meet the requirements for a board of trade seeking initial designation as a contract market.

II. Procedural History

The Commission published a Federal Register notice on February 1, 2000, requesting comments on MESL�s proposed application by April 3, 2000 (65 FR 4805). The Commission received four comment letters, all supportive of the Exchange�s application.² Through several letters dated January 27 through June 6, 2000, MESL provided the Division of Trading and Markets (�Division�) with additional information regarding MESL�s rules and the MESL System, and has amended its contract market designation application and rules to address questions posed by Division staff. In addition, by letter dated April 6, 2000, NFA described the trade practice surveillance, market surveillance, and disciplinary programs that it would operate for MESL.³

III. Commodity Exchange Act and Commission Regulations

As a contract market, MESL would be subject to the Commodity Exchange Act (�Act�) and to the same Commission regulatory provisions as any other futures exchange that the Commission has designated as a contract market. The Division has concluded that MESL�s proposed rule provisions would address each Commission regulation that requires a contract market to adopt and enforce certain rules. For those provisions of the regulations requiring MESL to take certain actions, the Exchange has submitted to the Commission affirmative representations in each instance.

The chart appended to this memorandum as Appendix A lists separate provisions of the Commission�s regulations requiring a contract market to: (1) adopt and enforce a specific rule or rules or (2) take certain actions. The left column lists the specific regulatory provisions, the middle column summarizes the provisions, and the right column sets forth how MESL would address each requirement. In some instances, certain regulatory provisions would not be applicable to MESL. In those instances, the right column of the Chart explains why the regulatory provision would not apply, and what MESL would do in the alternative, if applicable.⁴

IV. Governance

A. MESL Structure and Ownership

Pursuant to MESL�s Operating Agreement, the Exchange would operate as a for-profit Missouri limited liability company.⁵ Although MESL�s owners would hold all equity interest and voting rights in the Exchange, trading privileges would not be attendant to ownership. Those owners wishing to trade on the Exchange would be required to apply for trading privileges and successfully complete the standard Trading Privilege Holder (�TPH�) approval process described below.⁶ Conversely, TPHs only would be granted trading privileges and would have no Exchange governance authority or equity interests.⁷

Under the Missouri Limited Liability Company Act, all owners of a limited liability company are deemed �members� of the company. TPHs who were not owners would not sign MESL�s Operating Agreement, and thus, would not be �members� of the Exchange under Missouri law. MESL�s proposed rules, however, would deem TPHs to be �members� for purposes of applying the Act.⁸

MESL is wholly-owned by Mr. Ivan Bartling (REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT),⁹ Mr. Ross Tweedy (REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT), and American Milling, L.P. (REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT). REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.¹⁰ REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.¹¹ REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.

The Division has analyzed MESL�s ownership structure, and the various relationships within that structure to determine whether it would present a potential for any abuse of power or information that would be inconsistent with the Act or the Commission�s regulations.¹² REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT. MESL has indicated, however, that Mr. Bartling, REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT, Mr. Tweedy, and American Milling L.P. may trade on the Exchange. In order to address the potential that these individuals and entities might use their ownership influence to ascertain confidential information from the Exchange, MESL has agreed to establish an appropriate wall between itself and these individuals and entities. Specifically, MESL has represented that the aforementioned individuals and entities would be prohibited from access to any MESL position, market, or surveillance information. MESL�s rules and Operating Agreement also would serve to protect, material nonpublic information in accordance with Commission Regulation 1.59.¹³

B. MESL�s Board of Managers and Officers

1. General

The Exchange�s Board would be responsible for managing the property and business of MESL, including such actions as setting compensation for officers and employees, setting transaction fees, and approving TPH applications. In addition, the Exchange�s Board would be responsible for approving any amendments to MESL�s Operating Agreement and revisions and additions to MESL�s Rules.

Section 5.03(b) of MESL�s Operating Agreement provides that the Board would be comprised of five Managers, one of whom shall be Mr. Jump or his nominee, and one whom shall be the Exchange President. The three remaining Managers are selected by a majority vote of MESL�s owners. The Exchange�s current Managers include Mr. Jump, Mr. Stewart, Mr. Tweedy, Mr. Bartling, and James Hickey. Mr. Jump has been elected to serve as Chairman of the Board. Under MESL�s Operating Agreement, Managers would hold office until resignation, death, or removal for cause.

2. Board Composition

Commission regulations set forth requirements regarding service on, and composition of, a self-regulatory organization�s (�SRO�) governing board. For instance, Commission Regulation 1.63 generally requires contract markets to adopt rules which, among other things, prohibit persons from serving on governing boards if they were found, within the three prior years, to have committed a disciplinary offense.¹⁴ MESL Rule 204 would satisfy this regulation by requiring that no individual may serve on the Board or any Exchange committee if, in the last three years, he or she was found guilty of a disciplinary offense, is suspended from trading, or has had a registration revoked or is suspended from serving on a governing board under federal laws.

MESL Rule 202 would satisfy Regulation 1.64�s governing board composition requirements by mandating that at least 20 percent of the Board be �Public Managers� and specifically requiring that the Board be elected so as to satisfy the diversity requirements set forth in Commission Regulation 1.64. Accordingly, at least one Manager from MESL�s initial five-person Board must qualify to serve as the public Manager. MESL has represented that Mr. Hickey would be the public Manager. Although Mr. Hickey does not have direct experience in the futures industry, he has a vast amount of business experience.¹⁵ The remaining four managers all have considerable experience in various aspects of the futures industry and currently hold positions that can be deemed to satisfy the remaining diversity requirements of Regulation 1.64.¹⁶

3. Meetings

MESL�s Operating Agreement provides that the Board would have regularly scheduled quarterly meetings. In addition, special meetings may be called by or at the request of the Chairman, the President, or a majority of the Managers. Unless waived, at least one day notice of such a meeting must be given by the person or persons requesting the meeting. At any meeting at which a quorum was present, the act of a majority of the Managers present would be an act of the Board.¹⁷

MESL Rule 212 would satisfy the requirements of Commission Regulation 1.69 by providing that no member of the Board (or Exchange oversight or disciplinary committee) could vote on any matter in which the named party in interest was the Board member or his or her employer, employee, or any other person that had a business, employment, or family relationship with the Board member that would warrant abstention. Further, no Board member could vote on an action that would not be submitted to the Commission for prior approval if the member knowingly had a direct or substantial financial interest in the result of the vote, based on positions held, whether on the Exchange or elsewhere, either personally or at an affiliated firm. Consistent with Regulation 1.69, MESL Rule 212 would establish procedures for determining whether a Board member must abstain from deliberating or voting in any particular matter.

4. Executive Committee

Pursuant to MESL�s Operating Agreement and MESL Rule 207, the Board has established an Executive Committee comprised of the Chairman and President to manage the Exchange�s day-to-day operations, including executing and implementing previously established Board policy and recommending new policy.¹⁸ In addition, the Executive Committee would be responsible for reviewing TPH applications.

MESL has contracted with NFA to perform an initial review of TPH applications and to conduct appropriate background checks. The respective application would then be reviewed by the Executive Committee and referred to the Board with its recommendation. The Executive Committee would base its recommendation on its evaluation of the applicant�s character, financial standing, and trading background.

The Executive Committee also would have the responsibility to: (1) monitor TPH and Authorized Trader ("AT") compliance with Exchange rules;¹⁹ (2) inquire into the business conduct of TPHs and ATs and require detailed financial reports of any TPH relating to its trading activity; (3) hear disciplinary appeals; (4) recommend suspension of a TPH if it determines that there are substantial questions as to whether a financial emergency exists regarding the particular TPH; and (5) prohibit trading by a TPH which is excessive in view of its capital.

5. Officers

The Exchange initially would have a President, Secretary, and Treasurer appointed by the Board to fulfill the duties of these offices as described in MESL�s Operating Agreement and as determined by the Board. The Board also would have the authority to add additional officers as it deems appropriate. Officers would serve at the pleasure of the Board and may be removed with or without cause if the Board deems such removal to be in the Exchange�s best interests.

MESL�s Operating Agreement provides for indemnification of any person who becomes party to any legal proceedings as a result of their being an officer, director, employee, or agent of MESL. MESL would not, however, indemnify its officials for civil monetary penalties imposed by the Commission under Section 6b of the Act.²⁰

6. Emergency Actions

MESL Rule 419 would authorize the President, with the concurrence of at least a two-thirds vote of the Managers, to place into immediate effect temporary rules for up to 30 business days in response to an emergency.²¹ Among the actions that could be taken would be the suspension of trading, the ordering of liquidation-only trading, the modification of delivery terms and conditions, and the modification of trading hours. Such emergency rules could be effectuated without prior Commission approval and without compliance with the non-emergency rule review provisions of Section 5a(a)(12)(A) of the Act and Commission Regulation 1.41. MESL rules also would authorize the Exchange to take various actions in response to physical emergencies, which would include any circumstance which could have a severe or adverse effect upon MESL�s physical functions. Examples of a physical emergency would include a fire, bomb threats, substantial inclement weather, power failures, communication breakdowns, and computer or software malfunctions.²² The Division believes that MESL Rule 419 would be consistent with the requirements of Commission Regulation 1.41(f) and (g) which govern exchange temporary emergency rules and physical emergencies, respectively.

C. Arbitration

MESL has contracted with NFA to initially administer all arbitrations -- TPH v. TPH and TPH v. customer.²³ Pursuant to MESL Rule 801, MESL would adopt NFA�s Code of Arbitration and Member Arbitration Rules. NFA�s jurisdiction would be set forth under MESL Rule 802. With respect to controversies between TPHs, MESL Rule 802(a) would provide the Board with jurisdiction to determine whether a controversy arose from Exchange business and, therefore, should be referred to NFA.²⁴

V. Access to the MESL System

A. Trading Privilege Holders

Access to the MESL System would be limited to holders of MESL trading privileges, TPHs, and their authorized representatives, ATs.²⁵ Pursuant to MESL Rule 304, trading privileges only could be obtained by applicants that: (1) were clearing members; (2) had a clearing arrangement with a clearing member; or, (3) had an account with a firm that has a relationship with a clearing member. Therefore, in order for a non-clearing member to become a TPH able to enter orders into the MESL System, it must either obtain authorization from a clearing member willing to guarantee those transactions or enter into an arrangement with a person that has such authorization from a clearing member. Under such an arrangement, the clearing member would assume financial responsibility for all such guarantees. Only BOTCC clearing members would be eligible to act as MESL clearing members.

An entity or individual seeking to become a TPH would be required to complete and file a comprehensive application with the Exchange. The MESL application for TPH status would require significant disclosure regarding financial standing, including net worth and prior bankruptcies; relationships with commodities and/or securities exchanges, including the agencies that regulate them; involvement in civil or administrative litigation and criminal convictions; and general character and background information.²⁶ It also would require an applicant to meet certain other criteria, such as sufficient capital, and an affirmative representation that he or she is not subject to a statutory disqualification under the Act. At the discretion of MESL, applicants seeking TPH status might also be required to produce trading suitability letters from employers or others attesting to the applicant�s trading knowledge or background.²⁷

Although MESL's Board would have the ultimate authority to approve applicants, MESL would contract with NFA to initially review TPH applications and to conduct appropriate background checks. MESL's Executive Committee would be responsible for evaluating each TPH applicant's character, financial standing and trading background, and subsequently making a recommendation to the Board to approve or disapprove each application.²⁸ A favorable vote of a majority of the entire Board would be necessary to approve an applicant recommended by the Executive Committee. A TPH applicant approved by the Board would receive trading privileges upon payment of a $1,000 fee and signing an agreement to abide by the Exchange's rules.²⁹ Pursuant to MESL Rule 304, a TPH applicant that was rejected by the Board would not be eligible for another vote on its application during the six months immediately following such rejection.

TPH interests would be non-transferable, non-assignable and could not be sold or leased.³⁰ Under MESL Rule 306, TPHs could have their trading privileges suspended, revoked, limited, conditioned, restricted or qualified, if, in the sole discretion of MESL's Executive Committee, such action would be in the Exchange's best interest.

B. Authorized Traders

The trading privileges of certain TPHs (an FCM, IB or CTA only) also could be exercised by authorized employees designated as ATs.³¹ Each TPH would be responsible for monitoring its ATs' compliance with MESL rules, as well as any other pertinent regulatory requirements. Toward this end, MESL would require each entity TPH to list all ATs on its TPH application and to warrant that its ATs would observe and be bound by Exchange rules. In addition, the Exchange would require each AT to consent to abide by MESL's rules by signing a "Jurisdictional Consent" form.

The Jurisdictional Consent form would not address regulatory requirements but, pursuant to MESL Rule 508, each TPH would be responsible for determining whether its ATs required Commission registration. Under the Commission's current policy, an AT would be required to register with the Commission as an Associated Person (�AP�) of his or her employer only if such AT handled customer orders other than in a strictly clerical capacity. If, however, an AT that handled customer orders in a strictly clerical capacity also entered orders for the proprietary account of his or her employer on a discretionary basis, the AT would be required to register with the Commission as an AP.³² Pursuant to MESL's rules, TPHs would have significant supervisory responsibilities with respect to their ATs.³³ Further, MESL's TPH application process would require a TPH to provide MESL with an attestation that none of its ATs would be subject to a statutory disqualification under the Act. Each TPH also would have a continuing duty to ensure that any AT hired in the future was not subject to a statutory disqualification.

C. Trading Privilege Holders with Customer Accounts

A TPH would be required to be a Commission registrant if he or she executed trades for customer accounts.³⁴ All TPHs trading for customer accounts must exercise due diligence in the handling and execution of their customer orders.³⁵

In accordance with the provisions of Commission Regulation 1.35, MESL would require a TPH to prepare an order ticket for every customer order that could not be entered into the MESL System immediately upon its receipt.³⁶ A TPH, however, would be required to enter that customer order as soon as practicable given market conditions. For example, a customer order could be made contingent upon the execution of a separate order, and therefore, its entry would not be supportable by the MESL System at the time it was received. Thus, it would be the responsibility of a TPH that accepted a customer order involving a complex trading strategy to ensure the proper execution of such orders by transmitting all the instructions necessary to accomplish such trades into the MESL System as soon as practicable.

VI. Order Entry & Execution

A. Overview

Like other Commission-approved automated trading systems, MESL would anonymously match orders in accordance with an algorithm that would prioritize bids and offers on the basis of best price (which would have first priority) and time (which would have second priority), respectively.³⁷ The quantity and price of each and every limit order entered into the MESL System would be available for observation to market participants upon order entry.³⁸

B. Types of Orders

The MESL System would permit the entry of market and limit orders.³⁹ In addition, the System would accept fill-or-kill and immediate-or-cancel contingent orders.⁴⁰ MESL also has proposed to permit counterparties to enter into bona-fide Exchange of Futures for Physicals ("EFPs") through the Exchange.⁴¹

C. Trade-Matching Algorithm

The specific system entry and trade-matching requirements for each type of order would be established by MESL Rule 407. The algorithm, as it relates to various types of orders, would operate as follows:

1. Limit Order Algorithm

a. All limit orders entered into the MESL System would identify quantity and price, as well as the time period during which the order would remain open.⁴² MESL limit orders would be filled and executed in the sequence in which they were received on an "or better" basis. As such, limit orders, upon receipt, would be recorded and logged into the server as they were received and would be assigned order entry times to the nearest one-thousandth of one second.⁴³ Therefore, if a limit order to buy was entered at a price that was greater than the best "offer to sell," that limit order would act like a market order until all available "offers to sell" that were at or below the limit price were filled or the quantity of the order was filled.

b. A limit order having the best price would be assigned price priority. If more than one order had the best price, then the best price order that also held time priority would be executed first.

c. An order would not lose time priority if an order with a better price was subsequently entered into the MESL System; that order would, however, lose price priority.

d. Example:

Assume limit bids were placed at the following prices, times, and quantities:

Time ���������� Price ���������� Bids �������� Offers

Trader A������ 9:00 ��������� 72.00 �������� 3 limit

Trader B������ 9:01 ��������� 72.05 �������� 2 limit

Trader C������ 9:02 ��������� 72.10 �������� 1 limit

� In this scenario, Trader C's order would have price priority over the orders of Traders A and B, and Trader B's order would have price priority over Trader A's order.

Further assume that at 9:03 Trader D enters a limit offer at 72.00 for four contracts. The MESL System would execute the following transactions.

Time �������� Price �������� Quantity

C-D Trade ������������� 9:03 ������� 72.10 ������������� 1

B-D Trade ������������� 9:03 ������� 72.05 �������������� 2

A-D Trade ������������� 9:03 ������� 72.00 �������������� 1

� Trader D�s limit offer of four would be executed at 72.00 or better. Following the rules of price/time priority, Trader C�s bid for one contract at the highest price, 72.10, would be matched against Trader D�s limit offer of four contracts.

� Trader B�s bid for two contracts at 72.05 would then be matched against the remaining three contracts of Trader D�s offer. Two of Trader D's contracts would be matched, one would remain.

� One of Trader A�s bid of three contracts at 72.00 would be matched against the remaining contract of Trader D�s limit offer.⁴⁴ Although Trader A�s bid would meet the terms of the limit offer (at 72.00 or better), and has time priority, it does not have price priority over B's and C's respective orders, and would be the last to be matched.

2. Market Order Algorithm

a. A market order (also called an �at best� order) would be filled at the best price(s) available in the market at the time of order entry. A market order would be rejected by the MESL System if, at the time of the order's entry, no opposite limit order existed in the relevant contract and contract month. Accordingly, market orders only would be matched with pending limit orders and could not be matched with other market orders. Each market order would be filled to the quantity available at the time the order was entered and any unfilled portion of the market order would be cancelled immediately.

b. By definition, a market order would have price priority over any pending limit order(s) on the same side of the market because its assigned price(s) would be determined by the price(s) of pending limit order(s) on the opposite side of the market at the time of entry.

c. Example:

Assume limit offers were placed at the following prices, times and quantities:

Time �������� Price �������� Bids �������� Offers

Trader A���� 10:01 ������� 72.00 ����������������������� 3 limit

Trader B���� 10:02 ������� 71.95 ����������������������� 2 limit

Trader C���� 10:03 ������� 71.90 ����������������������� 1 limit

Trader D���� 10:04 ������� 71.85 ����������������������� 1 limit

Next, assume that at 10:05 Trader E entered a market order to buy three contracts. The MESL System would execute the following transactions:

Time ������������ Price ������������ Quantity

D-E Trade�� 10:05 ����������� 71.85 ��������������� 1

C-E Trade�� 10:05 ����������� 71.90 ��������������� 1

B-E Trade�� 10:05 ����������� 71.95 ��������������� 1

� Trader E's market order would be matched with the pending limit offers according to their price priority. Accordingly, Trader E's order to buy three contracts would first be matched against Trader D's limit offer of one contract at 71.85.

� One of Trader E's two remaining contracts would then be matched against Trader C's limit offer of one contract at 71.90.

� Trader E's remaining contract would then be matched against one of Trader B's limit offers of two contracts at 71.95.⁴⁵

� The remaining unfilled quantity of Trader B�s limit offer and the entirety of Trader A's limit offer would remain in the MESL System and would be eligible for matching. If Trader E�s bid only had been partially filled, the remaining, unfilled portion would have been canceled automatically.

3. Fill-or-Kill Algorithm

a. A fill-or-kill order must be executed in its entirety upon entry into the MESL System, and if not immediately executed, it would be cancelled. A fill-or-kill order must specify price and quantity and only could be matched against a corresponding limit order(s).

b. Example:

Assume that limit bids and offers were placed at the following prices, times and quantities:

Time ���������������� Price ���������������� Bids ���������������� Offers

Trader A���� 11:56 ���������������� 1.45 ��������������� 5 limit

Trader B���� 11:57 ���������������� 1.50 ���������������������������������������� 10 limit

Trader C���� 11:58 ���������������� 1.55 ���������������������������������������� 10 limit

Trader D���� 11:59 ���������������� 1.50 ���������������������������������������� 10 limit

Further, assume that at 12:00 Trader E entered a fill-or-kill buy order at 1.55 for 30 contracts. The MESL system would execute the following transactions in order:

Time ���������������� Price ���������������� Quantity

E-B Trade���� 12:00 ������������� 1.50 �������������������� 10

E-D Trade���� 12:00 ������������� 1.50 �������������������� 10

E-C Trade���� 12:00 ������������� 1.55 �������������������� 10

� Trader E's fill-or-kill buy order of 30 contracts at 1.55 entered at 12:00 would be immediately matched and executed in its entirety opposite Traders B, C and D.⁴⁶ Because Trader E entered a fill-or-kill limit order, Trader E's order is executed on an "or better" basis with ten contracts opposite Trader B at 1.50, ten contracts opposite Trader D at 1.50 and ten contracts opposite Trader C at 1.55.

4. Immediate-or-Cancel Algorithm

a. An immediate-or-cancel order would be an order that specified price and quantity, and must be executed in whole or in part upon entry into the MESL System.

b. In contrast to a fill-or-kill order, which must be executed immediately in whole upon entry into the MESL system or the entire order would be canceled, only that portion of an immediate-or-cancel order that was not immediately executed upon entry would be canceled.

c. Example 1:

Assume limit bids and offers were placed at the following prices, times and quantities:

Time ���������������� Price ���������������� Bids ���������������� Offers

Trader A���� 11:00 ���������������� 1.50 ���������������� 20 limit

Trader B���� 11:01 ���������������� 1.60 ���������������������������������������� 30 limit

Further, assume that at 11:02 Trader C entered an immediate-or-cancel ("IOC") buy order at 1.55 for forty contracts.

� While Trader C's immediate-or-cancel buy order at 1.55 would have price priority over Trader A's limit order at 1.50, Trader C's order would be immediately cancelled because there was no prevailing offer in the MESL System at the price designated in Trader C's order.

d. Example 2:

Assume that the pending orders do not change from Example 1 and at 11:03 Trader C enters another immediate-or-cancel buy order at 1.60 for 40 contracts.

The MESL System would execute the following transaction:

Time ���������������� Price ���������������� Quantity

B-C Trade�� 11:03 ���������������� 1.60 �������������������� 30

� Trader C's immediate-or-cancel buy order would be matched with Trader B's limit offer of 30 contracts at 1.60.

� The unfilled portion of Trader C's immediate-or-cancel buy order, the remaining ten contracts, would then be canceled automatically.

D. MESL System Opening

The Exchange has proposed an 8:30 a.m. daily market open for both of its barge rate futures contracts.⁴⁷ MESL Rule 403 would provide that the opening price for each trading day would be based on all orders entered into the MESL System prior to the relevant contract's market open, thereby establishing an equilibrium value.⁴⁸ All orders that had been entered into the MESL System up to 8:29 a.m. of each trading day would be eligible for matching at the open.⁴⁹ All new orders entered during the period between 8:29 a.m. and 8:30 a.m. would not be eligible for matching at the open and would not be included in the opening equilibrium calculation, but would be eligible for matching immediately upon conclusion of the open.⁵⁰

The following is an example of the proposed market opening equilibrium matching for MESL contracts with assumed buy and sell order quantities at a number of prices:⁵¹

Buy Order Volume	Buy Order Quantity	Price	Sell Order Quantity	Sell Order Volume
0	0	1.603	90-lot	240
5	5-lot	1.602	70-lot	150
12	7-lot	1.601	50-lot	80
22	10-lot	1.600	20-lot	30
67	45-lot	1.599	0	10
127	60-lot	1.598	10-lot	10
227	100-lot	1.597	0	0

In this example, trades would be possible between the prices of 1.598 and 1.602, inclusive. By comparing �buy order volume� to �sell order volume� it is clear that: (1) at prices of 1.599 and below, there would be greater volume to buy than to sell; and, (2) at prices of 1.600 and above, there would be greater volume to sell than to buy. The equilibrium range, dictated by the pressure between buy and sell volume, would be set between 1.599 and 1.600.

Once an equilibrium range had been determined, the MESL System would fix an opening price. In the above example, the opening price would be set at 1.600 because that would be the price level at which total �trade volume� would be greatest.⁵² At the market open, all orders that were eligible for matching at 1.600 would be filled at that price. Accordingly, the entire ten lot sell order at 1.598 would be filled at 1.600 (receiving a better fill); while the 20-lot sell order at 1.600 would only receive a fill of 12 contracts at 1.600 (receiving requested fill).⁵³ Moreover, the five lot buy order at 1.602, the seven lot buy order at 1.601 and the ten lot buy order at 1.600 would all receive complete fills at 1.600.

All buy and sell orders would be eligible for matching at the open based on their price and time priority. As noted above, price priority would always be assigned to the order with the best price. If more than one order existed at that price, time priority would govern each order's individual execution. Time priority would always be assigned to the first order at a price that bettered the market when it was received by the MESL System. Only one buy order and one sell order would possess time priority at any given time. An order would lose price priority, but not time priority, when an order at a better price was entered into the MESL System.

E. MESL System Closing

MESL has proposed a daily market close of 4:00 p.m. MESL Rule 404 would provide for the establishment of a closing price based on the last transaction executed during the closing range.⁵⁴ Generally, the closing price would be the price of the last matched trade of the trading session. If, however, there were no transactions executed during the last 30-seconds of the trading session, the period between 3:59:30 p.m. and 4:00 p.m., the closing price would be determined by the last trade prior to the closing range, if such price was between the final best bid and final best offer of the closing range.⁵⁵ Alternatively, if there were no transactions executed during the closing range or no trade that qualified as a closing-price trade prior to the closing range, the closing price would be based on either: (1) the price of the last order to buy, if the order's price was above the last transaction executed on the MESL System (or opening price); or (2) the price of the last order to sell, if the order's price was below the last transaction executed on the MESL System (or opening price). If there were no trades executed during the trading session, then the closing price would be set at the opening price.⁵⁶

MESL contends that the price of the last trade would be an appropriate means of establishing a closing price because it would be the most representative snapshot of the market price. MESL believes that the last trade price only would be inappropriate if there was a subsequent higher bid or lower offer, which would then be more representative of the market. In an orderly market, basing the market's closing price on a single transaction would not appear to be problematic. As a safeguard, MESL has proposed to reserve the right to set its daily closing price at any level that it deems appropriate to maintain the orderly administration of the market. MESL believes that this procedure would address those instances, in thinly-traded forward months, where aggressive bids or offers on the close may be lacking.

F. Exchange of Futures for Physicals

MESL would permit counterparties to enter into bona-fide EFPs through the Exchange.⁵⁷ EFP transactions entered into after 6:00 p.m. on any given trading day would be reported to the Exchange no later than 6:00 p.m. of the following business day. MESL proposed Rule 418 would permit a bona-fide EFP of any size to be negotiated at any price that was mutually agreeable to the transacting parties.

MESL has represented that it would circumscribe the conditions under which EFPs could be executed and would provide participants with procedures dictating how to document those noncompetitive transactions.⁵⁸ Specifically, one party to an EFP must be the buyer of a cash commodity, as well as the seller of futures, and the counterparty must be the seller of a cash commodity, as well as the buyer of futures. For every EFP transaction, MESL would require that the dollar value of the underlying cash commodity be the equivalent of the dollar amount of the cash commodity represented by the underlying futures portion of that transaction. EFPs would be cleared through BOTCC and designated in the Exchange's records as noncompetitive transactions. MESL Rule 418 would require clearing members to an EFP transaction to maintain and produce, upon request, documentation of the underlying cash component.⁵⁹

Moreover, it would be the responsibility of the clearing member that receives the futures position of an EFP transaction to report that transaction to MESL. This reporting requirement would be on an "as soon as practicable" basis, but in no event later than 6:00 p.m. of the same trading day. The reporting clearing member also would have an obligation to maintain all pertinent information regarding the EFP, including the identity of the parties, commodity, price, volume, delivery month, date and approximate time of transaction. MESL states that it would ensure that all required information, including an EFP designation and a customer type indicator identifier ("CTI"), were properly recorded by the Exchange on the same trading day that the transaction was reported.

In connection with MESL's rule enforcement program discussed below, NFA routinely would perform a review of selected EFP trades and their supporting futures and cash documentation to determine whether the EFP trades were bona fide transactions and were executed within MESL's prescribed guidelines. NFA also would review this sample to ensure that there were only two parties involved in the transaction and that there was a reasonable price and quantity correlation to the futures and cash being exchanged. An exception report would be generated to identify any EFP transactions that were executed for contracts outside of the relevant delivery month. Any EFP transactions executed at a price outside of the trading range for that day's trading session at or prior to the time of execution also would be identified.

EFP transactions would be subject to the same review as all other MESL trading activity and unusual activity would result in a trade practice investigation.⁶⁰ The Exchange represents that, in addition to NFA's routine EFP review, NFA would examine EFPs annually, pursuant to Commission Regulation 1.51(a)(3), as part of the Exchange's recordkeeping rule enforcement program. MESL has represented that should it determine that more frequent reviews were warranted, NFA would alter its review schedule and would perform "spot-checks" of EFPs, the frequency of which would depend on numerous factors, including but not limited to the volume of EFP transactions. Consistent with current industry practice, MESL would publicly report, as trade data, all EFP transaction information. EFP trade data would appear as part of its Open Interest Reports published on the morning after the EFPs' trade date.

MESL's rules would satisfy the requirements of the Commission's regulations with respect to the execution and documentation of EFP transactions, and would exceed those requirements inasmuch as MESL Rule 418 would establish the elements of a bona-fide EFP on MESL in accordance with the previously expressed views of the Division regarding these transactions. ⁶¹

G. Dissemination of Trade Data

MESL is currently in discussions with various trade data dissemination vendors regarding its barge freight futures contracts. DTN, Bridge, and Reuters currently disseminate information for MESL�s barge freight cash market. It is expected that these same information services would disseminate trade data from MESL barge freight futures markets as well. MESL has represented that it would not begin trading until it has an agreement in place with an established price dissemination vendor.

H. Open and Competitive Nature of the MESL System

The Division believes that MESL's automated trading system would not be inconsistent with any provision of the Act or Commission regulations. Commission Regulation 1.38 requires open and competitive execution, but it recognizes that there is more than one way to accomplish this end:

[a]ll purchases and sales of any commodity for future delivery, and of any commodity option, on or subject to the rules of a contract market shall be executed openly and competitively by open outcry or posting bids and offers or by other equally open and competitive methods, in the trading pit or ring or similar place provided by the contract market, during the regular hours prescribed by the contract market�

Moreover, Section 12 of the Act, as amended, 7 U.S.C. � 16 (1999),⁶² directs the Commission to "facilitate the development and operation of computerized trading as an adjunct to the open outcry auction system." While the MESL System would not provide for open outcry, it would allow for open access to the system by all holders of trading privileges. In addition, the MESL System would promote competitive trading by applying a trade-matching algorithm that uses non-discretionary rules of priority to execute transactions.

VII. Clearing and Settlement

MESL has proposed to outsource its clearing function to BOTCC. Under this arrangement, all MESL trades would be cleared by BOTCC clearing members through BOTCC.⁶³ MESL would pay BOTCC a fee for clearing services and would reimburse BOTCC for all costs related to the modification of BOTCC systems for this purpose. MESL trades would be cleared in accordance with proposed BOTCC rules for MESL ("BOTCC/MESL Rules") that mirror procedures and requirements that BOTCC currently applies to trades it clears for CBOT and MidAm.⁶⁴

Under the proposed clearing arrangement, MESL would indemnify BOTCC against loss relating to its clearing services. The clearing indemnification agreement between MESL and BOTCC would require MESL to provide BOTCC with a letter of credit, a financial guarantee, and an insurance policy or similar form of third-party guarantee. In return, BOTCC would guarantee, through the principal of substitution and novation, MESL's cleared trades in a manner similar to the guarantee that it currently provides for CBOT and MidAm trades.⁶⁵ Under BOTCC/MESL Rule 510, only BOTCC clearing members would be eligible to clear MESL transactions. Any BOTCC clearing member desiring to clear MESL transactions, however, would be required to sign a supplemental agreement with BOTCC that would account for MESL transactions.

During the trading day, the MESL System would transmit matched trade data to BOTCC within approximately one half-hour of the execution of each MESL trade.⁶⁶ Upon each trade match, MESL would immediately send electronic trade data to the pertinent clearing member.⁶⁷ By approximately 8:00 p.m. of each business day, BOTCC's clearing system would produce clearing member reports for that trading day's activity and make the reports available to clearing members via computer. Based upon that trade data, the clearing system would generate initial, variation, and maintenance margin requirements, and would transmit appropriate margin instructions to the approved depositories by 7:30 a.m. the following business day. The approved depositories would confirm to BOTCC their acceptance of the obligation to complete the funds transfers specified in the margin instructions by 8:30 a.m. that same day.

REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.⁶⁸

VIII. Compliance and Surveillance Program

Commission Regulation 1.51 requires that each contract market use �due diligence in maintaining a continuing affirmative action program to secure compliance� with various provisions of the Act, the Commission�s regulations, and the contract market�s own rules. In order to satisfy this requirement, MESL has contracted with NFA to carry out its self-regulatory responsibilities with respect to its trade practice and financial surveillance programs. NFA also would assist MESL in operating its market surveillance and disciplinary programs.⁶⁹ Under the terms of MESL and NFA�s agreement, in addition to paying NFA a start-up fee of REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT, MESL would pay NFA REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT. This type of fee arrangement should ensure that continuous surveillance would be conducted in an appropriate and consistent manner.

MESL also has retained Delbert Heath to serve as its Administrator of Investigations and Audits (�Administrator�). Mr. Heath, a MESL employee, would act as a liaison between NFA and the Exchange and, as discussed below, would work closely with NFA in conducting market surveillance. He also would be responsible for overseeing NFA�s work with respect to its performance of MESL�s self-regulatory obligations.⁷⁰

The Division notes that Commission Regulation 1.59(b)(1) subjects contract market employees to a total trading prohibition in futures contracts "traded on . . . the employing contract market" and that Regulation 1.59(a)(2) defines employee to mean "any person hired or otherwise employed on a salaried or contract basis" by an SRO. The Division believes that because MESL has contracted with NFA to provide the Exchange with compliance and surveillance services, those NFA employees involved in providing these services to MESL should be considered "employees" of MESL for the purpose of applying Regulation 1.59, and thus, should be prohibited from trading any MESL product.⁷¹

MESL would be the first contract market designated by the Commission that had contracted with an independent third party to perform most of its SRO obligations.⁷² The Commission contemplated such a situation, however, when enacting Commission Regulation 8.05. Specifically, Regulation 8.05(a) provides that an exchange enforcement staff may consist of �persons hired on a contract basis.� Commission Guideline No. 2 (1 COMM. FUT. L. REP. (CCH) Section 6430 (May 13, 1975)) provides guidance concerning what the term �due diligence� means in the context of an exchange satisfying its rule enforcement obligations. Guideline No. 2 states, among other things, that �if an exchange relies upon persons other than its employees to carry out its rule enforcement program, it is nevertheless the exchange�s responsibility to ensure that its obligations under the Act are met.�

In this regard, NFA would prepare and provide to MESL quarterly reports detailing the number and types of exception reports generated, the number of investigations commenced, the status of each investigation, and the nature of the violations alleged to have been found. As discussed below, MESL�s Administrator also would communicate regularly with NFA regarding trade practice and market surveillance and investigations. Similar to any other exchange, MESL would be subject to periodic rule enforcement reviews conducted by Commission staff. As part of MESL�s first rule enforcement review, the Division would examine carefully the development and implementation of NFA�s trade practice violation detection and market surveillance strategies, in addition to implementation of MESL�s disciplinary program.

A. Audit Trail

1. Overview

The Division believes that MESL�s audit trail would capture and retain sufficient trade-related information to permit NFA to detect trading abuses and to reconstruct all transactions. Customer orders would be tracked from time of receipt through fill allocation. The uninterrupted stream of timing information that the MESL System would collect regarding the various events which occurred as a result of every order entry and trade would enable NFA to reconstruct accurately an entire day�s trading activity. This reconstruction would include not only executed transactions, but all events, including the entry of each order, in the sequence of occurrence, timed to the nearest one-thousandth of a second.

With respect to order tickets, for those orders that were entered immediately into the MESL System, an electronic order ticket would be generated that captured the time of entry and included a unique order number. For those orders that could not be entered immediately into the MESL System, a written order ticket would have to be prepared that included the account designation, date, and time of receipt, and all other information required under MESL Rule 412.⁷³

An order would not be accepted by the MESL System unless it was entered with complete information including the full terms of the order and the identification codes for the associated TPH. The execution time of each trade would be recorded to the nearest one-thousandth of a second. Further, no order or trade information input into the MESL System could be altered without leaving a permanent record of the original data, the TPH or AT that made the change, and the exact time of the change.

MESL�s electronically-recorded data would be maintained in a single record as required by Commission Regulation 1.35(e) and would be viewable in the form of three separate logs. These logs would be preserved for five years. The �Order Transaction Log� would list the exact time to the nearest thousandth of a second of each order entry made by a TPH or AT and would show such information as order date, order number, account designation, CTI code, clearing member, commodity, contract month and year, quantity, type of order (buy/sell), qualifiers (market/limit, etc.) and price. This record also would contain data regarding the entry of every order into the MESL System regardless of whether it resulted in a trade.

The �Execution Transaction Log� would contain information similar to that in the Order Transaction Log, but only would contain the information specifically pertaining to each executed transaction such as execution time, buying clearing member, selling clearing member, transaction code, and transaction reference number. The �Changes to Executed Transactions Log� would contain the record of each change made to any aspect of a completed trade, except for unalterable match-critical data such as price, time, commodity, and month.

2. Review and Utilization of Trading Information

NFA would conduct annual back office audit trail and recordkeeping reviews of TPHs for which MESL would act as the designated SRO ("DSRO"). During the course of these reviews, NFA would select a group of TPHs and focus on their entries recorded in MESL�s Order Transaction Log and Execution Transaction Log. To ensure that the scope of the testing would be broad enough, NFA might choose to review all trades for a single trading day to confirm whether the orders were handled in accordance with the applicable MESL rules.

The trade times which constituted the original record of each transaction would be assigned automatically to each entry and event by the MESL System. Since these times would be unalterable, they would be presumptively accurate. MESL would not need to review trade-timing information to verify their accuracy, but instead, would confirm the level of compliance of individual TPHs with MESL and Commission requirements that each order be properly documented.

B. Trade Practice Surveillance

1. Automated Surveillance

a. Overview

NFA would utilize an automated system to perform MESL�s trade practice surveillance. This system would consist of an array of Windows-based applications that would operate in a client-server environment.⁷⁴ The heart of NFA�s system would be a relational database that would contain all MESL data relevant to the surveillance process.⁷⁵ The system also would include a database management application and a set of database analysis tools to help sort through the data and highlight patterns or anomalies. As discussed below, these tools would allow NFA to generate interactive exception reports that would allow analysts to drill down from summary data provided in an exception report to more specific trade data. Analysts also would have the ability to manipulate data and modify parameters.

NFA�s automated surveillance system would not be limited to transaction-by-transaction analysis, but also would identify patterns and new relationships, and would provide NFA with the capability to compile aggregate TPH and AT trading profiles. The profiles would track the distribution of personal and customer trades (e.g., 80 percent customer trades and 20 percent personal trades), the products usually traded, trading patterns, and performance.⁷⁶ Profiles would be linked to TPH and AT identifiers so that analysts could access particular profiles whenever suspicious trading activity was recognized. In addition, deviations from established profiles such as unusual profit patterns, drastic changes in overall volume, or unusual concentrations of trading activity between the same counterparties would signal the need for a detailed review of the component trading activity.

Similar to profiling, NFA also would have the capability to identify the degree of correlation among data. For example, NFA could review for a correlation of market activity between the Illinois Waterway and the St. Louis Harbor barge freight futures contracts by large traders. Specifically, an analyst could review a large trader�s positions and his or her profit and loss in both contracts to determine if two traders had a pattern of activity together that was unusual.

b. Exception Reports

NFA would utilize its analytical tools to create exception reports primarily based on CTI codes. NFA staff explained to Commission staff that NFA would modify the CTI categories set forth in Commission Regulation 1.35(e) in order to have a category that totally isolated personal trades.⁷⁷ Under Commission Regulation 1.35(e), a CTI 1 includes personal trades and all discretionary trades. Under NFA�s CTI categories, a CTI 1 only would include personal trades. Discretionary trades would be a CTI 2, 3, or 4, depending upon for whom the trade was executed.⁷⁸ NFA believes that isolating personal trades would enhance its capability to identify potential trade practice violations with respect to electronic trading and would contribute to better user profiles.

NFA�s automated surveillance system would generate the following exception reports for the surveillance of MESL trading: (1) Direct Trading Ahead of Customers; (2) Indirect Trading Ahead of Customers; (3) Direct Crossing; (4) Indirect Crossing; (5) Prearranged Trading; (6) Wash Trading; (7) Direct Money Passing; (8) Indirect Money Passing; (9) Counterparty Trade Percentages; (10) Marking the Close; (11) Transfer Trades; (12) Trade Cancellation; (13) EFPs; and (14) User Log-on and Log-off.⁷⁹ A detailed description of each report can be found in Appendix C.⁸⁰

When applicable, the reports would distinguish between �agency� and �non-agency� trading.⁸¹ For example, the Direct Trading Ahead of Customers Report would have one report for agency trading and another report for non-agency trading. The agency and non-agency reports would be generated using similar parameters but would focus on different CTI codes.

NFA would utilize corresponding report writing software to distribute these exception reports to analysts. The software would include a scheduling feature which would enable NFA�s automated surveillance system to generate reports automatically and to distribute them to designated analysts according to a set schedule. Once received, analysts could reconfigure report data and focus on the desired level of detail in order to meet their own specific analytical needs.

2. Non-automated Surveillance and Investigations

NFA would review trading around certain market events such as news accounts, price gaps, and price run ups, for possible rule violations. NFA also would provide resources to accept Commission referrals and information and complaints from anonymous or disclosed individuals regarding questionable market activity. In addition, NFA would work with MESL�s Administrator to keep abreast of any market information received by MESL. This information would be tracked in conjunction with NFA�s other surveillance activities and NFA would investigate any patterns of questionable activity.

NFA and MESL�s Administrator also would have access to the MESL System�s �supervisory screens.� These real-time screens would show all orders, including status, placed during the trading session; all rejected orders; and all log-on information for users logged-on during the trading session. In addition, NFA surveillance staff and MESL�s Administrator could drill down from a particular trade to see all information entered for both sides of a trade. The supervisory screens also could be used to view all activity for a particular TPH or AT.

If NFA identified potential trade practice violations or problems, NFA would commence an investigation and notify MESL�s Administrator. Among other things, MESL�s Administrator would be responsible for NFA oversight with respect to its operation of MESL�s trade practice surveillance program. In this regard, MESL has represented that its Administrator initially would review all exception reports and communicate with NFA�s compliance staff on a regular basis regarding the data identified on the reports, initiating investigations, and ongoing investigations.

C. Market Surveillance

Market surveillance responsibilities would be shared by NFA and MESL�s Administrator. In this regard, MESL�s Administrator would be responsible primarily for conducting �market supervision,� which would include monitoring real-time trading, day-to-day trading activity, open interest, and the cash markets. If the Administrator identified any problems, the matter would be referred to NFA for further investigation and possible disciplinary action.

To perform its market surveillance responsibilities, NFA would, among other things, subscribe to news services and maintain an ongoing dialogue with other exchanges. NFA also would use an automated market surveillance system that utilized real-time data to monitor market prices as well as concentrations of large trader positions. Specifically, for each contract, NFA would monitor: (1) the basis relationship between the MESL product and the corresponding cash market; (2) the price relationship between the MESL product and any related products traded on MESL or another exchange; and (3) the spread relationship between different months in the same MESL product. Statistical parameters would flag anomalies in each of these three areas and NFA would place special emphasis on ensuring that the applicable basis level converged as a contract neared expiration. NFA also would compile for each market a profile that would include information about the average size trades and other relevant market information.

Upon receiving large trader positions from MESL daily, NFA�s automated market surveillance system would aggregate all positions held by related parties. Once compiled, NFA would monitor large trader positions for concentrations of ownership and potential collusive or concerted activity by market participants. In addition, NFA would monitor for compliance with all necessary position limits, and, if applicable, for traders who exceed designated position accountability levels.⁸² NFA�s automated market surveillance system also would monitor and generate reports to analyze holdings and guard against corners and squeezes.⁸³ If special market situations were to occur, NFA�s automated market surveillance system would generate market movement alerts.⁸⁴

With respect to delivery of an expiring contract, NFA would maintain data that identified the last trading day, the first delivery day, and the last delivery day for the nearest contract month. As delivery dates approached, NFA staff would coordinate with MESL�s Administrator and large trader positions would be analyzed and traders would be contacted, if necessary. NFA or MESL�s Administrator also would contact speculative traders who remained in the market beyond the fifth business day prior to the last trading day. In addition, large hedge traders would be contacted to inquire about their plans to offset positions and potential delivery intentions. If a trader planned to make or take delivery, NFA would assess his or her ability to fulfill such obligations. NFA also would obtain information on the deliverable supply of a given commodity. If it appeared that market participants could obtain or sell the same commodity at a more beneficial price in the cash market, large traders would be contacted to inquire as to why they considered it advantageous to maintain their position in the futures market.

D. Financial Surveillance

With respect to financial surveillance, Commission Regulation 1.52(c) allows an SRO to delegate its financial examination and surveillance responsibilities to a DSRO for any member-FCM or member-IB that is a member of more than one SRO. NFA would perform MESL�s financial surveillance and examination obligations with respect to those FCMs or IBs for which MESL would act as the DSRO. In this regard, NFA has represented that it would perform the auditing and financial surveillance functions required by applicable Commission regulations and interpretations. These functions would include conducting annual examinations of MESL member firms for which MESL was the DSRO, reviewing periodic financial statements submitted by such firms, and monitoring daily customer funds held in segregation by those firms.

MESL Rule 507 would require all TPHs, including those that were not Commission registrants, to maintain minimum net worth requirements established under MESL�s rules or by the Board. In this regard, TPHs would be required to file annual financial statements with the Exchange and to demonstrate continued compliance with the applicable requirements when requested by the Exchange. TPHs also would be responsible for notifying MESL�s President immediately whenever they knew that their net worth had fallen below the Exchange�s minimum requirements. Until the time when such a TPH demonstrated to the Board that it was in compliance with the Exchange�s minimum net worth requirements, the TPH would be prohibited from engaging in Exchange transactions except for closing open positions.

E. Disciplinary Matters

MESL�s disciplinary process would be comprised of two stages, investigation and prosecution. As explained above, NFA would be responsible for conducting trade practice and market surveillance investigations. Pursuant to MESL and NFA�s agreement, NFA also would prosecute cases before a MESL disciplinary committee. Accordingly, once NFA�s Compliance Department determined that it appeared likely that an investigation would result in a referral for disciplinary action, an NFA attorney would be assigned to the matter. Appeals of disciplinary decisions would be heard by MESL�s Executive Committee.⁸⁵

MESL�s disciplinary committees would include a Business Conduct Committee (�BCC�) and a Hearing Committee. The BCC would be comprised of members of NFA�s own Business Conduct Committee and one MESL representative. Similarly, the Hearing Committee would be comprised of members of NFA�s Hearing Committee and one MESL representative. MESL�s rules would permit both the BCC and the Hearing Committee to appoint panels to consider matters rather than requiring that an entire committee consider a matter.⁸⁶

MESL�s disciplinary rules and procedures would be substantially the same as NFA�s disciplinary rules. Under MESL Rule 703, if NFA determined that there was reason to believe that a MESL requirement was violated, a written investigation report would be submitted to the BCC.⁸⁷ Within 30 days of receiving an investigation report, the BCC would determine whether there was a reasonable basis to believe that a violation occurred. If such a determination was made, a complaint would be issued. If the BCC found that a violation may have occurred but prosecution was otherwise unwarranted, it could issue a warning letter. The BCC also would have the alternative of sending a matter back to NFA for further investigation.

If the BCC issued a complaint, MESL Rule 705 would require that the complaint state each MESL rule alleged to have been violated and each act or omission that constituted the alleged violation. Furthermore, the respondent would be advised that unless a written answer was filed within ten business days of the date of the complaint, the failure to answer would be considered an admission of the facts and legal conclusions stated in the complaint. Failure to request a hearing within the same ten-day time period would be deemed a waiver of a hearing unless good cause was demonstrated.⁸⁸ MESL Rule 706 would provide that, with the exception of a summary TPH or AT responsibility action, a respondent may be represented by an attorney at any stage of an investigation or the disciplinary process.⁸⁹

MESL�s rules provide specific procedures for each step of a full disciplinary action, including pre-hearing procedures, Hearing Committee procedures, the issuance of written decisions, the negotiation and acceptance of settlement agreements, appeals, and the imposition of various penalties. For example, under MESL Rule 709, prior to a hearing, a respondent would be entitled to examine all of the evidence relied upon by NFA or relevant to the complaint. MESL Rule 710 would provide the respondent with the right to appear personally at a hearing and to call and to examine all witnesses.⁹⁰

Permissible penalties under MESL Rule 715 that could be imposed include: (1) a termination or suspension of trading privileges; (2) a bar or suspension for a specified period from association with a TPH; (3) a censure or reprimand; (4) a monetary fine, not to exceed $1,000,000 per violation; and (5) an order to cease and desist.⁹¹ MESL Rule 714(a) would permit a respondent to appeal a Hearing Committee decision to MESL�s Executive Committee by filing a written notice within 15 days after the date of the decision. Under MESL Rule 714(b), the Executive Committee also could review a Hearing Committee decision on its own motion. NFA also could file a petition to appeal a Hearing Committee decision to the Executive Committee, the granting of which would be discretionary by the Executive Committee.

F. Conclusion

The Division believes that MESL has proposed a satisfactory plan for operating effective trade practice surveillance, market surveillance, financial surveillance, and disciplinary programs. Among other things, MESL would: (1) delegate to NFA adequate power to detect, investigate, and take action with respect to rule violations; (2) make use of collected data for real-time monitoring and for post-event audit and compliance purposes to prevent market manipulation; (3) provide a clear framework for ensuring the financial integrity of transactions entered into through MESL; (4) enact rules to deter trading abuses; and (5) establish procedures for impartial disciplinary committees empowered to discipline, suspend, and expel members.

IX. System Security, Vulnerability, and Operational Issues

A. System Overview

The Commission�s Office of Information Resources Management (�OIRM�) has examined the MESL System for consistency with the International Organization of Securities Commissions� ("IOSCO") ten Principles for the Oversight of Screen-Based Trading Systems for Derivative Products (�IOSCO principles�).92 As part of its review, OIRM requested that MESL respond to a set of questions based upon the IOSCO principles. MESL responded to those questions by e-mails dated May 19 and 23, 2000. OIRM reviewed MESL�s responses and had several follow-up conversations with MESL; Exchange Cubed; and IBM, the provider of the MESL System.⁹³

The MESL System is based upon a trading system and matching engine that was first employed by a European equities exchange in 1989. Since then the system has evolved and been modified to meet the needs of other European equities and futures exchanges.⁹⁴ IBM has made minor modifications to an operational version of this application that would enable the system to provide a trading and reporting environment that would be suitable for U.S. futures and option trading.

MESL also has contracted with IBM to act as facility operator for the host equipment and to provide end-user support for customers, roles in which it has extensive experience. The centralized servers and communications equipment would be housed in an existing full-service commercial data center in Toronto, Canada. That data center currently hosts applications for a variety of large commercial enterprises with operational requirements that are similar to or exceed those of MESL.⁹⁵ The data center operator provides physical security for the systems it hosts through the use of access control systems and surveillance cameras, hazardous condition detection, reaction, and notification systems, and multiple power sources. Logical security would be provided for the MESL System through the use of operating system access controls, application-level authentication and access restrictions, and communication firewalls.

IBM also operates a call service center (�CSC�) in Toronto, Canada that would provide toll-free phone support for traders and other market participants. CSC operations are highly integrated with those in the Data Center, and therefore would provide an effective means for responding to trouble calls and otherwise facilitating communications with users. The CSC employs automated systems for problem tracking, support escalation, and notification processes.

A major financial information vendor, Bridge, whose existing private network already extends to many of MESL's prospective customers, would provide the Wide Area Network (�network�) over which the MESL System would be accessed. Strengths of the network configuration include reliability, security and performance.

One or more TPH servers and AT workstations connected to them would provide TPHs and ATs access to the MESL System. Those servers and workstations would be configured with hardware settings and software provided by MESL and must be registered with the Exchange in order for users to gain access to the MESL System. User access would be restricted to individuals registered with MESL using registered equipment with which they have been associated. TPHs would be responsible for management of the equipment and its users. The functionality of the TPH server would enable a TPH to centralize management of the authorization and assignment of its ATs� trading privileges.⁹⁶

The standard configuration of equipment at the premises of a TPH would include two TPH servers, a variable number of AT workstations, and two distinct communication paths between that equipment and the host. In the event of the failure of either server or its communications path, all communications between the host and the TPH would automatically move to the remaining operational path. Coupled with the robustness of the host platform and the network, this configuration would provide a highly reliable trading environment.

Although MESL would not initially maintain a disaster recovery site, the high level of reliability provided by the features and configuration of the MESL System�s components would reduce significantly the likelihood of the occurrence of a disastrous situation. In the unlikely event of a disaster that would require a trading halt, MESL has devised detailed plans to manage the notification and trade management processes related to forced shutdown and restart of the trading environment.

The capacities of the host computer and network facilities of the MESL System have been demonstrated to exceed considerably the level necessary to support projected initial trading volume. Components of the MESL System would be sufficiently scalable to enable MESL to easily increase system capacity to accommodate growth.

B. System Security and Data Integrity

IBM�s facility and the equipment contained therein are protected by a number of systems and procedures. All centralized computer equipment is kept in a locked data center that only is accessible to authorized personnel with an appropriate photo-badge security card. Strategically positioned video cameras enable the 24 hour/7 day on-site security staff to monitor and record activities in controlled areas. Data center personnel periodically review security exception logs generated by that system. Sensors within the building, including within the data center, detect fire and smoke and trigger automated sprinkler systems.

Several safeguards restrict logical access to the MESL System. Two levels of user identification ("ID") and passwords would authenticate users. The first authenticated user ID/password pair would provide access to the local equipment. The second pair would provide access to the host application. Access to the host would be further restricted by a requirement that an authorized user must be at a workstation with a network address that has been registered for use by that user. Authorized users also would be restricted by the network operating system and the application software to those actions for which they had been granted permission. Data Center personnel would monitor security logs to detect attempts at unauthorized access to the MESL System. The first line of defense against unauthorized use of the system would be the 24 hour/7 day active intrusion detection monitoring of all firewalls by the network operations center. Those firewalls would detect and block all unauthorized access attempts and alert system managers of suspicious activity.

The MESL System would employ the fault-tolerant features of the trading platform and network to ensure data integrity. Those features would enable the trading application to recover from an interruption in transaction flow without any loss of data. Communication protocols would ensure end-to-end reliable data transfer. Extensive internal checking by trading host components would ensure that data integrity was maintained during internal processing. Once data had been processed it would be stored on disk. The data on disk is backed up to tape on a daily basis and stored off-site. The MESL System's use of disk mirroring would ensure continuous access to data that had been committed to that medium.

C. System Reliability and Disaster Recovery

The trading application would be operated on a type of server that has a track record for continuous online transaction processing. Redundancy would be provided for essential server components, including the central processing unit (CPU), memory, disk storage and network interface cards. In the event of the failure of any of those components, the operating system automatically would detect the failure, isolate the failed component and recover from the failure. Recovery would be immediate and would have no impact on the application.

To protect against power outages, equipment in the data center is insulated from both short-term and long-term power outages. The data center receives power from two independent power grids through two separate control units. Each control unit is capable of supplying all necessary power to the data center, but only one unit is active. In the event of a failure of the active power grid or its associated control unit, all power requirements automatically switch to the back-up control unit. To protect equipment from power fluctuations, all raw power is fully conditioned prior to distribution to the data center floor. In the event of the failure of both control units, a battery-powered uninterrupted power supply ("UPS") has sufficient capacity to meet the power requirements of the entire data center while back-up diesel generators are automatically brought online. Redundant heating, ventilation and air conditioning units are maintained to provide cooling for the data center.

The long-distance communications network is designed to withstand any single fault in vulnerable components and support systems. Redundant communication lines and associated equipment would provide two paths between each TPH site and the host site. A failure at any point in one path would result in an automatic switch of all circuits to the other path. Both paths would be sized to accommodate the aggregate bandwidth requirements of all circuits mapped across those paths. The communication facilities are protected against power loss by the use of two independent power grids, each of which is backed up by a battery-powered UPS and a diesel generator.

In addition to the reliability of system components, system reliability would be provided by the activities of data center and network operations staff. Those employees would monitor the status of network servers and communications. In the event of a hardware or network problem, they would follow documented procedures for problem identification, reporting and recovery. The overall reliability of the MESL System would minimize the likelihood of a disaster situation. Due to the redundant nature of many system components, most system failures would go unnoticed by customers. In the event of a problem that would impact users, the CSC would be the focal point for tracking and reporting on the status of repair efforts. CSC staff would have access to appropriate support staff in the data center, network control center and application development group for assistance in identifying and correcting any problem. The CSC would maintain communications with users to provide status information and to coordinate with them with respect to any actions that they may be required to perform. It is only at the high end of the disaster scale, that being the total loss of the data center or the network, for which MESL does not currently have a disaster recovery plan that could be executed in a matter of hours or days. However, the probability for such disasters is not considered significant because of the robustness of those system components.

D. System Capacity and Performance

The initial MESL System configuration would be able to accommodate a much greater volume of trading than is expected at launch. Throughout the evolution of the MESL System, IBM has conducted tests to demonstrate the capacity and performance of its system. The results of those tests, both historic and current, support MESL's position that their system would easily accommodate the Exchange�s anticipated initial trading volume. The architecture of the MESL System supports MESL's position that it would be able to scale the system to accommodate significant growth in volume.

Data center staff would collect performance statistics and generate reports on a monthly basis for capacity planning purposes. IBM would work with MESL to upgrade or modify system components as indicated by those reports.

E. Conclusion

MESL, Exchange Cubed, and IBM have fully answered all of OIRM�s questions regarding the MESL System. As a final validation step in conducting its review, an OIRM staff member conducted an onsite review of the IBM Data Center and CSC on May 25, 2000. During that visit OIRM verified the MESL System�s physical and logical security features, observed a mock trading session, and verified the equipment configuration. Based on OIRM�s comprehensive technical review of the MESL System, OIRM believes that MESL has satisfactorily addressed the IOSCO principles for screen-based trading systems. An independent review of the system supports OIRM's conclusion that the MESL System would provide a fair and reliable electronic system for trading futures and options.

The Division recommends that the Commission inform MESL that its approval is based upon written submissions, explanations and representations provided by the Exchange describing the manner in which the MESL System would operate, as well as written submissions, explanations and representations provided by MESL and NFA concerning how NFA would assist MESL in performing the Exchange's self-regulatory obligations. The Division further recommends that the Commission inform MESL that any material modifications to the operation of the MESL System or MESL�s self-regulatory program must be submitted for Commission review.

The Division also recommends that the Commission inform MESL that, notwithstanding NFA�s role in operating the Exchange�s trade practice surveillance, market surveillance, financial surveillance, and disciplinary programs, MESL would be responsible for enforcing the terms of its Operating Agreement and all Exchange rules, and for maintaining an effective affirmative action program to secure compliance with applicable provisions of the Act, the Commission�s regulations, and MESL�s own rules.

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1 Since December 1998, MESL has been operating an inter-dealer exchange for barge freight in the cash market as the successor to the Merchants� Exchange of St. Louis, a not-for-profit entity organized in 1836 for the purpose of trading cash and futures products. The Merchants� Exchange of St. Louis ceased trading futures contracts prior to the Commission�s creation.

2 A summary of those comments, all of which address economic issues, can be found in a separate memorandum prepared by the Division of Economic Analysis which discusses the terms and conditions and the economic justification for MESL�s proposed contracts.

3 While not formal submissions, Commission staff met with NFA and MESL in Chicago on May 2 and June 2, 2000 to gain a better understanding of the MESL System and NFA�s trade practice surveillance, market surveillance, and disciplinary programs. In addition, on May 25, 2000, Commission staff visited the MESL System�s host facility in Toronto, Canada and the service center that would operate a help desk for the MESL System. See Section IX. below for a discussion regarding the security, vulnerability, and operation of the MESL System.

4 For example, due to the electronic nature of the MESL System and its attendant lack of a physical trading floor, a number of regulatory provisions that would apply to contract markets with open outcry floor trading would not apply to MESL.

5 A limited liability company�s operating agreement is comparable to a partnership agreement for a limited partnership or the combination of a corporation�s by-laws and a shareholders� agreement. The provisions of MESL�s Operating Agreement, which were included as part of MESL�s designation application, would be considered �rules� under Commission Regulation 1.41 which defines the term �rule� to include both articles of incorporation and bylaws.

6 See Section V.A.

7 MESL�s structure differs from the structure of most other contract markets in that it is not a non-profit membership organization. Neither the Act nor the Commission�s regulations, however, mandate a particular form of organization for a futures exchange. Further, there are various precedents for such an arrangement in the futures industry. Current members of the Mid-America Commodity Exchange (�MidAm�) (which is wholly owned by the Chicago Board of Trade (�CBOT�)), and the New York Futures Exchange (�NYFE�) (which is wholly owned by the New York Cotton Exchange (�NYCE�)) only have trading privileges, and neither governance authority nor equity interests, at their respective exchanges. MESL also is similar to FutureCom, LTD. ("FutureCom"), which is owned by its developers and is intended to be operated with the objective of making a profit. The Kansas City Board of Trade, which incorporated in 1973, also operates as a for-profit entity.

8 MESL Rule 129. Under Section 1a(15) of the Act and Commission Regulation 1.3(q), any individual or entity granted trading privileges at an exchange is considered a �member� of that exchange.

9 REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.

10 Mr. Jump (REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT) would serve as Chairman of MESL�s Board of Managers (�Board�), Treasurer, and Secretary. REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.

11 REDACTED MATERIAL SUBJECT OT CONFIDENTIAL TREATMENT.

12 No member of MESL's ownership group is subject to a statutory disqualification under Section 8a(2) of the Act.

13 As discussed below, Messrs. Jump, Tweedy, and Bartling would serve on MESL�s Board and Mr. Jump also would serve as MESL�s Secretary and Treasurer. Accordingly, they would be subject to MESL Rule 211 and Section 9.12. of MESL�s Operating Agreement which would prohibit Board members, officers, and any MESL committee members from using or disclosing material, nonpublic information.

14 For these purposes, Commission Regulation 1.63(a)(6) generally defines �disciplinary offense� to mean a serious violation of an SRO rule or a violation of the Act or the Commission�s regulations. Persons may be ineligible to serve on an exchange governing board for a longer period if they remain subject to a continuing disciplinary sanction, such as a registration revocation or suspension.

15 From June 1993 through April 1997, Mr. Hickey was President and Chief Operating Officer of a publicly-traded manufacturer and marketer of health care products. From July 1998 through January 2000, he held these same positions for another publicly-traded company in the medical device field. Currently, Mr. Hickey serves as a member of the board of directors for several companies.

16 Mr. Jump�s previous job positions include commodity buyer and merchandiser.

Mr. Tweedy currently manages three CBOT deliverable grain facilities.

Mr. Bartling is the President and CEO of International Commodities, Ltd. and also is a commodities specialist for the Farmers Commodities Corporation. His prior positions include grain merchandiser, barge corn trader, and hedging specialist.

Mr. Stewart previously worked for Cargill, Inc. as a business analyst and in various management positions for six years prior to joining the Exchange. He also is an attorney.

17 Section 5.03.G. of MESL�s Operating Agreement defines a �quorum� as a majority of the Managers.

18 Section 5.03.H. of MESL�s Operating Agreement permits the Board, by resolution adopted by a majority of Managers, to designate one or more Managers to constitute a committee. MESL has indicated that it may select additional Managers to serve on the Executive Committee.

19 As discussed in Section V.B., ATs would be authorized representatives of TPHs.

20 This complies with the Commission�s Policy Statement of Indemnification of Exchange Officers, Directors and other Officials. 41 Fed. Reg. 29474 (July 16, 1976).

21 MESL Rule 109 would define �emergency� as any occurrence or circumstance that the Board determines requires immediate action and threatens or may threaten such things as fair and orderly trading in, or the liquidation of or delivery pursuant to, any Exchange contract.

22 MESL Rule 419(b) would authorize, in the order of respective availability, the President, the Chairman, or the senior available Vice President, to take necessary action to deal with physical emergencies. Authorized actions would include delaying the opening, extending trading hours, or suspending trading in any one or more Exchange contracts. Suspension of trading may not last more than five business days unless approved by a majority of Managers. In the absence of Board action, restrictions imposed in response to a physical emergency may be removed by any of the persons authorized to impose such restrictions if the attendant circumstances have sufficiently abated. Any action undertaken in response to a physical emergency would be subject to review, modification, and/or reversal by the Board.

23 MESL represented that subsequent to its designation as a contract market, the Exchange would seek Commission approval to arbitrate claims relating to delivery issues in accordance with National Grain and Feed Association Barge Freight Trade Rules.

24 Pursuant to Commission Regulation 170.8, NFA's arbitration rules are consistent with Section 17(b)(10) of the Act and with Part 180 of the Commission's regulations.

25 MESL Rule 128 would define trading privileges as a "license to access the MESL System to place orders for any Exchange Contract traded on the Exchange." MESL Rule 129 would define a TPH broadly to include "any person approved by the Board to hold trading privileges on the Exchange." Further, MESL Rule 129 would clarify that, for these purposes, "person," would include both individual persons and entities.

As noted above, MESL TPHs would only hold trading privileges; they would not have equity or voting rights in the Exchange. Equity interests and voting rights would be held by the ownership of MESL who, conversely, would have no trading privileges at MESL unless approved pursuant to MESL Rule 301. TPHs also would be ineligible to receive any dividends or distributions (of cash, securities or other property) whether arising from a dissolution, merger, consolidation or otherwise.

26 Each TPH that was registered with the Commission as a futures commission merchant ("FCM") or introducing broker ("IB") would need to comply with the minimum financial requirements set forth in the Commission regulations, including Regulation 1.17's adjusted net capital requirements. Under MESL Rule 507, non-registered TPHs must maintain a net worth of at least $100,000.

27 MESL Rule 304.

28 See IV.B.4.

29 MESL Rule 305.

30 MESL Rule 302.

31 MESL Rule 101 would define "Authorized Trader" to include "any natural person who is employed and authorized by a TPH to place orders for Exchange Contracts on the MESL System." MESL Rule 303 would require that ATs: (1) must be natural persons and, (2) may only be employed/associated with non-natural TPHs.

32 The Commission recently required authorized employees of individuals or firms with trading privileges at the Chicago Mercantile Exchange ("CME") and CBOT, who act in a similar capacity, to register as APs. See CME Rule 574 and CBOT Rule 9B.11.

33 MESL Rule 608 would hold TPHs responsible for supervising their ATs and would hold TPHs accountable for their ATs' actions.

34 When the Commission adopted Regulation 1.3(x) and its definition of "floor trader," it specifically stated its intention not to include presumptively in that definition individuals who traded only for proprietary accounts on electronic trading systems. The Commission chose to defer the issue of such persons' registration for later consideration because at the time the immediate impetus for creating the floor trader registration category was specifically to safeguard against the types of abuses made possible by the trading floor environment and because the scope of the registration requirement could be affected by differences between electronic and trading floor environments. See 58 Fed. Reg. 19575, 19576 (April 15, 1993). The Division believes that the Commission's basis for making that determination would continue to apply in the case of MESL TPHs trading only for their proprietary accounts at MESL. The Division will continue to monitor trading on MESL and other automated trading systems in order to determine whether conditions warrant recommending changing this policy.

35 In addition, MESL also would provide a Risk Disclosure Statement to TPHs, for their own and customer use. Part One of MESL's Risk Disclosure Statement describes the risks inherent in trading on futures contracts generally. Part Two of the Risk Disclosure Document describes the risks that are unique to trading on electronic exchanges, in general, and MESL, in particular.

36 MESL Rule 412. See Section VIII.A. for further discussion of MESL's audit trail and record keeping requirements.

37 MESL's price/time priority trade-matching algorithm would be very similar to the algorithms used by CME (Globex), CBOT (Project A), New York Mercantile Exchange ("NYMEX") (ACCESS) and FutureCom.

38 Market, fill-or-kill and immediate-or-cancel orders, described more fully below, would not be displayed to the market. Public order view windows would provide market participants with information about active orders from all TPHs for screen-based trading. The public order view windows, which could only be configured by contract type, would not display individual limit orders but would consolidate them by contract, price, quantity and side of the market (buy/sell). They also would provide information on full market depth and the equilibrium price for a contract. See note 46 below. ATs' public order view windows could contain all (or a subset) of the entries displayed on the public order view for the contracts that they were authorized to trade. TPHs' public order view windows could contain a display of all of the contracts that their ATs are authorized to trade. Public order view windows could be customized. For example, TPHs would have the ability to specify whether the above-referenced information would be updated (refreshed) automatically, updated at a given time interval, updated in real time whenever a selected event occurs, updated when specific event(s) occur, or never updated automatically.

39 A "market order" would be an order to buy or sell a futures contract at whatever price was obtainable at the time the order was submitted to a centralized market for execution. A "limit order" would be an order which specified a price limit or other condition, such as time of an order. MESL limit orders would be designated as good-until-filled, day-trade or good-til-date.

40 A "fill-or-kill order" would be an order that must be executed in its entirety when entered into the MESL System, or else, if not immediately executed, the order would be cancelled. An "immediate-or-cancel order" would be an order that must be executed in whole or in part upon entry into the MESL System. If an immediate-or-cancel order was not immediately executed, the entire order or any part of the order that remained unfilled would be treated as cancelled.

MESL Rule 412 would require TPHs and ATs who entered orders into the MESL System to input for each order, the price, quantity, commodity, contract month, account designation (the number assigned by a TPH to each of its accounts, both proprietary and customer), CTI code and, for options, the strike price, "put" or "call," and expiration month.

41 EFPs are more fully explained in Section VI.F. below.

42 An order's life would be determined by its description as either a good-until-filled, day order or a good-til-date order. Unfilled good-until-filled orders would remain open until filled or canceled. Unfilled day-trade orders would be canceled at the end of the day. Unfilled good-til-date orders would remain on the MESL System until executed, canceled, or the specified calendar date triggering the order's cancellation had been reached.

43 For example, assume that Trader A and B entered identical orders into the MESL System, but Trader A's order was entered at 12:01:01.0018 and Trader B's order was entered at 12:01:01.0022. They each would be assigned the same order entry time of 12:01:01.002, but Trader A's order would be accorded time priority over Trader B's order.

44 The unfilled portion of A�s limit bid would remain in the MESL System and would be eligible for matching.

45 Trader E's market order would be matched against Trader B's, C's and D's respective offers even though each of these limit offers was entered after Trader A's limit offer of three contracts for 72.00 because they would each have price priority over Trader A's offer.

46 If , however, Trader E's fill-or-kill 30 bid at 1.55 did not have priority or if the prevailing offers were not sufficient to fill 30 contracts, then Trader E's entire order would have been automatically cancelled.

47 Unless otherwise stated herein, all time references denote Central Time.

48 Equilibrium value would be determined by the buy pressure and sell pressure where the largest volume of trading can occur.

49 If unfilled, a day order from a previous trading session must be reentered into the MESL System to be eligible for matching at the open. If unfilled, good-until-filled and good-til-date orders from a previous trading session need not be reentered into the MESL System to be eligible for matching at the open.

50 During the period between 8:29 a.m. and 8:30 a.m., the Exchange also would prohibit the modification or cancellation of any order that was previously entered into the MESL System.

51 The buy (sell) order volume column reflects the total volume of buy (sell) orders that could be executed at the specified price or higher (lower).

52 Twenty-two trades would occur at an opening price of 1.600 as opposed to 10 trades at 1.599.

53 Trade volume established the opening price as 1.600. There would be cumulatively 22 contracts to buy at the opening price of 1.600. The ten-lot sell order at 1.598 has price priority over the 20-lot sell order at 1.600. Therefore it would execute first and would receive an "or better" fill at 1.600. The remaining 12 contracts (cumulative 22 minus the executed 10) would then execute based upon time of entry to partially fill the 20-lot sell order at 1.600.

54 The closing range would be defined as the last 30 seconds prior to the close of the trading session.

55 For example, if the final bid of the trading session was 1.599 and the final offer was 1.601, and no trades were executed within the closing range, the last trade would establish the closing price provided it was at a price of 1.599, 1.600 or 1.601 (the closing range).

56 MESL Rule 404.

57 Under MESL Rule 418, the elements of a bona fide EFP would be: (1) a futures transaction and a cash transaction which are integrally related; (2) an exchange of futures contracts for the cash commodity, where the cash commodity contract provides for the transfer of ownership of the cash commodity to the cash buyer upon performance of the terms of the contract, with delivery to take place within a reasonable time thereafter in accordance with prevailing cash market practice; and (3) separate parties to the EFP, where the accounts involved have different beneficial ownership or are under separate control.

58 Id.; See also Commission Regulation 1.38 which requires that all purchases and sales of any commodity for future delivery which are executed in a noncompetitive manner be conducted in accordance with the rules of a contract market which specifically provide for such executions. Regulation 1.38 also requires persons involved in permissible noncompetitive transactions to identify them as such on all records pertaining thereto.

59 MESL Rule 418 would be similar to Cantor Financial Futures Exchange ("CFFE") Rule 305 which requires that, upon request, CFFE clearing members to an EFP transaction obtain and produce documentation of the underlying cash component.

60 To assist in its determination as to whether a particular transaction was a bona fide EFP, NFA would request all relevant documentation, including cash commitment, necessary to satisfy its inquiry. See also Section VIII.B.1.b. below.

61 See Concept Release regarding "Regulation of Noncompetitive Transactions Executed on or Subject to the Rules of a Contract Market," citing October, 1987, "Report of the Division of Trading and Markets: Exchange of Futures for Physicals." 63 Fed. Reg. 3708, 3711 (January 26, 1998).

62 Futures Trading Practices Act of 1992, Pub. L. No. 102-546, 106 Stat. 3590 (1992).

63 BOTCC is a privately-held, for-profit corporation chartered in the State of Delaware.

64 BOTCC/MESL rules to be implemented specifically for MESL clearing and settlement purposes generally would pertain to the following topics: (1) establishment of a risk committee to review applications for clearing membership and members' continued compliance with BOTCC's membership requirements; (2) emergency procedures for emergency circumstances referenced in the Act; (3) the method of clearing commodities for MESL contracts; (4) margins; (5) deliveries; and (6) bankruptcy and member default.

65 BOTCC does not require its member firms to contribute to a guaranty fund. Instead, BOTCC requires all clearing members to purchase shares of BOTCC stock based on their respective levels of trading volume and margin requirements. Outstanding shares of stock are periodically reallocated among members pursuant to BOTCC Bylaws in order to ensure that each member's relative share of ownership reflects each member's relative volume and margin requirements during the preceding twelve-month period. In the event of a clearing member default, BOTCC has substantial financial resources available REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.

66 MESL Rule 402.

67 MESL would not permit the busting of error trades under any circumstance.

68 REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.

69 NFA has established a Compliance Department, led by Yvonne Downs, Senior Vice President of Compliance, to perform these responsibilities. Prior to joining NFA in February 2000, Ms. Downs worked at CBOT for 21 years. For the last 12 of those years, Ms. Downs headed CBOT�s Office of Investigations and Audits (�OIA�), most recently serving as Senior Vice President of OIA and Trade Routing. In this capacity, she played a key role in designing and implementing CBOT�s electronic surveillance system, the Sophisticated Market Analysis Research Technology system. Initially, Ms. Down�s staff for conducting MESL�s trade practice and market surveillance would include three analysts. NFA�s Compliance Department also would continue to work closely with NFA�s Information Systems Department in further developing its automated surveillance systems, described below.

70 Mr. Heath worked previously at both CBOT and BOTCC. At CBOT, he served as Vice President and Administrator of OIA. At BOTCC, he served as Executive Vice President in charge of membership approvals, the Margin and Settlement Department, and the Risk Group.

71 The Division also notes that even without this interpretation of Regulation 1.59's definition of employees, all NFA employees are already prohibited under Regulation 1.59(b)(1)(i) from trading in any futures contract for which they have material non-public information because of NFA's status as a registered futures association. In addition, the Division notes that Section 3b of NFA's Code of Professional Conduct ("Code") already prohibits NFA employees from engaging in conduct prohibited by Commission Regulation 1.59(b). In particular, Section 3b of the Code prohibits NFA employees from �[acquiring or retaining] any direct or indirect financial interest in a futures account, leverage account or similar account (excluding a stock-option account) or margin account. NFA has represented that it would not amend the Code without first notifying the Commission. The Division would treat any such notice as a rule submission pursuant to Section 17(j) of the Act.

72 The Division understands that FutureCom also is contemplating hiring NFA to perform trade practice surveillance. A number of futures exchanges currently use affiliated exchanges to perform their self-regulatory responsibilities. For instance, the New York Board of Trade (�NYBOT�) handles compliance and surveillance responsibilities for CFFE. However, CFFE is not independent of NYBOT, as it is owned by NYBOT�s component exchanges--NYCE and the Coffee, Sugar & Cocoa Exchange, Inc. and their respective members.

73 MESL Rule 412, which implements the provisions of Commission Regulation 1.35(a-1) and (2)(i), would require that the following information be input for every futures order input into the MESL System: (1) price; (2) quantity; (3) commodity; (4) contract month; (5) order type; (6) CTI code; and (7) account designation. If MESL were to trade options on futures, the strike price, �put� or �call,� and expiration month also would have to be input.

On February 20, 1997, the Commission published an Advisory which provided that to the extent that an electronic trading system electronically recorded the customer order information required under Commission Regulation 1.35 (a-1)(1) and (2)(i), and satisfied certain standards, then a �written� record of such order need not be prepared (62 Fed. Reg. 7675). The MESL System would satisfy the necessary standards in that, for every order entered into the system, an electronic record would be generated that would include any modification made to an order, including any change or correction, as well as the time that the modification was recorded. An accurate record of when and by whom records were accessed and modified also would be maintained. In addition, the MESL System would capture all order-related times to the nearest thousandth of a second.

74 NFA has indicated that it is negotiating to provide its surveillance services to several other prospective exchanges. NFA would operate a dedicated server for each exchange for which it provided these services.

75 A relational database is a collection of data items organized as a set of formally described tables from which data could be accessed or reassembled in many different ways without having to reorganize the database tables. With respect to NFA receiving MESL data, MESL would transmit trade data to NFA at the end of each trading day and NFA would review the data on a T+1 day basis. Initially, the data would be provided to NFA electronically via e-mail. The transmitted data would include all order activity; all trades matched by the MESL System; all trades cleared by BOTCC; any changes to orders, matched, or cleared trades; and all quote requests. With respect to orders and matched trades, NFA has established a set of standard data requirements that MESL must satisfy.

76 With respect to trading patterns, the profiles would include, among other things, average time logged on per day; frequency of trading; average size of trades; users who are frequently on the other side of trades; intra-day timing of trades (on the open, on the close, early and late in the trading session); intra-month timing of trades (more activity at the beginning or end of the month); volume; and position duration. NFA�s performance profile would show profit and loss on a daily, weekly, monthly and year-to-date basis. The trade record may not, however, necessarily indicate whether a particular trade initiated or offset a particular existing position. Rather, it would simply highlight a potential profit or loss on a position.

77 MESL would not be the first exchange to modify CTI codes. On April 3, 1986, the Commission approved NYFE�s implementation of a new CTI code, CTI 5 (trade executed for a NYFE member not present on the floor). On January 15, 1988, the Commission approved NYFE�s addition of two more CTI codes, CTI 6 (trade executed by a Class A member for his or her own personal account) and CTI 7 (trade executed by a permit holder for his or her own account).

78 NFA�s CTI codes for MESL would be as follows: CTI 1- a user trading for his or her own account; CTI 2- any user trading for the benefit of a MESL clearing firm�s account; CTI 3� a user trading for the benefit of another user or utilizing discretion over another user�s account; and CTI 4- non-user transactions (customers). In the context of CTI codes and exception reports, �users� would include TPHs and ATs.

79 In addition to utilizing the User Log-on/Log-off Report to monitor usage of the MESL System, NFA has represented that it would randomly telephone users to verify that the person currently entering orders was the user assigned the unique identifier and password used to access the MESL System.

80 MESL Rules 601 through 615 would in accordance with Sections 4b and 4c of the Act and Commission Regulations 155.2 and 155.3, prohibit various trading abuses associated with dual trading. Toward that end, NFA�s exception reports would target such abuses, including pre-arranged trading, withholding orders from the market, trading ahead of customer orders, disclosing customer orders, and taking the opposite side of a customer order.

81 An agency trade would be a trade where one or both sides of a trade was for a customer order. A non-agency trade would involve no customers, only users trading for their own accounts. MESL would have both agency and non-agency trades.

82 NFA intends to obtain information regarding large traders from firms and BOTCC and would develop a database that contained the name and address of the respective account controller. NFA would query this database by name and address to determine possible affiliations. The open positions of large traders then would be reviewed, and, if it appeared that account holders or controllers were related, a determination would be made as to whether or not these accounts should be combined for analysis purposes. If there were speculative position limits, these limits would be cross-checked against large trader positions to determine if any controllers exceeded the limits. If it appeared that any one trader or controller had a concentration in a given commodity, they would be contacted to determine the reason for the concentration.

83 Those reports would include the following information: (1) total open interest for each commodity by contract month and a listing of large traders with their respective holdings, including an indication of account type, hedge or speculative, and the net changes in these items since the previous report; (2) the cause of change in open interest (e.g., EFPs or transfer trades); (3) the profit and loss for large traders monthly, the past 90 days, and year-to-date; (4) the spread differential between the two nearest contract months; (5) the total exposure by a large trader in a given market; (6) cash information and the current basis; (7) inverted markets and the reasons for the inversion; and (8) futures pricing information from exchanges that trade similar products.

84 Alerts would be generated for any market if the following were to occur: (1) a limit move up or down; (2) two consecutive days of limit moves in the same direction; (3) a three-day cumulative price change of eight percent or more; (4) a four-day cumulative price change of ten percent or more; (5) a five-day cumulative price change of 12 percent or more; or (6) a ten-day cumulative price change of 15 percent or more.

85 See Section IV.B.4. above for a discussion of MESL�s Executive Committee.

86 Panels of the BCC and Hearing Committee would include three members from the respective committee. Each such panel�s members would be required to have one MESL representative. MESL Rules 208 and 209.

87 Consistent with Commission Regulation 1.69, MESL Rule 703(c) would prohibit a BCC member from participating in a matter if the member, or any person with which the member is connected, had a financial, personal, or other direct interest in the matter under consideration.

88 If a respondent waived his or her right to a hearing, NFA�s Compliance Department could submit testimonial or documentary evidence to the Hearing Committee without notice to the respondent. The respondent would be prohibited from objecting to evidence, cross-examining witnesses, or presenting evidence on his or her own behalf. MESL Rules 705(b)(ii) and 708(c).

89 Consistent with Commission Regulations 8.25 and 8.26, MESL Rule 716 would provide procedures for the Exchange to summarily suspend a TPH or AT if the President, with the concurrence of the Board or Executive Committee, had reason to believe that such action was necessary to protect the markets, customers, or other TPHs. Among other things, the procedures would require that the respondent be provided an opportunity for a hearing promptly after the summary action was taken. Although the respondent would not be entitled to representation prior to the summary action, MESL Rule 716(b)(iii) would permit the respondent to be represented by counsel during the hearing.

90 MESL Rule 710 also would prohibit a member of the Hearing Committee from participating in a matter if the member, or any member with which the member is connected, had a financial, personal, or other direct interest in the matter under consideration.

91 With the exception of the termination of trading privileges, any of the penalties could be imposed by the BCC, a BCC panel, the Hearing Committee, a Hearing Committee panel, or the Executive Committee on appeal or review. With respect to the termination of trading privileges, MESL Rule 715(a)(i) would require a two-thirds vote of the members of the Hearing Committee panel or the Executive Committee present.

92 IOSCO Technical Committee, Report on Trading Systems for Derivative Products (June 1990). The IOSCO principles were adopted by the Commission on November 15, 1990. 55 Fed. Reg. 48670 (November 21, 1990).

93 Similar to NFA employees providing compliance and surveillance services to MESL, Exchange Cubed employees employees involved in providing services to MESL would be subject to a total trading prohibition in futures contracts traded on MESL. See note 71 above.

94 The trading system that would be the foundation of the MESL System is currently used by the Italian government securities market, the Bank of Greece, the New Delhi Stock Exchange, and the Amsterdam Exchanges� Options Exchange.

95 For example, the Toronto data center hosts the applications REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.

The Division and the Commission's Office of General Counsel do not believe that the location of MESL hardware in Toronto would impede the Commission's oversight of MESL or prevent MESL from being able to meet its self-regulatory responsibilities. By letters dated April 4 and May 5, 2000, MESL represented that it was not aware of any Canadian regulatory authority that would impose jurisdiction over MESL or the MESL System due to the host location. The Division notes that the Commission and the Ontario Securities Commission (�OSC�) are signatories to a Memorandum of Understanding (�MOU�) that permits the Commission to seek OSC�s assistance to secure enforcement of or compliance with the Act or Commission regulations as they relate to, among other things, the conduct of futures business by exchanges. Such assistance includes obtaining information and documents from persons and companies. The MOU provides that such assistance will be provided even when the subject matter of the request for assistance does not constitute a violation of the laws or regulations of the OSC. MESL also has represented, by letter dated June 23, 2000, that, �notwithstanding the location of any and all of the books and records of the MESL, MESL shall provide the Commission with access rights to inspect such books and records during normal business hours at any such location."

96 The TPH server also would enable ATs to perform certain actions offline, such as entering orders, while trading and monitoring market conditions online. For example, a user could enter and save an �inactive order� that would be sent through the network to the MESL System at a later time. An inactive order would reside only on the user�s terminal until such time that the inactive order was activated and sent into the MESL System. Thus, the MESL System would have no record of an inactive order until such time that the order was transmitted to the system. MESL Rule 412 would require that a written order ticket be prepared for an inactive order if the order was for a customer.