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4./\a8/l- 101-16
COMMODITY FUTURES IMPROVEMENTS
ACT OF 1989
HEARINGS
RKFORIt niX
SUBCOMMITTEE ON CONSERVATION, CREDIT,
AND RlTKAi DEVELOPMENT
or THE
COMMITTEE ON AGRICULTIIKE
HOUSE OP REPRESENTATIVES
ONE HUNDRED FIRST CONGRESS
FIRST SESSION
ON
H.R. 2869
JULY 18 AND 2«. 1989
Serial No. 101-26
OS «Ba«r. wl»
Printed for the use of the Committee on Agriculture
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COMMODITY FUTURES IMPROVEMENTS
ACT OF 1989
HEARINGS
BEFORE THE
SCBCOMMITTBB ON CONSERVATION, CREDIT,
AND KUEAL DEVELOPMENT
OFTHK
COMMITTEE ON AGEICULTUEE
HOUSE OF EEPKBSENTATIVES
ONE HUNDRED FIRST CONGRESS
H.R. 2869
JULY 18 AND 20, 1989
Serial No. 101-26
Printed for the use of the Committee on Agricultur
51 "2SU 1
3/l» 1
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COMMITTEE ON AGRICULTURE
E IKIKA) DE LA GARZA. Texas. Chairmon
WALTER B, JONES. North Carolina
GEORGE E BROWN. Jr., California
CHARLES ROSE, North Carolina
■GLENN ENGLISH. Oklahoma
LEON E. PANETTA. California
JERRY HUCKABY, Louisiana
DAN GLICKMAN, Kansas
CHARLES W STENHOLM, Texas
HAROLD L. VOLKMER. Missouri
CHARLES HATCHER. Georgia
ROBIN TALLON. South Carolina
HARLEY O STAGGERS, Jr.. West ViTginiH
JIM OLIN. Virginia
TIMOTHY J. PENNY, Minnesota
RICHARD H. STALUNGS. Idaho
DAVID R. NAGLE, Iowa
JIM JONTZ, Indiana
TIM JOHNSON. South Dakota
CLAUDE HARRIS. Alabama
BEN NIGHTHORSE CAMPBELL, Colorado
MIKE ESPY, Mississippi
BILL SARPAUUS. Texas
JILL L. LONG, Indiana
ROY DYSON, Maryland
H. MARTIN LANCASTER. North Carolina
EDWARD R MADIGAN. Illinois.
Hanking Minority Member
E. THOMAS COLEMAN. Missouri
RON MARLBNEE. Montana
LARRY J, HOPKINS, Kentucky
ABLAN STANGELAND, Minnesoti
PAT ROBERTS. Kansas
BILL EMERSON. Missouri
SJD MORRISON. Washington
STEVE GUNDERSON, Wisconsin
TOM LEWIS, Borida
ROBERT F. IBOBI SMITH, Orvgon
LARRY COMBEST. Texas
BILL SCHUETTE, Michigan
FRED GRANDY, Iowa
WALLY HERGER, California
CLYDE C. HOLLOWAY. Uniisians
JAMES T. WALSH, New York
BILL GRANT. Florida
pROPEssioNAL Staff
BebT R. PeSa. Staff Director
Daniel E. Brinza, Couiael
ChaSLeS HiLTY. Minority Staff Director
James A. Daves, Presi Secretary
Subcommittee on CoNaERVATtON, Crbdit, and Rural Development
GLENN ENGLISH, Oklahoma. CAoimwn
ROBIN TALLON, South Carolina
TIMOTHY J, PENNY, MinnesoU
RICHARD H STALLINGS. Idaho
DAVID R. NAGLE, Iowa
CLAUDE HARRIS. Alabama
HARLEY O. STAGGERS, Jii.. West Virginia
MIKE ESPY, Mississippi
BILL SARPAUUS. Texas
JILL L. LONG, Indiana
E. THOMAS COLEMAN, Missouri
SID MORRISON, Washington
STEVE GUNDERSON. Wisconsin
LARRY COMBEST. Texas
FRED GRANDY, Iowa
CLYDE C. HOLLOWAY, I
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CONTENTS
JULT 18, 1989
H.R. 2869, a bill to amend the Commodity Exchange Act to improve the
regulation (^ futures and options traded under rules and regulations of the
Commodity Futures Tradiiu Coromisston, establish registration standards
for all exchange floor traders, restrict practices which may lead to the
abuse of outside customen itf the marketplace, reinfbrce development of
exchange audit trails to better enable the detection and prevention of such
practices, eatatilish higher standards for service on governing boards and
disciplinary committees of self-regulatory organizations, enhance the inter-
national regulation of futures trading, regularize the process of authorizing
appropriations for the Commodity Futures Trading Commission, and for
other purposes...
Reports from Commodity Futures Trading Commisi
Report from U.S. Department of Justice...
Coleman, Hon. E. Thomas, a Representative in Congress from the State of
Missouri, opening statement
English, Hon. Glenn, a Representative in Congress from the State of Oklaho-
ma, opening statement
" "' ' " ' ■■ ' 1 Congress from the State of Ala-
Beurskens, Frank, on behalf of the National Grain and Feed Association
Prepared statement
Braude, Michael, president and chief executive offlcer, Kansas City Board of
Trade..
Prepared statement ...
1, Wendy L., Chairman, Commodity Futures Trading Commission...
Prepared statement
Letter of August 15, 1989....
Guttman, Z. Lou, chairman of the board of directors. New York Mercantile
Exchange....
Prepared statement
Letter of July 21, 1989
Smith, Hon. Neal, a Representative in Congress from the State of Iowa....
Prepared statement
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Eni^iah, Hon. Glenn, a Reprenntatm in Congraw frim the State of Okltiho-
ma, opening statement
WiTNnsn
Danker, Dave, vice president and general manager. Buchheit Grain, Inc
Prepared statement
Predrickson, John L., partner, KentUnd Eaevator and Supply, Inc
Prepared statement
" 1, Sanford J., profeaaor, department irf economics, Princeton Univer-
nty^....
_ repared statement
Joaaerand, Robert D., preddent, Natitntal Cattlemen's Association ~
Prepared statement „ _....
Kane, Joaeph J., floor broker, Chicago Board of Trade ,..«».».,. -.,..„.,...
Prepared statement _.„._ _ „.
Lebeck, Warren, on behalf of the National Grain Trade Council
Prepared statement „.„.„...«,..».>.»».^.
Lindau, James H., president, Minneapolis Grain Exchange _..»^
Prepared statement - «»—.„«„.«....
Hahlmano, Karsten, chairman, Chicago Board of Trade „.^ „.
Prepared statement -
Melamed, Leo, chairman of the executive committee and special counoel to
the board, Qiicago Mercantile Exchange
Prepared statement
Weems, Ralph, farmer, former president, American Soybean Association
Wibnouth, Robert K., president. National Futures Aseodation
Prepared statement ^
SuBMrrrxD Matkbial
Cheatham, linn, vice president, Logan County Farm Enterpriaes, Inc., letter
of July 10, 1989
Clancy, Gerald P., cocoa purchasing director, M&M, Mare, Inc., letter of
July 11, 1989
Conlin, Donald B., chairman of the board, New York Cotton Exchange, letter
of July 26, 1989
Dyer, Daniel L., partner, B. W. Dyer and Co., letter of July 18, 1989
Felton, Douglas, president, Amerop Trading Corp., letter of July 31, 1989
Flegenheimer, Mark, vice president, Amerop Sugar Corp., letter of July 31,
1989
Haller, RJ., president, Czarnikow Futures Inc., letter of July 25. 1989
Huber, Daniel R., group vice president, Carrall Inc., statement
Lawrence, Gary D., managing director, J.P. Morgan Futures, Inc., letter of
July 14, 1989
Lucas, Joe, merchandiser, Penwright Grain Co., letter of June 29, 1989
Vogel, Sarah, agriculture conuniaeioner, North Dakota, statement
Stone, Matthew, president, Weetway Merkuria Corp., letter of July 31, 1989 ....
Wildin. Doug, letter of July 26, 19M
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COMMODITY FUTURES IMPROVEMENTS ACT OF
1989
TUESDAY, JULY 18, 1989
House of Representatives,
Subcommittee on Conservation,
Credit, and Rural Development,
Committee on Agriculture,
Washington, DC
The subcommittee met, pursuant to notice, at 10 a.m., in room
1302, Longworth House C^ce Building, Hon. Glenn English (chabv
man of the subcommittee) presiding.
Present: Representatives Tallon, Penny, Stalling, Naele, Harris,
Stagers, Espy, Sarpalius, Long, Coleman, Morrison, Gunderson,
Combest, Grandy, and Holloway.
Also present: Representative E (Kilca) de la Garza, chairman of
the committee, and Representative Glickman, member of the com-
mittee.
Staff present: Bert R. Peiia, stftff director; Daniel B. Brinza, coun-
sel; Fred J. Clark, associate counsel; Joseph Muldoon, assistant
counsel; John E. Hogan, minori^ counsel; Alice Devine, minority
associate counsel; Glenda L. Temple, clerk; Bill Cherry, Jim
McDonald, James A. Davie, and David Ebersole.
OPENING STATEMENT OF HON. GLENN ENGLISH, A REPRESENTA-
TIVE IN CONGRESS FROM THE STATE OF OKLAHOMA
Mr. Engush. The hearing will come to order. Last February
Chairman de la Garza directed this subcommittee to conduct an in-
quiry into the futures r^ulatory structure before taking up any re-
authorization bills.
The work plan that we developed started with this statement:
The purpoee of the inquiry is to provide a sound factual basis for the Congreaa to
use while considering the need for changes in futures industry operations and regu-
lation. The ultimate goat is to assure the int^rity of these markets.
The subcommittee has provided the sound factual beisis during
the past 5 months through the pubUc briefingB by our staff. Today
we begin hearings aimed at the ultimate goal. The bill that Con-
gressmen Coleman, Tim Penny, and I introduced last week makes
drastic changes in some of the trading practices, especially in dual
trading.
The bill restricts the practice of a floor broker trading for both
his own account and that of customers, known as dual trading.
The bill restricts broker associations so they cannot do as a
group what each member cannot do alone.
(1)
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The bill eatablishee very strict goals which will improve the abili-
ty of the r^^ators to detect trafUng abuses.
The bill provides retail customers with additional protection
against fraudulent sales practices.
The bill requires changes in the disciplinary committee and the
governing board practices to reduce the chance for conflicts of in-
terest
The bill encourages CFTC to take the lead in initiating undercov-
er operations.
The bill requires registration of floor traders, which means that
every category in the industry will now be registered.
The bill puts teeth in the collection of civil penalties Etssessed by
the CFTC, and it provides for nationwide service of process and
venue.
The bill establishes a process of cooperation with foreign futures
authorities.
Taken together, these provisions meet the ultimate goal of our
work plan — to provide assurance about the integrity of the Ameri-
can futures markets.
I look forward to hearing our witnesses.
[H.R. 2869, the reports from the Commodity Futures Trading
Commission and U.S. Department of Justice follow; the hearing
continues on page 47.]
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H.R.2869
To iDMDd the Comnwdity Excbuige Act to improve the reguUtkm ot futures ud
optioiu traded under rules and reguluiona of the Commodity Futurei Trad-
ing Commiasioii, eitablidi teginnition itandardi for all exchange floor trad-
ers, restrict practices which ma; lead to the abuse of outside cuBlomers of
the marketplMe, reinforw development of exchange audit trails to better
enable the detection and prevention of such practices, establish higher itaod-
ards for service on governing boards and disciplinary committees of self-
regulatory organizatjons, enhance the international regulation of futures trad-
ing, regularize the process of authorizing appropriations for the Coounodity
Futures Trading Conmission, and for other purposes.
m THE HOUSE OF REPRESENTATIVES
JULI 12, 1S89
Hr. Enolibh (for bunself, Hr, Colbhan of Uissouri, and Ur. Pbnny) mtroduoed
the following bill; which was referred to the Committee on Agriculture
A BILL
To amend the Commodity Exchange Act to improve the regula-
tion of futures and optiona traded imder rules and regula-
tjona of the Commodity Futures Trading Commission, es-
tablish registration standards for all exchange floor traders,
restrict practices which may lead to the abuse of outside
customers of the maiketplace, reinforce development of ex-
change audit tnuls to better enable the detection and pre-
vention of such practices, establish higher standu'ds for
service on governing boards and disciplinary committees of
self-regulatoiy organizations, enhance the international reg-
ulation of futures trading, regularize the process of authoriz-
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2
ing appropriations for the Coniinodity Futures Trading
Commisaion, and for other purposes.
1 Be it enacted by the Senate and House of Representa-
2 title* of the United Statea of America in Congress assemhUd,
8 SECTION I. SHORT TITLB; TABLE OP CONTENTS.
4 (a) Shobt Title. — This Act may be cited as the
5 "Commodity Futures LnprovemeDts Act of 1989".
6 (b) Table of Contents. — The table of contenta is as
7 follows:
TABLE OF CONTENTS
9«c. 1. Shan tills; t&ble ol coDteati.
TITLE I— LDOTATIONS ON CEBTAIN TBADINO PBACTICB8
Sm. 101. Dull trading.
Sm. 102. Trading unong mambert o( bnAer inociatioiu.
Sec. 201. Audil truU.
Sec. 202. Talamuketiiig bvud.
Sec. 203. TJnderoDTer operttiDiu md enforceoKHL
Sec. 201. SeU reguUtoi; i
Sbc 206. Kequired nigiMnliiai o( floor tnden.
Soc 206. Enhutcaniflnt lA regiitTEtion reqnirementi.
See. 307. EnfoTcnHml ti ciyil mmiij penaltiei.
See. SOB. Elhin (nining for ingiimnti.
See. 309. NKtionwide lenriGe at proeen and venue.
TTTLE m— A88ISTAKCE TO FOKEION FUTURES AUTHORITIEB
Sec. SOI. Definition of foreign futarei autborit;.
Sec S02. Subpoena authority.
Sec. 303. Cooperation with forogn future! aulboritiei.
Sec. 304. InveitigatiTe amitance to foreign future! authoritiea.
See. SOS. Diielomre of iidramatioB receired btan foreign fnturel aotlioriliei.
See. S06. DitehMure of intoimation to fordgn future! aulboritie!.
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1 TITLE I— LIMITATIONS ON CERTAIN TRADING
2 PEACTICBS
8 SEC 101. DUAL TRADING.
4 (a) Pbohibition. — Section 4j(l) of the Commodity Ex-
6 change Act (7 n.S.C. 6j) is amended to read as follows:
6 "(IHA) The Commissioii shall issue regulations to pro-
7 hilnt dual trading by a floor broker in an; contract market in
8 which the Commission has determined the average daily
9 trading volume to be equal to or greater than the threshold
10 trading level established pursuant to this paragraph. For the
1 1 purposes of this subsection, the threshold trading level shall
12 be seven thousand contracts, based on a siz-monUi moving
18 average of the number of contracts traded on such contract
14 market. However, if the Commission determines that the
15 prohibition agtunst dual trading creates undesirable price vol-
16 atility, unacceptable widening of bid-ask spreads, or other-
17 wise threatens the public interest, the Commission may in-
18 crease or decrease the threshold trading level for such specif-
19 ic contract market. Any action by the Commission to adjust
20 the tiireshold trading level of a contract market pursuant to
21 this paragraph shall be reported to the Committee on Agri-
22 culture of the House of Representatives and the Committee
23 on Agriculture, Nutrition, and Forestry of the Senate not
24 later than three days after the Commission ti^es such action.
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1 "(B) If the ComnusBion has not detenniBed to prohibit
2 dual trading in a contract market pursuant to paragraph (C),
3 the regulations issued by the Conunission to implement para-
4 graph (A) for such contract market shall —
5 "(i) define the term 'dual trading';
6 "(ii) specify the methodology by which the Com-
7 mission shall detennine the average daily trading
8 volume of contracts on a contract market;
9 "(iii) provide for transition measures, as deter-
10 mined necessary by the CommisBion to prevent market
11 disruption or to protect the public interest, for a con-
12 tract market when the average daily tradmg volume on
18 such contract market mcreases to or above, or de-
14 creases below, the threshold trading level;
15 "(iv) provide that a floor broker m&y dual trade in
16 a newly designated contract market until the average
17 duly trading volume on such contract market has in-
18 creased to or above the threshold trading level;
19 "(v) provide for limited exceptions, as the Com-
20 mission determines necessary, to the prohibition
21 against dual trading required by paragraph (A) so that
22 a broker may execute spread trades for such floor bro-
23 ker's own account or trade for such floor broker's own
24 account for a brief period at the opening of the market
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1 in order to settle errors in trades made by such broker
2 on such account on & previous trading day;
3 "(vi) provide that a Qoor broker affected by para-
4 graph (A) shall indicate prior to the opening of trading
5 for any given day whether such floor broker shall trade
6 solely for such broker's own account or solely for cus-
7 tomers' accounts for the entire trading day, with limit-
8 ed exceptions as determined by the Commission pursu*
9 ant to subparagraphs (v) and (vii); and
10 "(vii) provide that a customer may designate an
11 individual floor broker to execute such customer's
12 orders for future delivery and trade for such broker's
13 own account, notwithstanding the provisions of para-
14 graph (A), if such customer, not less than once annual-
15 ly, executes a written form designating such broker by
16 name.
17 Such regulations may also provide that if the average daily
18 trading volume on a contract market increases to or above, or
19 decreases below, the threshold trading level, any change in
20 the status or dual trading otherwise required by paragraph
21 (A) may be delayed or suspended if the Commission deter-
22 mines that such increase or decrease is a temporary, unusud
23 occurrence.
24 "(C) Notwithstanding paragraphs (A) and (B), Uie Com-
25 mission shall, as it determines necessary, make a detennina-
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1 tion from time to time, by rule, regulatioii, or order, whether
2 or not dual trading, as that term may be defined in regular
8 tionB issued by the Commission, by a floor broker may be
4 allowed in contract markets where such trading is not prohib-
5 ited pursuant to paragraph (A). If the Commission detemuDes
6 that dual trading by a Soar broker shall be permitted, the
7 Commission shall further determine the terms, conditions,
8 and circumBtances under which such dual trading shall be
9 conducted. Any such determination shall, at a minimum, take
10 into account the effect of dual trading upon the hquidity of
11 trading in each market. Nothing in this subsection shall be
12 construed to prohibit the Commission from making separate
13 detfirminations for different contract markets when such are
14 warranted m die judgment of the Commission, or to prohibit
15 contract markets from setting terms and conditions more re-
16 strictive than those set by the Commission.
17 "(D) The Commission shall issue an order to exempt a
18 board of trade from the provisions of paragraph (A) if such
19 board of trade can demonstrate to the Commission that such
20 board of trade's audit trail (i) can detect any and all mstances
21 of trading violations which the Commission determines to be
22 attributable to dual trading, and (ii) is fully verifiable. Any
23 order by the Commission to exempt a board of trade from the
24 dual trading prohibition in paragraph (A) pursuant to this
26 paragraph shaD not become effective until after the expiration
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1 of ninet; days after the date of bwismittal of a report on the
2 CommisBion's detenninatioiis re^din^ such boaid of trade
3 to the Committee on Agriculture of the House of B«preBenta-
4 tives and the Conunittee on Agriculture, Nutrition, and For-
5 estryof the Senate.".
6 (b) Bboulations. — The Commission shall issue the
7 regulations required by section 4j(l) of the Commodity Ex-
8 change Act no Uter than two hundred seventy days after the
9 effective date of this Act.
10 sec 102. TRADING AMONG MEMBERS OF BROKER ASSOCIA.
11 TIONS.
12 (a) Pbohibition. — Section 4j of the Commodity Ex-
13 change Act (7 U.S.C. 6j) is amended by adding at the end
14 thereof the following new subsection:
15 "(3) It shall be unlawful, pursuant to regulations issued
16 by the Commission —
17 "(A) for a member of a broker association, for or
18 on behalf of any customer, to execute a transaction
19 such that another member of the same broker associa-
20 tion, trading for such other member's own account, or
21 the account of the association, takes the opposite side
22 of such transaction; or
28 "(B) for any member of a broker association to
24 trade with another member of the same broker associa-
25 tion, whether such brokers are trading for such bro-
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1 kers' own accounts, for customers, or for the account
2 of the broker association, if such transactions in any
3 month total more than 25 per centum of the totid
4 transactions of such broker; and
5 "(C) for any member of a broker association to
6 eogige in sucb other practices as the Commission de-
7 tennines necessary to prohibit or to curb abuses and
8 otherwise protect the interests of eustomers from po-
9 tential trading abuses by members of broker associa-
10 tions.
11 Such regulations shaD include a defimtion of the term 'broker
12 association'. Nothing in this subsection shall be construed to
13 prohibit the Commission or contract markets from prohibiting
14 trading by broker associations or their members, or from set-
15 ting tonns and conditions for such trading that are more re-
16 strictive than those set by this subsection.".
17 (b) Rbotjlations. — The Commission shall issue regu-
18 lations to implement section 4j(3) of the Commodity Credit
19 Exchange Act no later than two hundred seventy days after
20 the effective date of this Act.
21 (o) Repobt to Conobbss. — The Commission shall de-
22 tennine whether the public interest would best be served by
23 placing alternative restrictions on trading by broker associa-
24 tions and their members, and whether such broker associa-
25 tions, or fading by such broker assodations, should be pro-
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1 hibited. The CommisBioii Bhall report its determiiialioii and
2 any recommendations by the Commission for regulatory or
3 legislative initialiTes to implement such reoommendationfi to
4 the Committee on Agriculture of the House of Bepresenta-
5 tives aod the Committee on Agriculture, Nutrition, and For-
6 eatry of the Senate no Uter than two hundred seventy days
7 after the effective date of the regulations required under ^a
8 section.
9 TITLE n— ENHANCEMENT OF REGULATORY AND
10 ENFORCEMENT ACTIVITIES
11 SEC 201. AUDIT TRAUA
12 (a) Audit Tbail Rbquibbments fob Contbaot
13 Mabkets. — Section 4g(2) of the Commodity Exchange Act
14 (7 U.8.C. 6g) ia amended by—
15 (1) inserting "(A)" after "(2)"; and
16 (2) adding at the end thereof the following new
17 paragraph:
18 "CB)(i) Each contract market shall maintain or cauae U>
19 be maintained by its clearinghouse a single record that shall
20 show for each futm-es or options trade the transaction date,
21 time of execution (as required by subparagraph (ii)), quantity,
22 and, as applicable, underlying commodity, price or premium,
23 deliveiy month or expiration date, whether the transaction
24 involved a contract for future delivery or physical, put or a
25 call, strike price, floor broker or floor trader buying, clearing
HR 2869 IH 2
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1 member buying, floor broker or floor trader selling, olearing
2 member selling, symbols indicatiiig the buying and selling
3 customer or option customer types and such other informa-
4 tion as the Commissioa determines neoeaaary. Such record
5 shall enable such contnct market to rapidly reconstruct an
6 accurate record, aa determined by the Commiasion, of the
7 transactions executed on such contract market.
8 "(ii) For the purposes of subparagraph (i), the time of
9 execution of a transaction shall be verifiable and shaD —
10 "(a) be stated within an increment of no more
1 1 than one minute in length, beginning not later than one
12 year after the effective date of this paragraph; and
13 "(b) be stated within an increment of no more
14 than thirty seconds in length, beginning not later than
15 three years after the effective date of this paragraph.
16 "(iii^ The Commission shall report on the status of oom-
17 pliaoce with the standards imposed by this section and report
16 its findings to the Committee on Agriculture of the House of
19 Representatives and the Committee on Agriculture, Nutri-
20 tion, and Forestry of tlie Senate within one himdred and
21 eighty days after the dates specified in clauaea {BKiiXa) and
22 (BKiiKb), respectively.
23 "(iv) The Commission shall —
24 "(a) determine whether the record required by this
26 paragraph has enabled the affected contract mai^ets to
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1 rapidly reconBtruct an accurate, verifiable record of the
2 transactions executed on such contract markets, as de-
3 termined necessary by the Conunission to provide for
4 the effective enforcement of the appHcahle provisions of
5 this Act and the rules or regulations thereunder;
6 "(b) determine whetiier the recording and recon-
7 struction of the time and sequence of trades can more
8 accurately represent the real times of such trades
9 through the use of improved technologies or other
10 means and determine whether any regulatory or legis-
11 lative changes would be necessary or appropriate to
12 implement such improvements; and
13 "(c) report its Sndings pursuant to this subpara-
14 graph to the Committee on Agriculture of the House of
15 Representatives and the Committee on Agriculture,
16 Nubition, and Forestry of the Senate no later than five
17 years after the effective date of this paragraph.".
18 "(b) Audit Tbail Compliance As Condition fob
19 CoNTBACT Mabket DbsionatiON. — Section 5 of the Com-
20 modity Exchange Act (7 U.S.C. 7) is amended by adding at
21 the end &e following new paragraph:
22 "(h) When such board of trade demonstrates that eveiy
23 contract market for which such board of trade is designated
24 complies with the requirements of sections 4g(2)(B)(i^a) and
25 4g(2)(B)fii)(b)ofthi8Act.".
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1 sec »2. telemarketing fraud.
2 "(&) Pbohibition Against Tbadino on New Ao-
3 COUNTS. — The Commodity Exchange Act is amended bj
4 adding after Bection 4p (7 U.S.C. 6p) the following new sec-
■ 5 tion:
6 "Sbc. 4q. The Commiasion shall issue regulations to
7 prohibit any person, who has solicited a customer by tele-
8 phone to open a futures or options account from entering any
9 orders for such account for three days after the customer
10 signed any contract and a separate risk disclosure statement
11 opening the account. Such regulations shall not apply to —
12 "(1) accounts opened solely for the purpose of
13 making bona fide hedging transactions, as such tenn is
14 defined by the Commission, consistent with the pur-
16 poses of this Act; or
16 "(2) transactions that transfer positions in an ex-
17 isting futures or options account to another futures
18 commission merchant or such other person as deter-
19 mined necessary by the Commission.
20 (3) accounts, other than the first account, opened
21 by a customer with the same futures commission mer-
22 chant.".
23 "(b) Begulations. — The Commission shall issue the
24 regulations required by section 4q of Uie Commodity Ex-
25 change Act no later than one hundred and eighty days after
26 the date of leAactment of this Act.
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1 SEC SM. UNDERCOVER OPERATIONS AND ENFORCEMENT.
2 Section 8(a) of the Commodity Exchange Act (7 U.S.C.
3 1 2(&)) is amended by —
4 (1) inaerting "(1)" after "(a)"; and
5 (2) inserting at the end the following new para-
6 graph:
7 "(2) In conducting investigations authorized under this
8 Bubsection or other provision of this Act, the Commission
9 shall continue, as the Commission determines necessary, to
10 request the asaistance of and cooperate with the appropriate
11 Federal agencies in the conduct of such investigations, in-
12 eluding undercover operations by such agencies.".
13 SEC 204. SELF REGULATORY ORGANIZATION DISaPUNARY
U COHHITTEES AND GOVERNING BOARDS.
15 (a) DiSCIPLINABT COHMITTEBB AND UAJOB YiOLA-
16 T10N8. — Section 8c of the Commodity Exchange Act (7
17 U.S.C. 12c) is amended by adding at the end the following
18 new subsections —
19 "(5) The ConmiisBion shall issue regulations ta require
20 the establishment of a system of contract market disciplinaiy
21 committees. Under such system, each board of trade which
22 has been designated as a contract market shall —
23 "(A) establish one or more disciphnary committees
24 which shall be authorized by such board of ta-ade to de-
25 t«rmine whether violations of the rules of tJie board of
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1 trade have been oomnutted, to accept oSen of settle-
2 ment, and to impose appropriate penalties;
3 "(B) provide that disciplinaiy committees estab-
4 lished pursuant to paragraph (A) be composed of mem-
6 ben of the board of trade, or staff members of the
6 board of trade, such that the committee, or any hearing
7 panel formed by the committee to conduct disciplinaiy
8 hearings, shall be composed of a majority of persons
9 who are of a different trading status than the respond-
10 ent; and
11 "(C) provide that a hearing panel formed by the
12 committee to conduct disciplinary hearings may be
13 composed of fewer than the total number of members
14 of the committee.
15 For the purposes of paragraph (B), a disciplinary committee
16 member's trading status sh^ be detennined by whether such
17 member is a: (1) floor broker or floor trader, (2) member of
18 the board of trade other than a floor broker or floor trader, or
19 (3) staff member of such board of trade.
20 "(6)(A) The Commission shall issue regulations requir-
21 ing each contract market to establish and make available to
22 tlie public a schedule of major violations of any rule within
23 the discipUnary jurisdiction of such contract market.
24 "(B) The regulations issued by the Commission pursu-
25 ant to this subsection shall prohibit any individual found to
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1 have committed a major violatjoo of any rule within the disci-
2 plinary jurisdictioii of a contract mai^et from service on the
3 governing board of any oonb'fict market or repBtered futures
4 association, or on any diaoiptinary committee thereof, for a
5 period of time to be determined by the Commission.".
6 (b) Rboistebbd Futubbs Associations. — Section
7 17 of the Commodity Exchange Act (7 U.S.C. 21) is amend-
8 ed by addmg at the end the following new subsection:
9 "(rMl) The Commission shall issue regulations requiring
10 each registered futures association to estt^lish and make
11 available to the pubUc a schedule of major violations of any
12 rule within the disciplinary jurisdiction of such registered fu-
13 tures association.
14 "(2) The regulations issued by the Commission pursuant
15 to this subsection shall prohibit any member of a registered
16 futures association found to have committed a major violation
17 of any rule within the disciplinaiy jurisdiction of such regis-
18 tered futures association from service on the governing board
19 of any registered futures association or contract market, or
20 on any disciplinary committee thereof, for a period of time to
21 be determined by the Commission.".
22 (c) Public Rbpbesentation on GtovEBNmo
23 BOABDS. — (1) Section 5a of the Commodity Exchange Act
24 (7 IT.S.C. 7a) is amended by—
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1 (A) Btrikiiig "and" following the semicolon at the
2 end of paragraph (11);
3 (B) Btiiking "involved." at the end of paragraph
4 {12) and inserting "involved; and"; and
5 (C) adding at the end the following new para-
6 graph:
7 "(13) Ensure that outside members, as defined in regu-
8 lations issued by the CommtsBion, comprise at least 20 per
9 centum of the governing board of such contract market.".
10 (2) Section 17(b) of the Commodity Exchange Act (7
11 U.S.C. 21), as amended by section 204(bK2) of this Act, is
12 amended by adding at the end (he following new paragraph:
13 "(11) at least 20 per centum of the members of
14 the governing board thereof are outside members, as
15 defined m regulations issued by the Commission,".
16 (d) Reqclations. — The Oommission shall issue rcgu-
17 lations required by sections 5a(13), 8c(5), 8c(6), 17(bKll),
18 and 17(r) of the Commodity Exchange Act no later than one
19 hundred and eighty days after the effective date of this Act.
20 SEC. 206. REQUIRED REGISTRATION OP FLOOR TRADERS.
21 (a) Definition. — Section 2(aKl)(A) of the Commodity
22 Exchange Act (17 U.S.C. section 2) is amended by inserting
23 after the sentence begmning "The words 'floor broker' " a
24 new sentence as follows: "The words 'floor trader' shall
26 mean any person who, in or surrounding any 'pit', 'ring',
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1 'post', or other place provided by a contract market for Uie
3 meetiiig of persons similarly engaged, shall purchase or sell
3 solely for such person's own account any commodity for
4 future deliveiy on or subject to the rules of any contract
5 market.".
6 (b) Floob Tbadbb Rboibtbation. — Section 4e of the
7 Commodity Exchange Act (7 U.S.C. section 6e) is amended
8 to read as follows:
9 "It shall be unlawful for any person to act as floor
10 trader in executing purchases and sales, or as floor broker in
11 executing any orders for the purchase or sale, of any com-
12 modity for future delivery, or involving any contracts of sale
13 of any commodity for future deUvery, on or subject to the
14 rules of any contract market unless such person shall have
15 registered, under this Act, with the Commission as such floor
16 trader or floor broker and such repstration shall not have
17 expired nor been suspended nor revoked.".
18 (c) Rboibtbation Peocbdueb. — Section 4f(l) of tiie
19 Commodity Exchange Act (7 U.S.C. section 6f(l)) is amend-
20 ed by striking the words "or floor broker" and inserting the
21 words "floor broker, or floor trader".
22 (d) Bbpobts; Books ans Rbgobds. — Section 4g(l) of
23 the Commodity Exchange Act (7 U.S.C. section 6g (1)) ia
24 amended by striking the words "or floor broker" and insert-
25 ing the words "floor broker, or floor trader".
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1 (e) JiTBiSDicnoH OP THE Statbs. — (1) Section 6d(l)
2 of the Commodity Exchwige Act (7 U.S.C. sectioo lSa-2(l))
3 is amended by striking the words "or Qoor broker" and in-
4 serting the words "floor broker, or floor trader".
5 (2) Section 6d(8KA) of the Commodity Exchange Act (7
6 U.S.C. section 13a-2(8KA)) a amended by inserting ", floOT
7 trader," after the words "floor broker".
8 <f) COHHISSION AUTHOBITT TO BBQISTBB FLOOB
9 Tbadbbs. — Section 8a(l) of the Commodity Exchange Act
10 (7 U.S.C. 12a(l)) is amended by striking out the words "and
11 floor brokers" and inserting the words "floor brokers, and
12 floor traders".
IS (g) Refusal To Beoistbb.— (1) Section ea(2)(C)C9 <d
14 the Commodity Exchange Act (7 U.8.C. 12a(2HC)a» is
15 amended by inserting "floor trader," after "floor broker,".
16 (2) Section 8B(2KDKii) of the Commodity Exchange Act
17 (7 U.S.C. 12a(2)(^(ii)) is amended by inserting "floor
18 trader," after "Door broker,".
19 (3) Section^8a(3)(E)Cii) of the Commodity Exchange Act
20 <7 U.S.C. 12a(3)(E)(ii)) is amended by inserting "floor
21 trader," alter "floor broker,".
22 (h) REQimATiONS. — The Commission shall issue any
23 regulations necessary to inqilement the provisions of this seo-
24 tion no later tiian one hundred and eighty days after the ef-
25 fective date of this Act.
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1 SEC. 20C ENHANCEMENT OF REG18TKATI0N REQUIREHENTa
2 (a) Section 88(2)(C) of the Commodity Exchange Act (7
3 U.S.C. 12a(2» is amended by—
4 (1) inserting immediately after the word "decree"
5 the second time it appears "or solely on the basis of an
6 order, judgment or decree which is not deemed to con-
7 Btitute a disqualificatjon from regiBtration by the regu-
8 latory agency which initiated the injunctive action";
9 (2) in clause (ii) striking "involving any transac-
10 tion in or advise concerning contracts of sale of a com-
11 modity for future delivery," and inserting "where such
12 activity involves embezzlement, theft, extortion, fraud,
13 fraudulent conversion, misappropriation of funds, secu-
14 rities or property, forgery, counterfeiting, false pre-
15 tenses, bribery, gambling or deception of customers,
16 or";
17 (3) inserting a semicolon inmiediateiy after "Act";
18 and
19 (4) striking "or concerning securities;".
20 (b) Section 8a(2)(D)(iii) of the Commodity Exchange Act
21 (7 U.S.C. 12a(2)(DM)) is amended by—
22 (1) striking "or" immediately before "gambling,";
23 and
24 (2) insertiog "or deception of customers," immedi-
25 ately after "gambling,".
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1 (c) Section 8a(2MD)0v) of tiie Conunodity Exchange Act
2 (7 U.S.C. 12a(2)(DKiv)) is amended by—
3 (1) inserting "371, 1001," immediately after
4 "152,";
5 (2) striking "or" immediately after "1342";
6 (3) inserting "1503, 1623, 1961-1963, or 2314,"
7 immediately after "1343,"; and
8 (4) inserting "or section 7201 or 7206 of title
9 26," immediately after "18,".
10 (d) Section 8a(2)<E) of the Commodity Exchange Act (7
1 1 U.S.C. 12a<2)(E)) is amended by—
12 (1) striking "by any court of competent jmisdic-
13 tion," and inserting "in a proceeding brought";
14 (2) in clause (i) inserting "the Racketeer Influ-
15 enced Corrupt Organizations Act," immediately after
16 "1977,";
17 (3) in clause (i) striking out "or" immediately
18 after "bribery,"; and
19 (4) in clause (i) inserting "or deception of custom-
20 ers," immediately after "gambling,".
21 (e) Section 8a(2)(G) of the Commodity Exchange Act (7
22 U.S.C. 12a(2HG)) is amended by—
23 (1) striking "subparagraphs (A) through (F) of this
24 paragraph." and inserting "sections 8a(2) and 8a(3),";
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1 (2) striking "materul" the first time it appeua,
2 and inserting "materially"; and
3 (3) strike "application;" and insert "application or
4 any update thereto;".
5 (0 Section 8a(3)(D) of the Commodity Exchange Act (7
6 U.S.C. 12a(3)a>) is amended by—
7 {1) inserting "pled guilty to or" immediately after
8 "person";
9 (2) inserting a comma after "section" the first
10 time it appears;
11 (3) striking "within ten years preceding the filing
12 of the application or at any time thereafter,";
13 (4) striking ", including a felony"; and
14 (6) sticking ", more than" and inserting "more
15 than".
16 (g) Section 8a(3HE) of the Commodity Exchange Act <7
17 U.S.C. 12a(3)(E) is amended by—
18 (1) inserting "pled guilty to or" after "person";
19 (2) spiking "within ten years preceding the filing
20 of the application for registration or at any time there-
21 after";
22 (3) in clause (iii) atriking "or" immediately after
23 "bribery";
24 (4) in clause (m) inserting "deception of custom-
26 ers, moral turpitude or conduct inconsistent mth just
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1 and equitable principles of trade," immediately after
2 the word "gamblinj^";
3 (5) in clause (iv) inserting "371," immediately
4 after "152,"; and
5 (6) in clause (iv) inserting "or section 7203, 7204,
6 7205, or 7207 of title 26," after "18,".
7 (b) Section 8a(3MO) of the Commodity Exchange Act (7
8 U.S.C. l2aiSHGr) is amended by—
9 (1) striking "material" the first time it appears,
10 and inserting "materially";
11 (2) striking the comma after "appUcation";
12 (3) inserting "or any update thereto," after "ap-
13 plication";
14 (4) striking "thereunder, or" and inserting "there-
15 under,"; and
16 (5) inserting after "Commission" the words "or in
17 any registration disqualification proceeding".
18 (i) Section 8a(3)(H) of the Commodity Exchange Act (7
19 U.8.C. 12a(3KH)) is amended by inserting inmiediately after
20 "State court" ", in a Unit«d States military court,".
21 ()) Section 8a<3KJ) of the Commodity Exchange Act (7
22 U.S.C. 12a(3)(J)) is amended by—
23 (1) striking "or" after the first reference to "asso-
24 ciation";
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1 (2) mserting "or any foreign re^atory body that
2 the GommiBsion has recognized aa having a comparable
3 regulatoiy program," after the first reference to "orga-
4 nization";
5 (3) striking "or" after the second reference to
6 "association"; and
7 (4) striking "organization;" and inserting "organi-
6 zation, or foreign regulatoiy body;".
9 (k) Section 8a(3XKKi) of the Commodity Exchange Act
10 (7 U.8.C.12a(3)(KKi))!B amended by—
11 (1) striking "or" immediately after "bribeiy,"; and
12 <2) inserting ", deception of customers, or conduct
13 inconsistent with just and equitable principles of
14 trade," immediately after "gambling".
15 SEC. 207. ENFORCEMENT OF aVIL HONEY PENALTIEa
16 Section 6(d) of the Commodity Exchange Act (7 U.S.O.
17 9a), is wnended to read as follows:
18 "(dKD'In determining the amount of the money penalty
19 assessed mider paragraph (b), the Commission shall consider
20 the appropriateness of such penalty to the gravity of the vio-
21 tation.
22 "{2) Unless the person agunst whom a money penalty is
23 assessed under paragraph (b) shows to the satisfaction of the
24 Commission within fifteen days from the expiration of the
25 period allowed for payment of such penidty that either an
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1 appeal as authorized by paragraph (b) has been taken or pay-
2 ment of the full amount of the penalty then due has been
3 made, at the end of such fifteen-day period and until sudl
4 person shows to the satisfaction of the Commission that pay-
5 ment of such amount with interest thereon to date of psy-
6 ment has been made: {A) such person shall be prohibited from
7 trading on all contract markets and (B) if such person is reg-
8 istered with the Commission, such registration shall be sus-
9 pended.
10 "(3) If a. person against whom a money penalty is as-
11 sessed under paragraph (b) takes an appeal and if the Com*
12 mission prevails or the appeal is dismissed, unless such
13 person shows to the satisfaction of the Commission that pay-
14 ment of the full amount of the penalty then due has bem
15 made by the end of thir^ days from the date of judgment on
16 the appeal: (A) such person shall be prohibited from trading
17 on all contract markets and (B) if such person is registered
18 with the Commission, such registration sh^ be suspended. If
19 the person upon whom the money penalty has been imposed
20 fails to pay such'^nalty after the lapse of the period allowed
21 for appeal or after the affirmance of such penalty, the Com-
22 mission may refer the matter to the Attorney Qeneral who
23 shall recover such penalty by action in the appropriate
24 United States district court.".
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1 SEC. »8. ETHICS TRAINING FOR REGISTRANTS.
2 Section 4p of the Coininodity Exchange Act (7 U.S.C.
3 6p) is amended by —
4 (1) inserting "(1)" after "Sec. 4p."; and
5 (2) adding after the existing section 4p(l), as so
6 redesignated, Uie following new subsection:
7 "(2) The Commission shall issue regulations to require
8 new registrants, within six months after receiving such regis-
9 tration, to attend a truning session, and all other registrants
10 to attend periodic training sessions, to ensure that reg^trants
1 1 understand their responsibilities to the public under this Act,
12 including responsibilities to observe just and equitable princi-
13 pies of trade, any rule or regulation of the Commission, any
14 rule of any appropriate contract market, registered futures
15 association, or other self-regulatoiy organization, or any
16 otlier applicable Federal or State law, rule or regulation.".
17 (c) The Commission shall issue the regulations required
16 by section 4p(2) of the Commodity Exchange Act no later
19 than one hundred and eighty days after the effective date of
20 this Act
2 1 SEC 209. NATIONWIDE SERVICE OF PROCESS AND VENUE.
22 Section 22(c) of the Commodity Exchange Act (7
23 tI.S.C. 25(c)) is amended to read as follows:
24 "(c) The United States district courts shall have exclu-
25 sive jurisdiction of actions brought under this section. Any
26 such action must be brought within two years after the date
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1 the cause of action accrued. Any action brought under sub-
2 section {a) of tiiis section may be brought in any diatrkt
3 wherein the defendant is found or is an inhabitant or bvu-
4 acts business, or in the district wherein any act or transaction
6 constituting the violation occurred, and process in such action
6 may be served in any district of which the defendant is an
7 inhabitant or wherever the defendant may be found.".
8 TITLE m— ASSISTANCE TO FOREIGN PUTUBES
9 AUTHORITIES
10 SEC. 301. DEFmrnON OF FOREIGN FUTURES AUTRORITY.
11 Section 2{aKl)(A) of the Commodity Exchange Act (7
12 U.S.C. 2) is amended by inserting at the end a new sentence
13 as follows: "The term 'foreign futures authority' means any
14 foreign government, or any departanent, agency, govemmeo-
15 tal body or regulatory organization empowered by a foreign
16 government to administer or enforce laws, rules or regular
17 tions as they relate to futures or options matters, or any de-
18 partment or agency of a political subdivision of a forei^ gov-
19 emment empowered to administer or enforce laws, rules or
20 regulations as they relate to futures or options matters.".
21 sec 302. SUBPOENA AUTHORITY.
22 Section 6(b) of the Commodity Exchange Act (7 U.S.O.
23 15) is amended by inserting in the third sentence thereof fol*
24 lowing the word "Act" the second time it appears: "or for
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1 purposes of any action taken under Section 12(0 of this
2 Act,".
S SEC. 303. COOPERATION WITH FOREIGN niTURES AVTHORI-
4 TIES.
5 Section 12(a) of the Commodity Exchange Act (7
6 U.S.C. 16(a)) is amended hy inserting after "thereof," the
7 following: "any foreign futures autliority, or any department
8 or agency of a foreign government or political subdivision
9 thereof,".
10 SBC 304. INVESTIGATIVE ASSISTANCE TO FOREIGN FUTURES
11 AUTHORITIES.
12 Section 12 of the Commodity Exchange Act (7 U.S.C.
13 16) is amended by adding at the end the following new sub-
14 section:
15 "(f) On request from a foreign futures authority, the
16 Commission may, in its discretion, provide assistance in ac-
17 cordance with this section if the requesting authority states
18 that the requesting authority is conducting an investigation
19 which it deems necessary to determine whether any person
20 has violated, is violating, or is about to violate any laws,
21 rules or regulations relating to futures or options matters that
22 the requesting authority administers or enforces. The Com-
23 mission may conduct such investigation as the Commission
24 deems necessary to collect information and evidence perti-
25 nent to the request for assistance. Such assistance may be
23-500 0 - 90 -
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1 provided without regard to whether the facts stated in the
2 request would also coitBtitute a violadon of the laws of the
3 United States. In deciding whether to provide assistance
4 under this section, the Oommission shall consider whether (1)
5 the requesting authority has agreed to provide reciprocal as-
6 sistance to the Commission in futures and optJons matters;
7 and (2) compUance with the request would prejudice ^e
8 public interest of the United States. Notwithstanding any
9 other provision of law, the Commission may accept payment
10 and reimbursement, in cash or in kind, from a. foreign futures
11 authority, or made on behalf of such authority, for necessary
12 expenses incurred by the Commission, its members, and em-
13 ployees in carrying out any investigation pursuant to this sec-
14 tion or in providing any other assistance to a foreign futures
15 authority. Any payment or reimbursement accepted shall be
16 considered a reimbursement to the appropriated funds of the
17 Commission.".
18 SEC 305. DISCLOSURE OF INFORMATION RECEIVED FROM
19 FOREIGN FUTURES AUTHORITIES.
20 Section 8 of the Commodity Exchange Act (7 U.S.C.
21 12) is amended —
22 (1) by inserting at the end of subsection 8(a)(1), as
23 redesignated by section 203 of this Act, the following
24 new sentence: "The Commission shall not be com-
25 petled to disclose any information or data obtuned by
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1 the Commisgion firom a foreign futures authority if the
2 foreign futures authority has in good futh represented
3 to the Commission that such disclosures would be con-
4 trary to the laws of the foreign country from which it
5 was obtiuned; however, nothing in this subsection shall
6 prevent the Commission from disclosing publicly any
7 infonnation or data obtained by the Commission from a
8 foreign futures authority when such disclosure is made
9 in connection with a congressional proceeding, an ad-
10 ministrative or judicial proceeding commenced by the
11 United States or the Comniiasion, in any receivership
12 proceeding commenced by the United States or the
13 Commission, or in any bankruptcy proceeding in which
14 the Commission has intervened or in which the Com-
15 mission has the right to appear and be heard under
16 titie 11 of the United States Code."; and
17 (2) by inserting at the end of subsection 8{b) the
18 following new sentence: "Nothing in this subsection
19 shall apply to the disclosure of data or information ob-
20 tained by the Conmussion from a foreign futures au-
21 thority.".
22 SEC. 306. DISCLOSURE OF INFORMATION TO FOREIGN FU<
23 TURES AUTHORITIES.
24 Subsection (e) of section 8 of the Commodity Exchange
25 Act (7 U.S.C. 12(e)) is amended—
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1 (1) by insertiiig in Ae fifth sentence after "juris-
2 diction," the first time it appears the following: "or
3 any foreign futures authority";
4 (2) by inserting in the fifth sentence after "such"
5 the following: "foreign futures authority,";
6 (3) by inserting in the last sentence after "infor-
7 mation to a" the following: "foreign futures authority
8 or to a";
9 (4) by inserting in the last sentence after "dis-
10 closed by such" the following: "foreign futures author-
11 ity,"; and
12 (5) by inserting in the last sentence after "or
IS agency thereof the following: "or foreign futures au-
14 thority".
15 TITLE IV— AUTHORIZATION OF
16 APPRDPBIATIONS; EFFECTIVE DATE
17 SEC 401. AUTHORIZATION OF APPROPRIATIONS.
18 Section 12(d) of the Conunodity Exchange Act {?
19 U.S.C. 16(d)) is amended to read as follows:
20 "(d) There are authorized to be appropriated to carry
21 out this Act —
22 "(1) $40,000,000 for fiscal year 1990; and
23 "(2) $44,500,000 for fiscal year 1991.".
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SI
1 SEC. 402. EFFECTIVE DATE.
2 The proviBions of, and amendments made by, this Act
8 shall be effective upon enactment.
O
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Svptaabar G, 1989
Th* Honozabla B (Klka) d* la Sana
Chairauut, Comlttaa on Aqrlcultura
D.8. Hous* of Rapraaantatlvaa
1301 Longworth Hona* Otfica Building
Maahington, D.C. 20515
Daac Mc. Chainani
The ConBdaaion la pleaaed to expreaa Ita viawa on B.R. 2669, tha
CoBBodlty Futurea Iiqirovementa Act of 19B9, aa reported by yonx
Conmittaa on Auguat 2, 19S9. He atrongly aupport the pnrpoaa of
thia bill of incraaaiag public confidence in the integrity of
futnrea marketa by dimlniahing the potential for trade practice
abuae and atrengthening the CommiaBion'B regulatory ayatam.
Although we have acme reaervationa over certain aapecta of tha
bill, w* congratulate you and the other raembara of the Coimiittee,
particularly Subcommittee Chairinan Bngliah and Subcommittee
Ranking Minority Member Coleman, in developing thia la^ortant and
far-reaching laglalation.
There are a number of proviaiona in the bill that addceaa alleged
wrongdoinga that have been aet forth in the indictmenta and
admlniatrative aettlementa announced aa a reault of the
Inveatlgation in Chicago. At thia time, we do not believe that
theae actiona have dlacloaed information that requlrea any other
atatutory changea. If we find that additional changea in the law
■re neceaaary, however, we will pc(»^ly recoomiend them to the
Cowaittee . '
Aa I noted In my earlier teatimony, the Commlaaion haa undertaken
a study of certain iaauea regarding dual trading. We have mode
subatantial progreaa and we are confidant that the atudy will be
coiqileted early thia fall. Baaed on the reaulta of the atudy,
we expect to initiate a rulemaking concerning dual trading. Ne
believe that complex iaauea auch aa thoae Involved in dual
trading axe addreaaedimdat effectively, and with tha greateat
flexibility, through t|ulemaking nndeft our current atatutory
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authority rather than through amandment to the Commodity Bxchanga
In any event, with regard to the specific proviaiona of H.R.
2869, while we have aoma concarna over a dual trading prohibition
baaad on apaclflc voluna lavala, wa believe the bill providea for
sufficient flexibility to enable the CQinmlasiQD to Incraaae or
decrease these statutory levels on a market -by -market laasis
should it determine that such sdjustments are warranted. He are
alao pleased that the bill racogniiea that the audit trail alona,
as a record analysis system, cannot detect all typaa of trade
practice violationa and therefore is not the aole mechanism upon
which an exchange may base its request for an exemption from the
dual trading prohibition. Instead, the bill aats forth an
exemptive atandard under which the Commission may assess the
overall ef fectiveneas of an axchange'e compliance programs rather
than being obliged to determine that such programs detect all
instances of a particular abuse.
He still believe, however, that both the exeiptive and temporary
waiver standards need to be modified. ?lrat, GO days is too
short B tima period in which to completa ths initial evaluation
of exchange programs under the exemptive standard. This is
especially so since it is likely that most, if not all, exchanges
would file exemptions at about the same tims, which would have
severe rsaourcs in^licationa for the Commission. Since section
5a(12) of the Act gives the Commission six months to review a
single exchange rule submission, H.R. 2669 should give the
Commission at least six months within which to complete its
initial evaluation.
The ten^iorary waiver process also requires amendment. In order
to make the determination called for — that the exchange ia
likely to satisfy the exemptive standard — the Comniaaion
essentially would have to perform a full analysis as to whether
the exchange had mat ita burden of meeting the ezei^ttion
atandard. He suggest that the bill, be amended to pemit the
Conmisaion to develop appropriate waiver standards a* part of the
regulations concerning dual trading.
huUt Trail
An In^Toved audit trail has been a long-held Comaisslon goal and
w« have moved aggressively toward this goal since 1986. The
trade timing standard currently in effect under Commission rules
is a one-minute atandard. He are firmly committed to improving
the audit trail in the ways that are moat affective in datactlng
trade practice abuse. In this regard, we believe the requirement
to decreaae the trade timing standard to 30 seconds or leas in
three years should be deleted from B.R. 2669. The Comniaaion
needs maximum flexibility in determining whether a 30-sacond
standard ia appropriate for particular exchanges in particular
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circuiutancea. In other olrouBatancaa othar audit trail
in^rovementB may be more effactiva in datocting and prnvsnting
trada practice abiiee than a 30~BECi:>nd atandiird. For exaicpiei it
eXBcution and trade reporting systeins, and to impose more
rigoroua trading, racord collection, tine atomping and racord-
kaaping requirement*, which voiild improve audit trails and
provida other benefits. Th« Commiaaion has recently
anaouncad propoaad rulaa in this araa.
B.R> 3BG9 also would pravant th* Commission from designating an
exchange to trade a new futures contract unless the exchange oan
show that every contract market for which it is presently
designated complias with the audit trail requirements injioBed by
new section 4g(b)(2) of the Act. Although we understand that for
purposes of compilance, the CoDcnission may set trade timing
verifiable accuracy levelB at less than 100%, we nevertheless ara
concarnad that an exchange which axceeds these levels in
virtually all cases must ba denied a new designation. If, for
exorapi*' Qn* contract market within the exchange is unabia to
achieve that level for a given period becauoa of particularly
heavy volume or volatility, this is overly restrictive and could
prevent now products from being introduced to the detriment cf
the nation's economy. He believe the better approach la that
taken under present law where the Commission aaaeaaea an
exchange b overall parfortaanca prior to deelgnatlon. As noted
above this approach la also more consistent with the exeaptlve
standard the bill providea in the dual trading provlalons.
Brcksr AsBociotiona
We agree that it ia io^ortant for the Comtiasion to define and
identify broker assoeifttions for the purpoaaa of aurveillanca and
compliance programs and we are currently interviewing broker
association participants and stjdying current exchange practices.
Our study should be completed early this fall. He believe that
rulemaking is more appropriate than setting a statutory limit on
trading between aoaociation memberB aa set forth in H.R. 3869.
Effective monitoring of broker association activities m4y wall
require restrictions to be tailored to particular markets. Ia
this regard, paragraph (3) of new section 4j(c) could form the
basis of this type of rulemaking, and in our view, would be
sufficient statutory coverage of this area at this time.
Telemarketing rrand
B.R. 2S69 limits its focus on telemarketing to members of tuturea
associations against whom some action has been taken. Ha
believe the scope of this provision should be broadened to
ei^ower the Cooniiasion to sat the standards under which the
association would allow nanbara to solicit new account a by
telephone.
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Oad«xcoT*r Authority
He are plaased that H.H. 2669 recognizaa th* Ijiportanca of
cooparatlva law enforcenwnt with other agencies. We Blao
strongly support the bill's intention to send a signal that these
typea of undercover activities may be undertaken at any time.
Tha CooKiLisiian supports the provision that would bar individual
DHnnberB with algniflcant dlaciplinary records from service on
disciplinary or governing panela of exchangea and futures
aasoclations for a fixed period of time. We ar^ Already
undertaking a rulemaking in this area.
Co^Misition of Disciplinary CoaBlttees and Goreming Boards
He are concerned that the requirement in H.R. 3869 that a
majority of coiBlttee meadMrs bs from a different sector of
•xchange member a hip than the parson appearing before the
c<mmittee may diminish the technical expertise of the group
enough to slow down the process and to render a leas effective
and appropciate decision. We auggaat that the requirements
regarding comaittse composition and the stages in the
disciplinary process should be addressed in a flexible manner
ellowing for diversity across exchanges.
B.R. 2069 also requires that 20 percent of exchange and futurea
aaaociation governing boards be conposed of "outside' members, aa
defined by the ConmisHian. While we favor 'outside' members and
will develop a broad definition to Include groups such as market
users, we continue to be concerned that a statutory quota system
may not always achieve the desired results. In 19B5 we found
that the performance of public directors sometimes was limited by
dirsctora' abaenteelam, failure to prepare sufficiently, and
failure to provide expert asalatanca. These factors should be
recognized and considered before further restrictions concerning
board membership become part of the statute or the CooniBaion ' a
Required Rffgietratlon of Floor Traders
The CommisaioQ supports this provision.
Enhancement of Registration Reqoireaenta
The Commission supports this proviaion.
Enforcement of Civil Honey Penalties
The Commission supports this provision.
„Coogle
The ConimlBBioil supports this pr^vlalon.
Ha-tiomrida Sarvic« of Procaaa and Veaua
Tha CoimiBBicin support* this provision.
iDcreaaad Fanaltiaa Cor Falony Convlctiona
Th« C^mlaaion aupporta this provision.
Contrttot Harket Ifparjency AotioDs
During its markup, tha Committa* nodifiad H.R. 2869 to provide
that an axchaoc)* naad not obtain Comnission approval before it
may take emergency action, although it must make every effort to
give tha Commission prior notice of such an action. While we
continue to believe that there is no necessity for any change in
exchange emergency authority, we support the Committee's approach
as more in keeping with the concept of axchanga accountability
and rasponsibllity aa a a elf -regulator.
The Committee bill also provides that within tea days (or aa soon
as practicable) after receipt of an exchange emergency rule and
explanation, the Commission must approve or disapprove the rule
and file a report with Congraaa justifying its action. Me
understand that under this provision, the timing of the
Commission's response may be tailored so as to avoid undue market
consequences. For Example, if there were more than ten trading
days remaining in a contract after the exchange action, the
Commission could defer its dscision and not report until trading
ended, if prior action might interfere with orderly trading.
did not intend to require that the , Commission coo^lete its final
analysis of the exchange action in that tima or to immunize the
exchange from later scrutiny of its emergency actions. In this
regard, we believe the Committee report should make clear that
Commission approval would not insulate the exchanges from
subsequent civil liability to market participants or from
Commission regulatory or enforcement accountability under the
Act, should these be appropriate when all relevant facte and
clrcomatances are reviewed by the Commission or otherwise become
known at a later date.
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G«) Stndr of DallTscy Points
Th« ConmiBBlon suppocta this provision..
Trading on Hatcrial Ron-pnblic Inlorwatlon
Tba Comdaaion supporta now saction 9(f} of tha Act which will
niaha it a talony for amployeas of Balf-regulotory orgBnizations
OE aasibara of thaii: govarnlng boards and committaas , to usa or
disolosa, contrary to Commiaslon ragulatlona, matarial,
non-public information for non-official purposas. The
Connlsslon'B currant ragulations alraady addrass thla typa of
activity.
R.R. 2669 would alao add new sactlona 9(g) and 9(h) to tha Act.
Saction 9[g] would make it b felony for an individual, contrary
to Commission regulations, to usa bs the basis for any connodity
futures or option transaction for his or her own account, any
matarial, non-poblio information as to present or future cash
commodity or commodity future or option transactions of any
person of whom tha individual is an employes or principal whara
the aggregate of auch transactions are in amouata in excaaa of
reporting levels apacifiad by the Commisslan purauant to aaction
41 of the Act. Section 9(h) would inaka it b felony for any auch
aiploy** or principal to disclose such information conoamlng hie
fim'a transactions with the Intent that the recipient engage in
coKBodity futures or option transactions on the basis of tha
information and where the disclosure is unrelated to the firm's
buainaas. The Ccmmiaaion understanda that its regulations to
implement section 9(g) may provide for appropriate exemptions,
for Bxasple, where commodity producers who are also enployees of
grain elevators establish their own hedging poaitiono.
Tha Commission has some concerns cvar these two provlsiona. We
have not found problems associated with the misuse of proprietary
information aa contenplated by proposed sections 9(g) and 9(h) t^
an^Xoyees of reportable tradera. And while aa a general matter
wa agree that employees should not misuse their time'
information for personal gain in the futures or optlone markets,
wa believe more information regarding tha nature and magnitude of
this problam is needed in order to justify statutory aolutions
like those in tha bill.
Ao an altasnative, we are prepared to use our existing rulemalcing
authority to addrese this issue, to adopt any regulatory
prohibitions that may be warranted and to report to Congress on
any criminal provisions or other legislative changes that may be
necessary. A rulemalcing effort will permit ua to focua on such
complex questions as the type of firm information on cash and
futures positions that should be protected from misappropriation,
tdiich ei^loyees and principals should be covered, whether trading
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uid diBcloanre rulaa should bm lc«y«d only to reportable tr&ders
aa In the bill or be moce broadly based, the scope of appropriate
exemptions for personal hedging and other legitimate purposes and
irtiether the rules should apply to trading and disclosure In
related coantodity groups . Wn would welcome report language
•ndoraing this approach.
Co^Mtitiveneaa Study
The Comnlsaion supports this provision.
Mooitoring of Hedge BxeaptiMia
The Coaniaaion supports thia provision.
AeaiBtamca to Foreign Fatoraa Jtnthoritlaa
The C<]^BiBBion supports this provision.
Parlod of Raaiithoriaation
tie aupport the etated Intention of B.R. 2869 to make the
Comnodity futures Trading Comniasion a permanent agency.
Feraanent authorization ia consistent with regular and aotiva
Congreasional oversight of the agency which the Commiaaion haa
alwaya supported.
We eppreciate thla opportunity to praaent our vlswa to the
Conaittee. Pleaae be aaaured that the ooncarna expressed above
with respect to certain aapecta of H.R. 2869 do not detract frcM
our support of the goals of thia bill-
Very truly yours,
Wend^ C. Gram 'J-
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COMNOorrr future! THADMa comhimkm
8«ptud>«r 12, 1909
The Banorabl« B (Kllca) d* la Gacza
Chairman, Coiiiiiiltt*« on Agriculture
D.S. Bouse of Repreeentativea
1301 Longworth House Office Building
Haahington, D.C. 20515
Dear Mr. Chairman i
Aa you will recall, on January 23 and July IT, 19B9i we Bubnittad
for consideration by the House Agriculture Coontittee our
recMHMndationa for anendnenta to the Conmodity Exchange Act. Aa
explained in thosa ■ubniaaiona , theaa apiendnenta would enhance
the enforcenent of the Act by providing for cooperation with
foreign futures law enforcement authorities, nationwide service
of process and venue in private rights of action, flexibility in
imposing civil monetary penalties and registration of floor
traders. I am pleased that H.R. 2869 as reported by the
Ccmmittee Includes all of these proposals.
Title III of the bill would permit the Conmisslon to assist
foreign future* authorities. Thn bill's definition of foreign
futures authority includes a broad range of authorities,
including Independent governmental regulatory agencies, executive
agencies, local governmental authorities, self -regulatory
organizations and criminal authorities that edminlater or enforce
rules or regulationa as they relate to futures and options
In particular, the bill would permit the CojanisBlon to conduct
investigations upon the request of a foreign futures authority
without regard to whether the facts stated In the request
constitutv a violation of U.S. law. To facilitate the
de 'olopmeiit of a working relationship with authoritlBs that have
the broadest legal mandate to oversee future» aad options
matters, it is expected that the Coinmlssion will act upon such
investigative requests from a single authority or only n few
authorities in each country. Instead of from a wide range of
self -regulatory organizations with varying responsibilities.
In providing assistance, the Coamlssion would be required to
consider the public interest and the agreement of the foreign
futures authority to provide reciprocal assistance to the
Commission. The Cc^mission believes that investigative
assistance from foreign authorltlea would be a powerful tool in
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•ffttotivaly «nfoEciiig th« Coimodity Bxchang* Act in
invaatigatioiiB that zequica the gatheiing o( Information froa
forsign sources The CominiBsion expeetn the availability of lt«
aaalatance to foreign futures authorities to act as a strong
indac«B*nt to t-hese authorltifie to obtain similar authority Co
assist the Commission. As you are aware, th* proposed
investigative authority closely parallels the authority obt«in«d
by the Securities and Exchange CommiBSion last y«ac In •action 6
of th« Insider Trading and Sacucitiaa Fraud Bnforcanant Act of
19SS.
In addition, Titla Ill's amandMant to aactlon S(a) of the Act
provides protection from compelled disclosura of infomation
identified in good faith to the CotimiBsion by a foreign futures
authority as protected from such diBCloaure undar foreign law.
However, section 8(a) does not preclude the discloaura of such
information in the proceedings referenced therein. Thia
protection from compelled diHclosure is neceaeary to achieve the
full measure of effective cooperation vith foreign futures
authorities in enforcement mattarsi and is conalstant with other
proviaiona of aactlon 8 of th« Act which alraady protect certain
catagorias of infomation from public disclosure, in accordance
with subsection (b)(3)(B) of section 552 of title S, United
States Code.
Section 209 of B.R. 2669 would amend the Act to authorise
nationwide service of process in private actions brought under
section 22 of the Act, the provision which permits customers to
seek damages for violations of the Act. The amendment would
empower U.S. district courts sitting anywhere in the United
States to issue process against a particular defendant without
regard to whether the plaintiff can establish that the defendant
had minimum contacts with the state in which the U.S. district
court is located The propoHal also includes special venue
provisions for section 22 actions to grant plaintiffs greater
choice In their selection of the particular forum in which to
Tha amendment is prompted by a 19ST Suprena Court decision which
ruled that authorization for nationwide service of process in
private actions was not implicit in the Commodity Exchange Act.
As a result,, without this amendment plaintiffs may be precluded
from suing non-U. S. defendants anywhere in thia country. And as
against U.S. defendants, private plaintiffs will be subject to
the burden and expense of proving that the defendant is amenable
to service under a state "long-arm statute," and, failing this,
they may be relegated to suing in an inconvenient forum. This
amendment would place commodity futures customers on the same
footing as aecurities cuatomecB, in circumstances where there
arises a need for resort to federal court litigation, because the
federal securities laws expressly provide for nationwide service
of process.
„Coogle
Section 207 of H.R. 2ee9 would WMnd tha Act to (1) aliminate tba
requirement that CFTC conaider A wrongdonr 'a financial
circumstances In assessing a civil penalty and (2) provide that
if the wrongdoer doea not pay the penalty when dua, his existing
registration with the CFTC would outomaticolly be ouBpended and
the wrongdoer woald automatically be prohibited from trading on
all exchanqea. This provision will facilitate and provide more
flexibility to the Commission's admin is trative law enforcement
process in •electing appropriate sanctione and will provide
additional statutory incentives to wrongdoers to pay penalties
promptly. Congress has already provided auch incentives in
-connection with unpaid reparations judgments.
Under existing section 6(d) of the Act, the Comnission must not
only consider the gravity of the violation in imposing a monetary
penalty, but also evidence relating to the penalty's effect on
the wrongdoer's net worth or ability to continue in business.
Because this type of evidence ia generally controlled by
respondents, the Commission has required them to come forward
with a showing that a proposed penalty is excessive in light of
their net worth or ability to continue in business. Respondents
that did not wish to produce such evidence have been permitted to
waive the financial inquiry mandated by the Act. The Comraiasion
has viewed its waiver approach as consistent with Congress'
intention that respondents have protection from excessive civil
penalties. However, disputes over the proper application of
section 6(d) have generated considerable litigation, including
several appeals to the Courts of Appeals. This litigation itself
has been an additional burden on the Commission's enforcement
program. Some courts have interpreted the law less flexibly than
the -Commission and have required development of an evidentiary
record on net worth or ability to pay whenever the Commission
igiposes a civil monetary penalty in an adjudicatory proceeding.
This is particularly difficult when the respondent, who possesses
the information, fails or refuses to provide the evidence for the
Another troubling aspect of the net worth inquiry has cone to
light where a respondent claima inBolvency. Specifically, a
United States bankruptcy court has blocked the Commission's
prosecution of an administrative case, in part because the court
was persuaded that the Commission's obligation to consider net
worth would interfere with the respondents' personal bankruptcy
reorganizations. The Commission has appealed that decision.
Thus, the Cotmnission believes that the statutory requirement to
consider financial circumstances has been misconstrued to become
an inhibition to effective enforcement of the Act and should ba
deleted as provided by section 207 of the bill. This deletion
would not limit the Commiaaion'B discretion to consider factors
relevant to the remedial purposes of existing section 6(d).
These factors may include: (1) the harm to other persona
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reaulting tram the violation) (2) Bonatary or other b«n«fit to
the wrongdoar; <3| wh«theT thera haa b«en any caatltution aada to
paraona injuradf J4) prior aanctiona Inpoaad by tba CFTC or othar
•uthorltlaa) (5) factors tending to ahow mitigation or
rahabilitation; and (6) tha naad to detar tha wrongdoar and
othara trcm coMBittin? thaae violationa.
Ragiatratlon of floor tradara aa provided by aection 205 of B.R.
2869 would alao aaaiat law enforcamant. Hiatorically, floor
tradara have not baan raquirad to reglater andar tha Act bacauaa
they do not handle caatoster tradea or monay and bacauaa exchange
rulaa have eotabliahad criteria governing thair acceaa to the
floor. Bowavar, if floor tradara collude with brokara in
violation of the Act or of Comiaaion regulationa, thay ahould be
anbjact to tha aaaa regulatory aanctiona. By requiring floor
tradara to raaiatar, the bill would aubjact th«M to atatutory
diaquallflcation and fitnaaa raguirementa Ilka other raglatranta.
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w
vs. DepMimcnt of Jurtkc
Office of Legiiluive Affun
Septembec 12, 1989
>!• B da la Garza
Chairaan
CoaMlttee on Agrlcultura
U.S. Kousa of RapraBBntatlva*
Washington, D.c. 20515
Daar-Mr. Chairaan:
Thia Is to raltarata tha viaws of tha Depsrtaant of Juatica
ragarding anandBants to H.R. 1869, tha propoaad Coanodlty Puturaa
Inprovaaant Act, which vara adoptad by tha Subcoiuiitt» on
Conaarvation, Cradlt and Rural Devalopmant on July 26, 19B9 and
dalatad by tha full Cosnittaa on Auguat 2, 1989. Ha undaratand
that tha amandnants nay ba oftared again whan H.R. 2869 !■
Consldarad on tha floor of tha Houaa. Thasa anandnenta,
pravioualy offarad by congrasaBan Tallon, would anact criBinal
sanctions for an abusa arising froB dual trading on futuraa
exchangaa. Undar thaaa amendnants, 'front running,' in which a
brohar tradas for his own account shaad of his cuatonars, would
ba prohibited speclfloally and a tmowlng violation of that
prohibition would ba punlahabla as a falony.
Ab wa pravioualy indlcatad, the Departnant raviawad tha
amandBBnta and datamlnad that tha axisting antlfraud provisions
of tha Connodity Exchanga Act as wall as tha Bail and wlra fraud
provialona of Titla IB provide agiple statutory authority to
proceed against front running offansaa. Horeovar, proaacutlon of
front running offenses would not be facilitated by thaaa
anendnenta. Front running la in our opinion a violation of tha
Cosaodlty Exchange Act and Title is and thus is adequately
addraasad by existing law. Accordingly, we urge tha defeat of
any effort to adopt these aBendaenta when tha neasure is
considered by the full House.
„Coogle
Tha Office of HanaqeBant and Budgat haa advlud thla
Dapartsant that thara ia no objection to tha submlaalon of thl*
raport from the standpoint of the Adainlatration'a pcogran.
Co^^_yJ" Ca.*.-/^
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Mr. English. Mr. Coleman.
OPENING STATEMENT OF HON. E. THOMAS COLEMAN, A
REPRESENTATIVE IN CONGRESS FROM THE STATE OF MISSOURI
Mr. Coleman. Mr. Chairman, today we begin the fourth reau-
thorization of the CFTC in its 15-year history. We do so at a very
critical time in the Commission's history, the industry that it regu-
lates, and the customers that that industry serves.
We are all aware of the innovations that have taken place in the
futures industry in the last 10 years or so. Initiatives such as stock
index futures and related instruments have changed the complex-
ion of the futures industry. These and other initiatives have provid-
ed the industry with the tools it needs to conduct international
commerce in today's global economy. Yet many of its daily business
practices continue as they have for years in Uie face of these dra-
matic innovations the industry has experienced.
Therefore, I think it is appropriate for us to discuss publicly the
questions raised when innovation and tradition meet and whether
we have in place the saf^uards necessary to protect the customer
and the int^rity of the markets. That is, I think, a very important
part of this reauthorization deliberation which we are starting
today.
With this in mind, I am somewhat surprised and disappointed
that our witness list includes so few users, particularly b^ks and
other financial institutions. Of course, I look forward to hearing
from representatives of primary users, such as the Nationsil Grain
Trade Council. I believe their testimony will be important and
useful to this subcommittee. Even so, I would think that ottier seg-
ments of the futures markets would want to be heard.
Not long ago this subcommittee and many people in this country
were concerned about stock index futures and the relationship be-
tween these markets and securities. For this reason, I think it is
unfortunate that other regulators of financial markets who were
invited to be here today — Securities and Exchange Commission,
Federal Reserve, the President's Working Group — have all declined
to appear before us.
Just one additional observation: We are all enormously grateful
that the predicted economic collapse following the October 19 stock
market drop did not occur. For this reason, some people have for-
gotten that important event. But I think this subcommittee has a
duty to remember it and to help the Nation learn from it.
Mr. Chairman, as we turn our consideration to the Commodity
Futures Improvements Act of 1989, I want to b^in by stating my
primary reason for supporting this bill. I believe Uie industry needs
to make more prepress in refining its audit trail system. You may
recall that we considered this matter during the 1986 reauthoriza-
tion when the Commission was seeking a new standard for trade
recordation. At that time, the industry said that such a standard
would drive business overseas. In fact, trade volume records indi-
cate that that hfis not happened. In fact, I believe, an enhanced
audit trail proved its worth following the October 1987, market
break.
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48
Accordingly, Mr. Chairman, while I understand the exchanges
are making significant pn^^resB in their syBtems and commend
them for it, I think it is time for Congress to establish some stand-
ards in the law dealing with audit trails. I believe the effort and
expense of doing so will be more than offset in the future aa domes-
tic and global market users trade with the confidence that our fu-
tures markets are the fairest and the most efficient in the world.
As you know, under the bill before us, dual trading will be pro-
hibited in certain markets under certain conditions until additional
standards are met. We have heard fi*om some trsiders that a ban on
dual trading will harm, not protect customers. They state that the
better traders will trade their own accounts, leaving the customer
orders to inexperienced or inefficient traders. While this firgument
is plausible Eind although we have enabled the customer to name
his own broker who may also be trading for his own account, I am
willing in these hearings to accept additional testimony on this
matter.
I would also note that pursuant to the wishes of this subcommit-
tee and the committee chairman, this bill would discontinue the 4-
year reauthorization cycle. We believe that a 2-year dollar-specific
authorization will provide a better opportunity for us on this com-
mittee to perform our oversight responsibilities and be more re-
sponsive to CommiBsion and market needs. I look forward to these
hearings and the distinguished list of witnesses that we have in the
next several days and look forward to continuing our work togeth-
er, Mr. Chairmfui, as we mark up this bill hopefully by the end of
this July. Thank you.
Mr. EStolish. Tliank you very much, Mr. Coleman. Mr. Morrison.
OPENING STATEMENT OF HON. SID MORRISON, A REPRESENTA-
TIVE IN CONGRESS FROM THE STATE OF WASHINGTON
Mr. Morrison. Thank you, Mr. Chairman. I chose not to cospcm-
sor the measure before us, but I compliment our chairman and
ranking minority member for at least heading us down a legisla-
tive trfiil and it be, of course, the subject of I think, some rather
intense interest and experience that is starting this morning. I ap-
proach the subject with a very open mind. Futures trading is not
vitally important in my area of agriculture, so I am going to listen
to Neal Smith and others, our experts on the subject, because of
the importance in their own area.
I agree with my colleague, Mr. Coleman, that audit trsiil is going
to be, I believe, a significant part of our requirement. TowiutI the
industry in general, let ub make sure it works, that is our obliga-
tion. The subcommittee if it does work, do not fix it. If it does not,
we will do it right.
Mr. English. Thank you very much. Mr. Harris.
Mr. Harris. Thank you, Mr. Chairman, and I would ask a unani-
mous consent that my statement be made part of the record.
Mr. English. Without objection.
[The opening statement of Mr. Harris follows:]
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Thank you, Mr. Chairman, and good morninf to all. I am glad that this hearing
procees has at last b^un on the matter of CFTC Reauthorization, as 1 believe that
many of our constituents are eager to see what positive affect this subcommittee
will chooae to make on an industry that has lately cieen under a very critical magni-
fying glass. It is certain that as the hearings proceed we will hear testimony that
will speak to whether such critical scrutiny of the futures trading industry, and, of
course, the CFTC, in particular, is justified or not.
For myaelf, I will reserve judgment and wait to draw conclusions until th«ee hear-
ings are concluded. However, no one can deny that public perception of the intMrity
of the commodity ^tures trading markets and their re^latoty overseer, the CFTC,
is of vital importance to our economy and, ultimately, the welfare of every Ameri-
can: The end Duvers and users of these commodities.
Unquestionablv some of the perceived int^prity of the markets has been damaged
and I feel that tnis inquiry into any legislative and r^ulatoty shortcomings of the
system will be a signincant "first step toward shoring up whatever damage may
tuive been done to this necessary component of our free market system. Thank you.
Mr. English. Mb. Long.
Ms. Long. No statement, Mr. Chairman.
Mr. English. Mr. Staggers.
Mr. Staggers. No, Mr. Chairman.
Mr. English. Mr. Sarpalius, do you have any comments that you
care to make?
Mr. Sahpalius. No, Mr. Chairman.
Mr. English. We are very delighted that our first witness today
is a person who has long been interested in the subject of the ^-
tures industry and has been quite outspoken; one who has presents
ed a number of views that I think people have from time to time
cometo adopt; and one of those who was there with the creation of
the CFTC and participated in that overall effort; and one who is
highly respected for his knowledge of the futures industry.
And, of^ course, I am speaking of our colleague. Congressman
Neal Smith. Neal, we are delighted to have you here this morning
and would be happy to receive your testimony.
STATEMENT OF HON. NEAL SMITH, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF IOWA
Mr. Smith. Thank you very much, Mr. Chairman, for those com-
ments. Mr. Chairman and members of the committee, I want to
coi^rratulate you for making the first serious attempt to find out
what is wrong with the act and do something about it. In 15 years,
there has been a lot of talk, but there really has not been any seri-
ous attempt to fill in the shortcomings and you are doing it. And I
really want to congratulate you for that.
I will file my statement smd make a few comments here.
Mr. E^NGLiSH. Without objection, your complete written testimony
will be made a part of the record.
Mr. Smith. You know, 15 years ago we held 6 months of heeuings
over at the Small Business Committee and then this committee
held hearings aiter that. And it was clear at the time that we had
about three alternatives. The first one was to ban futures all to-
gether. At that time we could have easily passed a bill f^m the
Congress banning futures all together. The second option was to
put it all under SEC and there was a lot of criticism about setting
up a separate commission.
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But I was one of those who thought that it waa best to have a
separate commission, especially in the case of commodities. Be-
cause I think commodities and financial instruments are somewhat
different. And you will notice that the name of the commission is
the Commodity Futures Trading CommisBion. It is not the financial
futures trading commission. That was the primary reason fin*
having a separate commission.
I thjnk that the basic act that we passed in the House was pretty
good, but by the time we got throiigh conference at that time there
were some shortcomings in the bill. And unfortunatehr each time
we have tried to correct those, the industry has opposed corrections
and 80 some of them are still there.
I have been somewhat disappointed in the CFTC. I say that
frankly. It was 1 year before President Ford appointed any mem-
bers. Some of the members have not been what we might expect
them to be since that time, and in addition to that, they have not
always had the resources they needed, especially the computerized
resources. But on the other hand, it is not all their fault. Some of it
Congress has to share because the basic law does have shortcom-
ings in it that Congress has not corrected.
One of those, of course, is most visible at this time is the one in-
volving dual trading, and each time we have reauthorized the bill,
there have been excuses why you cannot ban dual trading. You
know what they are: Liquidity is the old one and then you have not
proven that there has been an^ fraud. Well, fraud and conspiracy
IS hard to prove. It takes a "stmg" operation to do it. But we have
a "sting" operation now, so there is not any question about itemy
more. That is no longer an excuse. It needs to be banned, and I
think that tmtil we get the computerized sj^tem, and I noted espe-
cially Congressman Coleman's remarks. This is the euiswer to it
really.
We need a system, instead of this old horse and buggy deal they
have in the pits. You need a system where you C£Ui go into Ksmsas
City or Okl^oma City or Des Moines, Iowa, sit down in the bro-
ker's office, and you can look at the screen and you can know im-
mediately whether or not you matched a trade. Immediately, not
the next day. Immediately. That is the answer to it. If we do that,
we do not need to argue about some of these things. Then we would
know that the trade is honest. We would know that the industry is
honest in that regard.
But until we get that, I would say that we ought to ban dual
trading, maybe with one exception. And that one exception would
be where you know or should know, when you walk into this office,
that the contract you are dealing with is so small or the office you
are dealing with, the exchange you are defiling with, is so small
that obviously the person on the other side is going to shift the risk
somewhere else to some other exchange or to some other contract.
Except for that possible exception, I just think we ought to ban
dual trading. If you ban dual trading, then you will put the encour-
agement that is necessary into this system where they will make
the reforms that are necessary, and that will encourage computer-
ized trading too.
Another visible problem is insider information, and it was
banned at the Securities Exchange Commission 50 years ago. And
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the same activity for which they are prosecuting people in New
York today would even be ill^eil if it is done on futures. And when
a corporate officer or an employee knows that his employer is
taking big positions — we are not talking about little positions, we
are not talking about the country elevator operator — we are talk-
ing about reportable positions in the case of commodities. When-
ever they know about some big positions they are going to be
taking, and they take one for themselves in advance, in that in-
stance they are really working against the interest of their employ-
er. And in many cases, and I cannot say in most because I do not
think it is so — in many cases employers have prohibited employees
from doing that and officers of the company, but in some cases
they have not. It just should not be permitted.
It is no longer just a matter of dealing with commodities now.
We have a lot of financial contracts. And the SEC has been enforc-
ing these with regfu'd to fuifuicial commodities or financieil con-
tracts, but you know they are banned &om doing things in New
York, that they are not in Chicago. And so they can go on to the
index futures and that is part of what happened in the catastrophe
we just Uilked about. And so the two are related. We should ban
insider trading too. It has spread to the financial futures now.
Another subject that I want to make mention that has not been
mentioned much right now because we do not happen to have that
kind of a movement ingrained that encourages thinking about it,
but it is the reporting of export sales. I had bills in on all of these
things, but one of the bills requires reports to be made to the CFTC
instead of USDA. USDA cannot enforce reporting. They do not
have any penalties to start with that amount to anythii^, They
cannot force foreigners to report to them.
But a lot of these big sales are hedged on our futures market, as
in the case of the one that wbs made on Canadian wheat a few
yefu^ ago. All was hedged on our market. They not only hedged it,
but th^ covered 60 mulion bushels more than they sold. And then
sold off later the 60 million bushels and made a big profit on it.
Our futures meu'ket, our farmers, our processors are the ones that
are ^^ng the bill. And we ought to make these reports come to
the CFTC because the CFTC can immediately then enforce the re-
ports to see whether or not they are speculating. They are in
excess of the spec limits and they can suspend them from trading
on CFTC and that is enough for a penalty. A small fine like they
have at USDA is not enough to enforce reporting.
The Americfm farmers have to give information, and they do
freely, that is printed all over the world about our crops and the
possibility of the size of the crop being bigger or smaller. And I do
not think there is anything wrong with reporting to the CFTC
either.
Now I have only highlighted three eunendments that I suggested,
and I know that you nave examined numerous ones and I compli-
ment you on the draft bill that you have. You have numerous
things in there that are very important, and I still think that the
business of shifting risks is still important to farmers and smedl
businesses. And I want to do it by amending this law.
But I have to say I have reluctantly come to the conclusion that
if we cannot get these minimum needed amendments this year.
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that protect a|;aiDst dual trading and insider trading and some of
these other things, then I think that the time has come to consider
seriously putting it under SEC where those are already prohibi-
tions.
I know that you are approaching this very seriously and any-
thing that I can do, it is not going to be much compared to what
you can do, but whatever I can do, I want to help you do what you
started out to do, and I want to compliment the committee for
what you are doing.
[The prepared statement of Mr. Smith appears at the conclusion
of the hearing.]
Mr. Enqush. Thank you very much, Neal. I appreciate it very
much. As you know, the subccBmnaittee is concerned over the ques-
tion of whether or not the CFTC has had adequate resources to do
its job. It is one thing to give an agency the responsibility; it is
something else to provide the resources. And we are certainly
pleased that the Appropriations Subcommittee included etdditional
funding in the bill that is going to be on the floor today to address
that.
If your two bills that you mentioned included any of the l«asla-
tion to be adopted by the Bubcommittee, how much additional fund-
ing do you thmk that would require?
R&. Smith. I think that it would not require any additional fund-
ing because if you ban dual treiding then &ey do not have as much
of a problem enforcing the law as they have now. As it is now, it
took several years to get the computer capacity, and I do not know
that they have it adequate yet. But for several years they did not
have computer capacity to follow these trades. On the Small Busi-
ness Committee I had a study conducted. I had three people work 9
months to really nciil down what had happened in one transaction
or one series of transactions that happened over a 15-day period.
Computer capacity, if it is adequate, ought to have naUed ihat
down right away in 1 week.
So if you ban dual trading, then you stop some of the practices
ttiat are so difficult for them to follow and it will take less re-
sources really. But they need all the resources they have even if
you hem dual trading. They have a budget of about one-third of
what the FCC does.
Mr. E^NGLiSH. How much of an impact do you think that lack of
budget, that small amount, has on the ability to carry out this re-
sponsibility?
Mr. Smith. It has some, however, I think that the shortcomings
in the law are much more important than a small increase in the
budget.
Mr. English. The other feature, I suppose I should not be mixing
the two, but of course the witness following you will be, is the
CFTC. The essence of the CFTC testimony I think is that basical^
other than some of the changes that they are recommending that
everything is fine. That there really Bxe not any major changes
that are necessary. Certainly beyond studies and whatever, but Sie
general thrust of the testimony is that the CFTC has eill the au-
thority that they need and basically everything seems to be in
pretty good shape as far as they are concerned.
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Your testimony would seem to be somewhat at odds with that.
How much of this comee down to resources? How much of it comes
down to the changes in the law? How much of it comes down with
r^ard to the attitude of the CFTC in what they see their role in
their job?
Mr. Smith. I think it is some of all of that. To start with, if th«r
have the capacity, emd they are using the capacity that is needed,
then why cud we have these scandals? Just on the face of it, it
shows that there is something wrong. And even the one that hap-
pened in soybeans — what happened in soybeans last week diouM
not occur. I mean, something is wrong when it is that late in the
contract and th^ have that severe an acljustment. Then you had
joeople dealing in the contract that have interests on bou sides.
There is something wrong with that.
So obviously some amendments are needed. And, of course, with
r^card to reporting sales, they do not even have the authority tx>
require anybody to report sales, so it is verv difficult for tiiem in
the case of the forei^ customer or even a State trading commny.
A country that has its own State trading company is veiy dimcmt
to know whether or not they indirectly are hedgmg or if they are
speculating.
So there are shortcomings in the law. I think there is enough
blame to go around for all three of those instances.
Mr. Enolish. Mr. Coleman.
Mr. CoLEBUN. Neal, thank you for testifying and yoiur positive
comments about what Glenn and I have tried to do. Mr. Morrison
calls the bill a starting vehicle, but it is one which we think has a
lot of language which ought to be retained in the final product
One of the things you mentioned and I think generally is per-
ceived as a positive thing has been this undercover, as you say
"sting" operation. And one of the things we put in the bill is to ^
to encourage the continuation of such potential undercover oper-
ations. And that may indeed require appropriations and additional
expenditures in one form or another. As you know, to make an op-
eration successful, you have to go through a lot of window dressing
and so forth and so on to make sure t^t your imdercover people
are not found out.
So there may be reasons for the Commission and for us and for
you to look at appropriations and to increase them to the extent
that we are going to have this as a successful deterrent. I think
that the industry recognizes, as well as the regulator and the Con-
gress, that just me threat of having somebody on that floor all the
time in an undercover capacity will keep some people from moving
over the brink into an illegal situation. So I just want to remind
you as we go forward togeuer that we may have to have some in-
crease for these types of activities, and we would obviously need
your support. And I think that you are supportive of that type of
effort, but it is probably going to cost some money.
Mr. Smtfh. I agree with you, but I want to remind you of two
things. One thing, of course, is the "sting" operation which was
conducted by the Justice Department — I happen to Chair the aub-
committee that handles their funding and I know it is going to cost
a lot of money — that would not have been necessary if we had pro-
hibited dual trading. They had to have a "sting" operation because
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54
tiiey have to lean on ftaud statutes and conspinu? statutes and
that is extremely difficult to prove, and you almost have to have a
"sting" operation in order to do it. If dual trading had been prohib-
ited to start with, these abuses could have been stopped without
going through all of that.
So I think t^t the amount of money needed to enforce this part
of it would be even less. But I agree with you that we need to nind
it.
Mr. Engush. Mr. Morrison.
Mr. MoBBisoN. You obviously have a very firm exposition on the
dual trading issue. However, you did allow that some smaller mar-
kets would prcd>ably be necessary to make the mark. A hUl intro-
duced before us includes the cutoff point of 7,000 contracts estab-
lished in that size. Do you agree with that number?
Mr. Smpth. I do not reaUy know what the number is, but I would
say that I would use this, as vou study it, as your basis. If I am
dealing with a small exchange because I prefer to deal with them —
perhaps I know them or they are close by — I ought to know that, if
it is a big contract, that they probably do not have enough people
there to match all the offers that need to be matohed. That they
are probably going to matoh it somewhere else or shift the risk. I
think that is tiie basis, and I do not know the number of contracts
that ought to be. Of course, where there are smaller numbers (^
contracts, there is more of a need to recognize that problem in
other ways. But the answer to it, of course, is computerized trad-
ing.
Mr. MosRisoN. So you agree with the tie-in that the bill provides
for the number of size
Mr. Smith. I agree there is a difference between a small ex-
change out in Kansas Ci^ or some place and Chicago. I do not see
any excuse for it in CBOT or in Merc, either one.
Mr. MoBBisoN. And yet the bill does provide for demonstrations
of approved audit trails. I think that would have an impact on the
trading issue.
Mr. Smpth. Well, it would, but the answer there Eigain is comput-
erized trading. We should not have to be fooling around with other
trails, niat is horse and bi^gy stuff. Guys getting down and yelling
at one another. We have computers in this country. We clmm we
are a leftder in computers. We ought to be able to go in — when I
was chairing the Small Business Committee, I think it was GE— I
do not want to use the wrong company, but I think that was who it
was. We had them do a study to see whether or not they could set
up computerized trading at that time. They said they could, but it
would cost some more money to do it, but at that time they knew
that the exchanges would not accept it anyway, BO they would not
spend the money.
For 10 years we have had the capacity to have computerized
MrTMoaRisON. That time was how many years ago?
Mr. Smtfh. About 10 years ago. That is the answer to a lot of
these problems.
Mr. MoBBisoN. The same computer program, right? To place the
appropriations process?
Mr. Smtth. It might. If it will, it sure will save us a lot of time.
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Mr. English. I am sure you are glad you did not cany that a
step further and say Congress went on that.
Mr. Smith. I thou^t of that too.
Mr. E^auSH. Mr. Harris.
Mr. Habsis. No questions.
Mr. ENOura. Mb. Long.
Ms. Long. No miestions.
Mr. English. Mr. Staggers.
Mr. Staggers. I thank our colleague for testifying, but I have no
questions.
Mr. English. Mr. Tallon.
Mr. Tallon. Thank you, Mr. Chairman. Neal, thank you for your
testimony. I just want to assure you that the committee and I and
all of us are serious about eliminating the potential for abuse. In
my mind, this means mnkiTig the practice of trading Eihead of your
customer in these markets a criminal offense. It means making
any sort of ban or penalty applicable to everybody, no matter how
la^e or how small, no exceptions. And it means protecting people
through greater surveillance and telemarketing restrictions. I
really believe that we can and we must protect the int^rity and
the competitiveness of these markets.
Obviously you know a lot about futures trading and you have got
great concerns about what I like to term "total market access."
The more familiar term is dual trading. You seem to — I am trying
to remember what you said — but I was thinking that you were
tfllUng about if the trades could be reconstructed immediately,
rather than waiting until after the markets close or the next day
that it would make any kind of a difference. I am not sure what
you mean as far as not making any kind of a difference?
Mr. Smith. Even then, there is trouble, if you have dual trading
in the big contract because you have the possibility of traders
working with one another. It ie not always the trader that takes
his own deck of cards and decides which one he is going to place in
his own hand ahead of others, he can work with somebody else.
Dual trading is just set up for fraud.
Mr. Tallon. Neal, do you get a lot of complaints from constitu-
ents about dual trading?
Mr. Smith. Actually the complaints, and it is reflected in the use
of the contracts, the complaints are they do not trust them. And as
long as th^ do not, they are not going to use futures themselves.
They are going to use them indirectly through elevators. Local ele-
vators hardly use them any more. They have somebody else do it
for them.
Mr. Tallon. So they are pretty big people that generally trade or
do most of the business in futures markete?
Mr. Smpth. Right. I think that is true, but even then, they have
their doubts and they know that it is right for abuse. They just
know that it is right for abuse.
Mr. Tallon. Maybe you can help me, because obviously you
know a lot about this. But the pretty big people who are generally
trading in the futures markets, do they have to use someone who
has total market access or who is a dual trader or do they have an
option?
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Mr. Smith. Some of them have their own seat. They would not
think of not having their own seat.
Mr. Tallon. But on all of these futures exchanges, are there
people there who do not trade for themselves, who are not engaged
in dual trading?
Mr. Shtth. Oh yes. Some of them do not trade for themselves.
Not all of them are dual traders.
Mr. Tallon. These futures markets that are very important and
in the interest of U.S. agribusiness and farmers and business gen-
eral
Mr. Shith. The dollar value in the futures now is even more
than the dollar value in securities. It is important.
Mr. Tallon. It is a veiy important market. But are not these
markets all over the world? These futures markets?
Mr. SbiOth. They are growing. Yes; there are some in other coun-
tries. I noticed whenever they had one of these great big sales over
wheat, they come to our futures market to offset it, to shift the cost
on to the American farmer and processor.
Mr. Tallon. But what kind of ban does the market, say in Japan
or in Europe or Great Britain, what kind of ban do they have on
what is called dual trading?
Mr. Saoth. I do not know exactly what hem each one of them
has, but I bet you this, I bet the one in Japeui will be computerized
before long if it is not.
Mr. Tallon. I do not have any more questions, Mr. Chairman.
Mr. English. Mr. Sarpalius.
Mr. Sarpauus. No questions.
Mr. English. Mr. Combest.
Mr. Combest. No questions.
Mr. English. Mr. Nagle.
Mr. Nagle. No questions.
Mr. English. Tlwjik you very much. We appreciate your testimo-
ny.
Mr. Smith. I just weint to make one other short statement. Sever-
al of you mentioned the resources and the amount of money that is
needed. I do want to mention this. 1 was just reminded. You know
some years ago. Chairman Johnson and Chairman Shad made an
agreement as to dividing up the futures and then after that C(m-
gress incorporated into legislation that agreement — fixed it into
place. I do not think the agreement was good to start with. I think
it ought to be ren^otiated. 1 am not advocating exactly what it
ought to be in the figreement, but I think that another thing you
might consider is releasing these two chairmen, so they can ren^o-
tiate a new agreement. Because if CFTC does not have the re-
sources they need, they could do without some of those financial
futures.
Mr. English. Thank you very much, Neal, I appreciate it.
Our next witness is the Chairman of the Commodity Futures
Trading Commission, Ms. Wendy Gramm, who is well known as far
as this subcommittee is concerned. Wendy, I want to say how
pleased we are to have you with us. If you would identify those
that came with you, I see that you did not bring any of the other
Commission members today; is that right?
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STATEMENT OF WENDY L. GRARIH. CHAIRMAN, COMMODITY FU-
TURES TRADING COMMISSION, ACCORIPANIED BY ROBERT
MACKAY, CHIEF OF STAFF; ANDREA CORCORAN, DIRECTOR, DI-
VISION OF TRADING AND MARKETS; DAVID KASS, DIRECTOR,
CHICAGO REGIONAL OFFICE; DENNIS KLEJNA, DIRECTOR, DI-
VISION OF ENFORCEMENT; AND STEVEN MANASTER, DIREC-
TOR. DIVISION OF ECONOMIC ANALYSIS
Dr. Gramh. Thank you very much, sir. I did not bring Conunis-
sion members today, but I did bring my technical stafi*. Here on my
left is Robert Mackay. He is my Chief of Staff, who has been going
over the l^islation in some detail. Andrea Corcoran is to his left
and is my Division Director for Trading and Markets. To my right
is Dave Kass who is head of our Chicago regional office and has
been the first person on the line with respect to the soybean mar-
kets. And then to his right is Dennis Klejna who is our Director of
tbe Division of Enforcement and Steven Manaster, our Director for
^e Division of E>:onomic Analysis.
I have brought them here, anticipating some questions of techni-
cal nature. I think that I can speak for the Commission with re-
spect to the Commission's policy positions on the legislative propos-
als we have before us this morning.
Mr. English. Let me also say, before you get started, Dr.
Gramm, that if you would care to submit written testimony and
care to summarize, without objection, the complete written testimo-
ny will be meide part of the record. And I may say that is for all of
our other witnesses. If there is no objection, all written testimony
will be made a part of the record.
Dr. Gramm. Thank you very much. I would like to do that, but I
would like to take a few minutes to go through the Commission's
position on the l^islative proposals this morning, particularly
since this is something that elII of the Commission is very much in-
terested in. I am pleased to be here to represent the Commissioners
and to represent our reauthorization proposals, as well as to re-
spond to the l^pslative proposals your committee has set forth in
the Commodity Futures Improvements Act of 1989.
This authorization comes at a time when the Commission's ag-
gressive enforcement prc^ram, as demonstrated by our participa-
tion in the undercover operation in Chicago and in the recent in-
vestigation in New York, has focused public, industry, and congres-
sional attention on allied abuses in commodity futures trading.
Your subcommittee stan has just completed a thorough inquiry
covering all markets and found the aelir-r^^atory systems to be
generally sound. The Commission also 1^ conducted its own
review of our oversight procedures and exchange trading practices.
Now, this subcommittee is considering r^ulatory euid l^islative
changes to further strengthen the Commission's ability to oversee
iutures markets.
The Commission supports the subcommittee's goals in this Eu*ea.
We believe that Congress has given us sufficient authority in the
Commodity E]xchange Act to fulfill our mandate. Thus, in our re-
quests that we sent forward to you, we do not ask for major l^isla-
tive changes at this time, although we are proposing some changes
to enhance our regulatory program.
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The Commisslon'B legislative requests consist of five parts that
deal with nationwide service of process, international law enforce-
ment, civil monetary penalties, automatic suspension euid trading
prohUiitions for fedlure to pay penalties, and registration of floor
traders. I will review each of tnem very briefly.
The flrst proposal would amend the act to authorize nationwide
service of process and special venue provisions in private l^al ac-
tions brought under section 22 of the act. This proposal is a custom-
er protection provision which would allow, for example, a customer
who is defi'auded by an out-of-State boiler room operation to sue in
his or her home Stete rather than being required to go to court in
the State where the boiler room actually had its principal place of
business. SpeciflcaJly, the proposal would allow private dainage ac-
tions to be flled in the district where the defendant is found, trans-
acts business, or where the transaction constituting the violation is
found.
Our second legislative proposal is in the area of international
law enforcement. As the process of internationalization of futures
and financial markets continues, cooperative enforcement efforts
with foreign futures authorities are becoming an increasingly im-
portant part of the Commission's enforcement responsibilities
under the act. Therefore, we are proposing a new section be added
to the act which would provide the Commission with explicit au-
thority to conduct investigations on behalf of foreign futures au-
thorities regarding violations of foreign laws, rules, or regulations
relating to flitures and options.
This l^islative proposal would enhance our ability to cooperate
with foreign futures authorities. There is worldwide intei^ in
such cooperation, and other authorities are seeking this authority
in their countries if they do not already have it.
Our third proposal eunends section 6(d) of the act to eliminate the
requirement that the Commission consider a wrongdoer's financial
circumstances when assessing a civil monetary penalty. This
amendment would give the Commission more flexibility in choosing
appropriate monetary stmctions in the administrative law enforce-
ment process.
Our fourth proposal also amends 6(d) to suspend automatically
the wrongdoer s registration with the Commission and to prohibit
him from trading on all exchanges if he or she fails to pay the pen-
alty when due. This proposal would create incentives for wrongdo-
ers to pay penalties promptly, and it is identical to the provision
already in the Commodity Exchange Act mandating automatic sus-
pension of registration and a prohibition of trading if a party fails
to pay a reparation judgment.
Our fifth proposal involves the registration of floor traders.
Unlike floor brokers, who trade for customers as well as for them-
selves, floor traders trade only for their own accounts. However, if
floor traders collude with brokers in violation of the act or Com-
mission r^ulations, they should be subject to the same r^ulatory
sfuictionB. Requiring floor traders to register would subject them to
statutory disqualiflcation and fltness requirements like other regis-
trants,
As I have said in earlier testimony, the Commission always
stands ready to ask for more authority if we determine that we
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need more authority. We already have added three new l^islative
propoeals to our l^islative package since the beginning of January.
Now with resp^ to the legislative proposals that the subcom-
mittee bill proposed, there are a number that are not addressed in
our legislative package. We appreciate the fact that you have incor-
porated our legislative propraals in your package. While the Com-
mission has not had the opportunity to fully consider and develop a
position on every aspect of the proposed bill, I would like to re-
spond today with the Commission's preliminary assessment of the
major provisions.
Allow me to say at the outset, however, that the Commission
shares the overall goals of this bill — to diminish the potential for
trade practice abuse, strengthen the Commission's regulatory
^tem, and maintain the integrity of futures emd options markets,
tliereby increasing public confidence.
An improved audit trail is a priority and has been a long-held
Commission goal. The Commission moved figgressively toward this
goal in 1986 by developing the l-minute trade timing requirement.
More recently, the Commission asked each exchange to improve its
s^tem for reporting and using trade timing information to en-
hance its own trade practice surveillance program and requested a
plan from each exchange for further improving their audit trail ca-
pabilities. Specifically, we have requested that each exchange
review the veriflability of trade timing data, accuracy levels, and
its procedures for assuring the accuracy of source records.
We Eu-e firmly committed to improving the audit trail in ways
that are most effective in detecting trade practice abuses. We must
be realistic, however, about the capabilities of these systems once
their potentiEil has been achieved. Audit trail systems are records
analysis systems and neither these nor any other kind of record
systems can detect all types of trade practice violations.
Accordingly, we believe that a careful analysis is necessary
before decreasing the trade timing standard to 30 seconds or less.
Chfuiging the timing standard from the current l-minute trade
execution requirement to 30 seconds or less, for exeunple, may not
provide sufficient improvements in overall audit trail capability to
justify what would be a significant increase in cost, particularly to
the smaller exchfmges.
Other audit trail improvements may be more efTective in detect-
ing and in preventing trade practice abuse. Such improvements
could include, for example, collecting trading cards more frequent^
ly coupled with more frequent trade matching, granting compli-
ance staff the authority to collect and copy trading cards on the
floor, and limiting the entry of verbal orders by members on the
floor. Similarly, we believe it may be a more effective use of other
exchfmge resources to move toward on-line order routing, execution
and trade reporting systems which would provide many other bene-
fits in addition to the improved audit trails.
We appreciate the subcommittee's support of our efforts to
achieve the audit trail improvements, and believe that our existing
authority is sufficient to accomplish this important objective and
we are actively pursuing that goal.
With respect to dual trading, we share the goals of the proposed
legislation to rid the markets of abuses connected with the practice
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of dxial trading. Indeed, the original purpOBe of the enhanced audit
trail was to obfain records to identify and deter trading abuses re-
lated to dual trading and trading Eihead of customers.
Earlier this year we began a study on dual trading to assess its
role in fostering trading abuses and to determine whether any limi-
tations on duEil trading would adversely affect market liquidity. We
expect our study to be completed in early October. We have con-
cerns about the use of contract trading volume to trigger a dual
trading prohibition. Using the average dfdly volume of 7,000 con-
tracts as a trigger, as proposed under the bill, could have signifi-
cantly different effects on different markets, depending on such
factors as the size and characteristics of each market's floor trad-
ing population.
Accordingly, we believe that if specific restrictions on dual trad-
ing are to be set, they are more appropriately set by the Commis-
sion through its rulemaking authority. Through the rulemaking
process we can apply a more flexible approach toward achieving
the goal of eliminating dual trading abuses which we and the sub-
committee share. The Commission would be able to evaluate on a
market-by-market basis the efficacy of dual trading, taking into ac-
count the effects of any limitotions on liquidity and the qualil^ of
the audit trails. In this regard though, we do welcome the elements
of flexibility provided in the bill in implementing the dual trading
prohibition.
With respect to undercover authority, the Conmiiasion has a
strong record of vigorous law enforcement. And in the exercise of
its own investigatory powers, the Commission has traditionetlly co-
operated with criminal and other law enforcement agencies, both
State and Federal. This has been most graphically demonstrated by
the Commission's active assistance in the undercover operation in
Chicago. We are pleased that the bill recc^nizes the importance ^
cooperative law enforcement with other agencies. And we also
strongly support the subcommittee's intention to send a signal that
these types of undercover activities may be undertaken at any
time.
We agree that it is important for the Commission to define and
identify broker associations for the purposes of surveillance and
compliance programs. However, we believe it is important to devel-
op date concerning trading activities of broker associations based
upon industrywide definitions of such associations before attempt-
ing to determine what limits on intrabroker association trading
might be appropriate. We are developing such information on
brwer associations through interviews of industry participante emd
the study of current exchange rules and practices. Our study
should be completed by the end of Ai^ust.
We beUeve that a rulemaking is more appropriate than setting a
statutory limit because effective monitor^ of broker association
activities could require restrictions to be tailored to particular mar-
kets.
The Commission supports the provision that would bar individ-
ual members with significant disciplinary records from service on
disciplinary or governing psmels of exchanges and futures associa-
tions for a fixed period of time. As stated in response to an inquiry
from the Senate Committee on Agriculture, Nutrition, and Forest-
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61
ry, we announced that we would promulgate proposed rules to ad-
dress this concern by October 1989, even though some exchimges
currently have rules prohibiting service on boards for certain peri-
ods of time.
We beUeve the bill gives us the flexibility to require self-r^ula-
tory organizations to establish what is a s^inificant violation in a
manner which will allow for sufficient diversity to reflect the dif-
ferent exchanges' rules and trading practices, and in the case of
the National Futures ABsociation, the different industry compo-
nents represented by the members.
Currently, some exchanges have a two-tier disciplinary process in
which one committee makes a determination whether charges
should be issued and another committee hears the case r^ardmg
possible actions based on those charges. Exchanges also require
members of a committee to recuse themselves from a matter if
they have a potential conflict of interest.
We are concerned that requiring a majority of committee mem*
hers to be from a different sector of exchange membership than the
person appearing before the committee may diminish the technical
expertise of the group enough to slow down the process and render
a less effective and appropriate decision. We suggest that require-
ments regarding committee competition and the stages in discipli-
nary process should be addressed in a flexible manner in edlowmg
for diversity across exchanges.
The bill would also require that 20 percent of exchange govern-
ii^ boards be composed of outside members, and it would require
the Commission to provide guidelines defining who is an outside
member. Most exchemges currently have rules which provide for
some d^ree of board diversiflcation, and the Commission has an-
nounced it will monitor governing board composition within the
rule enforcement review process.
While a requirement for a minimum percentage of outside board
members may add to the public confidence in the industry, the
Commission believes that a quota system does not always eichieve
the desired results. In a June 1985 report, the Commission found
that the performance of public directors sometimes was limited by
the directors' absenteeism, failure to prepare sufficiently, and fail-
ure to provide expert assistance. These factors must also be recog-
nized and considered before further restrictions concerning boara
membership become part of the statute or the Commission s rules.
The Commodity Futures Improvements Act of 1989 would re-
quire the Commission to develop procedures to assure that non-
hedging, first-time futures and options customers cannot trade on
newly opened accounts until 3 days after signing the account open-
ing agreement. We believe this amendment is not necessary since
under our current rules, no futures or commodity options trfuisac-
tions can occur legally until the first-time customer receives a cer-
tified written risk disclosure statement, acknowledges in writir^
that he or she has received euid understood the disclosure state-
ment, and the broker has in hand the signed statement, which he
or she must retain.
With respect to ethics, the Commission supports the idea that
registrants be educated in the purpose and functions of futures emd
options markets and in the rules £md r^^lations which they must
23-500 0 - 90 -
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62
observe to legetlly trade in these markets. Furthermore, industry
participants must understand the significant sanddons they face if
they abuse the meirkets and violate the law.
The Commodity Futures Improvements Act of 1989 prcwoeee sev-
etEil amendments to the registration disqualifications. These pro-
posals must be carefully evaluated for consistency with the statuto-
ry disqualification scheme Congress enacted in 1982. The current
prop<»al raises concerns that it is not fully consistent with the
logic that underlies the 1982 eunendments, and we are also con-
cerned about any amendment requiring the Commission to recog-
nize the authority of other regulatory bodies to create or apply ex-
ceptions to the disquEdifications listed in section 8a.
This is the fourth reauthorization the Commodity Futures Trad-
ing Commiaeion has faced since the Conunission was created in
19^4. During these 15 years, the futures industry has enjoyed un-
precedented growth. The Commission has developed into a mature
and able regulator. We support your proposal to make the CFTC a
permanent agency. The misconception that the agency may some-
how disappear is one that may erode public confidence and shotdd
be put to rest once and for all. Permanent reauthorization is con-
sistent with regular and active congressional oversight of the
agency which the Commission has alwa^^ supported.
The bill would aiao authorize $40 million for fiscal year 1990 and
$44.5 million for fiscal year 1991. The increase for fiscal year 1991
would be sufficient for over 80 additional staff members. I am sub-
mitting for the record a brief outline of the progress we have made
in dealing with the 1986 reauthorization issues and amendments.
Thank you, and I would be pleased to answer any questions you
might have.
^lie prepared statement of Dr. Gramm appears at the conclusion
of the hearing.]
Mr. English. Thank you very much, Dr. Gramm. I appreciate
your testimony. Without running the risk of oversimplification, as
I made the point to Congressmem Smith earlier I believe to kind of
sum up what your testimony is, I think on page 2 of your written
testimony. The first full paragraph you make the comment:
While the Commiseion supports the subcommittee's goals in this area, we believe
that Congress has given us sufficient authority in the Commodity Exchange Act to
fulfill our mandate to oversee the markets. Wiich I think we just basically say no
significant change is supported by the CFTC.
I think you Eire missing the point of this l^islation. The point of
the legislation is to try to lift the standards substantially higher
than what they are today. And as we said the overall thrust of this
effort is to try to make certain that the integrity of the American's
futures industry is protected and to make certain that the people
who deal on those markets, customers, have confidence in them.
And that we want to make sure that as far as our overaU ability to
detect any wrongdoing that that is raised to the highest possible
standards. And at least through our inquiry, we found that what
we have today does not meet that definition.
Let me also say too, I was struck by the fact, just out of the Wall
Street Journal yesterday— I do not want to give one paper an en-
dorsement, but in this particular case, they had a couple of refer-
' ences in here. We have a grain commodity adviser up in South
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Dakota who is quoted as saying that what has taken place last
week, as far as soybeans are concerned. It meikes us look like
crooks is what he says and then he goes on to say that we are
going to lose business over time. He is a trader that went out and
set up business a couple of years ago. He has about 80 farmers he
has had to go to now and ask for more money, and he said that
many of th^ farmers, that is the first time that they had ever
used the markets. And he said now they are angry that they ever
tried it.
They got another commodity brokage firm, a representative over
there, president of this firm over in Cedar Falls, Iowa. He makes a
statement that people are losing confidence. Not only did the FBI
investigation taint the image of the board, but now we have an
intervention that, for the casual observer it does not make much
sense.
We have a representative who deals with people overseas. It says
here a senior omcer of one of the international grain trading firms
said that the firm's foreign clients are incensed. "We are gettit^
ready for bitter reeictions from overseas." All of that does not
reedly encourage me at least to go along with the business aa usual
type approach as far as the futures industry is concerned, and that
is what we are talking about as ffir as standards. That is the mes-
sage that we got and I think that the fact that U.S. attorney's in-
v^tigation which became known to us back in January. All of this
seems to underscore that.
With r^ard to what has happened in Chicfigo in the last week
with T^ard to the board of trade in soybeans, what role did the
CFTC play in that decision process?
Dr. Gbamm. Mr. Chairman, if you do not mind, I do think that
the soybean situation is one where there hfis been a lot of question,
a lot of comments, and while I do not necessarily believe in the re-
ports of some commentors to gauge public confidence in these mar-
kets, I would like to go through and review very briefly with you
what has happened in the soybefin meu'ket.
Mr. English. If you could keep it brief. We are limited to 5 min-
utes here, and I have a number of other questions — 5 minutes for
me. In ffict, my 5 minutes just expired. Dr. Gramm. So we will
allow you to go through the procedure emd then I will let Mr. Cole-
man ask you all the tough questions about that procedure.
Dr. Graum. Basically, as you all know, the board of directors of
the Chicago Board of Trade on Tuesday adopted a resolution End-
ing that immediate action was necessary due to an emergency that
would threaten the fair and orderly trading and liquidation of the
July 1989 soybean contract. You should know that the CFTC as
well as the exchanges have a responsibility to ensure the orderly
liquidation of all expiring contracts.
As you know, we monitor routinely all of our markets. Since last
summer we have had concerns over various grains and have paid
particular attention to these markets this past spring, particularly
the old crop markets. I should point out just a few facts here. On
July 10, the open interest in the July contract stood at 40.3 million
bu^iels which is larger than any July expiration in at least the
last 6 years. There weis significant concentration of firms holding
those positions.
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In addition, the supply of soybeans in a deliverable position weis
12.7 million bushels, substantially less than the open interest of
40.3 million bushels. A large portion of these soybeans did not
appear to be evmlable for delivery on this contract, and the owner-
snip of the deliverable supply was concentrated as well. So, little
adoitional supply was expected to be placed in a deliverable posi-
tion. Now the price relationships that we monitor
Mr. English. The point I just wanted to ask you. Dr. Granmi, I
think most of this has been in the media. I just want to know what
role the CFTC played. What involvement did the CBTC have in this
action?
Dr. Gramm. The CFTC has monitored these mEu*ket8 for several
months. We have had some concerns and thereby monitored some
of the liauidations in the spring, particuUirly the May liquidation
of the ola crop soybeans. Ab is usual in cases like this, we will have
discussions with all of the major traders In the mfirket, as well as
other participants in the meu'ket to see whether or not there will
be an orderly hquidation of the contract.
Mr. English. The question was: Did you consult with, advise,
participate with, in any way in the decision that was made?
Dr. Gramm. We knew of their concern. We had discussions with
the exchange. We have had discussions with the exchange on a
daily basis.
Mr. English. Did you make any recommendations?
Dr. Gramm. We did not make recommendationB, but we did dis-
cuss some alternatives. We were in daily contact, not only at the
staff level, but at my level as well. We were not only in this expira-
tion, but in earlier expirations as well. Whenever we have had con-
cerns over orderly liquidations, this is the normal procedure that
staff follows as well as, if it need be, at the Commission level. We
have regular surveillance meetings of the Commission and all Com-
missioners were briefed on what was happening in these markets.
Again, we stood ready and stand ready to act in any situation
where we feel there is a problem that requires our attention.
Mr. English. Just one question. Did you support? Did you
oppose? Did you comment on this decision before it weis made?
Dr. Gramm. I was informed about the decision. In terms of sup-
porting or not supporting it, one of the things you should know is
that, as part of the self-regulatory process, we expect the exchanges
to carry out their responsibility for orderly liquidation. Of course,
we review all emergency actions after the fact to determine wheth-
er or not their actions were arbitrary and capricious. We also de-
termine whether or not the exchfinge followed procedures that
would prevent unauthorized disclosure or misuse of information or
conflict of interest problems.
Mr. English. But not whether they were good or bad decisions?
Dr. Gramm. Basically we do that as well, and that is part of the
post-review, the post-emergency action review that we do.
Mr. English. Mr. Coleman.
Mr. Coleman. Do you have the authority now under current law
to intervene with the exchanges? Can your role be more proactive
than reactive, and not done on a review basis?
Dr. Gramm. Yes, the Commission has emergency authority under
section 8a(9). We can direct the contract market to take such action
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as is in the Commission's judgment necessary to mtuntain or re-
store orderly trading in, or liquidation of, any futures contract, and
we have done so in the past.
Mr. Coleman. But you have decided not to do it in the current
situation, the soybean market?
Dr. Gramm. Well, let us saythat, as of this point in time, the
market is still open and the CBT has taken some action. We are
continuing to monitor the market and should additional action be
required, it would be taken.
Mr. Coleman. But at this point, it takes on a different chareicter
than if you had utilized your emeigency powers in the b^inning as
opposed to the exchange using its self-regulatory authorities.
Dr. Gramm. I think that the notion of having the exchange be
very much responsible for orderly trading is that they have not
only the responsibility, but also the incentive to make sure that
that action is sufficient to deal with the problem. And as you can
imagine, whenever you take an emergency action, there will be
people on either side.
Mr. Coleman. Winners and losers. And the Commission has de-
cided not to act in this case, and yet thousands of farmers are
being impacted on a daily basis by a roller coaster ride of prices
which are a direct result of trying to unravel what has occurred.
And there may be some who would fault the Commission for fail-
ure to preempt this process so that protection of the farmer, the
producer, and certainly other users of the commodity would have
had more protection. That is what we are asking you to comment
on.
Dr. Gramm. Are you suggesting the Commission should have
acted earlier or acted later? I mean the issue is that there are
always a number of options that face an exchange or the Commis-
sion. We have used a number of them, but that again
Mr. Coleman. I guess we are asking at what point in your inter-
nal decisionmfiking process bells go off, red lights flash, and some-
body is going over the brink, and you determine that your emer-
gency powers ought to be used to protect the public or the integrity
of the markets?
Dr. Gramm. Basically, some of the factors that we consider in-
clude the amount of open interest as compared to the deliverable
supply, the concentration of that deliverable supply, and the price
remtionship between the expiring contract, the nearby contract
and the cash price. There was a very large inverse relationship be-
tween the July and August soybean contracts. There are a number
of things that we have done and continue to do in any market
where there may be some concerns about orderly trading. We have
undertaken a number of these actions and will continue to monitor
these markets.
Mr. CoLEBfAN. But in answer to Mr. English's question, you did
not even make a recommendation to the exchange.
Dr. G&amm. Again, this is a market that is still open — there is
still trading going on; and it is a situation where we have discussed
with the exchange a number of alternatives they have raised, and
our concerns about those alternatives. As we do in all liquidations,
we have had constant discussions with large traders emd other
market participants.
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But again, let me point out that the action by the CBT utd the
resulting behavior in the market made it lesB necesaary for the
Commission to take more drastic action in the short run.
Mr. Coleman. That goes somewhat to the heart of what reau-
thorization 1b all about to the extent that Mr. Smith and others
may feel that self-regulation is not adequately protecting customers
and so forth. And, I guess when you have a situation that develope
like this one, we need to know that if self-r^ulation is not word-
ing, we got a backup. You are the backup, and in some cases you
have to come out of the shadows, so to speak, and move into the
forefront and become the protector. You are the final protector.
You are the public agency.
Dr. Gramm. I think at this point though your question, and
again this is a market that is open, has behind it a certain judg-
ment as to the outcome. I would say that in the market surveil-
lance area there are a number of steps that we take, have taken
and will take in order to ensure orderly liquidation in the markets.
Bear in mind that, in the 4 trading days since the emergency
action was taken, the congestion that was occurring seems to have
been reduced. The open interest has declined, for example, by more
than 20 million bushels, and the July futures premium to the
August future has declined from 40 cente to about 15 cents.
Mr. Coleman. Dr. Gramm, thank you, and let me aak you one
other question. When did you and the exchange get down to some
real nitty-gritty discussions about this. Tuesday weis their date of
announcement, I believe. When was the pressure building up or
when did the heat get intense enough that the Commission and the
exchange knew they were going to have to do something?
Dr. Gramm. We have been talking to the exchange about the ex-
piration of July futures since May.
Mr. Coleman. But on a real intense basis, when was it building
up? Was it 1 week before Tuesday? Was it the day before Tuesday?
C^ you give us an idea?
Dr. Gramm. It was the week before Tuesday, during that week,
but at the stafT level. Let me have Dave Kass address the monitor-
ing that typically goes on in a liquidation month when you have
these kinds of concerns.
Mr. Coleman. The exchange by then knew that something was
going to be done, either they were going to have to do it or you
conceivably could have done it?
Dr. Gramm. I would not say that at this point in time. We were
reviewing a host of possible actions. Whenever there are concerns
that arise toward liquidation, our staff, as well as exchange staff,
discuss these concerns with the traders to see what their plans are
for ensuring an orderly liquidation. I should point out that it is the
responsibility of all participants in the markets to ensure orderly
liquidation. These markets, in fact, are primarily for hedging pur-
poses and price discovery, rather than for delivery,
Mr. Coleman. And you predicated your action or inaction on the
basis of their fulfilling their responsibility?
Dr. Gramm. All of our action takes into account what has hap-
pened in the market, including the action that they take. And
therefore will have an effect on our decision to take further action
or not. It is also determined by what happens in the marketpkLce.
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Mr. Coleman. I guess what is frustrating to members on this
panel is that considering these actions or inactions in considering
and looking bfick, every day the market is up or it is down. It has
been down. Now it comes up a little bit and pltmges again and
farmers decisions and their returns are being affected. You almost,
I do not say cavalierly, but you are talking about looking at this on
some sort of academic context, and it is not. It is a real world.
People are losing their shirts on the basis of what is happening out
there, perhaps ^eir farms, find as a result any look back is not
going to protect their interest to that extent.
Dr. Gramm. What I want to make clear is that the Commission
has been monitoring these markets to ensure an orderly liquida-
tion. Again, there are a number of reasons
Mr. CoLEHAN. I just want to impress on you and the Commission
that they are real farmers, real producers, real users, reeil consum-
ers, and that a report that lands on our desk 6 months from now
about this is going to be something they can burn in the fireplace
over the winter, because it is not going to affect their real lite to
that extent when you have a market that people out here are
losing money on.
I wUl stop here. 1 have another series of questions, not on the
soybean issue, but on audit trails. Mr. Chairman, I assume we are
going to go around again.
Mr. Engush. Yes, I think we will have at least one more round.
I think we are going to have a lot of questions on this issue. Mr.
Harris.
Mr. Harris. Thank you, Mr. Chairman. Dr. Gramm, in this I
guess this is probably using the proper term, but in reading your
statement on page 2, you say, "Thus we are not asking for m^jor
legislative changes at this time." That sounds like a hedge to me. I
wonder why you would have that qualifier in there. Is there some-
thing out there that maybe we need to know about that you are
reserving judgment that maybe you would come in and say, now at
this time we do need to measure legislative
Dr. Gramh. I am glad you asked that question because I think it
is a very good one. What we have said is that at this time we are
not asking for more than what we have requested here. But as
more information unfolds, we may determine that we may need
more legislative authority to address, for example, information that
we may receive as a result of any indictments resulting from the
undercover investigation. That there may be other authority. We
may be getting more information from those sources. Should we de-
termine that we might need more authority — to aid in orderly liq-
uidations or whatever issue may come up — we stand ready to make
those changes.
I think it is importfmt to say that while some people have talked
about scandals in these markets, a point that I would like to make
here is that we do have information about the existence of the un-
dercover operation that we are participating in, and it may well
provide some very useful information on how we may improve our
s^tems and improve the ability of these exchanges and of traders
to perform and abide by the rules.
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With respect to the market emei^ncy and the order with aoy-
beans, we will be reviewing the emergency action as we do ul
emergency actions taken by exchangee.
Mr. Harris. Well, you will have to, I am sure, understand that
folks are getting pretty sensitive, after at least going through in
the House, the problem in the legislation concerning the savings
and loan. Now every time we pick up a paper about HUD that
maybe instead of hands ofT that occasionally we need some handa
on. This article that was in the Washington Post back in January
of thia year in quoting James Stone who was Chairman during the
Carter administration. He said, "The Congress and the Federal reg-
ulators have repeatedly been WEUned of the possibility of the dis-
honest traders. The escape protection have done nothing about it."
Do you agree with that?
Ch". Gramm. On the contrfiry. I think that with what we have
done, we have had significant improvement over the past few years
in the ability to detect trading abuses. The whole audit trail was
developed in order to better detect trade practice type abuses. The
fact that we have been involved in an undercover operation may
provide more information about those kinds of things; trading
abuses that may be occurring on the floor cmd how to better detect
them to make the markets even better than they have been in tiie
past.
I would disagree that we have a hands-off approach here. We
have very much a hands-on approach. The Commodity Exchange
Act's emergency authority ^ves us the ability to monitor the mar-
kets and to really r^ulate m a way that goes beyond, for example,
just disclosing and letting anybody do anything. We monitor quite
vigorously here, and I would point out that comment was made
early on. What is ill^al for one person to do by oneself is also ille-
gal for two people or three people to do. In other words, using an
accommodating broker to cheat a customer is still fraud and it is
illegal under the Commodity Exchange Act. And as a matter of
fact, in the trade practice cases, part of the challenge is to deter-
mine whether em accommodating broker has been used to defraud
a customer.
Mr. Harris. Mr. Chairmsm, my time is up. I have other questions
for later.
Mr. Engush. Ms. Long.
Ms. Long. Thank you, Mr. Chairman. Dr. Gramm, I think that
part of the solution or a big part of the solution in problems in
commodities trading and futures tradii^ can be dealt with fairly
efficiently with computerization. And it seems to me that the com-
puterization that we are talking about is really fairly simple. The
algorithms cannot be that complex. The only difficulty or the only
real challenge is in the volume of data input.
I guess my question to you is why are we not seeing computeriza-
tion used in a more widespread way in the commodity exchanges?
Dr. Gramm. That is also a very good question. We have seen a
tremendous Eunount of computerization of different aspects of trad-
ing ranging from records keeping and audit trail, to the various
surveillance programs. The Commission also has improved its com-
puter capabilities to monitor the markets. So Uiat is one aspect of
it.
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With respect to, I think, the more visible aspect of what is going
on in the pits, you should know that we have just recently ap-
posal, for example, in CBT where that role of proposals — there are
new screen traoine system that is totally computerized. The system
is in the testing phase right now. Basically, I think the question of
whether computerization will take over the markets is something
that market users will probably help determine over the long run.
And from my perspective, we at the Commission do review very
carelully a whole hcet of issues related to the GLOBE]X-type pro-
posals, for example, in CBT where that role of propoetds — there are
a number of screen trading proposals that have been made by ex-
changes. What the impact will be, whether or not they will replace
the pits, again, will be determined by the users. The pits have been
usenil to manv users for many years, so only time will tell wlu^
ultimately will happen, but there has been a fair amount of com-
puterization in the other aspects of exchange operations, as well as
Commission oversight.
Ms. Long. It seems that in so many industries that computer
technology has been used and we are sort of on the cutting edge in
the United States. But in this particular industry it seems to me
that we are really using some very archaic means of operation, and
there are probably a number of reasons for that. I would say that
computer producers are probably not as anxious to develop systems
and programs and hardwEU'e and software for this particular indus-
try because it is fairly limited.
But it also seems to me that there has to be some uniform or
consistencies in what is needed as you go from one exchange to the
other. And what we have tended to do in the past is set perform-
ance standards for the exchanges and we have said you must meet
these standards, but it seems to me that the CFTC could actusdly
play a more active role in helping with or assisting with the devel-
pment of computer technoI(%y that will be usable by all of the ex-
wment ol
changes.
I really think we need an accurate recording of the time orders
are placed, as well as the buys and so forth. I really think that that
is a key to solving some of the abuses in futures trading.
And I think and I guess what I am sumesting to you and asking
you to comment on is why cannot the CFTC play an active role in
providing assistance in developing the computer technolt^y to the
exchai^es?
Dr. Gramm. I think, first of all, that a view the Commission sup-
ports and would like to see is performance standards that £illow the
exchanges to compete with each other and to see what works. Even
with audit trail, we did not tell them how to do their audit tr^.
We monitor the output rather than the input. It is a view of the
Commission that the competition would generate the best results
in terms of what is useful to the customer and ultimately to the
user. And then the user will determine what best suits their needs.
There are a lot of different markets, some of which are very large,
some of which sire veiy small.
You should know that Qiere have been some totally computer-
ized screen trading systems that have been proposed in the past
and have fedled. In fact, the GLOBEX-type trading proposals are
really at the cutting edge of innovation in the futures area around
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the world. I think that we do "provide asaistance" when we review
the exchange proposals just by the hard questions that we ask.
How are you going to meet certain requirements? What is going to
happen under certain circumstances? What are you going to do
about this computer's security? What is going to happen if you
have two orders? How will the orders — how wm the prices be set?
What will be the sequence in which the orders are taken.
With respect to Government agency determining which system is
best and therefore imposing its judgment on all the exchanges and
saying this is what you should do, well that is something that the
CommisBion has stayed away from. That is someUiing that Govern-
ment is typically not really the best equipped to do. The market
users and the exchfmges in competing for business will do that. We
are there to make sure that they carry out all the responsibilitiee
that they have under the Commodity Ebcchange Act, but not tell
them that they have to do it by having a specific way of doing busi-
ness. That will be determined by competition.
Ms. Long. But as the regulating agency, you should be state-of-
the-art in terms of development in the area of computer technology
and how it can be used. And without mandating a certain system
or certain software or certain process, you ought to be able to do
more than ask questions r^arding how they are operating.
Dr. Gramm. Oh, absolutely. In our review, we do review these
systems in great detail. And we are monitoring, for example, from
the earliest stages right through to the testing phases to ensure
that these systems work as they are supposed to. Also, more impor-
tantly, are the ^sterns in accord with tne responsibilities of the ex-
changes and our rules and regulations. And, accordingly, given the
computerization that is occxirring and the demands because of the
new kinds of systems, we are enhancing and boosting our computer
capability.
Ms. Long. I guess my time is up, Mr. Chairman, but it just seems
inconsistent to me that we have computers for over 40 years and
the CFTC has been in existence for 15 years, and we are struggling
with problems in monitoring and r^ulation that really should be
way behind us in terms of technology.
Mr. Bngush. Mr. Tallon.
Mr. Tallon. Mr. Chairman, thank you.
Dr. Gramm, thank you for your testimony. If you could, please
help me with my time, which is limited. If it is sufRcient to give a
yes or no answer to this question, that is all I really want to know
because I still do not know if I have it clear in my mind.
Did the Commission at any time conclude that there viras a
threat to an orderly liquidation of the July soybean futures con-
tract at the Chicago Board of Trade prior to Tuesday?
Dr. Gramm. Yes.
Mr. Tallon. Thank jrou.
When did the Commission reach this conclusion, and what infor-
mation did you rely upon in making this independent market judg-
ment?
Dr. Gramm. It was a developing situation. We had been con-
cerned, really, since the prior expiration. We had been concerned
about July beans just as soon as the May liquidation was over. So
it has been a surveillance concern of the Conmiission for months.
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Mr. Tallon. But when did you conclude that there weis a threat
to orderly liquidation of the Jm^ contract?
Dr. Gramm. I think it is difticult to put an exact time on that.
Mr. Tallon. Dr. Gramm, what steps would the Commission rec-
ommend in the future to prevent emy possible threat to an orderly
liquidation in this market?
Dr. GrajiIM. Well, I think that what we will be doing is review-
ing— in our review of the emergency action, we will again give fur-
ther thought about whether or not there might be other changes
that would alleviate some of the liquidation or congestion concerns
that have been raised in this expiration.
Mr. Tallon. Dr. Gramm, as I have stated earlier, in my mind
the practice of trading ahead of your customer should be made a
criminal offense. As far as the CFTC is concerned, would you have
any comment on that?
Dr. Gramm. Trading ahead of a customer, because it involves
abuse of a customer interest, is fraud and, therefore, a criminal of-
fense under the Commodity Exchange Act.
Mr. Tallon. Has the CFTC found that dual trading abuses are
particulfu'ly dif^cult for exchanges to detect?
Dr. Gbamm. With the onset of the audit trail, which is the se-
quencing of trades, it made dual trading abuses easier to detect and
easier to bring cases like that. I would also say that it probably de-
terred dual trading abuses because of the record that would be
available.
Mr. Tallon. Would you say that in the last severed years there
has been a tremendous amount of developing on the part of the ex-
changes improved audit trails that has been a focus of the ex-
changes?
Dr. Gramm. Well, absolutely. Before 1986, and our 1-minute time
standard, the requirement was a 30-minute time standard. So in
just a few years, we have gone from a SO-minute bracket to being
able to sequence trades in 1-minute increments.
Mr. Tallon. Dr. Gramm, when you said that it is easier to detect
any trading ahead, what about in markets with daily volumes
above 7,000 contracts?
Dr. Gramm. Pardon me?
Mr. Tallon. It is also easier in markets that have in excess of
7,000 contracts traded daily?
Dr. Gramm. I think that the existence of the 1-minute time
standard and the audit trail vastly improved the ability of the
Commission to bring and detect dual trading abuses, or trading-
ahead abuses across all markets.
Mr. Tallon. Well, I have grave concerns about the restrictions in
the current l^islation that is before the committee. But in my
mind, if you are going to restrict dual trading, it needs to be — if
there is a problem, and I do not know and I will ask you some
questions later on. But if there is a problem, let us restrict it. I
mean, let us do away with it.
Anyway, I see my time is up, but maybe we ctin get back to that
again.
Mr. English. Mr. Combest.
Mr. CoMBBST. Thank you, Mr. Chairman.
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Dr. Gramm, does the Commodity Futures Trading CommiBsion
have the authority today to ban dual trading?
Dr. Gramm. Yes, we do.
Mr. CoMBBST. You have got a study under way that is going to be
out in October or September?
Dr. Gramm. Yes.
Mr. CoMBEST. Would you feel that any activities now to legisla-
tively ban dual trading as proposed in this bill would be prema-
ture?
Dr. Gramm. I do think so.
Mr. CoMBEST. It appears that dual trading is sort of the recipient
of a lot of the attention which has been given to the problem in
Chicago which was uncovered due to the sting operation. Does that
solve the problem if dual trading is banned?
Dr. Gramm. Not necessarily. And I stress ag{un that we may get
more information from the results of the undercover investigation.
But I think the point should be made — and Congressman T^lon, I
think, to your question as well — is that the Commission woiUd
rather focus on the issue of eliminating abuse, of all sorts of cus-
tomer abuse, and that may include the use of em accommodating
broker, for example, which would be more than just dual trading
abuse.
Mr. CoMBEST. So that alone really would not — you do think that
there are other ways to get at eliminating the problem of customer
^use that should be delved into, rather than simply a ban on dual
trading and an increase in the audit trail, timing of the audit trail?
Dr. Gramm. We are taking a broad-based approach, and part of
that approach is to look at dual trading once eigain, to get Eigain
some empirical information about both the benefits as well as the
costs of dual trading and the concerns there. And that is part of it,
but, again, the Commission works hard to eliminate customer
abuse wherever it occurs.
Mr. CoMBEST. I think the Commission comes into somewhat of a
unique position in that, given the concerns of a couple years ago in
the October market reai^ustment, the Commodity Futures Trading
Commission I think was given a pretty good pat on the back for the
work that it did in following the volatility of that day. There have
been a number of questions asked today about your role in the cur-
rent ongoing soybean situation, rect^nizing that people's futures —
no pun intended — but their future and their farms and everything
else depend upon maybe what it is you do. But you are not in the
business of regulating markets. You are not there to stop market
movement. You are Uiere to watch what is happening and to detet>
mine whether or not what is happening is l^al or ill^al, beisically,
more than to determine what the market is going to be on any
given day.
Dr. Grahh. Oh, in terms of directing what the price ought to be,
definitely so. But we do monitor the markets to ensure orderly liq-
uidations.
Mr. CoMBEST. Right. And I just want us to be clear that there is
not an indication given that you should be there just because some-
body hfts taken a bath. We do not particularly like that, but it does
not mean that you are supposed to step in just because somebody
has taken a bath.
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Dr. Gramm. That is right. The priman^ responsibility is to enaure
that the prices indicated by these markets represent the underly-
ing sum>ly and demand rather than anything u-tificial.
Mr. CoMBEST. You said that October is when the report on dual
trading that you have
Dr. Gramm. Yes.
Mr. CoMBBST. Thank you, Dr. Gramm. Thank you, Mr. Chair-
man.
Mr. E)ngu8h. Mr. Grandy.
Mr. Grandy. Thank you, Mr. Chairman.
Dr. Gramm, I want to address the more immediate concern, and
I say that because I was just home this week, and obviously the
talk at the grain elevators is in regard to the Ferruzzi matter, not
our pending reauthorization of the CfTC. And I guess the ques-
tions I want to ask you begin with: In your mind, is there a signifi-
cant difference between insider trading as it is defined and prohib-
ited by the SEC, and insider trading as it is defined, if it is defined,
by the CFTC?
In other words, what is your definition of insider trading?
Dr. Gramm. Basically, the disclosure of material nonpublic infor-
mation ia the notion of inside information. But in the futures mar-
kets, it has a little different cast.
First of all, in the securities markets, you are talking about
inside information as it relates to a particular stock.
Mr. Grandy. Right.
Dr. Gramm. All right, a particular company, information about a
company, issueswise. In the futures markets, you do not have that
same notion specifically. But you do also have to understand that
in the futures market hedging, just hedging, implies that you are
doing something with some knowledge about what is involved. For
example, if you are a farmer, the crop you are bringing to market,
the amount of soybeans you may be bringing to market in the fall.
So that is information, and obviously that kind of information is
just a r^ular business of the futures markets. But we
Mr. Grandy. OK, but let me just interrupt you there for a
moment, because this does relate to, at least in the minds of a lot
of my producers, what happened on the Board of Trade this week.
The fact that the July contracts were settled in the minds of a lot
of producers, prematurely forcing a 39-cent drop in the price of
befuis on Thursday or Friday, weis it inside information that occa-
sioned that settlement? There is nothing that I have been able to
find that is illegal about what happened, but to a lot of my produc-
ers, it is considered to be unethical, the perception being that some
of Ferruzzi's major competitors probably influenced the Board of
Trade to force those settlements, and thereby drop the bean prices
BO the Ferruzzi competitors could acquire be^is.
Is that insider information?
Dr. Gramm. Let me mention the other issues related to insider
trading that would be considered unlawful in our markets. For ex-
eunple. Commission regulations make it unlawful for employees of
seli-r^ulatory organizations to disclose or use materifil nonpublic
information. And we require the exchanges to have regulations
that would prevent their board members from using or disclosing
material nonpublic information that they obtained while discharg-
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ing their duties as board members. So, indeed, if a situation like
that had occurred, that would be violating the rules of the ex-
change. Or if there were employees involved, that would be violat-
ing tibe rules that the Commission had set forth. That, again — go
ahead.
Mr. Grandy. I was just going to say, our colleague, Mr. Smith,
Neal Smith of Iowa, testified. And I do not know if you heard his
statement or not.
Dr. Gramm. Yes.
Mr. Grandy. But he was tj>lking about insider trading, and he
says this:
Corporata officers awai« of a pending announcement of a large increaaed aato ot
purchase of a particular commodity or pooition in the future* market could use tliat
information to trade in futures for his own account before the information is made
Is that disallowed?
Dr. Gramm. That would be disallowed. Did he say of a large —
now, if it is a private company or if it is the exchange
Mr. Grandy. No. A private company I am talking about.
Dr. Gramm. OK. For a private company, if the individual used
information and had responsibility for the trading activity of that
company in the futures market.
Mr. Grandy. But if he did not, he could use that information?
Dr. Gramm. If he did not and if the company did not have rules
to prevent that.
Mr. Grandy. All right. Because that was his next statement. He
says:
Since it is contrary to the interest of the company they work for, some companiea
now prohibit their emplt^ees or officers from using inside information this way, but
some do not.
The purpose, I suppose, of that testimony is that Mr. Smith has a
bill and has had a bill for around 7 years to basically disallow that
practice. Do you think that is unwise to enforce that among private
companies?
Dr. Gramm. I guess I would reiterate the questions that I raised
to the Congressman when I spoke to him about this bill. That is,
wouldn't the companies themselves have the incentive to set those
ethical guidelines for their own employees if they felt the need to?
Second, is that a problem? Has there been abuse of that trust by
employees? Those are the two basic questions. I think I would like
to have the answers to those questions before we say that it would
be a good idea; it might not be a widespread problem.
Mr. Grandy. But based on what we have just been trying to
define as insider trading, emd in your position as the Chairman,
what happened between Ferruzzi and the Board of Trade and other
players v/aa not an example of insider trading that occasioned that
precipitous drop in the b^m market?
Dr. Gramm. Let me mention, as I stated earlier — you might not
have been here — that we will be reviewing the emei^ency action
that the CBOT took as we review all emergency actions. We will be
reviewing the whole liquidation of that particular market, includ-
ing whether or not they followed their own guidelines and proce-
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dures concerning conflict of interest. I have heard those charges,
and we will be reviewing that.
Mr. Gbamdy. But you are not prepared at this time to render a
decision as to whether or not that fits your deflnition?
T>T. Gramm. It is premature to say that we have concluded one
way or another on those Issues, but we are reviewing that.
Mr. Grandy. Thank you. Dr. Gramm, Mr. Chairman.
Mr. E)nglish. Mr. Penny.
Mr. Penny. Are you going to make recommendations in terms of
the practices at Chicago where they essentially reconstruct an
audit trail instead of having a hand»«n record immediately upon
the completion of a transaction?
Dr. Gramh. Well, yes.
Mr. Penny. My understanding is in Chicago it is reconstruct-
ed
Dr. Gramh. That is right.
Mr. Penny. And imputed as bo when those trades took place,
which is an awfully open-ended kind of system. It seems to me that
if you are concerned about the potenti^ for abuse, that we have
got to do better than they are now doing. And if you do not want
the l^islation that we have propoeed, wiat will you be proposing
to help US move Chicago toward a system where the transactions
are completed and recorded at the time they are completed, instead
of reconstructing it at the end of the day?
Dr. Gramm. We have reviewed the trade reconstruction systems
that some of the larger exchanges have. These systems permit re-
constructions of the trading, we believe, sufficient to give a pretty
accurate audit trail. The systems use information ^om a number of
other sources to actually reconstruct the trading sequence, which
is, of course, what is very important with respect to detection of
certain trade practice abuses.
Mr, Penny. Can you help walk me through how they do that and
what d^ree of int^rity we can ascribe to that system? It just
sounds to me like any time you are going to reconstruct the events
you are going to have an awful lot of gray area.
Dr. Gramm. Right. But you should remember that it is the ex-
change that is reconstructing the trading sequence pursuant to our
rulemaking, and that we monitor for basically the verifiability of
that information. And it is a somewhat complicated process, but let
me just very briefly tell you how it is done. A trader, when he
makes a trade, will give a time bracket when that trade occurred.
In reconstructing the time sequence, the system uses a lot of other
information, such as the information from the time and sales
report, information from trading cards on which members are re-
quired to record trades in order, execution times for the trades that
are of a certain type, and the entry times for customer trades.
There are certain kinds of trades that they are supposed to be re-
cording as well. So you are taking information from a number of
different sources that wilt then, using the larger time bracket, de-
velop windows in which trades can be located.
We would be happy to come up and provide you a lot more detail
on that. But we have reviewed those systems and found them gen-
ertdly to be consistent with the requirements of the Commodity Ex-
change Act.
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Mr. Penny. The New York Stock Exchange has a computerized
svBtem where I think they punch a card and send it throu^ a ma-
chine and it f^ts automatically recorded at the time of the activity.
Is it prohibitively costly to do something like that in the commodi-
ty exchanges? It just seems to me that the potential for atnue
would be leesened if there were an actual recording done at the
time of the transaction instead of, you know, maybe a listing <m
independent records here, there, and everywhere, and then trying
to coordinate those at the end of the day.
Dr. Gramm. The independent records, such as the time-stamping
of the order tickets before they come into the pit and after they
leave the pit, provide other corroborating information. When we re-
quired the audit trail, the 1-minute audit trail, the exchanges came
up with different ways of doing it, and they work differently. In
some markets— for example, in one market in New York — the
seller writes out zm extra card that they put in the pit, and then it
is taken h^ exchange employees and input into the system. That
may work in some marketa; it may not work as well in other mar-
kets.
Mr. Penny. If I might, Mr. Chairman, ask one other question,
and this gets to the situation with soybeans last week.
Here in Congress, and in most public bodies, we have, if not in
writing, at least generally understood policies about conflict of in-
terest. And if you are directly involved in the S and L industry,
you probably did not cast a vote on the S and L legislation a coupw
weeks ago.
What about those folks in the Chicago Board of Trade who stood
to make a heck of a lot of money on soybeans last week, and yet
might be on the governing board? Shouldn't we have some prohibi-
tion on their involvement in those kinds of decisions?
Dr. Gramm. Basically, the Chicago Board of Trade has a regula-
tion that — {igain, it is Uie result of a Commission regulation. We
require the exchanges to have conflict of interest policies with re-
spect to members who might be on decisionmaking boards so that
members taking action do not have a financial interest in the out-
come. We will be reviewing the CBT order to make sure that those
conflict of interest policies and related exchange rules were satis-
fted. We have received representations from the exchange that
they were satisfied.
Mr. Penny. Thank you, Mr. Chairman.
Mr. English. Mr. Espy.
Mr. Espy. Thank you, Mr. Chairman.
I would like to get back to the whole matter of dual trading. I
was late arriving at this committee. I wiis at a budget hearing. So
if it has been asked before, I apologize. But within the bill which
has been promoted and introduced, of course, dual trading is going
to be outlawed.
Dr. Gramm, you mentioned the study or the review, rather, that
you are undertakii^ at CFTC. I would like to know, as a part of
that study, have you evaluated or is there any consideration to
evaluate the extent to which fore^ exchangee will be advantaged
if we outlaw dual trading in our markets? In other words, if we
outlawed dual trading, would our brokers and our traders auto-
matically shift their focus to the London Exchange, for instance?
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And is this a part of your studjr? If it is, could this oommittee trust
a survey among your members where this question is asked?
How would you structure a survey to the extent that we could
trust the answer?
Dr. Gramm. Well, that is a very difficult question, and I think
that the way we would address it is this way: That whenever we
would do a rulemaking, we would want to make sure that the —
excuse me for using tiiese words — the benefits of what you are
trying to do, if you are trying to ban dual trading, what would be
the benefits there. And if the benefits exceed the cost, say if the
benefits from reduced potential for abuse would exceed the cost of
that particular rulemaking, then the implication would be that the
impact on our markets woiild not be that great. But it is something
tiiat I think is always worth considering because these meu*ket8 are
venr international.
With respect to making surveys about whether or not someone
would move to a different market, for example, or whether or not
trading would go overseas, that ia always a diJFficult question. As
economists, we tend to want to look at what people have done in
the past and get our implications from that, rather than saying in
X, Y, Z situation what would you do. So that kind of a survey may
get some thoughtful responses and be sometJiing worth lookmg at.
Again, it would be very difficult to say for a fact that it would have
that
Mr. Espy. But what is your opinion? Do you think that this
would happen? Do you think that would be a perceptible shift to
something like the London Exchange? If we decided to outlaw dual
trading, would they go automatically to another exchange where
this is permitted, in your opinion?
Dr. Gramm. I do not know that. I mean, it depends on — one
thing I would say is that there is a certain amount of fiexibility in
the proposal that is in the package here. And with some changes
and through rulemaking, one could try tmd ensure that the costs
would not exceed the benefits. But, again, I would stress that there
are a lot of things about dual trading, both on the ctxt and benefit
side, that really need, indeed b^ for study and careful analysis. A
rulemaking procedure allows the Commission better to eissess that.
I could not make that judgment right off the bat right now.
Mr. Espy. Thank you, Mr. Chairman.
Mr. English. Thmik you very much, Mr. V!spy.
Mr. Morrison.
Mr. MOERISON. Thank you, Mr. Chairman.
I would like to concentrate my questions on Information that I
think would be important to this subcommittee as we go about re-
authorization, our response, what needs to be fixed. The first ques-
tion, you mentioned two different things you are stuping. One was
the dual trading study, as I recall, that is due out in October.
Dr. Gramh. Yee.
Mr. Morrison. The second was the study of the broker associa-
tion, its relationship with the process, and that is due out in
August. Did I miss any evaluations that you are going through for-
Dr. Gramm. We are always evEiluating a number of other things,
and there are a number of other proposals that we have. We have
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two rulemakingB on — we are reviewing oral orders. We are dcring a
rulemaking— well, that would bar members that have a significant
disciplinary action from serving on a disciplinary committee.
Mr. Morrison. Probably the two that you have mentioned would
be of greatest significance to us in our deliberations.
I was also wondering if you could share anything at all with us.
Our investigation team working for the chairman has not had any-
thing at all they could share with us from the sting operation and
when we are likely to get any information at all from that activity.
Can you share anything at all with us?
Dr. Gramm. I am afrfiid that that information would have to
come from the Justice Department, and I think they are not shar-
ing that information either.
Mr. Morrison. You have do idea on time?
Dr. Gramm. It is not something that we could disclose.
Mr. Morrison. I am somewhat iruBtrat«d because, as Neal Smith
indicated, we finfilly have stepped in, zmd we have found out what
is wrong. And yet we do not have any idea what was wrong or how
to fix it because we do not have access to that information.
Dr. Gramm. I understand that and have made those views known
to the Justice Department as well.
Mr. Morrison. Mr. Chairman, I guess I express a concern. We
have got several things that I think would be very important to us,
the dual trading study and the broker eissociation study that are
coming later, and also I would hope at some point we would get
some information from the Justice Department. It is your inclina-
tion, though, to proceed with this bill rather rapidly.
Mr. Bngush, If the gentleman would yield, that would be tny
intent. Let me say, too, on the issue of the study, how many studies
have you done with regard to dual trading since the CrTC was
formed in 1974? If I remember correctly, you have had a study on
duEiI trading ongoing just about ever since, have you not?
Dr. Gramm. Well, we were asked in 1982 reauthorization to un-
dertake
Mr. English. I think you were asked before 1982, were you not?
Dr. Gramm. In 1976 as well.
Mr. Engush. In 1976 you were asked, and in 1982 you were
asked. These studies have been ongoing, that have been completed.
So, you know, that is the whole point. I am getting a list of all ihe
studies as to how many studies the CFTC has going on these days.
They are just about studying everything to death. I think it is
about time that we act. We need a little action, and that is the
whole point.
The question I think that we have before us that the members
are going to have to decide is the question of whether we are going
to raise the standards. That is the basic issue. Then the question is:
In what way we do that? Now, as far as any action with regard to
the U.S. attorney in Chicago, Mr. Coleman and I both approached
the Justice Department, the Attorney General, requesting informa-
tion. We do not know whether that is coming next week, next
month, next year, as far as any action by the Justice Department.
The CFTC is going to be out of existence by the end of this year, or
I should say by the end of this fiscal year, September 30. And I
think the real issue is whether we are going to act.
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If there are any surprises that should come out of the action of
the Justice Department, it is certainly my intent to take it up and
pass on in a timely mfuiner, as we would any other shortcomings
that we might find. But I think that it would be a mistake to leave
the CFTC hanging in limbo as we hope that some time before Sep-
tember 30 the Justice Department may or may not act.
Mr. Coleman. Would the gentleman yield?
Mr. Morrison. I will yield.
Mr. Coleman. I would like to comment on your concerns because
they are my concerns as well as far as the investigation and the
information that could help us in addressing some allied wrongs
that may have occurred in the Chicago pits.
Now, we did ask the Justice Department if we could talk with
them, even in a generic sense. We ao not want to know the individ-
uals involved or particular transactions, but if we could talk ge-
nerically about things so that we might have the benefit of their
investigation and information they have developed to this point.
They refused on the basis that it is an ongoing pmicy of the Justice
Department not to comment or provide any information prior to in-
dictments when it then is a matter of public record.
Well, no indictments have been forthcoming to date. Therefore,
no information has been forthcoming to date, and we have been
told that we are not going to receive any information. Bfised upon
the theory of obstruction of justice that somehow just the discus-
sion of these things on the cases involved and so forth would have
an impact, we accepted that, did not pursue it, and agree with the
chairman that if and when anything develops out of these investi-
gations that are not covered by current law, or wrongs that might
have been observed and documented that are not covered by cur-
rent violations, then we would certainly, I think with great expedi-
tion, write new amendments to the law.
So I think that the gentleman has a good comment. It ought to
be stated on the record exactly where we are in that process. Dr.
Gramm herself is bound by the same rules as the Justice Departs
ment and has likewise refrained and, in fact, has not provided us
any information. We will respect her position, which is a little bit
different than Justice, but rerognize her limitations as well.
Mr. Morrison. I thank both my chmrmen for the information. I
am not surprised by the answer. I just would love to have that sort
of tool to work into our deliberations.
Mr. English. If the gentleman would yield, I would agree. We
would love to have all the information that the Justice Department
may have or anybody else. But let me make one other point.
I think, too, in carefully weighing this, we looked at this very,
very closely. It is highly unlikely that the action taken by the Jus*
tice Department either is not already covered by current law or is
not covered by this legislation. So, you know, the overwhelming
odds are that that is something that is not going to have any bear-
ing. But I think that we all recc^nize that if there is that chance, if
there is something that should crop up that should require action, I
think you are going to find that Congress is going to be very eager
to deal with that in an expeditious memner, and certainly this sub-
committee will.
I thank the gentleman.
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Mr. Morrison. Ab a member of it, I would be disappointed if we
did not immediately leap to the challenge. I still want to know
what the FBI did.
Mr. E)nglish. Mr. Nagle.
Mr. Nagle. I want to ^o back to this, if I can. I know you have
talked about it quite a bit, but I want to go back to the actions of
the CBOT last week with regard to soybean futures. Prior to the
action of the CBOT in ordering the divestiture of soybean futures
by certain groups, who stood to make money? Who was in the posi-
tion to proHt before their action?
Dr. Gramm. Depends on what the fiction was, I guess, and the
Impact on the market.
Mr. Nagle. Well, let me just walk through it with you so we are
going on the same track here. I understand that before the action
of the CBOT that an Italiem organization or firm or company luul
managed to capture a good portion of the July futures market on
soybeans. Is that correct?
Dr. Grahm. I think that — typically, I like to discuss how we do
these things and how we monitor for orderly liquidations without
getting into specific names of participants in the market, particu-
larly when the market is still open and before we have finished our
review of it. We have indicated that we have had concerns about
the orderly liquidation of the market because of the lai^ open in-
terests relative to deliverable
Mr. Nagle. Well, I do not know why we cannot talk about it. It
was on the front psige of every paper in the country Iftst week. It
was — how do you pronounce it? Ferruzzi?
Dr. Gramm. Again, it is a situation not unlike the FBI probes
where, again, we are going to be reviewing these actions.
Mr. Nagle. Mr. Chairman, could I have your copy of the Wall
Street Journal article?
I have the Post and the Journal.
Dr. Gramm. I think the important factor
Mr. Nagle. Now, if the Wall Street Journal can talk about it,
w^ can't we?
Dr. Gramm. Well, I think the important factor, the issue that
you raise in your question, is what would have happened in ^e
market and what is the price impact. And, again, that is sometimes
hard to predict, what the specific price impact of specific actions
would be.
Mr. Nagle. I may have misunderstood you, then. I apologize. I
thought you said that CBOT took the action and you siffirmed it
Dr. Gramm. No. We will be reviewing the emergency action.
Mr. Nagle. And you have made no response to CEtOT in the in-
terim? I misunderstood that.
Dr. Gramm. No. We have discussed the situation with the CBOT
in our monitoring of the markets, but we have not judged, made
the judgment yet with respect to their emergency action. That is
something that is part of our review that would occur after — when-
ever an exchange
Mr. Nagle. I just want to understand this. Did you talk to CBOT
before they took the action?
Dr. Gramm. Absolutely. We had been in contact with the CBOT,
in discussions with them, really for several months, even.
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Mr. Naou:. For several months?
Dr. Gramm. That is ru^t.
Mr. Naqlb. Did CBOT tell you that they were going to take this
action before they took it?
Dr. Gramm. Yes.
Mr. Naole. Was there a decision made not to — what did you tell
CBOT when they told you they were going to do that? Say "OK?"
"Don't do it?" "Better wait?" We don't know anything Eibout it?"
"We can't talk about it?" What did you say?
Dr. Gkamm. No. I thanked them for the information.
Mr. Nagle. That is it?
Dr. Grahh. Yes.
Mr. Nagle. That constitutes the oversight, the CFTC oversight?
Dr. Geamm. No, absolutely not. No.
Again, we had been monitoring these markets and had, indeed,
monitored even the May expiration because there were some con-
cerns in the May expiration. We had had discussions with not only
the m^or traders but also other participants, had been discussing
the market with the CBOT and the concerns they raised, heid dis-
cussed even alternatives. But, again, they made the decision and
their committee made the decision about what particular emergen-
Cy action they were going to take. That was something that &ey
relayed to us. We have had discussions with them since then,
again, sharing information about what has happened in the
market. That is our normal behavior.
Now, whenever any emergency action is taken such as this, we
review all trading in that psirticular market. We review their
action. We review the procedures that they follow.
Mr. Nagle. Why was it— waited until apparently the third week
of July or the second week of July if this thing had been monitored
since — what, you said as early as May? That it weis becoming ap-
parent that one company was cornering the soybean futures for
July? Why did you wait until
Ih-. Gbamm. Again, let me speak about what we typically do in
monitoring for orderly liquidation of a market, and that is not to
prejudge tiie case in point. But what we do, aa the exchange does,
they have the responsibility to monitor for orderly liquidation.
Now, where congestion may occur typically is as the contract li-
quidates. So as we get close to the contract expiration period is
when we start to monitor very closely about what the intentions of
the traders are, those with, for example, large positions and wheth-
er or not they expect to stand for delivery, to determine whether or
not there could be psul^icultir problems. That is something that
Conamission staff does r^ularly for any market that may have a
concern. And, again, any action that needs to be taken may well
occur toward the end of the contract period, towfuxl the expiration
date, rather than earlier on.
Mr. Nagle. Well, speaking generically, without naming compa-
nies, it would seem to me that a fair summation would be that one
company that had bought a lot of July futures, a foreign company,
and a lot of individuEil fsuTners who had bought July futures would
n'jably have been hurt by CBOT's action, and companies that
filled July orders would probably have ben^ted. Would that
be just kind of a feiir overview?
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Dr. Grahm. Whenever you have an emergency action, there will
be — and because these markets are basi^ly a zero«um game,
there wiU be winners and losers, depending on what happens in
the market.
Mr. Nagle. Who won? Who lost? Just generically speaking, who
won and who lost?
Dr. Grahu. It depends on what those individuals in those mar-
kets were doing, basically.
Mr. Nagle. Broadly speaking, who won and who lost?
Dr. Gramm. Let me turn to Dave Kass, who is the Chicago Re-
gional Office Director, who could clariiy.
Mr. Kass. Basically, unless you know one individual circimi-
stance, he may have been spread, for example, long July, short
August; may have been hedged so that any price movement in the
futures market would have been offset by depreciation or apprecia-
tion in the cash meurket.
To say who won or who lost, you would have to grab some indi-
vidual and say, you know, what was your circumstance on that
Mr. Naglb. Well, we know one company that lost, and that was
Perruzzi, right? They clearly were a big loser when you ordered the
sale.
Dr. Gbamh. Let me just say
Mr. Naqlb. Can I just get that question answered yes or no?
Mr. Kass. It is a question that does not have that kind of an
answer.
Mr. Naglb. They are unhappy because they won? I mean, I am
reading the paper
Dr. Gramm. I think it is clear they are imhappy.
Mr. Naglb. It does not look to me like they are very pleased.
Mr. Kass. Let me just say, to the extent that any long trader in
the market with long futures positions has a hedge against pur-
chasing soybeans down the road, for either export or processing —
this is any long trader — the fact that now they would no longer be
eible to hold, say, a hedge in this market, obviously whether tiiey
have won or lost will depend later on what they will be able to buy
those soybeans for in a cash market. If they are, indeed, able to ac-
quire them for much lower prices, they even could have some ad-
vantage. But they have lost the hedge.
What the ultimate result is going to be may very well be the sub-
ject of lawsuits and evetything else down the road. But in terms of
any one individual trader to say who won or who lost — to the
extent there was demand for soybeans in this market, as evidenced
by long hedges against needs, that demand did not go away as a
result of the emergency action. The demand for those soyb^ns is
still in the mtirket.
Mr. Nagle. Mr. Chairman, if I could have the indulgence of the
committee to pursue this just for 1 minute.
You meem the CBOT talks to you, you talk to them, and then
you teike this action, and you do not know when you take tl^
action, or when you aay, "OK, thanks for informing us," what the
impact on the individual market traders is going to be?
Dr. Gramm. It is not quite that.
Mr. Naglb. And even 1 week later, you do not know, have not
got any idea?
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Dr. Gramh. No, that is not quite that. It really is, a^ain, a coop-
erative and — well, let us not put it that way. It is a kind of Eiction
where the exchanges have the responsibility to ensure orderly liq-
uidation, and we have the responsibility to ensure that they do.
And, generfilly, if the situation were to arise that we feel like w©
need to tfike an emergency action, or that the exchange has not
te^en sufficient action, then we can act.
Mr. Nagle. You meeui you could have said to CBOT, "Don't do
this?"
Dr. Gramm. We could have. We could have, yes.
Mr. Nagle. So by saying, "Thanks for the information," you in
essence said "Go ahead."
Dr. Grahh. No. Their board made the decision to
Mr. Nagle. But you could have stopped it.
Dr. Gramm. We could have taken an — there are a number of
emergency actions that we can take.
Mr. Nagle. You could have stopped the sale?
Ihr. Gramm. Yes.
Mr. Nagle. Thank you. And so by not stopping the sale, you in
essence approved of it?
Dr. Gramm. No, no. Again, it is their responsibility to ensure or-
derly liquidation in the markets, and it is their responsibility first
and foremost. Now, we review these actions, all along, ao if we
think that the action was not sufficient, we could take other action
even toward the end of the market, the market is still open.
Mr. Nagle. Well, let me just say this, and I thank the chairman
and the committee members for their indulgence. You know, in
trying to do this reauthorization, the fact that you have been moni-
toring the situation since May, we come to the last possible minute
and you could have ordered the liquidation sale before then, you
could have blocked the liquidation sale — and, indeed, I think some
serious consideration should have been given to that, given the
outcry that it created and the lack of confidence that has eroded
from the markets. I do not find your answers — and I do not mean
this harshly, but I do not find your answers very confidence-inspir-
ing. I mean, you cannot tell me who won, you cannot tell me who
lost, and you cannot tell me who is trading even though I can read
about it in the paper. You cannot tell me what conversations you
had, and I have to drcig out of you the fact that you could have
blocked the sale.
Dr. Gramm. These markets are still open, and I would point out
just several facts that I pointed out earlier that we did have a sig-
nificant inverse before the emergency action, where the July pre-
mium to the August premium had reached over 40 cents, which is
the largest July premium in at least the last 6 years. We had an
open interest of 40.3 million bushels with a deliverable supply that
was about 12.7 million bushels. In the 4 trading days since the
emergency action, the congestion seems to have been reduced. The
July futures premium to the August future has declined to about
15 cents, so it appears that the congestion has been reduced. And I
think one ought to remember why it is important to ensure orderly
liquidation of the markets. It is something that we require.
An example was what the exchanges undertook several years ago
to ensure onierly liquidation of the triple-witching day, for exam-
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pie. Orderly liquidation of a market is very important. If you do
n6t have order^ liquidation of a market, you will have a
Mr. Naole. Dr. Gramm, we are not arguing about orderly liqui-
dation here. We are arguing about an action Uiken by CBOT that
seemed to benefit some customers at the expense of others.
Dr. Graum. Any time there — and, again, as I mentioned earlier
in private, any time there is em action, emergency action that is
taken, given the nature of the markets, there are some that benefit
and some that lose
Mr. Nagle. But we cannot
Dr. Graum. With respect to their positions, that that is why the
whole issue of the conflict of interest and the procedures that they
followed are very important, and that we will be reviewing in this
case as well. These kinds of arguments, the concerns rEiised as well
as the complaints raised by people, are not unlike the kind of com-
plaints that you would hear in any emergency action that any ex-
change had taken of this nature. So it is expected.
Now, what we do is we again have to monitor the markets, and
again remembering that the public confidence in these markets
would be hurt in a far greater — have far greater impact if there is
not an orderly liquidation. And that is a real concern, that these
markets are not markets that are here primarily for taking deliv-
ery of the physical old crop July beems. These markets are primari-
ly there as hedging markets. Aiid it is the responsibility of all par-
ticipants in the market to ensure that they are abiding by the rules
of the game, the rules that we play in this country, to ensure that
there is, for example, orderly liquidation all the time. And partici-
psmts must know and play by the rules of that game.
Mr. English. I think we will have another round of questions.
This does complete the first round. We have the honorable chair-
man of the Wheat, Soybeans, and Feed Grains Subcommittee, a
person who hfis a great deal of knowledge in this particular area.
Dan, we are glad to have you join us today.
Let me say one thing before Dan asks his questions. We checked
and there are some 14 studies presently ongoing by the CPTC in
the fourth quarter of this fiscal year. So you have a lot of studies
going, and we look back to the act when it was first created, and
you started out with dual trading on that one. So you have studied
dual trading for about 15 years now, off and on. Is that not correct?
Dr. Gramm. Yes, but, again, I would point out that
Mr. Engush. Well, is that true or not?
Dr. Gramm. We have a lot of studies
Mr. English. Have you studied it for 15 years off and on?
Dr. Gramm. Probably so, but we have never had audit trail infor-
mation. And we did not get audit trail information until quite re-
cently. And I do not think you can really measure the benefits
from dual trading until we have that audit trail information.
Mr. English. We have had an audit trail for 4 years, and I sup-
pose. Dr. Gramm, if we really want to get into it. And if you want
to hang around here this afternoon, I will be happy to do it, as to
how well that audit trail is working, how much of that information
is being provided, and how good of a system that really is.
Now, if you want to do that, I will be happy to do it. The point
that I am making, though, is that the CFTC has looked at the ques-
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tion of dual trading now for 15 years — 15 years. They do a great job
of studying. We have a lot of studies going. We have, eis I said, 14
going on just in the fourth quarter of this year. Goodness knows
how many others. And I think that is fine, but at some point we
have to do something with all this studying. It has to come to an
end.
As I said, the whole thrust of the l^islation, of this effort that is
being made, is raising the standards. If the CFTC and you want to
join with us in showing us how we are going to substantially raise
the standards as opposed to settling for the status quo today, I
think we would be delighted to hear from you on that. And I hope
that you aH will help us in that area.
I think the point that Mr. Nagle made, you know, the CFTC
simply cannot sit on the sidelines and assume, simply because
"Thank you very much" means, you know, nothing, it is wrong. As
Mr. Nagle just pointed out, it means acquiescence. In effect, it is
tantamount to approval.
Dr. Gramm. Chi the contrary. I do not think that we are just sit-
ting on the sidelines, either on the soybean case or on all these
studies. I think the fact that we have a lai^ number of studies on-
going indicates that the issues that this Commission faces every
year changes. And so the studies that we are doing on broker asso-
ciations, which is a relatively new phenomenon, for example, is
something that would not have existed a long time ago; that as we
learn more, we will have more studies, but we are also doing quite
a bit.
The Commission was not standing on the sidelines in proposing
audit trail, for example. That was a Commission r^ulation, a pro-
posal that really grew out of one of the dual trading studies earlier
on, so that these studies do produce quite a bit of action. And we
have been quite active at the Commission not only studying but
also undertaking rulemEtking and actually doing things, helping
write new l^islative prop(»als, for example. And we do stand
ready to, again, take the results of these studies to further improve
our markets because they are innovative and markets with a lot of
public confidence. But that's not to say that they are markets that
are standing still.
Mr. English. Mr. Glickman.
Mr. GucKMAN. Thank you very much. And thank you, Mr.
Chairman, for allowing me to ask questions even though I am not a
member of this prestigious subcommittee and wish I were.
Dr. Gramm, do futures exchanges have to submit to you in ad-
vance of formal action taken emergency action orders by those ex-
changes?
Dr. Gramm. No, they do not.
Mr. Guckman. So the CBOT could take an emergency action
without notifying you in advance?
Dr. Gramm. lliat is correct.
Mr. Guckman. In this case, however, they did notify you in ad-
vance?
Dr. Gramm. They did.
Mr. Guckman. And you under the law have the authority to in-
tervene or to veto that proposed emei^ency action?
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Dr. Gramm. Hypothetically, we could take an emergency action
that would be counter, that would basically moot their emergency
action.
Mr. GuCKMAN. I want to understand. Under the law, you have
the authority to take emergency action of your own, right?
Dr. Gramm. That is right. That is correct.
Mr. Glickman. You could have taken an exact similar action on
soybeans that they took?
Dr. Gramm. Yes.
Mr. Glickman. Without them approving or acquiescing at all?
Dr. Gramm. That is right.
Mr. Glickman. And in addition to that, they can take that action
without your approval?
Dr. Gramm. That is right.
Mr. Glickman. Isn't that a mistake? Should they not require at
least — is there no requirement of notification to you if the ex-
change takes an emergency action?
Dr. Gramm. They do have to — there are some requirements in
the act. If an emergency rule, for example, were to be in existence
beyond 30 days, then they have to come to us. But let me turn
Mr. Guckman. Well, I do not want to get into a long, lengthy
analysis of this right here.
Dr. Gramm. They do have to notify us Eifter the fact by the fast-
est available means.
Mr. Glickman. What is that? Federal Express?
Dr. Gramm. Telephone, I would guess, and fax.
Mr. Guckman. But in this case, you were talking to them peri-
odically, and you knew in advance they were going to take the
action, right?
Dr. Gramm. Had reason to believe that the board, yes, would be
taking that action, the recommendations.
Mr. Glickman. Well, I think Mr. Nagle's point is an excellent
point, though. Once you know they are going to take an action and
you have been on the phone with them, unless you give them a
negative point of view, they have to assume that they are taking
that action under your auspices?
Dr. Gramm. Well, again, you have to bear in mind that what the
board actually decides at a meeting to consider recommendations,
for example, from the committee that is monitoring the situation,
could be different from what is recommended. We had an indica-
tion of what things might be recommended, but, these may or may
not have been what actuedly was decided in the board meeting.
Mr. Glickman. Mr. Chmrman, I suggest that in the authoriza-
tion process you ought to look at this relatioi^hip between the fu-
tures exchanges and the Commission when emergency actions are
taken to make sure there is not a gap there.
Second question on dual trading: Has the subject of front-run-
ning been discussed today at all?
Dr. Gramm. No, it has not been.
Mr. Glickman. OK. Can you define the difference between front-
running and dual trading?
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Dr. Gbahh. Dual trading siinply refers to the fact that in futures
markets an individual can trade for his own account and for his
customer's account on the same day.
Mr. GucKBiAN. OK. Front-running^
Dr. Grahm. Front-runnine refers to — and it is usually in this
context referred to intermarket front-running — a person uses non-
public information about a pofiition to take a different position in
another market expecting the first position to have a price impact
on the second. So it is t£e use of material nonpublic information
about a position or an incipient action in one market and profiting,
or taking a position to profit fiitnn that information in another
market
Mr. GucKMAN. Is iront-running a clear violation of Federal
criminal law?
Dr. Gbamm. We believe that it is a violation of the criminal law
because it would be abusing tlie information.
Mr. GucKMAN. But there is no Federal front-running statute
ri^t now, is there?
Dr. Gramm. There is no Federal front-running statute.
Mr. Tallon. Would the gentleman yield?
Mr. GucKMAN. Yes.
Mr. Tallon. Dr. Gramm, how many people have ever been con-
victed on criminal chat^ges by the Justice Department for trading
ahead or front-running in the futures industry?
Dr. Gramm. het me turn to my enforcement director.
Mr. Ki^JNA. We could get you exact figures, but it is a very
rarely prosecuted matter. iVpically, when a U.S. attorney is going
to bring criminal charges, they will utilize the mail and wire fraud
statutes rather than the Commission's antifraud statute. Neverthe-
less, there was a case which went to the seventh circuit in Chicago
which started as a Commission enforcement action and which was
a trading-ahead case brought under the mEtil find wire fraud stat-
utes. It was also prosecuted by the Commission's Enforcement Divi-
sion under the Commission's antifraud provision.
Mr. Tallon. Thank you very much.
If I would suggest to my colleague from Kansas, I believe vet^
strongly that we should consider putting criminal charges in this
l^islation, criminal charges for trading ahead, or front-running.
Thank you.
Mr. Guckmam. Do you agree with Dr. Gramm's statement that
fivnt-running is tradiiog ahead of an account that affects another
market? Comd you not have front-running with respect to the
same markets that you were trading in?
Mr. Klbjna. I think that we would call that trading aheztd.
Dr. Gramm. Treiding ahead.
Mr. Klejna. Absolutely trtiding ahead. Trading ahead of a cus-
tomer order by a commodity professional, there is no doubt in our
mind, would be a violation of criminfil law.
Mr. Glickman. Of course, some of the charges in the Chiceigo
cases right now are trading ahead and perhaps front-ninnii^; is
that correct?
Mr. Klejna. According to the public reports.
Mr. Glickman. Do you think it would be a wise move for this
committee to specifically make those charges criminal now? Or do
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you think if we did that it could jeopardize the criminal prosecu-
tions that are undergoing by the FBI? See, I want to make these
things criminal, but I do not want to let loose some crooks because
we have now said something is criminal that maybe we are not
sure was criminal before.
Dr. Gramm. I think that is a very good point, and I would afik
Dennis to amplify on this. The concern would be that by making it
criminal, something that already is criminal under our statute,
that it would call into question whether or not trading ahead of a
customer is a violation of the act. And that would be a problem.
Mr. Tallon. If the gentleman would yield?
Mr. GuCKMAN. Yes.
Mr. Tallon. I disagree. I think it is absolutely imperative that it
be made criminal in this legislation. We have no record of the Jus-
tice Department coming in and prosecuting on criminal charges
people who were trading ahead of customers.
Mr. Glickman. Well, the best way to handle this is to move
ahead with making trading ahead a criminal statute, euid let us
hear from the Justice Department. They are the ones that are pros-
ecuting this case. If they think that trading Eihead statute would
jeopardize a whole series of criminal indictments, then let us hear
from them. But it is hard for me to believe that we should not
make that a specific criminal statute.
Mr. English. If the gentleman would yield on that point, we
have asked the Justice Department for that information. It is my
understanding that unofficially, as they are preparing a letter for
U8, unofficially it is their opinion that that would jeopardize those
cases, and it would ceill them into question now.
Now, it is also my understanding — we would like CFTC to com-
ment on this — that the problem comes in not with the question of
whether this is, in fact, a criminal violation. The issue comes in
getting the U.S. attorneys to prosecute, just getting the U.S. attor-
neys to take it to court. Is that the gist of the problem. Dr.
Grtunm?
Dr. Gramm. OccEisionally. We have worked hard to promote coop-
erative enforcement, and I think in the past we have had to do a
pretty good sell job to get them to take some of these cases. Now, I
do not know specifically about the trading ahead cases.
Mr. Klejna. I do not think that anybody would think that the
current posture of the U.S. attorney's office in Chicago with respect
to these prosecutions or any matter about them is anything but en-
thusiastic.
Dr. Gramm. That is right.
Mr. English. The point I am making is not with the U.S. attor-
ney in ChiCEigo. I am talking about historically speaking. It is my
understanding that the CFTC has had difficulty in interesting U.S.
attorneys in this particular subject. It is difficult to get him to pros-
ecute, which explains the lack of fiction in this area; is that cor-
rect?
Mr. Klejna. Outside of the current situation in Chicago and a
few others, we have tried very head to interest U.S. attorneys in
commodity fraud prosecutions, and it has been, frankly, some
tough going, as the ChairmEin has indicated. That is r^ht.
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Mr. GuCKHAN. I just would make the point, I su^ested earlier
on this year that we ought to ban dual trading. But I think what
we want to han is the illegeil conduct. And I gueas my fear is that
until such time as you have the adequate audit trail requirements,
you have to bfin the trading because you cannot seem to get to the
conduct. I do not know. It is an unclear question.
The real problem is not frontrrunning or trading ahead. It is the
ill^al conduct that is the problem because that is when you are
abiuing the pubUc trust eis well aa the private trust. But if you
cannot target it with a scalpel, then you Eumost have to bludgeon it
to death with the absolute ban of dual trading, or something £ilong
with what the chairmfin has recommended.
Mr. Tallon. If the gentlemtm would yield, I just want to associ-
ate myself with his remarks, and I also want to state one more
time: If it is a criminal felony now, it will be a criminal felony
when we put it in this legislation, and it ought to be there.
Thank you.
Mr. GucsMAN. I thank the chairman for recognizing me. I WEmt
to also compliment him, Mr. Coleman, and Mr. Penny for the two
sections of this bill requiring some independence on disciplinary
committees, as well as requiring some public membership govern-
ing boards. I think those are excellent provisions.
Mr. English. Thank you very much. We appreciate it. Of course,
I am sure the gentleman recognizes that the l^islation has im-
proved, as it has been introduced, at least, does do exactly what he
IS talking about; namely, that it does set up procedures that if, in
fact, any ts^w of fraud whether it be front-running or anything
else, can be detected, so long as the system can detect it, it is fine
to do duEil trfiding. But if it cannot be detected, then it is banned
except imder certain conditions which the CFTC is allowed to
impose. And so we try to provide that type of flexibility he is
speaking about, and I appreciate that.
Let me say before we start our second round, there is the ques-
tion with regard to permanent status, and I want to make sure
that we have this in the record and that it is very clear eis to what
the intent is. It is the intent that the CPTX^ will come before the
subcommittee at the beginning of each new Congress and present a
budget for the next 2 fiscal years. We will consider that request
and initiate a bill to authorize appropriations at the appropriate
level. We will not consider any other legislative proposals at that
time. That does not mesm, of course, that we will not restrict funds.
We will identify where funds will be spent and so forth.
It is my further intention that this subcommittee will oversee
the CFTC s activities continuously, and at any time that we find it
necessary, we will propose and consider legislative changes. The
CFTC will be expected to propose legislative changes at any time
that the Commission deems it necessary. From this point forward,
let everyone know that the CFTC is considered to be just as perma-
nent as the Department of Defense or the Securities emd Exchange
Commission. These agencies and many others come before their au-
thorizing committees annually and biannually to request authoriza-
tion for funds for their functions. This, of course, does not relieve
the CFTC of appearing before the Appropriations Committee to
defend its request and our authorization. But this process tells the
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world that the CFTC is a permanent oi^anizataon, that its author-
ity will continue, and that this subcommittee and the full commit-
tee will have a role in deciding how the CFTC will be funded in-
stead of simply leaving it to the Appropriations Committee. So I
want to make sure that is very clearly understood.
I want to come back again and underscore that the purpose for
providing this permanent status is not to be taken that this sub-
committee or myself or any of the other authors of this legislation
are sayii^ that the CFTC has done such an outstanding job and is
so perfect that we want to bestow this on it. Instead, the intent is
to strei^hen the CPTC, to make certain that the CFTC has the
resources emd has the support of Congress, and that it is clearly un-
derstood in carrying out its responsibilities.
Dr. Gramm. We appreciate that support and also
Mr. English. Well, let me give you the "but" before you get to
that.
Dr. Gramm. All right. I thought I would be able to cut it off.
[Laughter.]
Mr. English. You may decide the "but" is not worth the first
part. The 'T>ut" peut of it is this question of elevating the stand-
ards. That is the quid pro quo of permanent status for the CPTC.
We strongly believe that the standards have to be substantially in-
creased and improved, Euid the purpose with regard to the other
provisions of this legislation is to try to put that in place. What we
are, in effect, saying that thrae standards shall be met, or there
will be no dual trading or there will be no new contracts or this or
that. It is not a question any more of setting standards at certain
levels. We are stepping in at this particular point, and we are
trying to make it very clear that we expect those standards to be
elevated. And we think that is something, certainly, that we would
hope that the CFTC would join with us in a vigorous manner in
helping us to reach those objectives.
I just wanted to make that very clear, and I also wanted to make
it clear as far as exactly what this permanent status meems.
Dr. Gramm. Absolutely. We appreciate that support, and we do
recognize — the whole Commission has always been very supportive
of very strong congressional oversight. Our view is that the more
people who have scrutinized and looked at what we have done, that
even if we cannot talk about certain issues on an ongoing basis like
investigations, et cetera, that nonetheless, upon close scrutiny, as a
number of outside people have done as well as congressional bodies,
that it has been good.
Mr. English. We will try one more quick round. The chairman
will do his best to adhere to the 5 minutes and hope everyone else
will, and then we will break for lunch.
I want to go back to the soybean issue and discuss this a little bit
more. The question comes down to the procedures. You responded
to Mr. Glickman's questions about procedures. I am more intere6t>
ed in the mechanism and the attitude of the CFTC than I am spe-
cifically who did what on what day. But as far as the way that this
kind of action is, I do not understand it. The exchanges are under
no obl^ation, the way that you responded to the question, they are
under no obligation to in advance of this decision notify the CFTC.
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It is only after the fact. "We have decided this is what we are goii^
to do." Ib that correct?
Dr. Gramm. Basically, yes. But basically when an exchange is
going to do an emergency action, they have notified us. They do
notify US, particularly when we are talking about an orderly liqui-
dation which is so important; there is a constant interactive proc-
ess going on. In fact, as long as I have been here, the exchanges
have told us beforehand when they were thinking about doing
emergency actions and the reasons for doing it. And I think that
communication is beneficial to our oversight.
Mr. English. Well, I agree with that, and that is all well and
good. I want to cut through, though, what the exchanges normally
do or may do.
Dr. Gramm. Right.
Mr. Enctjsh. I want to get down to specifically what is required
of the exchanges, what options the CFTC may have available to it.
As I underst^id it, there is no obligation, the exchange does not
have to notify the CFTC until after the action has taken place. Is
that correct?
Dr. Gramm. That is true.
Mr. English. Now, what would be your position in possibly
changing that notification?
Dr. Gramm. I think there is a difficulty that I can identify, and I
will turn to some of my experts on this. That is, let us suppose you
have an emergency situation occurring that the board of an ex-
change or a committee of the exchange would want to take action
on, lliey may notify us that they are going to do it or have a rea-
sonable expectation of doing it. But in that process, the board may
decide otherwise based on other information.
Mr. ENGLISH. The problem we are into, though. Dr. Gramm, on
this issue — and it goes, really, to part of what is in this l^islation,
part of which, if I remember correctly, you are not very enthusias-
tic about. And that gets into the question of public members on the
board.
Now, as it stands now on a number of these exchanges, primarily
what the board is made up of are the brokers. The action that they
are going to be taking to a great extent is what is going to be in
the best interest of those brokers, what is going to be in the best
interest of that exchange, which is an entirely different responsibil-
ity that, at least the way this member sees it, that you as chairman
and the members of the Commission have; namely, to look out for
the American public and make sure that the integrity of these
markets is maintained. So I guess the question that comes into
play here is that it would seem to me to be a mistake to assume
that the exchange interest and the CFTC's obligations are one and
the same.
Dr. Gramm. Well, first of all, with respect to the issue of govern-
ing boards, that is something that the Commission identifj^ quite
some time ago. I think that following the short silver study, we
made recommendations concerning the public members on the
board, where the public members serve as a witness. As I indicated
earlier, we do monitor the boEu*d8 to ensure that they are broadly
represented.
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Mr. English. As I remember in reading your testimony, going
over your testimony here, basically it is you do not want to estab-
lish any levels; you kind of want to leave to leave it up to the ex-
changes, kind of leave the flexibilitv, which seems to me you want
to water down basically what is in the legislation.
Unfortunately, my time is up. But the point I am trying to make
is that there are two different intereste here that have to be recog-
nized, and it may be that the committee may want to look very
carefully at that aspect.
Mr. Coleman.
Mr. Coleman. Mr. Chairman, let me clarify something. Mr.
Glickman made a comment, and Mr. Tallon made a comment. I do
not wemt the impression left that somehow H.R. 2869 is soft on
front-running because we have not made it a crime. There were
reasons given why it was not, but let me remind the subcommittee
that the prohibition on dual trading is much stronger. So I think
we have gone one step further, just to prohibit it, so there could
not be a crime — there could not be the opportunity for a crime to
occur. I think we have removed the cause of this concern, and I
want the record to show that.
There are some who are suggesting to make this a crime and
then do away with all the prohibitions or limitations on dual treid-
ing as a quid pro quo, and I suggest we intentionally did not put
that in this bill because we think we have a better way of handling
it. And I know that some have a different opinion, but I want the
record to show what our intent was — including Mr. Tallon's opin-
ion on this.
Mr. Tallon. Would the gentleman yield?
Mr. Coleman. I will yield briefly.
Mr. Tallon. Briefly. My concern is the negative impact that ban-
ning dual trading would have, which is completely legal, the nega-
tive impact it would have on the liquidity of the market.
Mr. Coleman. We are going to get into that, I think. We can ^t
into it with Dr. Gramm. We can get into it with the exchai^es. But
let me ask a question because it is an auditorial question. You may
want to refer to some of your panel of colleagues there.
On page 8 of your testimony, you talk about the 1-minute trade
timing requirement and moving the industry toward an ability to
improve their audit trails, et cetera, et cetera, and talking about
the potential of these capabilities— we are talking about computer
audit trails, of course — and achieving their potential, whatever
that might be. Now, that is in your stetement. There are no goals
that I know of or ateted stendards getting to there.
Having said that, let me point out that in our legislation we have
given you, the Commission, the determination, responsibility, and
the authority to review what the exchanges come up with under
our 1-minute time and our SO-second time execution and transac-
tion verification trail. But you have to come up emd say, yes, that
meets the approval of the Commission of rapidly reconstructing an
accurate verifiable record of these transactions as determined nec-
essary by the Commission to provide the effective enforcement of
the applicable provisions of this act, regulations, et cetera. You
have no stendards now. We have given you this responsibility and
flexibility.
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Now, let me ask you: Currently, what goals do you have in mind?
What requirements do exchanges have as far as audit trails and
the actual reconstruction of those transactions? Is there such a
standard today?
Dr. Gramm. Yes.
Mr. Coleman. And what is that?
Dr. Gramm. The standard that we have in our rule is a 1-minute
verifiable audit trail. Now that the audit trail has been implement-
ed, we have done a first-pass review over the audit trails that cover
roughly 96 percent of trading. In this review, we did raise a
number of issues that could further improve the audit trail data.
But we do have a standard in existence now, and we are asking the
^uhanges, and ourselves, about what further improvements in the
audit trail might be appropriate.
Mr. Coleman. All right. But is there a figure? When you recon-
struct trades, do you get an 80 percent accuracy rate or 90 percent
or 95 or 99 or what?
Dr. Gramm. That is right. We do in our rule enforcement review
look at the verifiability, the level of confidence in those particular
numbers. With respect to some of the computerized systems, they
automatically calculate those confidence levels. So we have not
only just the number but also some sense of Uie accuracy of those
data.
Mr. Coleman. I am trying to get the number. What is the
niunber?
Dr. Gramm. It differs for different exchanges.
Mr. Coleman. OK. What have you found to be the highest accu-
raCT?
Dr. Gramm. Over 95 percent in some exchanges.
Mr. Coleman. And what exchange was that?
Dr. Gramm. Let us see. Which exchange? Let me turn to Andrea.
Ms. Corcoran. We have done reports on all of the exchsmges — I
mean nine of the exchai^es, and we have two left to go: Coffee,
Sugar and Cocoa, and the New York Futures Exchange. And with
respect to each of those exchiuiges, we have inquired as to and de-
veloped figures as to the accuracy that they are achieving now.
I n'ankly would have to go back and look at those reports to see
which exchange has the most accurate timing at this point in time.
But Edl of the exchanges are in excess of 85 percent that we have
reviewed.
Now, the rule itself is a 100 percent compliance rule. I mean, the
point is that there has to be some preicticality in the way you apply
such a rule. What we have done is attempt to push each of the ex-
changes in the direction of making those changes that would im-
prove their accuracy level and improve their ability to verify.
I would point out that the audit trail you have now is light years
ahead of what we had prior to 1986. It can be used to reconstruct
trading. It was used in the market break by the SEC and the Brady
Commission to reconstruct trading. And it can be used to research
ofTenses very effectively, but it can be improved from a detection
point of view. And the Commission has moved very aggressively in
that direction.
Mr. Coleman. OK. So you have a rule now that requires 100 per-
cent accuracy which no one has yet met?
23-500 0 - 90 -
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Ms. Corcoran. That is rit;ht.
Mr. Coleman. But someone has hit 95. 1 understand the Chicago
Mercanl^e and the Board of Trade have 88 or 89 percent accuracy.
We will hear from them Thursday.
Dr. Gramm. I would also point out that those were rule enforce-
ment reviews of an earlier period, and in some of them, we have
asked them to make further changes.
Mr. CoLEHAN. So what is the incentive, what do you do to tell
them we want you to hit 91 next year and 95 in 2 years or some-
thing? What is it that is going to move them?
Dr. Gramm. If we were to set a schedule or make a determina-
tion that we want to have another standard or a different stand-
ard, or if we felt that an exchange was not meeting the current
standards that we had set, there are a number of things that we
could do, the least of which
Mr. Coleman. Current standard is 100 percent, and no one is
meeting that.
Dr. Gramm. In terms of^well, from our perspective, there are
still a number of things that can be done if we felt that the ex-
change was not meetii^ its affirmative responsibihty for compli-
ance and for carrying out all the rules of the Commission, from
bringii^ a lawsuit to not approving contracts, to disapproving con-
tracts that are already
Mr. Colebian. All right. There are things that you can do.
Dr. Gramm. Absolutely.
Mr. Coleman. But this gap between 100 percent and whatever it
may be for an exchange today, those threats are possible, and that
would move them up. And maybe you will or will not take tiiat po-
sition.
Now, I know I am runnii^ over my time, but this is an impor-
tant point. In the legislation, we have prohibited dual trading with
certain exceptions — 7,000 contracts, et cetera — but also Henbility
to you, the Commission, to issue orders to exempt exchanges from
this limitation, if you can detect any and all instances of trading
violations which the Commission determines to be attributable to
dual trading and is fully verifiable. How do you interpret that lan-
guage?
Dr. Gramm. That there could not ever be one instance of a viola-
tion that occurred in the markets. I think that that standard is so
high that it could not be met.
Mr. Coleman. AU right. What is the difference between that and
your 100-percent rule?
Dr. Gramm. The 100-percent standard is a standard that one has
as a target. Now, whether or not one wants to require 100-percent
verification of 100-percent competence level
Mr. Coleman. Well, 100 percent is 100 percent.
Dr. Geamm. Probably may well not be cost effective. I mean, that
is one of the things that we are reviewing right now since we have
gone to our first roimd of enforcement reviews.
Mr. Tallon. Would the gentleman yield?
Mr. Coleman. Well, now, let me ask this: Your 100 percent is a
. goal, and it has not been attained, may never be attained, I gather,
under current technology.
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Dr. Geamh. The Commission may decide that it may not be at-
tainable or that it is wise t<>
Mr. Coleman. You may withdraw that rule and put one in that
says 95 percent.
Dr. Geamh. We could.
Mr. Coleman. OK. Now, do you
Mr. Tallon. Would the gentleman yield?
Mr. Coleman. Let me go ahead and ask a question.
Now, do you think that we need to have some language different
from "any and all instances," which in my book is 100 percent? Do
you think that we are pushing
Dr. Gramm. I think that that standard is an extraordinarily high
standard that — as a matter of fact, the point I made earlier is that
when you use record surveillance to monitor meu'kets, there are
some things that might not be caught by the records.
That standard is extraordinarily high, "any and all." One of the
reasons it is very useful to us is to determine the extent to which
there are abuses or may be abuses that occur which records may
not be sufGcient to catch.
And don't forget that the abuse of the dual trading privilege is
typicEiIly the trading eihead of the customer, find that is trading
fdiead of a customer s account when you have an executable order
in your hand, so there is other information that must be available
as well in order to bring a case.
Mr. Coleman. And detection itself would require 100 percent in-
Dr. Gramm. No, not necessarily. I think the way the Commission
looks at it is that what is most important is the sequence of the
trades; the trade reconstruction capability is really what is most
important.
Mr. Colehan. I know my time has run over, but this language is
strict and it is strong, and we will hear more about it. And it may
be that what we want to accomplish for dual trading — once that
audit trail is in place — we may see we have a standard here that is
too high to be met, or it may not be. I want to hear from the wit-
nesses about that. And you are telling us as a witness that it
cannot be met.
Dr. Gramm. In my view, that's true. And furthermore, how
would we ever luiow — I mean, even with undercover operations,
there might be a time when there could be abuse that occurs, par-
ticularly if there is abuse, for example, with an accommodating
broker where there might be
Mr. English. Why don't you provide us with what you think is
absolutely the very maximum that we could expect in a standard,
and then we'U take a look at that.
Ms. Long.
Ms. Long. Thank you, Mr. Chairman.
Dr. Gramm, you advocate self-regulation. I have a question. If
you found in the soybean investigation that there was a conflict of
interest of the Boi^i members regarding the soybean contracts,
what would that say to you about self-regulation? I'm not saying
that is going to happen, but if you found that, what would your
conclusion about seu-regulation be at that point? Would it chaJoge?
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96
Dr. Grahh. I think it depends on what happens in response. If,
for example, there were a particular problem, I want to see what
the exchange did about that problem — did the exchange bring a
case? One of the things that we do in our review of the exchange is
to look at how well they monitor their own adherence to their own
rules and r^ulations.
And agftin, I should point out that this self-regulation is not any-
thii^ — well, it is certainly not like what I thought about self-r^u-
lation earlier on, and that is that we have a tremendous amount <^
oversight, but the important part about self-regulation that is dif-
ferent, I think, than in other areas is that the exchanges have the
responsibiht^ to carry out their activities and to cany out the
Commodity Exchange Act.
So not only does self-regulation try to rely on the competitive-
ness between the exchanges to do the best job — obviously, tbeir
ability to stay in business has something to do with their making
sure that the customers and the users are satisfied and have confi-
dence in the market. OK, that's reinforced. But what this act does,
which I think is different, is that it gives them also the affirmative
responsibility, with us standing there with an awful lot of author-
ity and power to not approve their contracts, basically to counter-
mand anything they might wemt to do.
There is £Ui awful lot of authority, and I think the Commission
has over the years been very mindful of that authority, and we
would not want to abuse it, either.
But the fact of the matter is that the exchanges have the flexibil-
ity and the ability to move faster than Government agencies typi-
Cfuly do. Nevertheless, the Commission is always ready to bring en-
forcement action on its own, including enforcement action against
an exchange, if we think they are not carrying out their responsi-
biUty.
Ms. Long. Let me ask you about emergency action. We know
what happened to the markets, find we know how the drop in
prices fiffected farmers last week when the Chicago Board of Trade
took emergency action.
In your judgment, do you think that before rather than after,
before Ein exchange takes emet^ency action, they should notify you
rather than waiting untU afterward?
Dr. Gramm. 1 haven't identified yet any problem in the process
of notification. As a matter of fact, the exchanges typically have
notified me before in areas where they don't have to— in ma^in
changes, et cetera — and I have not as yet identified a problem. But
again, bear in mind that we will be reviewing all of tYas in terms of
the process and notification just hasn't been a problem.
I^. Long. But pragmatically, given that you have the authority
to order them not to take the specific emergency action that thev
might be planning, I guess I have a disagreement with you. ft
seems to me that you can be a much less biased, much more objec-
tive body to determine what kind of emergency action
Dr. Grahm. I think one of the things — and again, it is something
that 1 will maybe want to think about and visit with my fellow
commissioners about — you have to remember that when you are
dealing with an emergency, typically, there are things that are oc-
curring minute by minute. Commission action requires a majority
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97
vote of the Commission. We are, under the Government in the Sun-
shine Act, to wire and notify people of a meeting 7 days in ad-
vance, even for a closed meeting. I think the way the system is
working now, we haven't found any problems in the proc^ itself
because we monitor these markets very carefully ourselves, and it
is an interactive relationship not only with the exchanges but also
with participEmts in the markets, to ensure the orderly liquidation.
That is critically important if these markets are going to have the
kind of public confidence that they have had over the years.
So I haven't identified a problem there yet, and what we don't
want to unwittingly do is to reduce the ability of exchangee to take
auick action if they determine they need to — again bearing in mind
liat we are always there to second^uess. They also have to consid-
er the impact on their pEirticipants and how irritated their partici-
pants would be as well.
But again, it is something that I'll think some more about and
certainly it is em issue — the whole emergency action issue — that
will be reviewed in due course.
Ms. Long, liiank you.
Mr. English. Mr. Tsillon.
Mr. Tallon. Mr. Chairman, thank you.
Dr. Gramm, if we were to totally ban dual trading, it would very
likely have an adverse impact on the liquidity of the futures meu*-
kets in this country, would it not — yes, ma'am?
Dr. Gramm. If banned, it may well have. Again, that is one of
the areas that we are looking at empirically
Mr. Tallon. I know, we are waiting on the October study, and I
guess there is no way to get it before October. It is just pretty obvi-
ous to me, and it should be to anybody else, that certainly, if we
have a total ban on du£il trading that it would adversely impact the
liquidity of markets in this country, futures markets.
Dr. Gramm. That certainly is what we have been told.
Mr. Tallon. Dr. Gramm, what about foreign markets that com-
pete with our markets here — what kind of restrictions do they have
on dual trading? Is it true that they have no restrictions on dual
trading?
Dr. Gramm. Let me turn to Andrea. In the London markets, they
allow dual trading. E>o you know with respect to the other mar-
kets?
Ms. Corcoran. We have not made a survey of the foreign mar-
kets, but I would frankly be surprised if many foreign markets
have restrictions on dual trading. After all, it is only recently that
foreign countries have restrictions on insider trading at all in the
securities markets
Mr.- Tallon. If you could provide that information for me, I
think it would be very helpful in light of the l^islation that we're
looking at here and the restrictions that we are going to put in,
because it would seem to me if there is no ban on trading in for-
eign markets, and if it would have a negative impact on the liquidi-
ty in our markets, we would certainly stand, Mb. Gramm, to lose
business to foreign markets, would we not?
Dr. Gramm. Yes.
Mr. Tallon. Thank you very much.
[The information follows:]
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August 15, 1989
Vba Honorabl* Clann Bngliab
Chairau
Snbco^Bittaa od Conaarvation,
Cradit and Rural Daralopaant
Co^Bittaa OD Aqricultnra
Dnitad Stataa Houaa of RapraaaDtativaa
1301 LoDgwort:h Houaa Offica Building
WaahiDgtOD, D.C. 20515
D*«r Cbairwan Bngliah:
During ^y t««ti«any on Tua»d«y, July 18, 1989 bafora jour
anbi; u— iitta#, yon inquirad whatbar foraign juEisdictiona paradt
or prohibit tba practica of dual trading on covaodity aackata in
tbalr joriadictiona .
I •■ ploaaed to aapplaaant ay taaponaa on thia iaaoa with
inforaation ralatod to tha atatiiB of dual trading in Anatralla,
Franca, Japan, Ontario, Quabac and tha Dnitad Kingdoa.
Spacifically, inforaation collactad by tlia Co^KKlity Fntnraa
Trading Coaaiaaion ('Co^aiaaion' ) on tha practica of dual trading
on aajor co^aodity aarketa in tha abova-raf arancad JDriadictiona
Indicatea that dual trading la peraittad on aoch aarkata.
Howsvar, aa far aa tha CoaaiaaioD eon aacartaln, aoat
jnriadictiona alao iapoaa raatrictlona aimilar to tboaa iapoaad
by tha CcaaiaaiOD on aoch practica. For axaapla, tha laws in
affect in tha Dnitad Klngdoa raquira that in exacuting tradaa,
firaa anat aubordinata thair intecaata to thoa* of their
Vary tmly yoora.
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Mr. Taixon. Ms. Gramm, it is obvious that we are not going to
maintain the status quo. We need to have some standards for an
improved audit trail to get at the retd problem here, which is not
dual trading; it is "front-rurming" or trading ahead of the custom-
er. I would think that the CFTC would be in the best position to
come to this committee — I know the exchanges in New York and
Qiicago are different; I know they have fiieir inherent differ-
ences— but to make recommendations to this committee so we don't
negatively impact on the efficiency of these markets. I think that is
tiie greatest service you could provide this committee at this time. I
am speaking for myself, but that is certainly something that I wish
you would consider.
Dr. Gramm. We will certainly try to do the best we can, because
I do think it is important that the committee get the beet and the
most information possible. You share some of my concerns.
Mr. Tallon. If the CFTC could address that right away, I think
the whole committee would like to see it — whether they agreed
with it or not, I think it would be very helpful.
Finally, does the bill that has been introduced give the CFTC all
the necessary flexibility to avoid any possible negative effects of a
dual trading ban on markets?
Dr. Gramm. No, it does not as it is currently drafted.
Mr. Tallon. Thank you.
Mr. CoLEBfAN. Wait just 1 minute.
Mr. English. Let me go over that a little bit. I believe you want
to reconsider that answer, don't you. Dr. Gramm?
Mr. Tallon. Let me ask the question again. I'm sorry. Does the
bill give the CFTC all the necessary flexibility to avoid any possible
n^ative effects of a dual trading ban on markets — of course
Mr. Engush. Are you going to answer for her, or do you want
her to ztnswer?
Dr. Grahh. We'd have to review that pretty carefully, but we do
have the concern that it does not
Mr. English. Let's go through that very carefully, then. Dr.
Gramm, bo that there is no question with regard to this issue.
With regard to the l^^lation
Mr. Tallon. I yield to the chairman.
Mr. English. 1 appreciate the gentleman yielding. [Laughter.]
He has had the gavel over there all day, trying to play chairman,
so I'll take it back.
The point that I am trying to make, though, is under the legisla-
tion £ts it stands, any contract that trades on an average, 6-month
average, of less than 7,000 contracts per day is exempt unless the
CPrC determines that in fact it would not affect liquidily, it would
not have an impact, and they can impose less than 7,000 con-
tracts— correct?
Dr. Gramm. Yes.
Mr. English. Well, maybe to speed it up, I'll just go through it,
and then we'll see if there is any question with regard to it.
Dr. Gramm. OK.
Mr. English. It also metintains that for any contracts that would
go over that 7,000 at any particular point, or transition— there is a
transition that is allowed for the CFTC — it also allows for the pro-
vision that should in fact we find it is an aberration, the CFTC de-
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termines it is an aberration, tihey are not required to impose a ban
on dual trading. Should the CFTC determine that in fact this does
have a negative impact — and I don't have the exact words in front
of me; there are about three different provisions, which are ex-
tremely broad tuid extremely generous — which in effect says that
should the CFTC determine on any of these contracts that it would
have this kind of n^ative impact that the CPTC does not have to
impose a bein on duEil trading.
That's an awful lot of leeway — in fact, we're probably going to
get some criticism that it is a very big loophole.
Dr. Gramm. Well, I guess — and again, it is something that
Mr. English. Is it true that you do have that flexibility in the
l^islation?
Dr. Gramm. We do have flexibility. The bill gives us flexibility.
However, I do question
Mr. Engush. Is there anything here — let me just ask you, and
we'll cut through all this — is there any danger that you can per-
ceive of, any threat or any danger in which the CFTC under this
l^islation would not have the authority to suspend a ban on dual
trading?
Dr. Gramm. To suspend — wait, now
Mr, English. Is there anything n^ativethat you can perceive,
any kind of danger that comes up that CFTC would not have the
authority to act?
Dr. Gramm. What about GLOBEX, for example, where you don't
know who is on the other aide of a particular trade, and basically,
since you don't know who is on the other side
Mr. English. I'm just asking you — I'm asking the questions — the
question is can you come up with anything, any particular kind of
instfmce, in which this is in any way going to threaten a contract.
Dr. Gramm. Well, I'll use the new GLOBEX screen trading
system as an example — if you don't know who is going to be on the
other side of a particular trade, how would this pEU-ticulEU* bill
Mr. English. The whole point, though. Dr. Gramm, that we are
getting at here, and the question that Mr. Tallon was pointing to,
is a threat to the contract. You know, I'm not asking you with
regard to your detection; that's up to you all. You £dl are the ex-
perts, and you all ought to be able to detect whether dual trading
is taking place or not. The point that I am coming down to is can
you come up with a single instance in which this would threaten a
contract that is not covered under the provisions of this bill.
Dr. Gramm. That would threaten a contract — in the sense that in
order to remove the ban on a particular contract
Mr. English. I'm not talking about removing the bfui. I'm asking
you CEm you come up— the whole point that we came down to on
this. Dr. Gramm, is this question: Does this in any way threaten a
contract, from the standpoint do you not have all the authority
that you would need that if in any way a contract is threatened by
this action of banning dual trading, that you could not impose dual
trading?
Dr. Gramm. The problem is that the standard is that if the prohi-
bition would create undesirable price volatility — unacceptable wid-
ening of the bid-ask spread, for example
Mr. EInglish. And?
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Dr. Gramm. And it seems to me that^^iat is sometiiiiig that may
well be in litigation. Those are, agetin, difficult judgment terms.
Mr. EbfOLiSH. Well, then, why don't you just say, "No, I cannot
come up with anything," because that's what you're sajring.
Dr. Grajoi. lui't that an example
Mr. KsQuSH. I don't think so.
Dr. Grahu. Where, if the issue is the empirical proof that this is
unacceptable price volatility, caused by the dual trading ban
Mr. English. That's a judgment call. We're giving you that judg-
ment. Dr. Gramm. We're giving you that judgment. That's for your
determination, that's for your judgment call. And alt I'm sajring is
you've got
Dr. Grahu. But those terms would come out in litigation as to
whether or not it is unacceptable price volatility due to the dual
trading ban, which would be very — it is a difficult standard. It is
difficult in terms of the evidence that would be required — again,
these are somewhat more technical issues of how this would be car-
ried out. And therefore, I have some real concerns about how we
would implement it. While the bill on its face gives some flexibility
there, I have some concerns about how would you actually imple-
ment it, even given these ways that we can opt out or allow dual
trading. Determining, for example, the amount of acceptable or un-
acceptable price volatility or liquidity in a market is very difHcult.
And determining how much price volatility or lack of meu-ket li-
quidity is due to the dual trading ban is a very difficult empirical
issue. I mean, this might be the economists' employment act of
1989, and I would again hesitate
Mr. English. Let me say, Dr. Gramm — come on, let's drop the
sham here — you are opposed to any kind of ban on dual trading.
Dr. Gramm. That's not so at all. I really do have an open mind
on this
Mr. English. Let me go ahead and finish my statement. To me it
has become very clear that's what your position is. I don't know of
any Government body — I don't know of any regulatory agency —
when you take those three provisions that are contained in tliat
law, that couldn't take it and do just about anything they want to
with it. If there is criticism of it, there probably should be strong
criticism that it needs to be tightened up. We are trying to provide
the maximum eimount of flexibility.
Now, there is one point, and I would certainly agree to this, and
that is that whenever the CPTC takes this action, they are going to
have to come up before this subcommittee and justi^ that action.
And I would certainly hope that should the CFTC exercise euiy one
of these provisions that they would be prepared to do that; I would
hope that you in effect would be able to back up the stance that
you've taken. That's basically what this provision has done.
But to try to tell us what the language that is in that l^isla-
tion — my goodness, there isn't a bureaucrat in this town wordh his
salt that couldn't take that and do just about anjrthing they want
to — but the one provision is that you'll have to come up and justify
it before this subcommittee.
Dr. Gramm. I am sure that we could pass a rule on anytlung that
would implement the Conunodity Exchange Act. The question was,
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do I think we have the sufficient flexibility here. I should point
out
Mr. English. No, that wasn't the question. That was not the
question. I asked you if you could come up with any specific exam-
ples in which
Dr. Gramm. Oh, that was the second question, the follow-up ques-
tion.
Mr. English. That would in any way threaten any contract that
is available, and you haven't.
Dr. Gramm. Again, I think those are issues— as I said earlier in
my testimony, the Commission is taking a broad brush look at this,
but there are some very diiTicult technical questions about this peir-
ticular bill that I would like to review.
Now, on your statement that I am opposed to a ban on dual trad-
ing, I don't think that is correct. I have not come from any perspec-
tive except one of looking at the issue using the best information
that we can have which includes for the first time information that
we will have ofT the audit trail; it may include additional informa-
tion from the Justice Department. And I have not in my mind
made up any position with respect to dual trading or being opposed
to the ban on dual trading.
Mr. English. Mr. Nagle.
Mr. Nagle. Hi. See, I m the nice guy here. [laughter.]
Let me ask you something else, if I can.
Mr. Smith was here before you — I think you were in the room —
and he mentioned something that I wanted to make inquiry about
In his testimony, he said:
The law as it hae been developed under our various securities statutes is based on
the unfairness of allowing traders to profit from their own accounts with the use of
infoimation not available to others in the marketplace. The same type of activiW
that securities law prohibits is not illegal in futures trading, and the acts for which
people are being prosecuted in New York would not be illegal in futures.
Is there a ban on insider trading in the futures markets?
Dr. Gramm. No, but there are a number of practices which are
unlawful by either rule or regulation that could be considered in-
sider trading for the futures markets. For example, trading ahead
of one's customer
Mr. Nagle. No, no, we're not talking about that. Let me go fur-
ther.
An official of the futures exchange, an account executive, a floor broker, or even
tiie backroom staff of a futures commission merchant, could use nonpublic informa-
tion regarding a laree, reportable position in futures contract of his customers
where flie anticipated transaction leads to profit in their own account.
Dr. Gramm. This is in the futures exchange
Mr. Nagle. Yes.
Dr. Gramm. Of a futures exchange.
Mr. Nagle. All right. Well, there are two rules that I think are
worth mentioning. One is that there is a Commission rc^rulation
that says employees of an exchange may not disclose or use non-
public material or nonpublic information. Furthermore, we have
required all exchanges to have regulations that would prohibit
members from using material, nonpublic information, that they
obtain in the course of their serving on various boards and commit-
tees of members.
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Let me pursue t
Dr. Ghamm. So that would be covered.
Mr. Nagle. Now, if I were a trader, and I got wind of the fact
that CBOT waB going to meet and discuss a possible liquidation
sale in the futures market in soybeans for July, and I got that at 2
o'clock, and the Commiesion took its afternoon at 3 o'clock, would
that be an "illeged" activity by CFTC r^ulation?
Dr. Gramm. Are you saying that someone picked up a rumor
that there might be a meeting?
Mr. Naole. Well, a rumor bfised on good — there are good rumors
and bad rumors. Suppose I picked up a good rumor.
Dr. Gramm. Well, rumors would not be illegal. Now, if a board
member disclosed information that is material nonpublic informa-
tion, that would be a violation of that r^ulation. But rumors
abound in all markets, on the securities side as well.
Mr. Naole. Well, let me just ask you this, then. I don't mean
this in terms of hostility, but I think maybe Mr. Smith raised a
good point when he was here. Is there anybody that favors permit-
ting trading on inside information?
Dr. Gramm. Well, if I am a large cotton farmer, and I know I am
going to bring a certain number of bales of cotton to market, and I
use that information myself to hedge on the futures market, that is
hedging, and that is really a function of the futures market
t£r. Nagle. I understand.
Dr. Gramm. We wouldn't consider that insider trading, but in
some sense we have to be careful.
Mr. Nagle. I mean the type of inside information that is prohib-
ited in the securities market; is that permitted in the futures
market?
Dr. Gramm. Agetin, insider trading in the securities markets
refers to nonpublic information about a company, about actions
that a company may take and the impact on the price of their
stock — their individual stock, which is a little different. So we can't
just transpose from the securities markets into the futures mar-
kets.
However, I would point out that there are a number of insider
trading-like prohibitions and rules that are already unlawful,
either through rule or regulation or through the customer abuse
aspects of this act.
The one area, I think, where Congressman Smith pointed out — I
think there was one area where there aren't rules — and that covers
the employees of a company, a private company, and whether or
not that employee would use that material, nonpublic information,
of an impending action of a private company.
Now, we would argue that if that person had a responsibility, for
example, for trading for that company and used that information,
that that would violate their fiduciary responsibility to the compa-
ny, and therefore would be a violation under our rules.
However, if it is, say, just somebody who works for the company
who may learn that the company or know that the company may
be bringing a certain amount to market, and therefore trades,
using that information, trades on the market, that would not be
covered by our act.
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Mr. Naqle. My time is out, and I want to move along, but could
I ask you to do this — would you, before the end of the week, please
review Mr. Smith's bill, H.R. 60S
Dr. Gramm. Yes, we would be happy to.
Mr. Nagle. And respond as to the CFTCs reaction to that. I
don't mean this in any antfigonism, but I don't think anybody ap-
proves of prohibited insider trading practices or inside information
practices, and I think that if we have to strengthen it to ensure the
sanctity of the market, it is a proper step that we all ought to join
in, and maybe we all ought to join Mr. Smith where we can in
doing that. But I would be interested in your reaction to it, and I
know you did not know I was going to eisk you this morning, so
w^ don't you study it tind get back to me?
Dr. GsAMH. Absolutely, we'd be happy to.
Mr. Nagle. Thank you very much.
Mr. English. Mr. Penny.
Mr. Penny. Thank you, Mr. ChEiirman.
Let me go to soybeans. You indicated that you saw for several
weeks this crisis, if we can call it that, developing in which there
was a monopoly in terms of one firm holding a high percent of
those soybean futures.
Didn't you also testify that you were in regular contact with the
Chicago Board of Trade about that impending problem?
Dr. Gramm. Yes. May I make a prefatory comment? There have
been a number of statements by members about what we saw or
what our position was, and I want to be very careful. It is like what
I do to reporters sometimes when they say, "Do you mean this?" I
would just like to be sure that what I say about the markets, in
fact, that we are concerned, and we monitor these markets — that is
what I mean — and that I haven't necessarily come to conclusions
as to the existence or nonexistence of other speciiic problems in
markets.
Mr. Penny. But you saw the situation developing.
Dr. Gramm. We saw a situation developing where we had surveil-
lance concerns about the orderly liquidation.
Mr. Penny. And you talked on a regular basis with the Chicago
Board of Trade about this development?
Dr. Gramm. We share information, yes.
Mr. Penny. One of your roles is to assure orderly liquidation in
the market. Wouldn't it have been more orderly for some decision
to have been made earlier about liquidating those contracts so that
it could have occurred over a longer period of time, leading up to
the July 20 deadline?
Dr. Geamm. Let me speak more generally, rather than the specif-
ic case, which again, we are going to be reviewing. But again, the
market emergency or congestion at the liquidation doesn t neces-
sarily occur 2 weeks out. You can see a problem occurring, but if
the people with large, concentrated positions begin to liquidate,
then you won't necessarily have a problem.
Dave, would you like to expand on that?
Mr. Kass. Yes. It has been mentioned that we have monitored
this for several weeks, but obviously, there are always opportuni-
ties for the situation to resolve itself, either through availability of
additional soybeans — for example, this year we had a limit up
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105
move with a weather Bcare in early July and made more soybeans
available, and farmers sold more. Now, if that had continued at a
higher price level, perhaps the farmers would have sold more.
In addition, there is the Brazilian situation and many labor prob-
lems that have stymied the export of that crop, and producers have
gone on strike. Now, if that had resolved itself, it may also have
made other soybeans available to satisfy needs in the markets. And
that is a day to day, hour to hour thing that you monitor. We are
in contact with all the major traders. If there are longs, we are
asking about intentions to take delivery, what are they securing in
the physical markets to meet their needs. If there are shorts, we
are asking about their abilities to make delivery and what are they
doing to secure supplies in the physical market; what about owner-
ship. We do have broad inspection powers under the law that we do
examine routinely in instances of concerns, specific contracts of
commitment — if a trader tells us he or she has processing needs,
we will examine his or her weekly/daily processing capacities and
how they have been utilizing that.
We examine specific export sales — what is the quantity, what are
the shipping dates, when do they need these, what ports are they
going to ship out of, what types of soybeans, and what efforts they
have made to acquire those soybeans
Mr. Penny. Are all those pieces of information things you are
looking at? I know you don't want to be specific, but as this whole
thing was developing, were you looking at all these other factors as
well to determine whether there was a legitimate reeison for cer-
tain firms to be acquiring
Dr. Gramm. Absolutely.
Mr. Kass. Without fail, any time any market — if a long, for ex-
ample, says we need May com, July soybeans, whatever it might
be, and we must take July deliveries because of our immediate
pressing need for processing exports, whatever it might be, we gen-
erally ask for verification in terms of photocopies of export con-
tract, records of processing requirements they have been using;
and on the other hand, shorts, if they indicate that they have
hedges against this, against the inventory, or they have the where-
withal to acquire the com or soybeans, we examine those capabili-
ties as well.
Mr. pENPnr. Are you free to say whether you were satisfied with
the information about the need of this firm to acquire that volume?
Mr. Kass. First of all, we haven't confirmed or denied any specif-
ic firm being involved in this. There obviously is a matter of some
court record of one particular firm having certain positions which
were revealed through a court record in Chicago last Thursday.
But we obviously cannot comment on an ongoing market situation.
Mr. Penny. What might have been the market reaction if a liqui-
dation order had been signaled — if, by such-and-such a date, this
trend continues, we will force a liquidation — would it have the
exact same effect, only 3, 4 days earlier, or 1-week earlier?
Mr. Kass. I don't think you can prejudge that. I was around
when we took the Hunts to court in soybeans in 1977, and on a
day-to-day basis as we were in District Court, as the testimony was
coining out, soybean prices were going up or down depending upon
who looked like they were going to be successful
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Mr. Penny. So instead of waiting until last Thursday, I guess, if
a week and a half or 2 weeks earlier, we had said, look, we are ap-
proaching July 20, and on July 12 or 13, we are going to take this
action if things don't correct themselves by then, that wouldn't
necessarily have resulted in a more orderly ^nd of exchange?
Mr. Kass. I think I would like to leave open the possibility that
those sorts of things were being done.
Mr. Penny. Do you think that they were being done in this case,
that the signal was being sent?
Mr. Kass. I cannot comment on this case, hut it would not be im-
usual for us to take actions with individual traders.
Mr. Penny. Does the CFTC have the authority to step in and dic-
tate to a board that that
Dr. Gramm. We can take the action ourselves.
Mr. Penny. But you generally choose not to
Dr. Gramm. No, that s not true.
Mr. Penny. You generally choose to kind of talk back and forth
and let the board decide how to handle it and then review it eifter-
WEU'ds to see if they did the right thing?
Mr. Kass. Without commenting on July soybeans, we often take
actions, and we may have in this case, that don't meike the press.
We don't like to become a market factor.
Mr. Penny. You are neither confirming nor denying that you
took action on this prior to last Thursday?
Mr. Kass. It is not unusual for us to take actions in terms of cau-
tioning traders, warning traders formally, in terms of curbs and re-
strictions on their hed^ng capabilities and things like that in past
liquidations. Now, whether we have done those things already, or
contemplate that in this liquidation, we're not going to comment.
Mr. Penny. Thank you, Mr. Chairman.
Mr. Engush. Thank you very much, Mr. Penny. I appreciate it.
I think we'll recess, and our next witness will be Mr. John Dam-
gard.FIA.
Let me also say. Dr. Gramm, before jrou leave, there is certain
mformation that we requested last week, and it is my understand-
ing that will be provided to us on Friday; is that correct?
Dr. Gramh. I'd like to discuss that with you further, as I indicate
ed yesterday. I have some concerns about information that is confi-
dential, marketrspecific information.
Mr. English. Well, it is my understanding that we had reached
an agreement, or at least my staff in talMng to your staff had
reached this agreement last Friday that we would not. So you are
telling us you have not agreed to give us that information?
Dr. Gramm. No. I believe that what the discussion with staff ulti-
mately was was that we would have to discuss that, the principles,
meaning
Mr. English. Well, let me state very clearly this subcommittee
intends to obtain that information. And if I need to take it up with
the other subcommittee members, I will.
Dr. Gramm. I appreciate your expression of that view. I would
like to spend some time discussing that a little further.
Thank you.
Mr. English. We will recess until 2:30.
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[Whereupon, at 1:40 p.m., the Bubcommittee was recessed, to re-
convene at 2:30 p.in. this same day.]
AFTERNOON SESSION
Mr. English. The hearing will come to order.
This afternoon our first witness will be Mr. John Damgard who
is president of the Futures Industry Association here in Washing-
ton, DC.
John, we want to welcome you here and we would be happy to
receive your testimony.
I might remind our witnesses that perhaps either were not here
this morning or maybe forgot, that without objection your full writ-
ten testimony will be made a part of the record, so feel free to sum-
marize and any of you that have planes might want to summarize
even more than the summary, I do not know.
STATEMENT OF JOHN M. DAMGARD, PRESIDENT, FUTURES
INDUSTRY ASSOCIATION
Mr. Damgard. I am pleased to do that, Mr. Chairman. I am de-
lighted to be here, and I will submit my whole statement for the
record. I would like very much to touch on the parts that the FIA
feels are the most important.
Mr. Chairmfin and members of the subcommittee, my name is
John Damgard, and I am here today in my capacity as president of
the Futures Industry Association, "rtiank you very much for the op-
portunity to appear before you today on behalf of the members of
the FIA.
The FIA is the nationed trade association of the commodity fu-
tures and option trading industry. Our r^ular membership is com-
prised of more than 100 of the largest futures brokerage firms,
known as "futures commission mercluints" or "FCM's." They
handle more them 80 percent of the transactions on the U.S. fu-
tures exchanges.
At the FIA, our primary concern is to protect the interests of
those who use and benefit from our markets. Today, the FIA is
pleased to offer its support of H.R. 2869. Congressmen English,
Coleman, and Penny have introduced a bill that the FCM commu-
nity believes can be the basis for reforms that will usher futures
trading into the 2l8t century.
We share the view embodied in the legislation that an improved
audit treul is the key to these reforms. An audit trail that can be
verified and that accurately reconstructs the sequence of trading in
a timely manner has been the goal of the U.S. futures community
for the entire 14 years of the CTTC's existence.
In 1974, the House Committee dreifted amendments to the Com-
modity Exchange Act which established a system of self-regulation
in the industry, accompanied by active oversight from the newly-
created CFT€.
The premise of the Commodity Exchange Act is that the ex-
changes will police themselves and that the CFTC will review the
efficacy of these efforts. It has long been the view of the FIA that
without a verifiable audit trail, which accurately accounts for
every trade, the exchanges, the CFTC, and indeed Congress itself
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108
lack the tools necessary to assure the public that the markets are
free from abuse.
We believe that until a verifiable audit trail is in place in every
exchange, the fiitures industry, the CFTC and Congress will be vul-
nra^ble to public criticism and skepticism — no matter how well
founded — about the integrity of the system.
The exchanges have mside tremendous advances in their audit
trail systems during the last few years. That prcwress can be seen
both in the CFTC rule enforcement reviews— highlighted in a
recent report by your subcommittee's inquiry team — as well as in
the sustained growth in the volume of futures trading. But there is
more work to do and sometimes the last mile is the most difficult
to traverse.
The bill under consideration today requires that the ezchanges
refine their audit trfuls within a stated timefrsune. Namely:
First, after the first year the legislation has been in effect, the
exchanges must provide the verifiable time of execution for every
futures or options trtide in increments no greater than 1 minute.
Second, no later than 3 years from the effective date of the legis-
lation, the exchanges must refine their audit trails to increments of
no more than 30 seconds.
The FIA strongly supports these amendments to section 4(gX2) of
the act. We believe, however, that analyzing the audit trail's effica-
cy and exploring new technologies to achieve optimal enforcement
of the CEA are paramount. This work should be ongoing, and Con-
gress should request yearly reports on its progress.
The subcommittee has indicated its belief that existing audit
trails may not detect some trading abuses which accompany dual
trading, "rhe subcommittee therefore proposes limiting a broker's
ability to engage in dual trading, except in special situations,
where an average volume of over 7,000 contracts are traded daily.
The only exclusion is a case where the exchange's audit trail can
detect any and all insUmces of trading violations that the CFTC de-
termines to be attributable to dual trading and where ibe audit
trail is fully verifiable.
A recent Chicago Mercantile Exchange special committee report
addressed the public confidence issue that can accompany dual
trading. As the report said:
The CME's special committee suggested that that exchange ban
dual trading and in mature, liquid markets. This would affect
about 80 percent of all transactions on the CME.
Thus, both Congress and the special committee recognized that
while some abuses may accompany dual trading, banning it Eilto-
gether might adversely affect the less liquid markets. The FLA has
supported this view with the important caveat that whenever dual
trading is permitted, there should be adequate safi^uards in place
to assure the integrity of the market.
An audit trail system that detects abuses and an exchange that
wiU take actions against those who abuse the Efystem provide such
safeguards.
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FIA, therefore, believes that H.R. 2869 correctly links dual trad-
ing to a more precise audit trail. It is difficult, however, for Con-
gress to l^islate whether certain markets are sufficiently liquid or
whether they require the liquidity afforded by dual trading.
We would prefer that the Congress direct the CFTC to review the
efficacy of such a liquidity test. In particular, we believe there may
be other considerations — quite apart from how many contracts are
traded — in determining what is an active, liquid market.
Moreover, since the CFTC reviews and monitors the performance
of audit trail systems, the CFTC is in a better position to assess the
system's abUity to detect and prosecute trading abuses.
The CFTC currently is addressing dual trading and has promised
a report on economic and other aspects of this issue by September.
We respectfully suggest that it is in the best interests of the cus-
tomers Euid the industry alike to take a closer look at the CFTCs
study and others underway before acting definitively on dual trad-
ing.
Telemarketing fraud: The subcommittee's inquiry team has fo-
cused on the solicitation by a few firms of persons who, unaware of
the risks of trading futures and options, are enticed to become cus-
tomers through high-pressure sales solicitations.
'Ilie FIA understands the subcommittee's concern with high pres-
sure sales. Individuals and firms who use such tactics to defraud
customers do not belong in the industry, and we support all efforts
to remove them.
We are concerned, however, that the Ifuiguage the subcommittee
is proposing will result more in frustrating the legitimate users of
futures and options than eliminating the bad apples. The r^^ula-
tors will have difficulty in determining what is a first-time sales so-
licitation and the firms will have a next to impossible time super-
vising for compliance with the rules.
Some of our large firms have told us that they would be forced to
hold all customer trades for 3 days because of the supervisory prob-
lems related to the compliance.
Unlike others in the financial services arena, futures profession-
sia already provide specific risk disclosure statements to all futures
and options contracts, and these disclosures must be acknowledged
and returned before a firm may take a customer's trade.
In most cases this procedure £done would provide customers with
a cooling off period. Futures professionals must comply with NFA
rules which regulate the content of all communications between
NFA members and the public. These rules specifically prohibit
fraud, deceit and high pressure sales practices.
It was noted during the recent subcommittee hearings that the
NFA program to answer ads and pose as potential customers is an
effective way to discover high pressure tactics and take action. This
system should be enlaiged and adopted by other industry self-regu-
latory organizations that have a responsibility in this area, and we
believe it will.
The FIA would like to continue to work with the subcommittee
to help it fashion a proposal that is appropriately directed at those
persons and firms on the periphery of the industry who are using
unlawful sales techniques.
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Undercover operations: The FIA supports the l^al application of
such undercover procedures. On governing boards and disciplinary
committees, the FIA supports the requirement that disciplinary
committees be composed of persons who are of a different trading
status from the respondent.
This requirement appears to be reasonable with the additional
proviso that an exchange be able to put nonexchange members on
such panels in special cases.
Whether governing boards should be comprised of at 20 percent
public members has already been decided by several exchanges
which have opened their boards to have more outside members.
Our only caveat is that public members should be expected to have
a working knowledge of futures markets.
The FIA has al»} been concerned about increasing the actual
representation of nonfloor interests on exchange boards. To that
end, we have asked the Congress and the CFTC to encourage ex-
changes to have broad representation on their boards.
Registration requirements: It is in everyone's best interests to
keep persons with questionable backgrounds from entering the in-
dustry, and we support strongly what is in the legislation.
Re^tration of floor traders: We fully support its enactment.
With respect to ethics, we fully support the efforts to increase in-
dustry registrants' knowledge of and sensitivity to ethical consider-
ations involved in soliciting and handling customers' accounts and
trading in futures markets, whether for customers or for proprie-
tary accounts.
Whether the "sunset" of the CFTC is a real or perceived prob-
lem, the FIA believes Congress should take every step necessary to
give the Commission permanent status. We support the appropria-
tions figures for 1990 and 1991 and commend the subcommiUee's
actions to eliminate any uncertainties in the Commission's future.
The CPTC should have permanent status, similar to the Securi-
ties and Exchange CommissioD, because it will provide for stability
and continuity of r^ulatory leadership.
We can also support all of the CFTC proposals as discussed by
Chairman Gramm earlier. I would add th^ caveat to my testimony.
The specific language of all of H.R. 2869 warrants closer review
than was possible during the time we were given to prepare this
testimony.
Therefore, we ask the subcommittee's permission to submit addi-
tional comments and suggestions for the record should we feel that
to be necessary.
Thank you very much and I am pleased to answer any questions.
[The prep£u*ed statement of Mr. Damgard appears at the conclu-
sion of the hearing.]
Mr. EbjGLiSH. lliank you very much, John. I appreciate your tes-
timony and let me say also that, at least speaking for this member,
I appreciate the attitude of the FIA. I think that certainly with
your testimony, you have struck the right note.
It is a question of whether we are going to raise the standards
and how we can best obtain those standards. I appreciate your atti-
tude and FIA's attitude in trying to help this subcommittee come
up with those solutions.
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I think the real question that we come down to, as I mentioned,
is the question of how we can best obtain the standards. The issue
with r^EU'd to the question of dual training and discovering abuses
in dual training is exactly how high those sttmdards can be.
Chairman Gramm mentioned the fact that she did not feel we
c<Hild meet the standards that fire expected in this legislation.
Do you have any suggestions or thoughts with regeird to just
what la likely to be a obtainable goal at some point in the future?
Mr. Dahoard. I don't know that we are in the beet poeition to
assess the speciiics, and I think I referred to the fact that 7,000
may not be just the absolute perfect number for determining
whether or not it is a mature contact.
Perhaps such things as open interest and the types of contracts
that are being traded— whether they are speculative or hedge posi-
tions—should have some bearing onthat, as well. Indeed in 1974,
you created the expert agency, the CFTC, to deal with these kinds
of issues, and I don't know that they have ever had as strong a
message from the subcommittee to give them some backbone as
tb^ have received today.
Our own feeling is that this carrot and stick approach the sub*
oommittee is using is quite appropriate, and it is less important to
us to determine just exactly what a specific test is in terms of an
audit trail or when duetl treiding should be allowed and when it
should not be allowed. What is important is to know that the sub-
committee is going to continue to keep pressure on the CFTC and
the exchanges, and in fact the entire industry, to make sure that
Uie needs of the customer and the end user and indeed those that
benefit from the market are paramount and that the exchanges are
going to be required to consider what is in the best interests of the
customer.
Mr. English. Well, I think that is a good point. I think we would
agree with you with the question of where that level should be.
I suppose it is like a drinking age, driver's licenses, taxes, or any-
thing else. There is an arbitral? point in which a number is estw-
lished. I might say for those who may not be familiar with it, the
number 7,000 came primarily from the standpoint that some people
we tallied to within the industry, 5,000 seemed to be the number
that most people agreed you reached the point that a contract was
mature and liquid.
We simply went to nearly half again as much as a safety factor.
Now, anyone who would like us to consider reducing that down to
five and hit tliat number that everyone told us about, I suppose we
could reconsider it.
But what we have tried to do instead is to build in safety factors,
and in this case, neeirly half again as much asasafety factor, we
put the safety factor for transition to give the CFTC, so that we do
not have a disruption on the contract.
We have included a provision that if it is an abberational in-
crease, it goes over the 7,000, it should not be included. We have
also included, of course, the fact that should the CFTC find in cer-
tain cases Uiat even to include, I might say, otherwise threaten the
pidtlic interest— which I mentioned this morning is pretty broad
language— gives them a good deal of flexibility to make sure that
we do not damage those contracts.
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But there has to be a point to begin. That is the whole point. The
bottom line is there has to be a starting point. I think that we have
to underscore the fact that we still have a good deal of distance to
do.
We have some people I think, unfortunately, that are willing to
look back. They look and say, "Well, look how far we have come"
instead of looking at how far do we have yet to go, and we are look-
ing forward to working with FIA and trying to make sure that we
establish goals that may just barely be on the outer reach of the
industry, and we are going to prod and push, not only the industry,
but if we have to, we are going to prod and push the CfTC if they
require us to, to make sure that they help us reach that point.
Again, I just want to thank you for your testimony and I appreci-
ate your suggestions.
Mr. Damgabd. We are plefised to be here. We really support the
thrust of the legislation. We believe the audit trail is more impor-
tant than the dual trading provisions.
We think the key is really the Utopian perfect audit trail. Maybe
that is unreachable, but I do not think we should stop trying to
reach it and I think that the image of impropriety in our markets
is probably as damaging as impropriety itself.
In the exchanges' defense, I believe that they tire doing an infi-
nitely better job than they have been doing in the past, and I think
that computerized trade reconstruction in Chicago and the empha-
sis that the New York exchanges have put on audit trail in the last
few ye£u^ have made it less likely for people to be able to cheat
and get away with it.
As a result, I think customers are getting a better deal than ever
before, but it is never going to be good enough as long as there is a
belief out there that there is something wrong.
I think I emphasized that volume is growing at a very, very fast
rate in our markets. Somebody is doing something well and I think
we ought to tell the exchanges that they are doing some thin^
very well.
But that does not mean that we can let up, and do we have spe-
ciiic answers about whether or not dual trading should be allow^
here or there, I think probably the exchanges should be heard on
that subject louder than we do, but we think thq carrot and stick
ajiproach that you are using is something that, in the long run,
will be very, veiy good for tl ' '
Mr. English. Thank you.
B very, veiy good for the int^rity of our markets.
Mr. Coleman.
Mr. Coleman. Thank you, Mr. Chairman.
I too would like to commend you, John, and your association for
the constructive comments that you have made on the record
today. I, in looking through your testimony really do not see that
you have any problems with the bill except for a couple of caveats
that you have already mentioned.
Let me say that there has been some suggestion that what this
bill represents is somehow going to move onshore much of the fu-
tures industry from this country. I would like to have you comment
on that possibility, probability, and mention was made about other
exchanges in the world and what rules they have, and so on, and so
fbrth.
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It seems to me that if we can restore the reputations that have
been somewhat smudged here in the press and also to provide total
confidence in the exchanges emd the transactions being accurate, it
seems to me people would want to flock to an institution that has
these types of safeguards.
I would like to have you comment on this.
Mr. Damgard. Well, I think you are absolutely right. I mean I
think the way to run the markets offshore, frankly, is to destroy
their reputation for integrity.
I am not saying that they are in the least bit destroyed now, and
I think we have to be very, very watchful of foreign competition. I
think the offshore market s biggest opportunity would be if , in fact,
our markets received a black eye ana they would be able to pros-
per.
I also think that we are the established marketplace; the rest of
the world comes to the U.S. futures markets to do their risk shift-
ing. Our markets are the envy of the world. Not surprisingly, other
countries have decided that if they are financial centers, they will
have futures markets, as well.
We have seen a lot of activity in Japan and London in the last
few years. These two centers tire particularly interested in develop-
ing risk-shifting markets to complement their cash markets.
I think that it is probably reasonable to assume that as the Japa-
nese markets mature and have liquidity, that the Japanese will use
the Japanese futures markets to some degree, instead of the United
States markets.
The Japanese Banking Federation has gotten together and
formed a futures msirket in currencies, and that market will be op-
erating during daylight hours in Japan. The Japanese exchange
probably will have some effect on the business of the Chicago Mer-
cantile IMM. I think it was in response to that, that the Chicago
Mercantile Exchange, in conjunction with Reuters, came up with
the GIX>BEX idea, a 24-hour trading system.
Growth in absolute terms remains much greater in U.S. markets
than it does in the intemationfil meu'kets. However, as they come
on-stream, I suspect these new international markets will be more
attractive to people in their time zones.
Mr. Coleman. Thank you.
Mr. English. Mr. Combest.
Mr. Combest. John, in your testimony where you mentioned
about midway down on the second page, where you talk about the
Chicago Mercantile Exchange special committee report and that
th^ suggested dual trading be banned in mature, liquid markets.
Granted the fact that you do not know where the right level is, if
it is 7,000, 5,000, or whatever the case may be, how do we deter-
mine what that right number is?
Mr. Damgard. I am proposing, Mr. Congressman, that maybe
that is something that t^ CFTC on an ongoing basis, using more
than just strictly a volume test, might be in a better position to
judge.
I think what this committee has done today, and what it appears
it will continue to do, is give the CFTC a lot more courage to act in
these areas than it has ever had before.
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I am not saying that there is anything wrong with the 7,000
figure. I am simply saying that I do not know. In the limited time I
have had to discuss that figure with a cross-section of my board of
directors, there was no unanimity — as there hardly ever is in a
membership organization — that one figure is a magic figure.
So, for that reason, I am unable to sit here before you and tell
you that I know precisely the right number. More importantly, we
are endorsing the emphasis on the audit trail and the legislation in
that area.
That is not to say that maybe 3 years from now, the people that
have had to live by the 30-second requirement can not come back
here and to the CFTC and make a strong case that the require-
ment is too rigid and should be amended.
But I do thmk that you are doing the right thing by holding the
exchange's feet to the fire on audit trail and dual trading, because
I think that is going to eliminate the customer abuses.
Mr. CoMBEST. From the penalty standpoint, being in the business
you are in and you are representing the industry, would you rec-
ommend that the penalty be a set penalty for a certain type of
trading abuses, or do you believe that should be left up to me ex-
change that would be policing the trading?
Mr. Damgard. I think the penalty should he a strong deterrence.
Mr. CoMBEST. I agree.
Mr. Damgard. With regard to specific levels, I frankly am not
very knowledgeable about what those levels are right now. Howev-
er, I think the penedties should be quite painful and I think some-
times those penalties should be banishment from the industry, and
let the shoe fall wherever it may on that.
The last thing that this industry needs are the few people, the
kind of cling to the periphery of the markets, that bring us this
bad name.
The futures industry is Em extremely important industry that
touches every facet of economic life. Let these guys who are bring-
ing UB the bad reputation go back to selling aluminum siding.
Mr. CoMBEST. I agree. I guess the question is, and I think, hope-
fully, the industry rect^nizes that it is to their best interest that a
lot of the problems and perceptions, as you have indicated, the per-
ception can be more significant than the truth, whatever the public
perceives, but that the perceptions are bad and can have tremen-
dously negative impacts.
I think we should make it very painful, too, literally, very pain-
ful for individuals to he involved in illegal trading. I guess the
question I have — and when I ask this of the exchanges as we go
through these hearings over the next several days — is: Should we
legislate that penalty or should we leave that up to the CFTC, or
should we leave it up to the exchange that basicedly regulates and
determines the penalty?
But I think the more severe, the more harsh, the more of a deter-
rent there is in the penalty phase, the more the perception will be
of confidence in the market. Off the top of my head, I would say
that a good, strong message in the report language would alert the
CFTC and the NFA and indeed the exchanges themselves that the
committee expects to see these penalties be quite severe.
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I think they ahould be fitting with the crime. I mean I don't
think the penalties for the equivalent for a parking ticket should
be as strong as the penalties for cheating a customer and abusing
the system. Thank you, Mr. Cheiirman.
Mr. English. Ms. Long.
Ms. Long. No questions, Mr. Chairman.
Mr, English. Mr. Gunderson.
Mr. Gunderson. Thank you, Mr. Chairman.
Two questions. First of all, as I reviewed your statement, I weis
struck by the ffict that you seemed to support almost every recom-
mendation.
Mr. Damgard. Except the telemarketing. We are not so keen
about that.
Mr. Gunderson. Enforcement, that kind of thing, I am not criti-
cal of that. I guess I would ask more of a philosophical question
from your perspective.
To what degree do you feel in-house exchange governance en-
forcement mechanisms working and what degree do we try to
define that balance, CFTC regulation and exchange in-house gov-
ernance? It seems to me that that is a philosophical question you
have to face in light of inquiries.
Mr. Damgard. Well, the Futures Industry Association obviously
represents a broad cross-section of all elements of the industry, but
we have our roots in the brokerage community with the Shearsons,
the Merrills, and the Dean Witters, and large Chicago houses that
Etre not such household names like Refco, Stottler, and Gelderman.
There have been concerns expressed from time to time that the
governance of the exchange does not always take into consideration
the views of those that feel that they are the links with the outside
world.
In other words, we believe we are the link to the customer and
we can best represent the public's interest in how these markets
work. The exchanges are indeed owned by the seatholders, and the
FCM community is far outnumbered by the local floor trader in
terms of owning seats. From that standpoint, the FCM's voice is a
minority, and while that has been frustrating in the past, I would
not say we have not seen some progress.
I believe that that progress will continue and I believe with hear-
ings like this, and with the interest of this subcommittee, it will
probably continue at a little faster rate than it otherwise might
have.
I would at this point not be so inclined as suggest that we legis-
late in this area, because I think that the CFTC, as the overseer,
has a strong idea of the subcommittee's goals in this area.
Mr. Gunderson. One of the areas that I have been concerned
with is developing policy area, the whole area of international fu-
tures, development of foreign futures as competition. How do we
strike a balance in our regulations that do not drive people on to
foreign exchai^es, and yet at the same time, try to preserve integ-
rity?
I Eun a little struck b^ Chairmfm Gramm's proposal that they
wemt authority to investigate and regulate foreign. I do not know,
it seems to be a bit of a unique propcsal, but I see that you support
the whole concept of cooperative enforcement efforts.
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I would like you to elaborate a little as to what you see that we
can rationally do in this area.
Mr. Damgard. Well, the theory of course is to make certain that
customers outside the United States are not subject to the same
standards as customers within the United States. We do not want
to disadvanteige U.S. customers on U.S. markets.
By the other hand, I do not think it is in the best interests of
futures trading worldwide for pockets of liberian futures trading
crop up and business flows to the mEU*ketpleice that has the least
regulation. Ultimately, that will cause the futures industry great
embarrassment and a bleick eye.
Futures trading has led the way in terms of being a 24-hour
global business perhaps because products like crude oil and gold
have worldwide appeal, whereas, 100 shares of a specific stock like
PEPCO may have limited appeeil.
I think that foreign markets are bound to grow and we ought not
to worry about that growth. We ought to spend more time worry-
ing about our own markets and encourage regulators to come up
with some sort of worldwide r^ulatory parity.
To that end, I think that the CFTC engages in twice a year meet-
ings with their fellow regulators worldwide.
Mr. GuNDBBSON. Thank you.
Thank you, Mr. Chairman.
Mr. English. Thank you very much, Mr. Gunderson.
John, we appreciate your testimony. Thank you very much. We
are looking forward to working with you.
Mr. Damgakd. Thank you very much, Mr. Chairman.
Mr. English. Our next witness is Mr. Frank Beurskens who is
with the National Grain and Feed Association here in Wetshington.
Mr. Beurskens, we want to welcome you here to the subcommit-
tee today.
STATEMENT OF FRANK BEURSKENS ON BEHALF OF THE
NATIONAL GRAIN AND FEED ASSOCIATION
Mr. Beurskens. Thank you, Mr. Chairman.
Mr. Chairman and members of the subcommittee, my name is
Frank Beurskens, and I Eun president of Advance Trading, Inc., in
Bloomington, Illinois.
My compemy works with both cooperative and private country
grain elevators and directly with farmers, aa well as numerous
small conamercial hedgers in the marketplace.
I am presenting this statement today on behalf of the National
Grain and Feed Association. The membership of the National
Grain and Feed Association encompasses more than 1,300 compa-
nies representing some 5,000 facilities that handle and merchan-
dise about two-thirds of all U.S. grain and oilseeds.
Members of the National Grain and Feed Association rely heavi-
ly upon the futures markets to hedge purchases and seiles of grain
and/or grain products. Continuation of a viable futures market is
critical to a competitive and efficient marketplace for agriculture.
Futures markets provide efficiency and risk transferral mecha-
nisms necessary to offer marketing services at the lowest possible
cost, which benefits both the producer and the ultimate consumer
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of agricultural commodities. Futures markets are truly the comer-
stone of an efficient meirketplace.
This year, 1989, marks the 15th anniversary of the Commodity
Futures Tradii^CommiBaion as an independent body regulatine fu-
tures treiding. We continue to believe that all futures markets
should be regulated by an independent r^ulatory body.
We support an open-ended reauthorization, with no specific sun-
setting of the CTTC. CTTC, in our view, has earned the right to
become a permanent Federal agency, eind absent the need to
embark on the reauthorization process every 3 or 4 years, should
be able to devote more of its resources to actual market surveil-
lance and enforcement activities for which it was intended.
WhUe not under active consideration, the issue of margin setting
authority being vested in one or more Government agencies re-
mains a primary concern for our industry. There seems to be con-
tinuing confusion about futures market margins that cause some to
believe that there is a similarity between margins on securities and
margins on futures.
The function of the futures market is not to transfer title, but
rather to transfer price risk. Futures margins act much as a per-
formance bond, and depending upon price volatility and risk in any
^ven market, is subject to change, and in our judgment, only the
individual exchanges have the capability to deal with the logistical
realities of margin setting-responsibility.
Notwithstfmding the current investigations of some exchange ac-
tivity, from our perspective as commercial hedgers in the market-
place, we believe that the commodity markets are generally func-
tioning very efficiently under the current regulatory structure.
We believe that an overreaction in the name of regulation could
well do considerable damage to efficiently running meu*kets. At the
same time adequate self-r^ulation by exchanges, self-regulatory
oreanizations and the CFTC must be taken very seriously if the
seu-r^ulatory structure is to be maintained with confidence.
A principal issue of these hearings and of H.R. 2869 is how best
to r^ulate the markets to minimize potential abuse of dual trading
practices. First, it is vital that Congress understand that the prac-
tice of dual trading is^very necessary in mtmy meu-kets to maintain
market liquidity.
Adequate liquidity is important to all hedgers as the cost of plac-
ing hedges in the market can go up tremendously in a thin, lightly
traded market. Clearly, however, the use of dual trading can be
abused, and close surveillance by the CFTC and exchanges is neces-
sary-
H.R. 2869 would ban dual trading in markets whose daily volume
exceeds 7,000 contracts. However, as we understand, there would
be a number of exceptions to this rule.
While this section of the bill is well-intentioned, and correctly
links the potential for dual trading abuse with the need for im-
proved audit trails, we believe the provision would create a number
of problems.
First, it is very difficult to determine a single volume, whether
that is 7,000 contracts traded daily, or some other figure that de-
fines a liquid market, that does not need the flexibility of dual
trading to encourage volume.
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Second, allowing customers to give written authorization to bro-
kers to override the dual trading ban would lead to the question of
just who is the customer. Is the customer, for instance, the futures
commissioner merchant sending order to a broker on behalf of a
client, or the introducing broker sending order to a futures clearing
merchant, or would every public customer have to authorize a par-
ticulEU- floor broker to be able to dual trade?
Third, but most importantly, the eiccuracy of the audit trail is
parEunount to improving exchange surveillance and should be pur-
sued vigorously, but technological feasibility and the cost of 100
percent accuracy have to be reviewed.
We believe that dual trading is an important part of marketplace
efficiency and Congress should endeavor to avoid an outright ban
of dual trading in any futures market, if at all possible.
WMle we agree with the intentions of Congress to guEU-d ageiinst
abuse of dual trading, we believe it is very d^cult to set such spe-
cific guidelines applicable to all markets, without creating some
8ul»tantial adjustment difficulties in certain markets.
We would support an approach giving CFTC specific legislative
objectives and authorizing CBTX^ to write specific rules with strin-
gent penalties for noncompliance. We believe this approach would
provide adequate public protection and preserve the market liquidi-
ty necessary for market efficiency and viability.
Other items addressed by H.R. 2869 include a specific restriction
on trading between members of broker associations. Artificial re-
strictions on trading volumes place an additioned constraint on effi-
cient marketplace performance. Thus, if there is a means of equiva-
lent protection through better audit trails or some other mecha-
nism that does not add another market restriction, it would be
deemed as more desirable.
We support the provisions in H.R. 2869 that would prohibit the
participation on governing boards and disciplinary panels by those
members found guilty of major rule infractions.
Our association also welcomes the expansion of representation of
nonfloor membership on governing boards of exchanges.
Mr. Chairman, we fully support other provisions of H.R 2869 in-
tended to encourage a high level of ethics and integrity in the func-
tion of the futures market.
We have appreciated this opportunity to present our views on
CPTC reauthorization, and I would be happy to respond to any
questions the subcommittee may have.
[The prepared statement of Mr. Beurskens appears at the conclu-
sion of the hearing.]
Mr. English. Mr. Beurskens, I appreciate it very much. The
question was Eisked earlier — I thought Mr. Nagle might be here be-
cause this is the question he raised, and I want to raise it with
you — as a result of the actions taken last week on the Board of
Trade, do you have any idea of what the real effect on cash prices
W£i8 to farmers, what kind of a loss farmers may have suffered?
Mr. Beurskens. It is difficult to separate the impact of weather
on price. That has been a very volatile factor reflected in yester-
day s meu-ket of being limit down.
But if we look at several different markets from the period of
last Tuesday, the day before the announcement by the Board of
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Trade, and compare those to the closing prices Friday, it should
give us an indication as to what the final impact would have been
to a producer.
If we look at the export market, which is as many articles have
mentioned, a mfgor factor that was involved in this debate, the
value of soybeans delivered to the Gulf on Tuesday, July 11, was
$7.24^ cents a bushel. That was the day before the announcement.
On Friday, at the close, July 14, the price of soybeans delivered
to the Gulf was $7.24V4 cents, one-quiu-ter of the penny a bushel
less IViday them the day before the announcement was made.
If we look at Peoria, Illinois, the price for beans delivered to a
terminal, to a riverhouse in Peoria, on the Tuesday before the an-
nouncement was $7.03 a bushel, and the price of beans Friday was
$7.02W, three-quarters of 1 cent less.
If we look at Decatur, Illinois, which is a primary processor
market, the bid to a farmer on Tuesday before the announcement
was $7.23 a bushel. On Friday, at the close, that price was $7.06^
cents a bushel, 17 cents less.
If we were looking at the new crop prices during this same
period, the new crop price for soybetms on Friday was actually 7Vi
cents a bushel higher than it was the day before the Board of
Trade made that decision.
The realities are in the pricing. No. 1, the trade has known, as
was mentioned earlier, not just since last May, but this situation
has existed in the soybean market for over 1 year, and all of the
professionals in the market — and one would have to be pretty
absent of news not to realize that there were fewer deliverable
stocks than there were positions, open interest in the market-
place — to understand that there really was not business for any-
body particularly a farmer to have any futures position in a July
contract.
Our firm, representing country elevators and producers, had one,
5,000-busbel contract long in the July contract Wednesday morn-
ing, and I think that weis indicative of any professional that has
been in the marketplace. There was no reason to be in the July fu-
tures contract for a novice particularly.
So, from a cash bid standpoint, one would really have to question
the articles that have been in the Post and the Journal as to just
where did these massive price losses occur. I do not see them in the
bids that are reflected from what I have just quoted you.
Mr. English. Mr. Coleman over here was just reading in the
newspaper there is a 26-cent difference.
Mr. Beurskens. What market, what location?
Mr. ENGLISH. This was on the Board of Trade.
Mr. Beurskens. What day?
Mr. Engush. Today's paper is what he has.
Mr. Beurskens. There was a weather forecast Friday that had a
three-quarters to l!i4-inch of rain in the entire grain belt.
Mr. English. How many cents does that eidd or take away?
Mr. Beurskens. From what I gathered yesterday, the market
was down 30 cents in beans and 10 cents on com, the maximum
permissible amount.
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Mr. English. So, are you telling ub that basically you cannot say
how much farmers lost or what kind of this impact that this had
on us, is that basically what you are telling me?
Mr. Beurskens. Yes.
Mr. English. So, nobody can tell, you do not know whether it is
weather, you do not know whether it is this action?
Mr. Beubskens. The only way an individued could mfike a state-
ment that a producer lost money is if he sold beans Wednesday
after the announcement and liquidated everything he owned, then
he honestly could say that he lost money.
If he still owns the beans that he owned last Tuesday, he may
have lost money, but it has been a result of the weather, not as a
result of any move by the Chicago Board of Trade.
Mr. English. So, you are telling me that in effect, when the
price falls aa a result of action, that it has no impact on farmers?
Mr. Beurskens. No more impact than we have had ever since
the 100 years the Board of Trade heis been in existence.
Mr. English. I guess that is where a lot of farmers would say it
has had one heck of a lot of impact. I have had a lot of my farmers
tell me that.
It is a price-setting mechemism, is it not?
Mr. Beurskens. Yes, it is.
Mr. English. So, if it is setting the price, and something has an
impact on it, how does that not have an impact on fEU*mer8?
Mr. Beueskens. The final decisionmaking still lies in the farm-
ers' hands. The price of soybeans at fall was $9 a bushel in the
Midwest, yet the majority of all producers in the United States felt
that that was not an adequate price and consequently held on to
their soybeans.
It is a function of the market to determine what that price
should be, and it appears as if it has done a very accurate job.
Mr. English. That is true up to a point. If, in fact, the price of
my product was higher 1 week ago than it is today, and someone
artincially took an action that drove that price down, an action
which I was not a part of and not a participemt in, I have lost, did I
not?
I mean there is no way that I can get away irom the fact that
someone, through an arbitrary decision, cost me money.
Mr. Beurskens. If the farmer was located anywhere tributary to
the inland waterway system, his bid was exactly the same Friday
afternoon as it was Tu^ay.
Mr. English. Well, I am sure a lot of farmers are going to take
comfort in that out there, that they did not lose anything. I think
they are going to strongly disagree with you.
I imagine you will probably get a little mail on that if the press
report says that you take that position, because I think that any-
time that the market price goes down, they figure that they loae
money, and it is hard for me, quite frankly, not to agree with them.
I think they do, too.
Mr. Beurskens. My point for bringing up the price changes or
lack thereof is to emphasize the fact that the information that has
been in the newspapers concerning the activity of last week is by
no means enough information for emy of us to formulate an opinion
one way or the other until we see uie expiration of the July con-
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tract this Thursday and untU the CFTC and the Chicago Board of
Trade can make public exactly what did happen last weelt.
I think until we see that information, the information in newspa-
pers really should not be looked at aa an accurate source of infor-
mation.
Mr. Engush. Mr. Colemfin.
Mr. CoLBMAN. 1 am a little bit surprised that the chief users of
the exchanges would not want to see a comprehensive audit trail
established as soon as possible to assure the accuracy of your
trades being transacted in an atmosphere
Mr. Beurskens. We would like to see the audit trail as soon as
possible.
Mr. Coleman. But I gather from your testimony you kind of
wafEle a little bit on that as we go through here. I guess it is just
time, I think Glenn mentioned it earlier, 15 years we have looked
at this issue, and pursued it, and we Eire trying to get it established
at a higher percentile and a faster pace I think it would help every-
body.
Let me just say, in your question about authorizing brokers to go
ahead and dual trade, that it is our intent, at least the chfiirman
and my own, is that we would have every public customer author-
ize a broker in order to dual trade.
You raise that £is a question, and I would want the record to
show that is our intent. That may or may not, in your mind, be the
correct response, but that is our intent for the record.
t thank you for your testimony.
Mr. English. Mr. Combest.
Mr. Combest. I have no questions.
Mr. English. Ms. Long.
Ms. Long. Yes, Mr. Chairman.
I would like you to provide some kind of estimate of the amount
of liquidity that is provided by dual trading, how much you believe
it enhances the markets.
Mr. Beubskens. All I could respond is as a participant in the
market what I sense, because I do not have the numbers to support
what I sense.
One of the most common transactions that a country elevator
would enter into in the marketplace is the concept known as
spreading, where we will buy one month and sell another month at
the same instant.
Oftentimes, particularly with the advent of the elimination of
Government storage programs. Commodity Credit pn^ams, stor-
ing grain, the function of the msirketplace now is to pay merchants
to store grain and keep it off the market from fall and reward you
by paying a premium for grain delivered in the future versus the
nearby.
It is a very normal transaction for a country elevator to be, for
instance, buying December com and selling May com at a specific
spread difference. That transaction is typically handled by a spread
broker in the pit, and there are many instances where the best
spread brokers in the pit have at times had to take a position, one
(k the sides of that transaction, into their own account in order to
get that spread treided at what they felt was the market.
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If we eliminate dual trading, we could impair the ability for
spreads to be traded in the marketplace which would directiy
imptict the ability of a country elevator to be able to profitably op-
erate his facility.
Mb. Long. I would like to see some hard data on that because it
seems that whenever we ask a question, for example, how much
was the price affected, you say you cannot give us some kind of es-
timate, that you do not believe that it was really eifTected.
Yet, you make a statement as part of your testimony that dual
trading provides liquidity that is needed in the markets. I would
like to see some numbers to support that particular statement.
Mr. Beurskens. From our perspective, in terms of quantitative
information to support that statement, it does not exist because we
do not have anytmng to compare it against. That is, there are no
markets that have not allowed dueil trading to compare the liquidi-
ty, and it would be venr difficult to support that
One can only go oif of experiences in terms of trading in the
marketplace which may or may not be adequate for what you are
asking.
Ms. Long. But in the interests of consistency, when you want to
make a point in your favor, or in favor of your particular position,
you seem to hedge, to use a term. I think that if you are going to
be consistent, and if you axe going to be convincing, at least to me,
and I would hope to my colleagues, you are going to have to pro-
vide some hard data to convince us of the importance of dual trad-
ing for liquidity.
Mr. Beurskens. I appreciate that.
Mr. English. Mr. Gunderaon.
Mr. GuNDKRSON. No questions.
Mr. English. Mr. Tallon.
Mr. Tallon. Mr. Chairman, thank you.
You mentioned and I cannot find it in your testimony — is it all
right if I call you Frank?
Mr. Beurskens. That is fme.
Mr. Tallon. Thank you— a futures clearing merchant. Was that
a term you used in your testimony?
Mi-. Beurskens. Yes.
Mr. Tallon. A real concern, of course, is ht)nt-running or trad-
ing Eihead of a customer. By any kind of ban on dual trading on a
trading floor, we are in no way addressing any kind of front-nm-
ning or trsiding ahead of a customer that could possibly oonir with
a futures clearing merchant, is that correct?
Mr. Beurskens. It is our desire, as I believe was mentioned in
the testimony, that we are strongly in favor of maintaining a
highly accurate audit trail, and with the availability of that audit
trail, fronts treiding should be caught and penalized severely.
We do not like the concept of banning dual trading entirely
solely as a method to try to catch that portion of that volume that
potentially could be front-running activity.
Mr. Tallon. But what I am trying to determine is there could
be — there could be, if we are looking at the abuse which is front-
running or tradii^ ahead of a customer, off the floor, and if we
wanted to really look at improving the audit trail, perhaps we
might even need to look at the — again using your term the futures
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clearing merchant — and how orders were being handled when they
receiv^ them.
Mr. Beursk£N8. You are right.
Mr. Tallon. Thank you.
Mr. Engush. Thank you, Mr. Tfdlon.
Mr. Beurekens, we appreciate your testimony. Thank you very
much.
Mr. Beurskens. Thank you.
Mr. English. I am going to recognize Mr. Coleman to introduce
our next panel of witnesses.
Mr. Coleman. Mr. Chairman, our next panel consists of two indi-
viduals, the chfurman of the boeird and the president of the Kansas
aty Board of Trade.
I am happy to welcome to our hearing and to our subcommittee,
Michael Braude, who is the president, and Roger Stover, who is the
chairman this year.
I have had an opportunity, of course, to visit with these folks
from time to time as a local Congressman and also to thank them
for providing us information and insight into the industry from
time to time. I look forward to their testimony.
STATEMENT OF MICHAEL BRAUDE, PRESIDENT AND CHIEF EX-
ECUTIVE OFFICER, KANSAS CITY BOARD OF TRADE, ACCOMPA-
NIED BY ROGER STOVER, CHAIRMAN
Mr. Braude. Congressman English, Congressman Coleman, and
distinguished members of the committee, Roger Stover, the elected
chairman of our exchange, and I very much appreciate the invita-
tion to appear here today to discuss the Kansas City Board of
Trade's view^ on your proposal to reauthorize the CFTC.
I am Michael Braude. I am president and chief executive officer
of our exchange.
Mr. Chairman, a member of your subcommittee staff visited the
Kansas City Etoard of Trade on two occasions during the course of
your subcommittee's work and we want you to know that we ap-
preciate the spirit of cooperation that characterized those visits.
We felt that the intent of both of his visits was to learn as much
as possible about the operations of the Kansas City Board of Trade
and in particular about our audit trail.
Let me preface my remarks with the statement that since I
joined the exchange 5Vz years ago, my experience hfis been that
the CPTC has done an exemplary job at governing our industry
through a very chedlenging period of time, a time of phenomenal
growth in trading volume, in numbers of products treided, and in
the diversity of instruments available for trading.
I would like to move now to the specific provisions of your bill.
First of £ill, permanent reauthorization. Our exchange unequivo-
cally supports the proposal to make the CFTC a permanent govern-
ment agency. Our industry has matured over the past 10 years into
a key fiictor in international risk management, and the CFTC has
proven itself as a capable regulator during that period.
We feel that the process of continual reauthorization causes an
unreEisonahle drain on the agency, the industry, and in fact on con-
gressional resources. The current structure hindere the effective-
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124
ness of the Commisaion by making it a political pawn precisely at
those crisis moments when full Commission resources are needed
to deal with the situation at hand.
Moving now to dual treiding. Since the news broke earlier this
year of the investigations into the Chicago commodity markets, we
feel that dual trading has become the battering ram of those who
would like to see the industry constricted.
Our exchange would like to use this opportunity to put forth that
dual trading, in and of itself, is not the problem; dual trading is an
accepted. Intimate and necessary component to fiituree trading,
peu-ticularly at smaller exchanges like ours.
The key to dual trading lies in whether the exchange in question
has the appropriate systems in place to detect dual trading abuses.
I think we have heard that over and over again today.
These procedures may vary by exchange, depending on such vari-
ables as the number of traders in a particular pit, trading volume,
and the sophistication of the exchange's computerized surveillance
system.
We at the Kansas City Board of Trade are continually upgrading
the effectiveness of our audit trail surveillance ^stem, eis are most
other exchanges, because we have long recognized the need to inno-
vate to keep up with the ever-changing markets.
Dual trading has been allowed ^ese many years in the trading
pits because it yields a significant economic advantage. By improv-
ing the liquidity of the pit, dual trading helps to assure as narrow
a bid-flsk spread as possible, with benefits accruing to all partici-
pants in that market.
A natural consequence of restricting dual trading is to reduce
the efficiency of the pit by constricting the population of brokers
available to fill orders. This reduces pricing, as well as execution
emd efficiency. If not handled with care, restrictions on dual trad-
ing can intensify the very problems this subcommittee is trying to
solve and perhaps cause a few more.
Current CFTC r^ulations clearly detail the responsibility of ex-
changes to survey, examine, and investigate their markets to pro>
tect against trading abuses, including those that result from dual
tradii^.
It is our opinion that any exchange that can demonstrate itself
capable of fulfilling that duty should be fdlowed to continue to dual
trade. Conversely, any exchange that cannot prove itself capable
should not be allowed to dual trade.
Your committee recognizes that a key to effective monitoring of
trading activity, including dual trading, is through an effective
audit trsiil. We completely agree with you. Our exchange, the
Kansas City Board of Trade, was the first exchange to require what
we call "timing to the minute." Let me be clear that means
manual timing to the minute.
We practiced manual timing to the minute in our pits long
before we were required to do so by the CFTC. Our system has
been recognized for its effectiveness since its implementation.
Nonetheless, people who have not been directly involved in the
development of such timing systems should be fully aware of the
difficult nature of the work involved.
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While the Kansas Cit^f Board of Trade is more than willing to
work toward the committee's proposed 1-year requirement of a
stricter 1-minute standard and the 3-year requirement of a 30-
second rule, we urge the committee to allow the CFTC reasonable
flexibility in determining how and when the standards have been
met.
The challenge of the task will not be clear until the work has
hemn.
On broker associations, our opinion on broker associations is
similar to our opinion on dual trading. Broker associations in and
of themselves are not the problem if an exchange has a mechanism
in place to detect violations of trading rules. In fact, formal and in-
formal broker associations may help the markets by improving
trading accuracy and efRciency.
Resbicting the type and degree of trading between members of a
broker association is second best to again having the procedures in
place to detect any abuses as they occur.
The placement of restrictions also assumes that broker associa-
tions are a formal business entity, when in fact the m^ority of
such associations are quite informal and can very easily be cemiou-
flaged or disbanded to circumvent restrictive rules.
To be effective, any proposal that deals with broker associations
should, at a minimum, define what a broker association is and re-
quire that groups meeting that description be recognized as such
with the appropriate exchange.
On governing boards, our exchemge has no problem with your
proposals to make members found guilty of certain exchange viola-
tions ineligible to serve on governing boards and certain exchange
committees or disciplinary panels for a set period of time.
Likewise, our exchange has no problem with having 20 percent
of its board members fn)m outside the exchange. Parenthetically,
we practically do that right now.
On other issues, our exchange can also accept the provisions as
put forth in the proposal to require the establishment of discipli-
nary committees at each exchange that are large enough to include
a majority in a category other than that of a person being tried.
We can accept requiring the CFTC to place stricter procedures to
r^ulate telephone solicitation of commodity accounts.
We can accept requiring the CFTC to establish standards to reg-
ister floor traders, and finally, to require new registrants to attend
ethics training.
In summary, the Kansas City Board of Trade applauds the sub-
committee's recommendation to make the CFTC a permanent
agency. The exchange also respects the committee's attempt to pro-
tect the public good by tiying to legislate agfiinst potential trading
abuses, specifically from dual trading and broker associations.
However, we feel that those issues, as well as the general good of
the investing public, can best be served by focusing each ex-
change's efforts on developing a comprehensive audit mechanism
to seek out rule violators.
Those exchanges not able to meet a reasonable standard should
be made to confront the consequences.
The U.S. commodity industry has established itself successfully
in the intemationed financial marketplace. As in any growth indus-
23-500 0 - 90 -
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try> however, coDtinuiiig succesB will depend on how we meet the
cnallenges that lie ahead.
The committee's proposal, if modified to include some of our sug-
gestions, we think provides a very acceptable framework on which
to base these efforts.
We commend you for your work in drafting this legislation. We
thank you for the opportunity of appearing here today, and Roger
Stover and/or I would be happy to answer any questions you have,
Mr. Chairmem.
[The prepared statement of Mr. Braude appears at the conclusion
of the hearing.]
Mr. English. Mr. Braude, I guess the question comes down to
the fact that you all have a very high percentage of competence or
accuracy in your audit trail.
Mr. Braude. Yes, we do, Mr. Chairman. I believe that had the
representative of the Commission emswered specifically your ques-
tion today, we would have been one of the exchanges cited.
Mr. English. Well, we have the numbers on it here, and in look-
ing at this, sa I understand it, your overall accuracy rate is 96.8
percent and it ranges all the way from 96.5 for some transactions
up to — at least it is my understanding on wheat option — up to
99.14.
Mr. Braude. That is correct. We take pride in that.
Mr. English. Some people would say, in fact I have heard it said,
well, the saxaXl exchanges can do that, but the big exchanges
cannot.
Is that in fact true, Eire the techniques that you all are employ-
ing that much different from the other exchanges that allows you
to reach that, or is it simply because the volume that you trade in
on a number of these different contracts is smaller and therefore
allows you to reach that accuracy?
Mr. Braude. Mr. Chairman, I think that is a factor, but respect-
fully, I cannot comment on what the other exchanges can do. We
have kind of a full-time job doing what we think we have to do.
Now, I think size is certainly a factor, but I really think that is a
question that the other exchanges would have to answer.
Mr. £]nolish. Well, they are going to say they are not that famil-
iar with what you are doing.
Mr. Braude. Just as we invited your subcommittee staff down,
we would be happy to have any exchange come in and study our
audit trail procedure anytime they want.
Mr. English. So it is going to be up to our stafT to tell us what
the differences are between each of the exchanges and whether or
not they can meet these goals?
Mr. Braude. Well, quite frankly, one of the things that we tried
to do when your staff was out in Kanseis City was to demonstrate
to them that there are unique qualities to an exchange, and obvi-
ously our goal was simply to show them what we do, how we do it,
emd the effort that we have made to achieve as close to that 100
percent as we can, and frankly we are very proud of what we have
achieved.
Mr. English. And you are not familiar, then, with the differ-
- ences between how you conduct your audit trail as opposed to how
one of the other exchanges conducts theirs?
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Mr. Braude. Well, I am somewhat familiar, but again, I am not
familiar enough to describe it in detail. I think every other ex-
change is going to appear here.
Mr. English. Mr. Stover, are you familiar with that?
Mr. Stover. No. I mean I have only traded in Kansas City and
visited the Chica^ Exchange, I believe.
Mr. Engush. Well, you are aware of the fact that your audit
trail is different from other audit trails?
Mr. Braude. Absolutely, and so is our timing mechanism.
Mr. Stoves. Timing mechanism, I Bum>OBe.
Mr. English. So, your approach is dinerent?
Mr. Braude. Yes, sir.
Mr. E^NGUSH. The elements that are contained in that are differ-
ent?
Mr. Braude. Yes, sir.
Mr. English. And it would appear that some are working better
than others.
Mr. Braude. Yes, sir.
Mr. English. And we have got some exchanges that seem to be
having a great deal more success than others in reaching these
goals.
Mr. Braude. Yes, sir.
Mr. English. Do you feel you are at the point that you have
achieved perfection?
Mr. Braude. No, sir. We think, as I mentioned in our testimony,
we are continually refining. In fact, I think in the period since the
representative of your subcommittee was in Kansas City, we have
made a couple of automated changes that hopefully will get those
percentage flguree higher than what you just cited.
Mr. E^NGLiSH. I also note, the point that I made, it appears on
some contracts you have a higher ;>ercentage of accuracy than you
do on other contracts.
Does it vary irom contract to contract as far as the accuracy is
concerned?
Mr. Braude. Yes, sir. ^ain, the lower volume contracts have
the higher percentage of accuracy, and what we are working on
now is to get it up on the higher volume ones.
Mr. English. Does the fact that certfiin times of the day, when
they are involved, you have fast trading with r^ard to some of
your contracts, you have that kind of volumes or not?
Mr. Braude. I think we have worked pretty hard on eliminating
those differences, and I do not believe you would find that the case
right now.
Mr. English. So you do not have so-called fast trading?
Mr. Braude. We do have fast markets, yes, sir.
Mr. English. During that particular period, is it harder to obtain
this d^ree of accuracy than it is at others?
Mr. Braude. Yes, it is, but we do increase our surveillance, par-
ticularly our visual surveillance at those periods of time.
Mr. Engush. So, biisically, we are talking about the greater the
volume, the greater the amount of activity at a certain time, the
more d^cult it is to maintain the accuracy of the audit trail?
Mr. Braude. I think that would be £in accurate statement.
Mr. English. Thank you very much.
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Mr. Coleman.
Mr. CoLBifAN. Michael, I will not ask you to comment on other
people's audit trails, but let me put you in somebody else's shoes.
Maybe you would be more familiar with this.
Let's assume that you had control over the CPTC and that you
were trying to get some of your sister exchanges that had a larger
volume, lers say, in Chicago and New York, come up with an audit
trail which is more precise than what they currently have.
How would you do that?
Mr. Bhaudb. Well, Congressman Coleman, very frankly, I do be-
lieve— and I was not trying to be facetious in answer to the chair-
man's question — I think they do have a different set of problems
and I really would not be so presumptuous as to try to address
those.
We tried to make the point when your staff was out, and I have
tried to make it here today, that each exchange is unique and we
have got a pretty full platter trying to meet the needs of our own
exchange.
I would tell you again that any exchange is welcome at any time
to come out and we would
Mr. Coleman. I am not trying to ask you to cast aspersions on
somebody else's administration of their exchange, but you were
here this morning, you heard me ask Wendy Gramm, and you
heard her testimony. Somehow I guess the desire is to keep mud-
dling through like we have been with some sort of amorphous
vision of w^t an accuracy percentage ought to be. We know the
exchanges Eire trying to come up with some package to get it up to
90 percent, and somehow that is going to be the goal. Basically,
other than cutting off new contracts and a few hassling maneuvers
that the Commission can do, I guess they are just holding out hope
that the exchanges are going to do this on their own.
I guess what we are saying is that it is going to have to be more
than just hope, and if you were not doing a good job in Kansas
City, we woiAd ask you to do better, and we would not jiwt hope
that you would do better.
Mr. Bbaudb. Well, Congressman Coleman, I would say that
philosophically, I would not have any problem with setting a
rather high percentage and memdating that that percentage be
met. I mean I do not think that that is an unreasonable request.
Mr. Coleman. We have not even gone that far.
Mr. Beaude. I understand that.
Mr. CoLEHAN. We have only said to them to come up with some
sort of device which is verifiable to reconstruct the accuracy as de-
termined necessary by the Commission, so they can enforce provi-
sions of the act. So, it would not have to be 95, 96. It could be 91, 1
do not know.
Mr. Bbaude. We find nothing unreasonable about that.
Mr. Coleman. You should not have any problems with that.
Mr. Braude. Absolutely not.
Mr. Colehan. I know you are stating this for the record. It abso-
lutely does not impact your operation at all now, and you are
under 7,000 contracts. So what you are saying here today is not
self-serving.
Mr. Braude. That is correct.
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Mr. CoLEUAN. It ia more of what you refilly believe in a philo-
sophical manner.
Mr. Braude. That is exactly right.
Mr. Coleman. Let me ask you this question, though, that was
askml of Dr. Gramm. You have read Uie bill here, and we give
them all sorts of exemptions or ways to opt out of this ban on dual
trading even if it "threatens the public interest" whatever that is.
Would you not say the Commission would have plenty of oppor-
tunities to exempt people from this prohibition?
Mr. Braude. I would believe that is correct, yes.
Mr. Coleman. I mean they could increase, if nothing else, the
7,000 contracts to 300,000 contracts, and everybody would be
exempt.
Mr. Braude. I agree with that. Congressman Coleman, you hit a
point that I think deserves some emphasis, and that is that last
year in our wheat pit, which is our major pit, our average volume
of trading as defined by this bill was about 5,300 contracts a day,
so, yes, we would be exempt.
You are filso 100 percent correct that philosophiceilly — and I
think that is the spirit of your bill — we believe that dual trading
should be permitted in any pit that heis a satisfactory audit trail.
I think essentially — you and I visited about this personally many
times — we are saying essentially the same thing.
Mr. Coleman. Yes. We heard testimony today. We have a study
going on about dual trading and its impact, and yet we are not
sure, £md nobody seems to know for sure in the industry, what
impact this will have on liquidity, even when you have 100,000 con-
tracts.
Mr. Braude. I can tell you, and I think this addresses a little bit
Congresswoman Long's question, we have done a pretty extensive
study to see what percentage of the volume of our wheat pit trad-
ing ia done by dual traders, and it runs somewhere between 25 and
30 percent.
Mr. Coleman. And that is a small volume.
Mr. Braude. Yes, compared with an average daily volume of
about 5,300 contracts.
Mr. Coleman. Could I ask one question of Mr. Stover.
We have heard some testimony that if we prohibit dual trading,
that the people who would be doing trading on the floors would be
more inefficient, less experienced, they would not be handling it
right, you know these arguments, you have heard these Eirgiunents.
Could you comment on that, again not for your exchange, but for
others.
Mr. Stover. It has not been many years ago, maybe 3 or 4 years
ago, that there was very little activity in the grain meu'kets and in
our futures pits specifically. I think it has been that way since I
have been in the business. Since 1971, we have had up cycles, stor-
^e years, trading years, and it is difficult to maintain qualified
personnel from slow times to good times.
I think that when markets are very, very slow, a person is not
going to have enough brokerage to make a living on. This goes
sometimes month to month or we will have flurries in the summer
and then it will slow down to very small volumes.
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You have r* period of time where you need broken to get their
feet on the g.-< md and to establish themaelves before they get sub-
stantial decks i orders, eind for them to survive and pay the bills,
they are going to have to do some trading, as well as try to pick up
the scrap decks.
When you come down to an exchange, you do not walk in there
without a lot of competition. So, it is a matter of trying to hang on
until you get any business established, and it is tough sometimes.
I guess what I feel is that in many instances, with the elimina-
tion of dual trading, the current brokers would be more monopolis-
tic, less competition.
Mr. ENGLISH. Ms. Long.
Ms. Long. The Chicago Board of Trade last week called an emer-
gency order and required Uquidation of soybeans above a certain
level. In earlier testimony today, when we were tallring with Dr.
Gramm, we talked about the role of the CFTC, and it seems to me
that it might make more sense or might be more effective of the
CFTC were notified before that kind of order were made, and if the
order were, in fact, made by the CFTC given that the CFTC should
be the moet objective body to make such a determination regarding
the specifics of the order and when the order is made, and so forth.
Do you see aiwproblems with requiring an exchange to, first of
all, notify the CFTC before making such an order? The second part
of my question is: What kind of problems or are thereany prob-
lems with requiring that the order come from the CFTC rather
than from one of the exchanges?
Mr. Braude. I might mention in the 5'^ years that I have been
at our exchange, the only emergency actions we have taken were
during the week of October 19, 1987, when a couple of times we
suspended trading, not in our wheat pit, but in our value Une pit
because there was so much trading with the S and P.
On those occasions, Congresswoman Long, we did notify the
CFTC prior to taking that action. So, I think that in answer to the
first part of your question, I think no, there would be no problem
in notifying them I»fore the action.
Now, whether or not the action should be — again, as I think was
testifi^ to this morning by Chairman Gramm, the CFTC stjll has
the power to order emergency action, so that it kind of seems to me
that if, one, we notify them in advance, and two, they still have
that power, you have about accomplished what you are saying.
I guess under their emergency power, we notify them in advance,
if they do not -want it, they can just institute some other emergen-
cy action, so I think you could accomplish it.
But do I see any problem with notifying them in advance, the
answer is no.
Ms. Long. Thank you.
Thank you, Mr. Chairman.
Mr. English. Mr. Gundeison.
Mr. GuNDERSON. No questions.
Mr. English. Mr. Tallon.
Mr. Tallon. Mr. Braude, I think you mentioned in maybe a
question Mr. F)nglish or Mr. Coleman asked you, that there Etre in-
herent differences in exchanges, whether it is a hvestock contract
or a sugar contiBCt, the trading volume is different. You do not
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know what kind of technol<%y and what kind of software exactly
another exchange is using.
I jiifit simply say that we might be aware when we start mandat-
ing time stamps and one thing and another, that we understand
that we are dealing with different entities.
Would you CEU% to comment any further on that?
Mr. Bkaude. Yes. You look at a typical day. Congressman, in our
wheat pit there is probably 45 to 50 traders on a good day. If you
look at some of the pits in Chicago, there is 700 to 800 people in the
S and P pit, or the Tretisury bond pit at the Merc.
Obviously, the technology involved in floor reporting or any
other factor is different, so, yes, I would certainly concur with that.
Mr. Tallon. Thank you very much. I yield back the balance of
my time, Mr. Chairman.
Mr. English. I want to thank you both for your testimony. It has
been extremely helpful to us. I also want to tell you how much I
appreciate the cooperation that you gave to our staff over the past
few months and the hospitality that you have shown the subcom-
mittee.
Mr. Braude. Thank you. The welcome continues.
Mr. Stover. Thank you.
Mr. English. Thank you very much.
Our next panel is Mr. Bennett J. Com, who is president of the
Coffee, Sugar, find Cocoa Exchange in New York; Mr. Lou Gutt-
man, who is with New York Mercantile Exchange in New York
City; and Mr. Robert E. Fink, who is chairman of the Commodity
Exchange, Inc., in New York.
As I understand it, Mr. Guttman, you will testify first, is that
correct?
Mr. Guttman. Yes, Mr. Chairman.
Mr. English. Let me also say that after reviewing your written
testimony, we want to encourage you to summarize that testimony
and we appreciate it very much.
STATEMENT OF Z. LOU GUTTMAN, CHAIRMAN OF THE BOARD OF
DIRECTORS, NEW YORK MERCANTILE EXCHANGE
Mr. Gltttman. I will endeavor to go through this as quickly as I
cein, Mr. Chairman. I do want to emphasize the last few pages of
our testimony because I think it is quite important to us in New
York, and it might help us through these next few weeks, possibly
months.
Mr. Chairman, members of the conunittee, my name is Lou Gutt-
meui. I am the chairman of the board of directors of the New York
Mercantile Exchange. On behalf of the exchange, I wish to thank
you for the opportunity to appear before this committee to present
our views concerning H.R 2869 and the reauthorization of the
CFTC.
With your permission I would like to submit my written testimo-
ny for the record and I will briefly summarize it for you.
It is abundantly clear that H.R. 2869 seeks to send a message to
the public that Congress intends to act swiftly and firmly to rectify
perceived defects in the r^ulation of Aitures markets.
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We do not dispute the value of this message. Although we believe
that the allegations of abuse in our markets are more a matter of
perception than fact, it is undeniably in our interest to ensure that
the public confidence in the int^rity of our markets is maintained.
Wmle we support the message, as well as the concept of
strengthening the regulatory system, we differ fundamentally as to
the means chosen to achieve those objectives.
For the first time, the bill seeks to impose congressional man-
dates in a level of detail traditionally reserved for the CFTC and
the exchanges, who are the experts familiar with industry practice,
customer needs, emerging technology and alt of the other practical
realities of day-to-day life.
The bill ignores msiny important differences among the regulated
markets and the customers that use them. The net result, we be-
lieve, would be to weaken rather than enhance the efficiency of the
system. These weaknesses would be exploited by our overseas com-
petitors who are actively developing look-alike contracts and at-
tempting to take our business overseas.
In the final analysis, under H.R. 2869, the American public
would lose the benefits of liquid and efficient markets they em'oy
today.
tt is both premature and unnecessary to r^ulate with the detail
contained in H.R. 2869. The present regulatory structure, with its
flexibility, has fdlowed the U.S. markets to provide internationally
envied risk-shifting and price discovery forums that have been cm
immeasurable value in achieving price certainty and stability to
farmers, oil producers, refiners, industry, the financial community,
and ultimately, to consumers.
Mr. Chairman, the system works. Reaction to the press reports
in January of a Justice Department investigation into commodity
trading in Chicago demonstrates that the system works. Virtually
every commodity exchange in the counti? has performed an exten-
sive review of its own trading rules ana practices over the last 6
months.
Many constructive recommendations for regulatory reform have
been offered by the NYMEX regulatory review task force and the
special review committees formro by the other exchfmges.
The essential conclusion of the NYMEX task force was that the
appropriate method to regulate against trade practice violations
WEis through rules designed to prohibit improper conduct, an audit
trail sufficient to recreate the sequence of trading, surveillance,
and compliance systems that identified trade practice violations,
and a disciplinary process that both punishes the violator and
serves to deter future violations.
On dual trading, however, the task force recognized that dual
trading was not a problem in itself. The task force, therefore, did
not recommend banning this otherwise beneficial practice merely
because of an apparent perception that it created a confiict of in-
terest.
Until studies determine with certainty that such an action would
not threaten the efficiency and liquidity of the markets, which will
ultimately harm the commercial and public participants that the
regulatory structure is designed to protect, the composition of the
markets should not be tampered with.
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Thus, the task force offered many recommendations for strength-
enic^ the regulatory structure, but at the same time, it attempted
to ensure that the markets maintained their highly respected pric-
ing capabilities.
We respectfully request that Congress take the same measured
approach in its reauthorization of the CFTC. On a positive note, it
appears that many of the provisions of H.R. 2869 are consistent
with the NYMEX task force recommendations.
We believe that they represent a reasonable efTort at fine-tuning
the Commodity Exchange Act and system of CFTC and exchange
regulations that govern our industry. Our specific comments on
those provisions are contained in an addendum to my written testi-
mony.
The dufd trading and audit trail provisions of the bill, on the
other hand, seem to represent — with all due respect, Mr. Chair-
man— a "shoot first find ask questions later" approach. I^ey place
at risk the efficiency and viabUity of our markets.
We are fearful of such a method of legislation, because once the
damage is done to the markets, it will be irreversible. Accordingly,
we respectfully request that the subcommittee reject those provi-
sions of the bill.
If I may briefly digress — I do know I am limited for time — the
trading populations on the commodity exchange floors are com-
prised of three groups of participants, Mr. Chairman: floor brokers
who exclusively execute customer orders, floor traders who serve
exclusively as market-makers, absorbing risk by trading for their
own accounts, and the so-called "dual traders" who may both exe-
cute customer orders and trade for their own accounts on the same
day.
These three components, though not necessarily comprised of
equal numbers of traders, are the three legs of the stool that sup-
port the open outcry auction market system.
That system, in turn, provides the most efficient pricing system
in the world. On an average day, there are approximately 450 trad-
ers on the NYMEX floor, spread among crude oil, heating oil, gaso-
line, propane, platinum, pEdladium futures trading, crude oil, heat-
ing oil, and gfisoline options trading.
The liquidity provided to the markets by dutil traders varies de-
pending on a wide range of circumstances. It varies between com-
modities, times of the trading, and the particular exchanges.
In New York, for example, the limited number of qualified floor
treiders makes each individual's contribution to the market more
significant and less replaceable.
In our crude oil market — in response to Ms. Long's question ear-
lier— at its most active time, 65 percent of our traders are dual
traders. They trade 35 percent of the total volume as market-
meikers for their own account. They also provide a significant
amount of brokerage service for customer orders.
I am not going to suggest that if you cut the dual trading leg
from the stool that the stool will immediately fall. What I am sug-
gesting is that in light of the vast amount of domestic commerce
that relies upon the stability of the stool for support, any proposal
that includes a provision for an immediate or contingent market-
wide termination of dual tradii^ should not be adopted.
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At the present time, there is no evidence that dual trading is an
evil unto itself. All that is being said is that the practice creates
the perception of a conflict of interest.
We submit that dual trading is not the problem. Like other po-
tential conflicts of interest, it can be r^^lated through the strict
enforcement of rules designated to prevent the abuse of any con-
flict that may arise.
Mr. Chairman, two proposals have been floated to address the
perception problem associated with dual trading. The NYMEX's
board of directors met early yesterday and would like to offer up a
third proposal which our sister exchanges in New York, COMEX,
and the New York Cotton Exchtinge, cotton agree in principle, and
our sister exchange of Coffee, Sugar and Cocoa will consider.
The two pending proposals, o^ered by the proposed bill and by
the Chicago exchemges, tie a market's privilege to have dual trad-
ing to audit trail accuracy and/or market trading volume.
We submit that this is the wrong approach. If there is a lack of
confidence in the ability to police the markets to protect the public,
then strengthen that ability. The punishment of banning dual trad-
ing will hurt market participants, not help them. It will meike mar-
kets less efficient and drive up the cost of doing business.
For these reasons, NYMEX — and as I indicated, with the under-
standing in principle of our sister exchanges — offer the following
tdtemative proposal:
(a) Congress should not legislate, but mandate that the CFTC,
with the &11 consultation of each exchange, shall determine aa ap-
propriate standard for each exchange, to ensure the accuracy of tiie
exchange's audit trail. The CFTC shall take into account the
strengths and unique characteristics of each system's method of
audit trail creation.
(b) The Commission, with the full consultation of each excheuige,
shedl develop criteria to determine whether each exchcmge is in
compliemce with its standard.
(c) To ensure that the traders on the floor of the exchange, who
actually initiate the audit trail, are held to the highest standards,
Congress shall mandate that the Commission, through r^ulation,
shall require exchanges to adopt rules mandating each floor
member to adhere to strict, objective standards for audit trail accu-
racy.
"Hie exchange rules shall provide speciflc and harsh sanctions for
failure to comply, including, ultimately, the loss of duEd trading
privileges and/or suspension from membership.
We believe that tins proposal, more than any we have heard to
date, most directly confronts the issues at hand. All brokers should
be held to the highest standards in audit trail creation accuracy.
An accurate audit trail is the optimum means to examine the
trading of the individual for violations such as trading ahead of
customer orders.
Under this proposal, Mr. Chairman, Congress will legislatively
ensure the highest audit trail standards. The CFTC will retain its
regulatory authority to ensure that the standards are carefully tai-
lored to achieve Congress' goal while preserving t^e competitive-
ness of the U.S. futures markets.
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The exchange will benefit by being permitted to address the
issue in a forthright and direct manner. If an individuEil cannot
adhere to the strict audit trail creation accuracy standard, the indi-
vidual should be punished.
Finally, and most importantly, with thifi proposal euid the many
other surveillance end compliance improvements that are being
implemented, the institution — meaning the exchanges — and the
trading public benefit fi'om systems capable of detecting trading
abuses and by retaining the most liquid and efficient futures mar-
kets to conduct their hedging and price discovery.
On top of that, Mr. Chairman, Congress will have ensured that
each participant in the process is fully accountable for the integrity
of the system.
I thank you for your time and consideration. I welcome any ques-
tions you may have.
[The prepared statement of Mr. Guttman appears at the conctu-
sion of the hearing.]
Mr. English. Thank you, Mr. Guttman.
Mr. Com.
STATEMENT OF BENNETT J. CORN, PRESIDENT. COFFEE, SUGAR,
AND COCOA EXCHANGE
Mr. Corn. Thank you, Mr. Chairman. Good afternoon. My name
is Bennett Com. I am the president of the Coffee, Sugar and Cocoa
Exchange in New York City.
I have already provided the subcommittee with my written testi-
mony, I will now briefly summarize some of the principal issues we
especially wish to bring to your attention.
Our exchange, which has been in existence since 1882, is the pre-
eminent market in the world for trading futures and options in
coffee, si^eir, and cocoa. Our contracts are heavily used by commer-
cial interests engaged in the production, exportation, distribution,
and processing of these three commodities.
We are and always have been dedicated to maintaining the high-
est standards of integrity in our markets and over the years we
have made major commitments of resources to that end.
This has been done as a matter of discharging our self-regulatory
responsibility. It has also been done as a matter of enlightened self-
interest. This exchange operates with powerful competition from
eight rival exchanges overseas, most notably the London Futures
and Options Exchange, which actively trades futures on coffee,
sugar, and cocoa.
It is very important for us to maintain marketplaces of the high-
est quality, for if we do not, it is a very simple matter for our larg-
est customers simply to take their business overseas.
In other words, we have the same goals as the subcommittee. We
have to. Our livelihood depends on it.
We are very concerned, however, that in a well-intentioned effort
to benefit the trading public, the bill presently pending before the
subcommittee, H.R. 2869, will actually have the opposite effect.
In some of its most important provisions, the bill proceeds from
an unproven and, we believe, incorrect premise. It then attempts to
solve a problem which has not been shown to exist, and to do so in
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a way that could seriously damage the U.S. futures markets in-
stead of strengthening them.
Section 101 of the Dill would in effect ban dual trading in mar-
kets having an average daily trading volume of 7,000 contracts,
unless the relevant exchange can show that its audit trail satisfies
requirements that may well be impossible to meet.
We would be affected by this provision in that at present our
sugar tutures trade well over 7,000 contracts per day, while cofifee
and cocoa futures trade just under that eimount.
Dual trading plays a very important role in our exchange. A
quick preliminary survey indicates that in our sugar futures
market, over 50 percent of the floor traders are dual traders, and
those dual traders accounted for as much as 80 percent of the
volume on the trading days we reviewed.
If dual trading were banned, trading volume could be significant-
ly affected. That, in turn, could reduce liquidity and ^erec^ injure
our markets.
In our case, the problem would be compounded by the fact that a
loss of liquidity will make our foreign competitors more attractive.
It is premature to adopt a ban on diial trading at this time.
The subcommittee staff has indicated that on the basis of its in-
vestigation, it did not consider dual trading to be a serious problem
since, among other things, it is one of the easiest abuses to monitor
for and todetect-
The CFTC presently is conducting a thorough study of dual trad-
ing. The GAO is conducting a study of the futures markets, and the
U.S. attorney in Chicago has been reported to be conducting an in-
vestigation of certain trade practices.
It would make far better sense to wait until the results of those
studies and that investigation are released before decithng whether
any l^islation regarding dual trading is warranted, and S so, what
the precise nature of that l^islation should be.
Nevertheless, if the Congress concludes that the protection of the
U.S. trading public requires the abolition of dual trading, then the
conclusion should apply as much to trading on foreign exchangee
as on U.S. exchanges.
In other words, if dual tr^ling is to be banned, then no one
should be permitted to solicit or accept orders from U.S. customeiB
for execution on foreign exch2mges that permit dual trading.
On a separate point, the bill would direct the CFTC to exempt
any exchange fivm the dual trading ban if they can show that its
audit trail can detect any and all instances of trading violations
which the Commission determines to be attributable to dual trad-
ing, and is fully verifiable.
We have in place a tight audit trail procedure that has been ex-
tremely effective. We are constantly striving to improve it and we
expect that we will soon meet the performance standards set by
the CFTC.
However, the standards set forth in the bill may well be impossi-
ble to comply with. There is no system we are aware of in being or
on any drawing board that can detect any tmd all instances of any
violation.
Furthermore, there is no indication whatsoever as to what it
means to require that a system be "fully verifiable." The bill is
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structured so that an exchange would be banned from dual trading
during the period it talces for the CFTC to determine the adequacy
of its audit trail, a period that could last a year or more.
If the CFTC eventually determines that sm exchange has met its
burden, there must then be a 90-day waiting period after the CFTC
reports its findings to Congress. Only then could the exchange
resume dual trading, but by that time, liquidity could already have
been lost and the harm could already have been done.
The exchangee should be permitted to have dual trading unless
and until the CFTC determines that any applicable standards have
not been met.
We have a number of detailed concerns which are spelled out in
my written testimony. I hope the subcommittee will carefully con-
sider the issues we have raised.
Mr. Chairman, that concludes my oretl testimony. I appreciate
the opportunity to testify before you today. If you have any ques-
tions, I will be happy to emswer them if I can, or I will submit the
answers later if I am not able to provide them now.
Thank you.
[The prepared statement of Mr. Com appears at the conclusion
of the hearing.]
Mr. English. Thank you, Mr. Com.
Mr. F^k.
STATEMENT OF ROBERT K FINK, CHAIRMAN OF THE BOARD,
COMMODITY EXCHANGE, INC.
Mr. Fink. Thank you, Mr. Chairman, members of the subcommit-
tee. I am pleased to have this opportunity to share COMFIX's views
on the Commodity Futures Improvements Act of 1989.
Mr. Chsdrman, we would appreciate it if you include in the
record of these heftrings our written testimony, as well as an ad-
dendum, that details our reaction to some of the bill's provisions.
Thiuikyou.
Mr. Chairman, more them 6 months ago, when it first learned of
undercover operations at its two largest commodity exchanges, the
U.S, futures industry embarked on a course to determine whether
current trade practices and regulatory methods promote and
defend l^al and ethical behavior on our trading floors.
The mere possibility that the investigations in Chicago, and sub-
sequently in New York, would reveal undetected misconduct was
enough to cause all of us, exchanges and regulators alike, to mobi-
lize in a broad effort of self-examination and reform.
At COMEX., we have always viewed that process as both healthy
and necessary. It was evident that despite possible failures in some
of its parts, the system as a whole and the means by which it heals
itself were working properly.
Somewhere along the way, however, that process got twisted. We
have been diverted from the goal of honestly identifying and solv-
ing our problems. Investigation has given way to guesswork, analy-
sis has caved in under the weight of assumption, and honest solu-
tions have been undermined by the forces of expediency and com-
promise.
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I am very sorry to say, Mr. Chairman, that we have before us
proposals for reform that have as their main virtue the appearance
and only the appearance of having accomplished something.
Let me begin with that part of the process designed to identiiy
the problem. Six months aiter the announcement of undercover op-
erations in Chicago, very little is known about the nature and con-
clusions of those investigations.
It is difficult to understand how we can be proposing reforms
when we have Eilmost no reliable information about the very events
that launched us on the course of reform.
Until we know more, it is not possible to say whether any of the
potential misconduct is isolated or widespread, nor is it possible for
us to determine whether the types of conduct which are the subject
of the investigation were already detected by exchanges surroil-
lance prc^ams, and sanctioned tlirough their disciplinary process-
es.
In addition, as Mr. Com has pointed out, the CFTC has proposed
a schedule of administrative actions that will deal with issues, such
as audit trail, dual trading, and the composition of exchange disci-
plinary committees and governing boards.
We believe that the prudent course would be to allow the work of
the CFTC in these areas to proceed to a conclusion. The absence of
information from the Federal investigation and the unfinished
work of both the CFTC and the exchanges themselves have com-
bined to create an atmosphere in which the problems are poorly
defined end the solutions are, in some cases we believe, premature
and unfocused.
Instead of being based on hard facts and clear reasoning, some of
the current proposals for reform seem to come more from a thirst
for action and the perceived need for a quick fix to complex issues.
Our views on the particular provisions of H.R. 2689 are detailed
in our written submission. Some of the suggested remedies, such as
those dealing with a more efficient CFTC reauthorization, have
merit. Others, such as those dealing with the composition of gov-
erning boards and disciplinary committees, Eu-e worthy of consider-
ation, but should be left to the exchanges if measures are to be
anything more than window dressing.
Particularly disquieting, however, is that some of the proposed
solutions not only miss their vaguely defined targets, but also inad-
vertently score a direct hit on vital and healthy parts of the fu-
tures trading system.
Chief £unong these, Mr. Chairman, is the centerpiece of H.R,
2869, the provisions dealing with dual trading and audit trail. Mr.
Chairman, the polemics of the dual trading debate have been aired
extensively in recent months.
I won't recite agfun the many ai^uments in favor of the practice.
On the strength of these ailments, though, and in the absence of
direct evidence linking dual trading to widespread abuse of custom-
er orders, the industiys system of dual trading should be allowed
to continue.
We further believe that the continuation of dual trading for an
exdiange should not be tied to its audit trail performance. Penaliz-
ing an entire exchange for the failure of certain members to main-
ly Co Ogle
tain an adequate audit trail injures all of its members and custom-
ers by restricting a practice that has proven benefits.
If a mfu'or purpose of this legislation is to tie the continued exist-
ence of dual trading to a verifiable audit trail, we believe that the
correct approach is the one emerging from the joint COMEX/
NYMEX discussions on the subject.
In this approach, the focus of enforcement would be on those in-
dividual exchange members who have failed to live up to audit
trail standards established by the CFTC.
It would be the job of the exchange to enforce those standards
among its members, and it would be the job of the CFTC to see
that the exchanges themselves are carrying out such enforcement.
This combination of exchange enforcement and regulatory over-
sight is in keeping with the or^nal intent of the self-regulatory
mandate.
For some months now, COMEX has had before the CFTC a re-
quest for a rule change that would fillow our exchange to automati-
cally sanction without the benefit of a trial or hearing any member
whose time recordation is unsatisfactory.
We are prepared to include in that proposed schedule of sanc-
tions a measure to suspend the dual trading right of any individual
member whose violations rise above a threshold established by the
Commission.
It is our recommendation that legislation be enacted that would
require all futures exchanges to implement this type of program.
We believe that this is the most direct and the most effective
means of dealing with the issues.
COMEX believes that an effective audit trail is a critical element
in the detection of misconduct on its trading floors. We also expect
that if we as an exchange fall short of the standards required by
the CPFC, we will be sanctioned under the existing regulatory
mechanism.
We are aware also that if we fail to meet acceptable standards on
audit trail or any other measure, for that matter, or if we fail to
enforce our own rules in any way, we are subject to the punish-
ment of sanctions up to and including the revocation of our right to
exist as a contract market.
Mr. Chairman, the central question before us is whether the ex-
change with CFTC oversight can properly discipline themselves. As
I have stated in other testimony, the experience at COMEX tells us
that it can. It can if the exchange places rule compliance high on
its list of operating priorities. It can if it endows its compliance
force with independence of action, that places it beyond the influ-
ence of any member or special interests, and it can if its discipli-
nary committees impose sanctions that make the clear statement
that no matter how big or small the violation or the violator, mis-
conduct willnot be tolerated.
There is nothing quick or glamorous about these measures. They
are the standard elements of any good rule enforcement pn^ram.
Coupled with the enhance vigilance of the CFTC, they provide the
only sensible way to get where we all want to go — the elevation of
industry practices and the promotion of legal and ethical stand-
ards.
Thank you very much, Mr. Chairman.
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[The prepared statement of Mr. Fink appears at the conclusion of
the hearing.]
Mr. English. Mr. Fink, I find your interpretation in r^ard to
what Congress intended or what Congress should do, or what Con-
gress' role is to be rather interestii^.
I noticed in your testimony on page 3 — and I quote — you state:
The precedent of congreasjonal involvement in the hands-on regulation of these
markeU, prior to CFTC action, is not a course that was contemplated when the
CFTC waB established and is a course that has not been followed to date.
I noticed on page 12, you state, "Congress should not be legislat-
ing to combat a perception."
On page 19, the third pareigraph dealing with disciplinary com-
mittees and the make-up, you state that "we believe that this issue
of committee composition is not a proper subrject for Federal legis-
lation."
I guess, Mr. Fink, I need to explain to you a little bit about how
the Congress operates and how this law came about. When this I^-
islation was created, the whole concept was that it would be reau-
thorized Eis a commission, to make sure that the Commission was
carrying out the will of Congress the way that Congress intended.
The whole concept behind that is from time to time to review
and make sure the Commission has been carrying out its duties as
it should be. As far as the issue of dual tradmg is concerned, Mr.
Fink, I want you to understand that this is something that has
been underway for 15 years, off and on, a study has been underway
for 15 years.
So this is not something that the Congress on the spur of the
moment has thought up, nor this subcommittee. This subcommittee
has made it very clear that we intend to protect the public's inter-
est, we intend to take action.
"Fhe real question that we come down to is not a question of
whether the U.S. Congress, in particular this subcommittee, has ju-
risdiction and the responsibility to deal with this matter. We
intend to do it because we see that eis our responsibility.
So, I appreciate your opinion with regard to what the Congress
should or should not do, but I think you should understand right
off the top that we see this is our responsibility, and if at any tmie
and in any way we do not think that the CFTC is cemTing out its
responsibility in the way that it was intended, nor in the way that
the Congress feels that it should be, the Congress deiinitely has the
right, and that is the bottom line, Mr. Fink.
Mr. Fink. Thank you for that chastisement, Mr. Chairman.
Mr. English. Mr. Coleman.
Mr, Coleman. Mr. Com, I think your commente about banning
dual trading in this country under certain circumstances, that no
orders could be filled for U.S. customers, and where foreign ex-
changes do not have a similar ban, some sort of reciprocity would
be in the order, something that we might want to take a look at
and see if it is practiced or not.
But if we get into that game, I suppose then every time that we
do or do not do something, that they might do at another exchange
or another counts?, we nught be getting ourselves into a real fast
loss here that we may not be able to control I do not know.
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You mentioned sometMng here that we have not seen before and
I think we have to consider.
Mr. CoKN. We just raised to your consciousness the concern of
public protection should cut across the entire playing field where
U.S. citizens will be participating in markets, especially those that
compete with U.S. meirkets, euid it could be to the detriment of the
U.S. markets.
Mr. CoLKMAN. Mr. Fink, the COMEX's accuracy of its audit trail
is what?
Mr. Fink. I believe the number the last time that we had a rule
enforcement review is 87 percent, sir.
Mr. Coleman. I understand that it varied between 84 and 89,
and that the recent period of review actually was the lowest period.
What have you done to increase the eiccuracy of that audit treiil?
Mr. FmK. We have taken two m^or steps. One is to raise this
issue and the level of oinsciousness of our membership. We have
made it clear to them through notices, through disciplinary actions
that have been imposed by our supervisory committee, that the ex-
change will not take lightly any member's failure to properly
recoil his trades.
In Eiddition, we have, as I mentioned in my testimony, made a
request to the CFTC in order to expedite the entire process of pe-
nalizing those people who have failed to properly record their
trades, to impose a schedule of summary actions that would subject
them to punishments without the benefit of any long and delayed
hearings.
Mr. CoLEBiAN. Under the current scheme of things, what is the
incentive to your exchange to increase this percentile of accuracy?
Mr, Fink. Obviously, we are under the pressure of the r^ulatory
authorities who conduct routine rule reviews of our recordation
Bjrstems. They have from time to time prodded us on to higher
standards since the rules became effective in 1986.
We have, in addition to that
Mr. Coleman. Have they taken any action against you?
Mr. Fink. They have not taken any action against us as far as I
am aware.
Mr. Coleman. They have not failed to approve any contracts on
the basis of your rate?
Mr. Fink. They have not. I do not believe that our performance
was in any way regarded as substandard from an industry perspec-
tive.
Congressman Coleman, if I may point out, that the provisions
initiating the 1-minute time recordation went into eflect about 2
years Eigo. Despite appearances to the contreuy, the implementa-
tion of Uie practice is not an entirely easy one.
In markets that are very active and very volatile, recording that
extra bit of information was a practice that was not easily adjusted
to by our membership. We do the beat we can and we continue to
improve as time has gone Inr.
We believe that a goal of 90 percent in the short term is an easy
target, and we expect to continue to improve in the long run. TTTbat
spur to improvement is being imposed on us, not only by the CFTC,
but is being initiated on our own behalf because we feel it is in the
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best intereete of our customer body to make sure that an audit trail
is verifiable.
Mr. Coleman. Well, I think all three of you have a similar view
of this issue, and yet all three of you are concerned about things
moving offshore.
It seems to me that it would be very easy for you to counteract
that by increasing the integrity of your individual markets so that
they are above reproach and suspicion and question. By putting in
place whatever it costs to put an audit trail in that would maintain
the highest accuracy, instead of having to be prodded by the Com-
mission or we having to do this by legislation would be the best
action.
Mr. Fink. I believe you are right. COMEX believes you are right,
and as I said, not only have we been prodded by the CFTC, but we
have initiated our own measures to get that improvement in place.
Mr. Coleman. I must say that all three of you have similar
views, but, Mr. Fink, you have a way with words that Mr. EngU^
has not chastised enough. It would be interesting to see your next
testimony before our committee because I have never heard some-
body go out of their way to throw sand in our face here as we are
trnng to work on this legislation.
The other two gentlemen had similar views, but they at least I
think made their presentation in a fashion that one should, and
not try to be confrontational or argumentative. I would just surest
that you might take a cue from these other gentlemen when you
come up here again. It is much better to do it that way.
We understand you hold views that are sometimes emotional. We
run into this all the time with these issues, but I just think that
you ought to do it in a different feishion.
Mr. Fink. Congressman Coleman and members of the subcom-
mittee, I apologize if my remarks are interpreted as being impu-
dent and/or uninformed. If they appear that way, they stem — their
flavor stems entirely from a very strong feeling on the part of
myself and the part of the exchnnge, that there are important
issues at stake here. We may have made an overaggressive attempt
to defend them.
Mr. CouaiAN. Let me also say to all of you that we are very
mindful of your concerns, and we have tried to address thoee. And,
yes, we are operating in an imperfect world and yes, we do not
have the study yet from the Commission, and yes, there has been
one going on in some fashion I guess for 15 years, and yes, we do
not have any indictments in Chicago yet, and yes, we have also
provided gaping holes for people to drive a mack truck through
here if you so desire.
So, we are trying to be fair at the same time, and I do not think
that there is anything in this bill that is so onerous that it is going
to put people out of business, or move things offshore, or make
your life miserable.
Dual trading! We have all these things in here for the Commis-
sion to recognize and to look at and to be concerned about, and to
provide exemptions for, and I think that the time has come — and
you all have to go outside the framework of this committee and
subcommittee and recognize that when we go to the floor of the
House, there are other people who are interested in this subject.
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who are lying in wait down the hall from here, who would love to
have you in front of their committee right now, and they do all
sorts of interesting bills, and so forth, and may in fact have amend-
ments to this bill waiting, I do not know.
So, I would caution everybody who wants to come in and rip up
this l^islation. We eire open-minded about suggestions, we Imow
we do not have a perfect product, but to come in here and just sug-
gest that it is, as Mr. Guttman said here earlier, and others, that
somehow the premises are misshaped and put the cart before the
horse, and all this other stuff, we have tried to balemce that off
with these exemptions, giving the Commission flexibility, and to
recc^nize those shortcommgs in any piece of legislation.
ll^nk you.
Mr. E^NGLISH. Let me also say at this particular point that I have
taken note oi the fact that each of you three gentlemen, and those
that have preceded you, have failed to take note of the provision in
the law which gives the CFTC the authority, should they find that
there is undesirable price volatility, unacceptable widening of the
bid-ask spreads, or otherwise threatening to the public interest pro-
visions, gives the CFTC that authority to make that judgment not
to take that action.
It seems to be failed to he rect^ized or appreciated, and I am
going to be listening with great interest as far as the testimony
m>m other exchanges and other interested parties. If that fails to
be recognized and understood, if it is, in other words, an insignifi-
cant feature, if it has little meaning, I will offer an amendment to
strike it, and we will move on from there.
Ms. Long.
Ms. Long. Thank you, Mr. Chairman. I really do not have any-
thing to add except to say that if the system were working as it
should be, and in the best interest of the public, we would not be
holding these hearings and working the long hours that we are
worki^ trying to find meaningful solutions.
Mr. English. Mr. Tallon.
Mr. Tallon. Thank you, Mr. Chairmsm.
Mr. Com, you talked a little bit about and certainly stimulated
my interest and Mr. Coleman's interest about the overseas markets
and how they compete with your exchange, and I think that we
have determined through testimony today that they do allow dual
trading.
Could you elaborate on that a little more?
Mr. Corn. Well, there are approximately eight foreign exchanges
that compete with the Coffee, Swar, and Cocoa Exchange. The pre-
eminent would be the London Fox which trades in coffee, sugar,
and cocoa.
The coffee and cocoa contracts Eire approximately the same size
in overall volume as ours, emd sugar, we Eu*e significantly larger
than they are.
In the last few years, the London Fox has made significimt
changes to their contract to be more competitive with ours. In par-
ticular, they went from the sterling contract to a dollar contract
because world sugar is priced against the dollar.
Most recently, the London Fox introduced an amendment to
their contract to add Cuba as a delivery point, which is against the
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law here in this country. Again, the reason was to create a more
competitive situation against our marketplace.
The major commercial users of our market £u*e the same m^'or
commercial users of their market, just as they are with the Paris
Bourse which is now part of the MATIF. They have direct commu-
nications to those marketplaces, like they do to ours.
I think the fact that our market has grown in stature and
volume over the years is contrary to some of the points I have
heard here, where people are indicting what is happening on tiieee
markets, are making comments that there is something wrong in
these markets is just to the contrary.
It proves the point that these markets work, that these commer-
cial interests believe these are the most efficient and effective mar-
kets in the world for the products that they are trading.
If that were not the case, we would have lost volume to these
markets years ago, smd every day that participEmts, the commer-
cial users Emd the large public customers are making a free deci-
sion whether they will trade here on my market or they will trade
Now, if I was doing something wrong, and we were not enforcing
our rules properly, or in answer to a question Mr. Coleman asked
Mr. Fink earlier, the incentive for me to have a good audit trail
and to improve it, is the fear that I am going to lose customer busi-
ness elsewhere.
The int^rity of my market is the most important thing I have to
offer my marketplace and the people who use it.
Mr. TALLON. Tliemk you, Mr. Com.
Mr. Guttman, you mentioned in your testimony, I believe, impor-
tant differences among the exchanges and we heard testimony ear-
lier from I think the Kansas City Board of Trade, about some of
the important differences.
I wish you would elaborate on that a little bit more when we
think about what we Eire going to mandate as far as time stamping
or audit trails or accuracy or whatever that we might need to t^e
into consideration those tfifferences.
Mr. Guttman. Well, there are certain procedural differences and
there are certain physical differences. If we compare our exchange,
NYMEX, or any exchange in New York compared to Chicago, on
either one of those two exchanges they have both have approxi-
mately 3,000 brokers on their floor which shift among pits, so to
say.
In New York, on the New York Mercantile Exchange, we have
450 brokers. In our pits we trade enei^, which is crude oil, heat-
ing oil, or gasoline, and just like a physical barrel, a refiner takes a
barrel of crude oil, cracks it to get two parts heating oil, three
parts gasoline.
As he is performing that physical function, he also performs the
paper function to hedge those contracts on our exchange, eo we
have one broker that runs between three rings, getting the pieces
into place.
If I take out, based on the certain volume provisions, the dual
traders in our pit, Emd eliminate 150 of those brokers, which will
not be able to perform that function of moving between the pits to
get my legs of the trEmsactions down, we feel, as an orgEmization,
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that it will have displacement factors, which is very important to
our exchange, and will have the impact that we are fearful of
You asked Mr. Corn a question, and I would like to echo his sen-
timents, if 1 may. We trade energy. A barrel of crude oil literally,
in terms of heat, it has a certain value. It is just a question of price
differentials between different brands.
We trade West Texas Intermediate Crude Oil. Ten years ago we
approached the industry and they indicated to us that they would
be interested in creating an energy contract out of this. We did. We
started trading crude oil and gasoline.
The international community has come to our exchange to hedge
their Dubai, their Brent, commodities that we do not even trade
here in the United States, whereas, WTI is our benchmark.
But there is a fme basis point that exists between Dubai and
WTI, and they are willing to come into our marketplace and trade
WTI regardless of the fact that it is not what they are using. They
are using something completely different; 3^ percent of our daily
volume and open interest is from foreign overseas hedgers.
We indicated or I at least indicated in my statement, the London
Exchange has created a parallel exchange to us. Singapore has cre-
ated an energy exchange, and the government of Singapore allows
10 percent caps on taxes on activity that is hedged off on their
shores. MITI, the Ministry Industry of Trade and Finance has now
empowered a blue-ribbon panel in Japan to explore their creation
of an energy exchange, smd now Rotterdam in the next couple of
months, is starting up their own energy exchange.
What is happening is the hedging mechanism which we created,
we provided under the CEA, is now being cloned, copied and com-
peted with. Ab Mr. Corn said, it is in our best interest to maintain
that audit trail integrity. It is in our best interest for those custom-
ers of our marketplace to come in and get a fair price for their par-
ticipation, but they will not come into our marketplace if for some
reason, one, we cannot provide it, or items, such as^again, I do not
want to say the 7,000 lots is arbitrary, because the provisions are
there — but we do not know at what number one could say that the
markets will still maintain their efficiency if we establish these
numbers, and the direction that the New York Mercantile Ex-
change Board has taken the other day to bring to your attention is
let's get to the root of the problem.
It is the individual trader on the floor that initiates the audit
trail system. He is the first one that writes down the transaction
on his pad. That is the commencement of our audit trail system.
Let's go to the root of the problem.
These individusils on our floor have a license to earn a living.
They have a franchise. They have something to protect. If they
know they are threatened, what is about to oe taken away from
^em, we wUl get their collective efforts through our system.
What we are simply su^esting is hit the guys or the individuals
who are causing this possible inability to get to 90 percent rather
thim penalizing the entire institution from its position in the inter-
nation£iI community.
Mr. Tallon. Thank you very much, Mr. Guttmtm.
Mr. Chairman, If I can ask a question that will take 5 seconds to
answer.
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Mr. Pink, what percentage of the floor traders on COMEX are
dual traders?
Mr. Pink. Based on the sample of data that was taken by the
CFTC, 43 percent as of late 1!)SS.
Mr. Tallon, Thank you.
Mr. English. Mr. Nagle.
Mr. Nagle. Is there, in the opinion of the three of you. any alter-
natives that the exchangee, the New York exchanges could agree to
with r^ard to the chairman's position for the mark-up bill on dual
trading, and a complete laissez-faire, let's just continue to do what
we have done before? Is there a method, is there ground there be-
tween the two to meet both concerns over the sanctity of trading
and the other?
Mr, GuTTMAN. Congressman, the New York Mercantile Ex-
change put forth a proposal which we. at New York, find common
ground on. I believe that the Chicago exchanges, when you will be
interviewing them on Thursday, might give it their consideration.
The emphasis we are now placing on is rather than volume or
open interest in any particular month, we will look to target in the
individuals that abuse the audit trail efficiency of our markets.
If we can isolate those individuals, those are the individuals
which we would look to penalize. If we can do that effectively, we
feel that Congress does not have to legislate these items, but set
the direction, instruct the CFTC this is where we want to be, this is
what we want you to do, and have the CFTC work with each ex-
change, take a look at their audit trail systems, they are familiar
with our audit trail mechanism, and get it up to a point of eflicien-
cy that is satisfactory to this particular committee.
Once that is done, mandate sanctions for individuals who cannot
abide by those guidelines. We feel that Congress, under those cii^
cumstances, can satisfy itself that if the CFTC gets together with
the exchai^es, creates that efficiency, rules are mandated as to
whkt basically should be the criteria for that efficiency, and ulti-
mately the floor individual who defies or does not live up to what
is expected of him, he loses his dual trading privileges and poeedbly
suspended from the exchange.
What we are suggesting is to work it from the bottom up to
achieve the objective of what we are looking for.
Mr. Nagle. Mr. Fink.
Mr. Fink. Congressman Nagle, we agree in principle with the
idea that is being suggested by NYMEX. It places the focus we be-
lieve in the appropriate place, that is, on the individual member
who has gotten us into the soup.
Establishing an audit trail requirement for an exchange as a
whole will ultimately wind up measuring just an average. It will do
nobody any good if we have an audit trail requirement in which 90
percent of the members have a 95 percent compliance, but there
are a small number of members, 5 percent of the members who are
at 50 percent.
Placing the blame on, placing the responsibility on, and provid-
ing the incentive to the individual broker is the way we think we
all should go.
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COMEX is suggesting a refinement that suits its particular
needs. We are not clear whether it is suitable to the entire indus-
try.
We have had before the CFTC now for several months a request
for a rule change that would allow us to impose summary sanc-
tions, fines, without benefit of trial against those members who
have failed to properly record their trades and conform to the ex-
isting 1-minute requirement.
We are prepared to alter that request for a rule change to have
it include a summary, automatic suspension of dual trading privi-
leges if the violations for time recordation rise above a certain
level.
Mr. Nagle. Mr. Corn.
Mr. Corn. Congressman Nagle, I have been spending the last few
days of last week and from Sunday on of this week down here in
Washington. I did not catch up with the Merc's proposal until
about half an hour, about 2 o'clock when we broke for recess.
Since I am only a president, and not a chairman. I have got to go
back to my board and bring this to their attention. I am not in a
position now to agree in principle, but it is something I have jis-
sured Lou and Bob that I will bring to their attention immediately.
and we will give it serious consideration.
Mr. Nagle. Now, is there a problem — if this has been jisked
before, then just tell me and we will move on — but is there a prob-
lem, once you find a violator with the time length that it takes to
actually go through and go against that violator and take sanctions
against that violator?
Mr. GlHTMAN. On the New York Mercantile Exchange, we have
a due process. The \-ioIator has a right to appeal it. In fact, it can
be appealed right up to the CFTC. As long as the CFTC has, in
terms of reviewing it, it could take a 7- or 8-month process.
I could mention a case we have on record right now where an
individual floor broker was fined S5.000 for a violation. It went
through the disciplinary process on the New York Mercantile Ex-
change. It has gone all the way up to the CFTC. It is 9 months. It
has cost our exchange, in terms of outside legal bills, close to
316,000 through this appeals process for a $5,000 fine.
What we are suggesting over here is if the committee could work
with us to achieve this particular proposal, that we employ a limit-
ed due process to these individuals, so they could be fined quickly,
expeditiously, and not have to take 7 or 8 months to get to the end
result of what we intend to do.
Mr. Nagle. Mr. Fink.
Mr. Fink. Congressman Nagle. we found at COMEX that in the
vast majority of cases where we have sought to prosecute people at
the exchange for their failure to properly record times, that the
data that was used to support those prosecutions were usually cut
and dried, and we found that there was no need to tie up our disci-
plinary processes and no need to prolong the process by having a
hearing.
In the vast majority of cases, when somebody has failed to con-
form to the audit trail standards, it is pretty obvious both to the
exchange and to the person that is violating,
Mr. Nagle. Mr. Corn.
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Mr. Corn. I would say about 99 percent of our cases get settled,
and I would tend to agree with Mr. Fink that on recordkeeping ^-io-
lations. they are pretty cut and dried, because we are able to get
the information right off of the broker's trading card if he is not
proWding us with the appropriate information.
Mr. Nagle. One of the things that puzzles me, it seems like ev-
er>'body has a different auditing system. Is that fair. COMEX is the
same as Coffee, Sugar, Cocoa, the same as \YMEX? Does even.--
bodv have a different auditing system?
^lr. GlTTMAN. Each one of our exchanges has a different system
of creating the audit trail. On the New York Mercantile Excliange.
the CFTC asked us close to 10 years ago to come to a 1-minute time
standard, which we implemented by using what we call a pit card
system.
It is a pit card that is the size of a baseball card, and even,- trade,
transaction by transaction, is recorded by the broker onto this pit
card system and submitted immediately to an exchange official for
him to clock the proper time of the trade.
That card then gets fed into the computer systems and is dis-
played on a CRT terminal throughout the floor for peer re\iew by
his fellow brokers and the compliance department as to the tr2ms-
action size, the price, and the time the trade took place.
We feel that this real-time transaction-by-transaction audit trail
is ver>", ver\- elTective. but it causes an extra burden upon our bro-
kers because, first, they have to record it on a pad. and take an-
other step and rerecord the transaction on a pit card.
We, based on the CFTC's re^iew. are So. S6 percent efficient, and
it is just really a question which the CFTC, I believe, has to decide
whether our S5. b6 percent, which is recorded twice, is possibly
more effective than other system at 92 percent which is impute<]
through some mathematical model in a computer.
So. on our exchange, we are completely different from our sister
exchanges in New York, and I assume are different than our fellow
exchanges in Chicago, So. it is really an exchange-by-exchange case
study as to who might give the information in a more uniform
basis.
Again, our S5. S6. on a real time, minute-by-minute submission to
an exchange official, might be more accurate than an imputed 92.
93 percent through some mathematical computer model.
Mr. Naglz. All systems are different, my conclusion is correct?
All right. Are you permitted under CPTC rules currently to ex-
change information on your auditing systems, do you have a joint
commission that studies auditing systems? Is there a joint commis-
sion between yourselves and the Chicago pjeople?
Mr. Glttman. We have a joint compliance effort in terms of co-
ordinating our compliance acti^-ities amongst the exchanges, but I
do not know of any joint efforts in terms of computerization.
We run our svstems on a Tandem. I believe that COMEX runs
theirs on an IBM. Some other exchange might run it on Digital
Equipment, The hardware and the procedures, the way we gather
the information are different.
Mr. Nagle. The thing I was curious about — and as Mr. Fink and
Mr, Com responded — if somebody is building a better mousetrap,
do CFTC regulations currently enable you to exchange that infor-
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pliance responsibilities. This regulatory framework Is considerably
broader in scope than applicable to most any other CFTC r^[is-
trants.
All this leads NAFTA members to believe more vigorous enforce-
ment of existing futures industry regulations may be more effective
in preventing abuses than increased regulatory layers of ethics
training. This is in large part due to NAFTA's concern that serious
problems must be very carefully considered in developing any regu-
lations to implement such a requirement. Would this requirement
create a fmancial hardship on individuals in smaller firms, for ex-
ample, by imposing travel to central locations for initial or refresh-
er training sessions?
For these kinds of reasons, NAFTA urges extreme care in craft-
ing any ethics regulations, and we commit our full assistance to
the CFTC for that purpose. In fact, NAFTA could undertake to pro-
vide any such required training for its members and would encour-
age Congress to suggest such an approach for members of NAFTA
and other similar trade associations.
Mr. Chairman, we appreciate the opportunity to present the
views of our association, and I will be happy to answer any ques-
tions.
[The prepared statement of Mr. Isaacson appears at the conclu-
sion of the hearing.]
Mr. Engush. Thank you very much, Mr. Isaacson. I appreciate
that,
I did not hear you make any reference to the provisions that we
have in there, for instance, the provision that says that customers,
if they so wished their broker to continue in the capacity of dual
trading, they can give that approval. That decision rests solely with
the customer.
We feel that he should have that right to make that decision. We
also, of course, did not hear any comment with regard to the ele-
ments contained in the bill that states that the Commission has the
right to suspend dual trading, or should reinstate dual trading on
any contract, or not even ban dual trading on any contracts should
they find that it creates undesirable price volatility or unaccept-
able widening of the bid-ask spreads, or otherwise threatens the
public interest — public interest, that is pretty broad.
I guess I am having trouble understanding why you and others
did not make reference to this. It would appear to me that these
would be elements that you would want in this legislation, that you
would want to continue to see included.
Mr. Isaacson. Our perspective may be slightly different than the
typical speculative customer who may feel he has been hurt by
dual trading in the past.
Most of us who have been in the business for some time, and are
managing rather large sums of money, know the brokers on the
floor that we are doing business with and have done business with
over a long period of time.
One of the processes that we go through as we select a broker to
execute our trades is we get to know that person. And we have a
feel for his ethics. Our concern is not that dual trading may b©
wrong or may be right. Our concern is that at some point it im-
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pacts on the people we are doing business with on the floor, it im-
pacts on the customers we represent.
Mr. Engush. Let's follow that a Uttle bit. Let's say that you have
got this broker out there and he trades for himself, as well as for
his customers. This legislation becomes law. Basically, he then
sends you a piece of paper which states that you sign off and agree
that you recognize and understand that he is trading both for him-
self and for you, and that you give him the authority to continue to
act in that guise.
Now, tell me what is different, then, from that point on in the
way he treats you and the way it is today.
Mr. Isaacson. There is nothing different from our point of view.
I guess the major problem we have with the elimination of dual
trading is that it may not eliminate some of the other problems
that exist on the trading floor. Some of the other problems that
exist will likely be eliminated as a result of better audit trails.
Mr. English. That is fine and we are certainly willing to go after
other problems, but we are dealing with this particular problem
right now.
Mr. Isaacson. Yes, sir.
Mr. English. I guess what I am trying to walk you through, I am
trying to find exactly where this problem is that exists.
Now. you have on the one hand, for you, you say it does not
make any difference, because you know your broker, you do not
care whether the guy is trading for himself and for his customer at
the same time, but we have got other customers that may very well
object to that, and should they not be given the opportunity to say
no, I do not want this guy that I am doing business with to trade
for himself at the same time he is trading for me, should they not
have that right?
Mr. Isaacson. Sure, We think that they should have that right.
Mr. English. So that provision, you would agree with?
Mr. Isaacson. That provision we would agree with. The way it
should be structured perhaps is that if there is a floor broker who
is dual trading and he says he is dual trading — and my counsel's
interpretation may not be your interpretation — but once a person
starts dual trading, and they tell the customer they are dual trad-
ing, that is it. There does not have to be any ongoing type of com-
munication with the customer about dual trading.
Mr. Engush. Once he has signed off and made that determina-
tion, yes, that is correct. Certainly the broker can go back and
forth. He may decide one day he wants to trade for himself and an-
other day he is going to trade for the customer, that is fine.
Mr. Isaacson. We have no problem with that.
Mr. English. Then, the next question, I would assume that any
problem that you have with regard to any impact it might have on
the markets.
Mr. Isaacson. We have a problem if it involves liquidity, if for
some reason it puts other traders out of the market, if it puts dual
traders out of the market who do not represent commodity trading
advisors and pool operators.
Mr. English. Then, the question with regard to liquidity, does
that then not also fit into the action that the CFTC can take with
regard to allowing dual trading when we talk about undesirable
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154
price volatility, unacceptable widening of the bid-ask spreads, or
otherwise threatens public interest?
Certainly I would not think the CFTC would think that the
elimination of liquidity is in the public interest, would they?
Mr. Isaacson. No, I do not think so.
Nfr. EbfOLiSH. So, that takes care of that problem, does it not?
Mr. Isaacson. Yes, sir.
Mr. English. Then, tell me where the problem is.
Mr. Isaacson. Our problem, I think is more in a paperwork type
of situation find a l<^istical type of situation.
Mr. English. Paperwork?
Mr. Isaacson. From our perspective, we do not think the system
is not working. We think the system is operating just fine right
now. We do not have a problem with the way trades are executed.
Mr. English. I guess, then, what you are telling me is you do not
really have an objection to what we are doing in this provision, I
mefui there is nothing that you come up with to say that in any
way this is going to cause a problem, it is basically you prefer
things are eis they are, as opposed to going to a new approach, is
that right?
Mr. Isaacson. We do not think the new approach necessarily
eliminates the problems that we see on the trading floor on a day-
to-day basis.
Mr. Encush. But you agree or at least you ciinnot come up with
now fmy problems that it creates?
Mr. Isaacson. No, but what we are saying is you are institutit^
a new measure that is different, and we are not sure what the
impact is going to be: If it has a substantial impact on our clients,
because liquidity is impaired
Mr. English. But we have already given the CFTC that author-
ity to deal with that, have we not?
Mr. Isaacson. If they act rapidly.
Mr. English. And if the CFTC has any doubt in their mind, cer^
tainly they are not going to do anything that is going to be hairnfiil
to that contract, are they?
Mr. Isaacson. Harmful to the contract, maybe harmful to liquidi-
ty, I'm not sure. I'm not sure how fast they would make a decision.
Mr. Engush. If they have the authority to do it, they can do it
instanteneous, could they not?
Mr. Isaacson. Well, as Congressman Colemem said, sometimes
the reality of idealism is not always there. Sometimes it may be
idealistic that they will act right away. However, it may be a sig-
nificant period of time before they act, and if that affecte liquidity,
and it affects some of the commodity pools or some large sums of
money that are being managed in the market, even for a short
period of time, it can have a detrimental impact on NAFTA mem-
bers and their clients.
Mr. English. So, bfisically what we are faced with, in your opin-
ion, the question of the tradeoff comes down to trading off the cus-
tomer's right not to use a broker who is involved in dual trading,
to not to take action to do anything that may eliminate some of the
potential abuses.
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155
That is on one hand, but on the other hand, in your opinion,
what outweighs that is the fact that CFTC may not act responsi-
bly?
Mr. Isaacson. I am not saying they may not act responsibly. I
am saying they might not act in a timely manner.
Mr. English. That would be responsible, would it not?
Mr. Isaacson. They may have a different opinion of what is re-
Bponsible thfui I do.
Mr. ENGLISH. Mr. Coleman.
Mr. Coleman. No questions.
Mr. English. Mb. Long.
Ms. Long. No questions.
Mr. English. Mr. Nagle.
Mr. Nagle. Just for my own education, if I could.
If I approached your company and said that I wanted you to
handle my purchases, and I did not want someone handling the
purchases who is engaged in dual trading, would that be done cur-
rently?
Mr. Isaacson. We are more similar to eui investment advisor
than a floor broker. You would come to me emd say I would like
you to manage my futures account and I have a preference for
what broker to use. We would call the broker that you said to use.
Mr. Nagle. In the industry itself, if I called for a broker and said
I want you to trade my account for me, I do not want you to
engage in dual trading, is that done? In other words, is there addi-
tionfd cost, under current practices of the various exchanges, if I
request that dual trading not take place, is there eui additional cost
to me, do I have to pay an additional fee, or is there an impedi-
ment to my getting access to the markets?
Mr. Isaacson. I think that depends on how big of a client you
are. If you trade one contract of wheat and one contract of com,
and you went to the brokerage firm and said I would like to know
if the broker was dual trading or not, they might give you that
option, they might not. It might not be cost effective for them to do
that.
I would guess the bulk of our members' feeling is that when you
use a person who is not trading for themselves, they are not as ex-
perienced nor as qualified as someone who is dual trading.
Mr. Nagle. Hang on just 1 second. I thought you said
Mr, Isaacson. If you are referring to where I spoke about extra
cost, added cost of dual trfiding, we feel that there could be added
costs because floor brokerage would likely increase.
Mr. Nagle. "NAFTA believes dual trading should be allowed to
continue subject to disclosure to customers that a broker intends to
trade for his own eiccount. Existing CFTC regulations require just
such disclosure to prospective customers of commodity training ad-
visors and commodity pool operators. This disclosure would allow a
customer to choose for himself without the market having to suffer
the cost I have just described."
I guess my question is currently: If I am the average farmer out
there with 100 acres of com, and I want to go in and use the
market, if I am raising 1,000 hogs a year, marketing 1,000 h(^ a
year, can I without extra cost, without extra penalty, or without
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difficulty, get access to a trader who does not engage in dual trad-
ing?
JAt.
Idr. Isaacson. I cannot answer that question. That is a different
area than we deal in. If you came to my firm and you wanted to
open an account with me as a trading advisor, I would have to give
you about an 18-page risk disclosure document that would tell you
among other things if we were trading for our own account.
I would imagine if a farmer wanted an individual that was not
dual tradit^ on the floor he would probably pay some premium
somewhere along the way.
Mr. Naglb. Let me iisk you this. If you went to the disclosure
requirement, would that cost then be passed on to the customer
who opts not to have a trader engaged in dual trading, as you envi-
sion it under your testimony on page 4?
Mr. Isaacson. I think there is a potential for increased conmiis-
sion cost, increased cost to the ciutomer if he uses a trader who is
trading just for clients, and is not dual trading.
Mr. Naglb. In terms of the action that this committee should
take — I listened to Mr. English's questions very closely, and what
Mr. English has basically done has required an affirmative act on
the ptLrt of the customer to permit dual treiding, euid the customer
has to say it is OK to dual trade — would you envision under that,
that would be additional cost to the customer?
Mr. Isaacson. 1 would envision that if the customer said I want a
trader who is not dual trading, I want a floor broker who is ju^
trading for customers, that there would be increased cost to the
customer.
Mr. Nagle. What, in your mind, would be the difference between
requiring an affirmative act by the customer to permit dual tcBd-
ing and an affirmative act b^ the customer not to permit dual trad-
ing? Would there be any difference?
In other words, instead of my bein^ required to say yes, you may
dual trade, I could say, unless I said I do not want you to dual
trade, you would be permitted to do so, is there a distinction there
in terms of either cost or
Mr. Isaacson. No, I think that a customer should be alerted to
the fact if there is a potential conflict of interest and the cost may
be more. The customer should be made aware of that.
We think that full disclosure is the way to go. Then let the cus-
tomer make his choice. I am not understanding your question be-
Mr. Nagle. No, you are, you are doing a good job.
Let me ask you this. It is the last question. I may take you on
this one beyond the area of your expertise. But if I wanted to trade
on COMEX currently today, and I did not want to have dual trad-
ing, is there an additioneil cost for me to do that by the broker?
Mr. Isaacson. When you say eui additional cost, do you mean an
additional commission cost?
Mr. Nagle. Yes.
Mr. Isaacson. When I say additioned cost, I mean there may also
be additionfil hidden costs because the person who is trading only
for customers may not be as effective in getting good execution for
the client as the person who is dual trading.
Mr. English. Why is that?
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157
Mr. Isaacson. Because the person who is dual tradii^ has the po-
tential of mnlcing income off trading for his own account. A person
-who is trading just for customers, who is getting 50 cents or 75
cents or $1 a trade, is doit^ that because he may not be as effective
in the pit as a person who also trades for his own account.
It is the law of suppljr and demand, and he is going to be the
most effective in gaining income for himself.
Mr. Nagu. I do not understand why that is.
I yield to the Chairman.
Aur. English. I guess the only point that I want to make, of
course, that would oe yourperception as it is now, the feeling that
that is the way it is now. Would it not be true, though, that if the
Erovisions of this legislation became law, then each day that same
roker is going to have to decide whether on that day he wemts to
trade for customers or whether he wants to trade for himself?
Mr, Isaacson. My perception is that on the floor
Mr. EnOUSH. In other words, we are going to have all these good
traders that are going to be available to be able to trade for cus-
tomers, so in effwt, we are going to be helping all these fine cus-
tomers out there that do not wemt dual traders.
Mr. Isaacson. My perception is that I want the person that is
trading for himself also because I have a belief that he is a more
effective broker than one who is just trading for customers.
Mr. English. But you agree there are people on the other side,
who take the other side and say, hey, I do not trust that guy who is
going to be trading for himself at the same time he is trading for
me? If it comes down to the interest as to who is going to get the
good deal and who is not, you know, he gets the good deal and I get
stuck, and I never know the diiference.
That is what the fear is for some people, correct?
Mr. Isaacson. That is right.
Mr. English. So, it is opinion.
Mr. Isaacson. That is right, just so the customer knows what he
is getting into. We have never taken the time to quantify it, and
we certainly do not have the resources to quemtify it — but if you
look at trading advisors that are putting orders through several dif-
ferent brokerage firms, the sfime orders at the same time, there
might be a way to quantify the effectiveness of traders. Many trad-
ing advisors keep a record of which brokenige house gives them the
best fills. You could perhaps look and see which brokers were dual
trading.
Mr. E]nglish. I thank the gentleman for yielding.
Mr. Nagle. I thank the chairman. My time hsa expired.
Mr. English. I guess just one other follow-up on that point. The
Iuestion comes down as to how to handle the issue on dual tradit^.
7e are talking about the way that this bill is written. In ex-
changes, there may be some contracts where dual trading is al-
lowed, simply because of the volume.
There may be aome contracts in which dual trading is allowed
simply because the CFTC, for reasons of liquidity, or whatever it
may be, feels like that is necessary. There may be some contracts
where dual trading is banned in certain times of the year because
of the activity and the way that that particular contract — all of
that flexibility is built into the provisions under this law. It also
^:
23-500 0 - 90 -
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158
states that a person then who is involved in dual trading, if the
customers that he has — and I have one, a good friend of my family
back in Oklahoma who says gosh, I have been using tajs same
broker for years, 1 trust him, I believe in him, and I want to use
him, I do not care whether he is trading for himself or not, fine,
they can go ahead and sign off and they are taken care of.
But for all those people out there who do not know that, who do
not feel confident of that kind of a system, all those people who are
going trough various orgauiizations that are handling them, and
putting them tc^ether, they do not have any say in mis in many
cases.
A lot of people do not have £my say aa to who their broker is, do
they?
Mr. Isaacson. I do not understand. Why wouldn't they have a
say in who their broker is?
Mr. English. Well, if they are trading with Merrill L^ch or
someone like that, now, there, as an individual, I will go m there
and they are not going to know who the broker is, are they?
Mr. Isaacson. Well, I would assume they will now if the provi-
sions of the bill go into effect.
Mr. English. But I am talking about today, as it is.
Mr. Isaacson. No, they do not.
Mr. English. And they have no say about it today.
Mr. Isaacson. Probably not, but they do not care enoi^h to in-
quire.
Mr. English. And most people do not, do they?
Mr. Isaacson. They do not.
Mr. English. That is the reaUty- ^ guess what I am coming
around to, it would appear to me when you add up all these ele-
ments, all these provisions, there is a tremendous amount of flexi-
bility in here to meet an awful lot of different situations.
Basically, what we come down to is the bottom line, is that
people who do not feel comfortable in having a broker that is deal-
ing for himself at the same time he is dealing for ^em, they are
going to be protected.
It basicfdly says that for thoee cases — and we are t,alking about
those markets with a lot of volume, a lot of action, fast trading—
and whenever we talk about these percentages, when we are deal-
ing about these percentages emd we say, well, it has got an 86 per-
cent reliability factor, or even a 95 percent, we are not t^>lking
about every contract in every minute of that day.
There is some parts of the day it is probably going to be a whole
lot more reliable, euid other parts of the day it is going to be nearly
as reliable.
If we are talkii^ about abuses that are going to be taking place,
the time that it is going to happen is when there is a lot of action
most likely, a lot of action, a lot of activity, hard to keep track of,
hard to watch, cmd it is not going to be during the rest of the day.
It may be in the first few minutes of each day, it may be in the
last few minutes of each day, and that is basically what this bill
and those provisions deeds with, is that not correct?
Mr. Isaacson. A lot of the things that you are referring to in
■ those first few minutes and last few minutes such as curb trading
or wash trading are not going to be eliminated by letting the cus-
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tomers make their choice of whether they want a dual trader or
not.
I think the only way to ehminate those problems is with better
audit trails, increased ethics and more vigorous surveillance of the
floor.
Mr. English. We agree with you 100 percent. What we are
simply saying, though, is that under the dual trading provisions,
and whenever you get all these people, and you get a lot of folks
going, it is tougher, it is tougher on the sj^tem, and places more
demands on the system.
All we are saying is, give us a better system, give us a system in
which we can nu^e sure that we can idenUiy those kinds of
abuses, fine, go ahead and dual trade. I do not have a problem with
it philosophically, fine, let's just make sure that we can identify it.
I guess that is where I am comii^ from at least.
Gosh, I appreciate your testimony.
Mr. Isaacson. Thank you for listening.
Mr. English. You did a good job. It is a pleasure to have you as a
witness.
Mr. Isaacson. Thank you.
Mr. English. We will recess subject to the call of the Chair.
[Whereupon, at 5:25 p.m., the subcommittee was adjourned, sub-
ject to the call of the Chair.)
[Material submitted for inclusion in the record follows:]
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■ nu SMn (D-iAi
, AMI tiuun, DBvsLonmr
B BOOBI KUCULTaRB CCMMITTSB BBCMtltK
Jnll II. 191*
but I thought thai
r«nd«ted by propai
whara ■ ganuln* •<
iHJor lagBantt of
Tha SEC had accoapJ
(till thtnk thara 1
y oparatad luturai lurk
3 that confldanea
■Tvad Hhlch bacallta
i*hed a
laiuring intaqrity
Ekat and tfaa tuturaa raaponi
Ignad to thair Juiladlctlon
or producaia and proceaaoEi
(tlnq □( riak [or b«*ic coum
Lto orqanitatlon Hith pilsary
than aacutttlaa. Tha prlncipi
ulata coiKodiCy futuiaa, not I
indicated by Cha fact tha new
Putuiaa tiading CoaBlailon,
thair fauK
tha latei
trading thi
financial fututaa and optlona and davotad proportionataly
raaourcaa to tha coamodltiei and haa In ay opinion
adequataly with tagard to conanoditlaa. Although
laaded to aiaura Intagrity in tha
> liH prior to tha linal enactsai
COB tha aichangaa thoaa shoctcaainqi
Again, I congratulata you for >akli
il aarioua effort ao far (inca tha Act hi
il affectively with thla inportint aubli
candal which haa divalopad In Chicago vi:
naadad aiaendiiienta including banning
originally
: and hopefully
I help
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oTlqinall)F t>ais«d. rapre
[ the noit vlmibl* probleiai aff^etin? tha Integrity
hange* and Cha publlc'a confldonca In tha uikatt
Cor thalr own accounts at tha
lor cuitoawra ia laplata olth
of i
• Ceawodity r
■ axchangaa auccaaatully lobblad (or an axcaptlon with
euaa that it was naadad Cor liquidity. Baeh tlma tha
■ b«<n caauthorliad alnca than thay hava aought and racalvaf
acna additional tlaa oith tha axcuaa thay naad tlna I9i anothar
study or that thay Hill pacfaet aona luprovanwnt in tha audit
SoH «van uaad tha axcusa that ainee crlninal chaatlng
tradara had not baan provan, wa (hould aaauma naithar
1 chaatlnq nor rulaa violatlona wera occurring. Sinca
■ding Haa not prohibltad and tha avtdanca of fraud and
naplracy »•• aitranaly difficult to aoqulra, criminal acta
) not be provan without a Hjor and anttanty difficult
and ccatly law anforeeaient ating opacationi but that haa noo
baan accoB[liahad *o any claim that abuiea may not b* ■ problao
la no longar an axeuia. Othara claimad a battar audit trail
■ould protact cuatomara but the Exchanqei vlgcroualy opposed
even nodaat l^rovamanta in tha audit tcall ayatam propoaad
by tha crtC. Tha flocr tradaca thaaaelvaa hava no faith in
tha ability of the exchangaa to detect and prevent cheating
•a evidenced Hhan I. 000 flocr traders two yaaii age signed a
pacition to hold a nambaishlp referendum on a propoaal to prohibit
dual trading in stock Index futuraa and options.
Until the old horsa and buggy mathq^ of dealing in tha
pita haa baan replaced by a fully ImplaiaBntad system of computariied
trading vhich permit* a custcner located In a bioker's office
in any ststa to knew lasiMdistely whether ha ha* matched an offer
or hla offer haa been natehed, there ahould be no mora than
one exception to a dual trading prohibition] and that 1* where
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ahould knew tha ritk that hia ordar la piobably b*ln9 axacutad
by tha floor tradar who uy vaty wall alao ba Cradlnq (or hla
own account. It ia now claat that dual trading ahould ba outlawad
and I ucga tha Cowlttaa not ba lullad Into anothac dalay in
outlaHing dual trading. It ahould ba outland noa.
profit foi thair
that la unavallat
typa of activity thai
in (utucaa trading ai
aacutad In Mv York
An official of
a floor biokar or a'
BHrchant could use i
raportabla poaltion
anticlpatad tranaac
Tha coipoiaca offici
I the lack of a piohtbition
■ tuturaa aarkata In tha
a. I hava a bill IH.R.
aaaaa thia problaa, whlcl
a aackata Mich tha a
would prohibit
I not illogal
cutlva,
uaitlon
baan davalopod undar our 1
tha unfalrnaai of allowing
icounta through tha uaa of
othara In tha ucket placi
:ha aacuritlaa laoa prohibit
tha acta for which paopla
[uturaa aichanga. an accoui
tba back [<
public lBf<
.n futuraa contracts of cuatoaara or tha
.ona of othara to profit in thalr own aci
Fho ia awara of a ipandlng announowant
ila or purchaaa of a particular co^wd.
uaa Market could uae that Infonutlon
: hla own account before tha infomatl'
>ga I conducted In tha Snail Buainaaa
f of a futuraa eeaaia
CO trade in futuraa
la Bade public. Hei
Co^lttaa proved boh had done bo. Since
the Intereat of tha coiqwny thay work for,
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prohibit thaii oip
Ctala Hay. but lan*
ttem (uoh laslda 1
:ilV auffar
I (tea U(in9 lntlda
[ on* lutoca* tradar
■all B
into Inaldar abuaa* In tba cattli
■boiiad that al tha )15t Billion :
futUE** tradata, 1114 nillion lor 7] pai
Inaidot* — flocr tradari, otflcara
officara of agcl-bualnaai (ira* who
Thoia Hltb accaaa to inaida inConutticn consliti
tha vait lulorlt]' of tha tiaa and thoaa Hlthout
inlonaation wars conalataot loaart Boat of tha <
have paaaad ilnc* that atudy and aavan yaaca hava paatad
an aaiandaant naarly Idantleal to my cucrant inaidai
bill, Baa paaaad by tha Houaa of Rapraaantatlvaa as par<
tha 1>B1 CRC naauthociiation bill. That aoMBdMnt vaa
dioppad in Contaranca and anothac CFTC atudy of tha pcobla*
waa aubatitutad.
Tha SBC la vlgoroualy antorcin^ tha lav to atop inaidi
eonnaction with takaovara. But aoau
lada by Urga
:1 iiaa aada by potantlal
tcadlng cattla futucaa.
ultina
u4y
a knoHladgi
■ovoBant of largo ropoci
but now iavolvaa finani
tha proviaiona of a.R.
bill.
inpanding takaovac aay not only
.ock but alao nay trada in tha Indax
iha potantlal to naka auch largar profltai
ThlB pioblaa not only involvaa
:abla poaitlona in agrlcultuial pcoducti
■ackata aa wall, t urga you to Incorr
In thia yaaca CFTC loauthociiatlon
■hi eh I
alao requait that tha Subccnaltta* giva conaidi
idditlonil bill II
It would maka important lapi
■■port •aia* reporting ayatai
1 in 1971-73, and aavacal tii
«tlva, and tlaaty inforaation, baeonaa crucial
nd prtvata deeiaion making In markatlng gi.
t tha DSbA. Aa w* initl
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■ tha purpoaa of lapi
:tlng latg* asport ■
It UIDK aiipoTC raportl
■ not protact pcodu<
■ bainq rlppad olt.
th« 0
Foralvn icaCa ci
^arnatlonat aiipoi
coBflr "Ith USD* [utaa, nor will thay onlai
thiough tha CPTC.
H.R. 601 vould maka tha axpott rapoi
part of tha Connxlltv Bxchang* Ket adiiln]
and caqulr* raporta to tha CPTC inataad <
Kith tha *9rlcultui* Dapattaant aftar tha poattio
hava baan takan. this vould hava tha folloiiing a
II Poraiqn aicportar ttzma, [oiaiqn affillat
and Bubaidlarlaa of D.8. i
country tcadlnq ccapaniat
co«9altad to coaply hlth i
a vaiy graat axtant to ha<
and to (pacolata Kith tha
adaquataly
tarad by tha CTtC
aly batoq filad
rai,n
ba aflaetivaiy
ting raportl ng
; gcaln tranaaotton*
bold* a
futuiaa poaltlon In aseaaa of CPTC apaculativa
poaltion liKita would ba raquirad to rapoft
■Ignlflcant caah grain transactlcna to aupport
thalr hadglng axaaiptlon froai apaculativa llMlta.
Mqulrlng thaaa additional ftnu and foralgn
affiliataa which ara taking larga poaltiona
af tha trua daaand for thaaa copoditlea and
ara axcaadlng tha apacalatlon llnlta.
Blnca tha CoMOdlty Eiichanga Act raqulraa
raporta of eaih grain tranaactlona to aupport
a hadglng axaaptlon to (paculativa trading
and poaltion liatta. if thay filad raporta
with tha CPTC and It vara aada public an anporting
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f lr> would n
larj* grain
: b* able
ranaaotion and taka
a apacutatlva
r tKo baloia
OUT pcodueara, naichanti and pcoooiton oar*
informad of tha naw dtkand.
Th* cnc could gioia alfaetivaly aaeut* ceaiillaDea
with tha EapoiElng caqulraiH
USDA. Th« axlatlnf authority of th* CnC
to (iKpand OE dany tcadlng prlvl
■■ th* ability to Inpoaa
Only t
■ton can (oraign atata trading ceap*i>ia( and
ba cequlrad to coaiply with our lav. Only
■porting procadurea paaaad by th* Houaa In ISS:
:ance in favor of another study can
CPTC naadi thla infon
th* only agancy which can adaqui
could furnish
tnfonatlon tl
orlglr
I USDA now hia.
mars ara a*k*d t
I Infomtlon on h
n they will harv*
a by t
OH, tza
including the Soviet Union. It i
the ■■■• kind of tinely, accurate
dMund for grain be provided by i
a In thay plant and
aupply infomation
I, to the whole world,
on about the export
iBl grain trader!.
CONCLUSION
> only highlighted the mott vialble naada for anendmenta
ilao covered In bill* I have had pending bafor* thla
[or several yaarsi however. I know thla Subconittee
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in businaam U
captad the inpoitanc taaponaibilit
lltltltlllllll
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TcBtlBony of
Dr. Handy h. Crana
Chairman
Caaaodlty Futures Trading Conission
Bafora th*
SubcoBBlttaa on Conaarvatlon,
Cradit and Rural Davclopaant
of th* coamitt** on Agrlcultura
U.S. Hous* of R«pr*a*ntBtiv*s
July IB, 1989
Mr. Chairman and Kaabara of th* Subconnltta* :
1 ajB plaaaad to con* bafor* you today r*pr«B*nting th*
CoMHodity Futures Trading Coamisalon to pr«s*nt our
raauthorltation proposals and to rsspond to th* Icglslativ*
proposals put forth in th* cemodity Futures l*provm*nts Act of
19B9. This raauthoritation comb at a tl>a whan th« Conmission's
aggr*sslv* *nforc«a*nt progran — d*nonBtrat*d by our
part iciftat Ion in th* und*rcov*r oparatlon In Chicago and th«
r*c*nt inv*stigation in N*v York ~ has focussd public, industry,
and Congressional attention on allagad abusaa in cawaodity
futur** trading. Your Subcoanittee staff have just coMpleted a
thorough inquiry covering all MarkatB and found th*
B*lC-r*gulatory systsas to b* generally sound. Th* Coaalssion
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also has conducted a r«vi*w of ovorsight proc*dur*s and axchanga
trading practices. How, this Subcowaittaa is considering raqulatory
and lagislatlvs changes to aven further strengthen the
CoMiission'B ability to oversee futursa aarlcets.
While the conmlsslon supports tbs Subeoaaittee's goals in
this area, we believe that Congress has given us sufficient
authority in the Comnodity Exchange Act to fulfill our vandate to
oversee the Karkets. Thus, we are not asking for Major
Isgislativa changes at this tiae although we too are proposing
so*e changes to enhance our regulatory program.
Before addressing the specifics of our legislative proposals
and responding to certain aspects of the Comnodity Futures
Ii^rovevents Act of 1989, I would like to highlight Ba*a of our
recent, »ore Bignlficant regulatory activities:
* The Conaiseion is collating an 18-Bonth review of
iaproved audit trail systess. In 1986, the Comlsslon required
exchangee to iaple»ent significantly iaproved audit trails which
«ust detereine the execution tl>as of all trades to the nearest
Minute. Nhlle the ConMission found that the exchange systeas
getMrally were adequate at this initial stage of i^pleaentatlon,
we called on the exchanges to develcqp a plan for achieving
iaproved coapliance and for l^roving the accuracy of source
docuaante used In obtaining execution tiaes.
* In February, after an extensive review process, we
approved the caiicago Harcantlle Exchange's proposed Globex systea
for trading CHE contracts after regular trading hours. Globex is
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tb* first •Icctronlc trad* •xccution •ystca at a U.S. futures
• In April 19BT, tha Coamission approvad axtandad trading
hours for tb* Chicago Board of Trada (CBT) . Thia rula ehanga
allowad th« CBT to coiipsta for ovarsaas trading businasa in U.S.
Traasury bond futuraa and option contracts and in U.S. Traaaury
not* futuraa and options contracts vhmn it conducted tha tlrat
night trading sasslon at a U.S. futuraa axchanga.
* In January, wo lasuad an Intorpratation clarifying that
cartain hybrid instruments aro axoludad froM tha Coniasion'a
jurisdiction and proposad a ragulatory axavption for otbar
hybrids with option coMponanta. Yastarday, w« Isauad a final
rula providing a ragulatory axaaption for auch hybrida, and a
policy ststamant regarding tha ragulatory traatvant of cartain
■wap transactions.
• Intamationally, wa hava Bovad forward by astabliahing
co^arativa arrangaManta with foreign regulators and
Bel f -regulators to permit tha offer and sale of foreign ^tion
products in the U.S. and to permit foreign brokers to market
foreign products to U.S. cuatomars without ragiatarlng with the
Coaisslon. He ara continuing to establish financial inforaatlon
sharing arrangaaants vlth foreign jurisdiction*.
* After October 1987 and during such of 19S8, wa davotad .
substantial efforts to addreaalng the implloations of the price
break in the stock aarkat. During that period, tha futuraa
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■krk«t ragulatory systca proved durable and no futuraa brokaraga
tirm* Callad. In tha paat yaar, axctaangaa and Barkat ragulatora
bava i^l«»ant«d wany of ttaa reconsendations of tba Brady Task
Forca and tba Praaldantlal Dorking Croup on Financial Harkata.
For axa^Ia, coordlnatad circuit braakar aachanlaas bava baan
iq^lasantad acroaa aacurltiaa and futuraa aarkatat and eradlt,
claarlng and aattlaMant syataaa bava baan iaprowad to facilitata
afficlant caah flows.
• Although tba Coaaiaalon baa baan aictraaaly productlva
In a nuibar of naw araaa slnca ttaa laat raautborl cation, ttaa
ongoing vork of ttaa Coaalaaion continuaa to conauaa our tima and
attantlon. An axaaipla of auch activltias was tba aignlficantly
Incraaaad aarkat survaillanca, whicb occurrad during last
■UMvar's drought. Nhila prleaa wara volatila dua to tha qraat
nncartaintias ragardlng ttaa impact oC ttaa drought on crop ylalds,
no wirkat problaaw azoaa at ttaat ti>a ttaat raquirad Coaaission
intarvantlon.
During tha draught, I partlclpatad on tba Prasldant's
Intaragency Drought Policy Coanittaa, chairad by tban-Agrlcultura
Sacratary Vfnq'
COMCtSSlOH'S ICCXBLKTTVE HWFOBALB
Mow I would Ilka to turn to our laglslativa proposals. Tba
Coaalssion's laglalative raijuaat consists of fiva part* ttaat daal
with natlonwida sarvioa of proeass, Intamational law
anfoTCaaant, eWll aonetary panaltiaa, autoaatlc aoapanslon and
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trading prohibitiona for failure to pay panaltiaa, and
ragistration of floor tradara. I vlll raviaw aach of than
briafly.
Tha firat proposal vould axand th« Act to authoriia
nationwlda aarvlca ot procasa and apaclal vanua proviaiona in
private lagal actions brought undar Sactlon 22 of tha Act, tha
provision vhich parvita private righta of action undar tha Act.
Thia proposal la a cuatomar protaction provision vhich vould
allow, for axanpla, a customar who la dafrsudad by an out-of-
atata boilar roan operation to sua in hia hone state rather than
being reguired to go to court In the atata where tha bailer room
haa its principal place of buslnaaa. Specifically, the proposal
would allow private daaage actions to be filed In the district
where tha defendant la found, tranaacta buaineaa, or where the
transaction constituting the violation occurred. Thus, thia
aaendnent would «ake it eaaier for conmodlty futures and options
custonera to bring private actlona, placing tha« on an egual
footing with cuatonera who aue under Federal securities laws.
Our second legialatlva proposal Is In the area of
international law enforcement. Aa the proceaa of
internationalization of futurea and financial aarketa continues,
cooperative enforcement efforts with foreign futures authorities
are becoaing an Increasingly Inportant part of the Commission 'a
enforcement reaponaibilltiaa undar the Act. Therefore, we are
proposing a new Section 13(f) be added to tha Act which would
provide tha Coamlaaion with explicit authority to conduct
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invaBti^stlons on behalf of foraign futuraa authoritlas raqarding
vloIationB of foraign lam, rulaa, or ragulatlona ralatlng to
futuraa and optlona.
niia laglalativ* proposal would wthanca our ability to
cooparata with toraign tuturas authoritlas. It would allow tha
CoMaisaion, at Ita dlscration, to conduct inveatigations in tha
U.S. at tha raquaat of foraign futuraa authoritiaa avan 1£ no
violation of O.S. law ia Ivpllcatad. Tha Sacuritlas and Exchange
Comisalon (SEC) waa granted siailar Investigative authority In
tha atcufltiea Barkats last yaar, and a nuabar Of our »ajoT
foreign counterparta either already have this eutbority, or are
currently seeking it.
Before conducting en invaatigation for a foreign authority,
the Conission would be required to conaider whether the foreign
authority had agreed to provide siailar assistance and whether
grenting assietance would be contrary to the public interest of
the U.S. The aaandBent would also allow the ConniBsion to
provide confidential enforcasent inforaatlon to a broader range
of foreign futures authorltiee, including foreign self -regulatory
organisations (SROe) .
Our third prepoaal aaends Section 6(d) of the Act to
eliainste tha requireaent that tha CoBBission conaider a
wrongdoer's financial circumstanceB whan aasaaeing a civil
■onetery penalty, nils aaendaant would give the Conission >ore
flexibility in choosing af^ropriate aonatazy aanctiona in tba
sdBlnistr stive law enforceaent process.
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R)* fourth proposal alao aundB Saction 6(d) to auspand
■utOHiticBlly ttta wrongdoer's roqiBtratlon with the CoimiBBion
and to prohibit hia tron trading on all exchanges If ha falls to
pay the penalty whan due. This proposal would create Incentivas
for wrongdoers to pay penalties proaptly. It is identical to the
provision alrsady In the Cooaodity Exchange Act vandatlng an
■utOMtic suspension of registration and a prohibition oC trading
If a party tails to pay a reparations Judgnent.
Our fifth proposal involves tha registration of floor
traders. Unlike floor brokers, vho trade for custoaars as well
as for thensalvas, floor traders trade only for thalr own
accounts. Historically, floor traders have not bssn required to
register under the Act because they do not handle customer trades
or nonay and because exchange rules have established criteria
governing thsir accsss to the floor. However, If floor traders
collude with brokers In violation of the Act or of Couilssion
rsgulations they should ba subject to tha sane regulatory
sanctions. By requiring floor traders to register, for example,
this proposal would subject them to statutory disqualification
and fitness reguirencnts like othsr registrants.
He believe that the registration of floor traders would also
assist in preventing parsons with floor privileges who are
sanctioned at one evchanga froM Boving to other exchanges.
ccMHODiTY rDTOBES zimtovoiEirrs ACT or 19S9
niere are a number of legislative proposals in tha
Subcommittee hill that are not addressed in our legislative
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paekAg*. Nhil* th* CoMilBsion has not bad th« opportunity to
fully consider and davalop a position on vvsEy aspact of tha
proposad bill, I would lik* to raspond today with tha
CoiHission's praliBinary assaaaaant of tha sajor provlslMw.
Allov >a to *«y at tha outsat, bowavar, tha ComniEslon sbaras tha
ewarall goals of this bill ~ to divinlah tha petantial for trad*
practiea atausa, strangthan ttaa CoHilasion'a ragulatory systaa,
and vaintain tha intagrlty of futures and options Barkats,
tbaraby incraasing public confidanca.
ftndit Trail
An Isprovad audit trail Is a priority and has baan a
long-hald CoMaisaion goal. Tha COBBiasion aovad aggraeelvaly
toward tbia goal in 19SC by developing tha ona-slnuta trade
tiaing raqulrasant. Nor* racantly, tha coBBiaaion askad aacb
•xcbanga to Ivprova its aystaa for reporting and using trade
tlaing lnfor>atlon to enhance Ita own trad* practice surveillance
program and requested a plan from each exchange for further
improving thalr audit trail capabilitiea. Specifically, w*
r*queat*d that each exchange review the veriflability Of trade
tlaing data, accuracy larvela, and its procaduras far assuring
accuracy of source records.
Ha are flnily coaaitted to iaprov* tha audit trail in vaya
that ar* the Bost effective In detecting trade practice abuse.
He Miat be realiatlc, however, about tha capebllltles of these
systaa once their potential baa been achieved. Audit trail
systau are records analyaia ayateaa and n*lther these nor any
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oth«r kind of aystcs can d*t«ct all typaa of trada practic*
violationa .
Accordingly, wa ballava tbat a caraful analysis la nacaaaary
bafora dacraaaing tha trad* tialng standard to 30 saconda or
lasa. Changing tha tlalng standard froa tha currant ana alnuta
trada axacutlon raqulremant to 30 saconda or laaa, for axaapls,
■ay not prenrlda aufficiant IvprovaKants in overall audit trail
capability to justify what could ba a algniflcant incraas* In
cost, particularly to tha analler axchangaa.
Othar audit trail inprovenents say ba »ora afCactiva In
datactlng and preventing trada practica abuse. Such ivprovaaants
could includa collactlng trading cards «ora traquantly couplad
vlth aora frequent trade patching, granting conpllanca atsff the
authority to collect and copy trading cards on the floor, and
liaiting tha entry of varl»al orders by aeMbers on the floor.
Siallarly, we believe it may be a aora effective use ot exchange
resourcaa to >ove toward on-line order routing, exacution and
trada reporting ayateaa which would provide aany other benefits
In addition to laproved audit tralla. tfith their Increased
ectasia on conputerlzation, tha exchanges are >oving toward
on-line systaas and we should avoid requiresenta that could
discourage this davelopaent and poaaibly force a detour back to
nachanical systaaa.
we appreciate the SubcoBBittee's support of our efforta to
achisva audit trail iaprovaaenta. We believe that our existing
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authority !■ ■uftlci«nt to accoBpllah this Important objcctiva
and ar* actively pursuing that goal.
oaal Trmdlng
W* Bhar* tha goal* of tha propoaad laglalatlon to rid tha
Karkata of abuaaa connacted with tha practica of dual trading.
Indaad an original purpoaa of tha anhancad audit trail vaa to
Atain raeorda to Idantity and dater trading abuaaa ralatad to
dual trading.
Earlier thla yaar wa bagan a atudy on dual trading to aaaasa
Ita rola In foatarlng trading abuaaa and to dateraina vhattaar any
llBltationa on dual trading would advaraaly affact aarkat
liquidity. Ha axpact our atudy to ba conplatad In oarly October.
Slnoa our analysis ia not yat coaplata, wa baliava that a
statutory raatrlotlon baaad on apacific volume lavala would be
prematura.
He have concama about tha use of contract trading velu«e to
trigger a dual trading prohibition. Using the average daily
voluaa of 7,000 contracts as a trigger, as proposed under tha
bill, could have significantly different affact* on different
■arkats depending on auch factora as the site and character 1 sties
of each Barket's floor trading population. For exaaple, the
effects In the cattle futures pit, tha gold pit, and the
Eurodollar pit could all be quite different.
Accordingly, wa believe that if apeciflc restrictions on
dual trading are to be sat, tbey are aere appropriately set by
the Coaalssion through its rulemaking authority. Through the
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rul««aking procasB va can apply m' moT9 flaxlbla approach toward
achlaving tba goal of allvinating dual trading abuses which w«
and tha Subcoaaittaa shara. ni* Coanlssion would ba abl* to
evaluate on a market -by -market basis the efficacy of dual trading
taking into account tba aftacts of any llaltatione on liquidity
and th« quality of audit trails. In this regard, va welcome the
alavants of flexibility provided In the bill in laiplenentlng the
dual trading prohibition.
Dndarcovar Authority
The Commission has a strong record of vigorous law
enforceaent. In the exercise of Its own investigatory powers the
CoBMlssion has traditionally cooi^ratad with criainal and other
law enforcement agencies, both etata and federal. This has been
most graphically denonstratad by the ComnlsBlon'a active
assistance in the undercover operation In Chicago. We are
pleased that the bill racognlces the importance of cooperative
lav enforcement with other agencies. He also strongly support
the Subcommittee's intention to send a signal that these types of
undercover activities nay be undertaken at any tine.
Broker Associations
He agree that It is Iv^tortant for the ConiBlssion to define
and identify broker associations for the purposes of surveillance
and compliance programs. However, we believe It is Important to
develop data concerning trading activities of broker associations
based upon an Industry-wide definition of such associations
before atteai^lng to determine trtiat lialts on intra-broksr
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sBBOciatlon trading alght b« •i^roprlBt*. M« ar* davBl^ing
Inforaation on brokar asaociations through Intarvlawa of industry
participants and tha study of currant axchang* rulas and
praotlcaa. Our study should bs co^ilatad by tha and of August.
Wa ballava that a rulasaking la Bors appropriate than
sstting a statutory lislt l>«causa affsctlvs sonltaring of Baroker
association actlvitias could rsqulra rastrlctions to ba tailored
to particular sarkats.
qualification fro* £
smlng Boards
Tha Comnlsalon aupporta tha provision that would bar
Individual sanbara with significant disciplinary racorda fros
servics on disciplinary or qovamlng panala of axchangaa and
futuraa associations for a fixed period of tlse. As statad In
responae to an Inquiry fros the Senate Comittea on Agriculture,
Nutrition and Forestry, we announced that wa would promulgate
propasad rules to sddraas this concern by October 1989, av«n
though Bona exchanges currently have rulaa prohibiting service on
boards for certain periods ol tise.
Na believe tha bill gives ua tha flexibility to require SBOs
to establish what is a significant violation In B smnner which
will allow for sufficlant diversity to reflect different
exchangee' rules and trading practices, and in the case of the
National Futures Association, the different induatry c^iponents
represented by tha sesbarB.
Coaposition of Disciplinary rii^lll asi end Governing Boards
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Currantly, bob* axchangas hav« a two-ti«r disciplinary
process in vhich on« conaltta* aakas a dstcrsination whathar
charges should b* issued and another coKuittee hears the case
regarding possible action based on those chargaa. Exchangas also
raguira aanbars of a coaslttae to recuse tha*salves from a natter
if they have a potential conflict of interest.
Wa are concerned that requiring a aajorlty of comnittee
■eMbers to be fro* a different sector of axchanga ■ambeTshlp than
the person appearing before the connittee nay dininish the
technical expertise of the group enough to slov down the process
and to render a leaa effective and appropriate declelon.
Practically speaking, at soae exchanges it also nay be difficult,
iMcause of the United size of a nenbarship group, to achieve a
balance between exchange nesbershlp groups. Because of the
difference among exchanges In nesber composition, products
traded, and size, ve suggest that the requirements regarding
coimlttee conpoBition and the stages In disciplinary proceas
should be addressed In a flexible nanner allowing tor diversity
across exchanges.
The Conmodlty Futures Trading Improvements Act of 19S9 also
would rectuire that 20 percent of exchange governing boards be
conposed of outside members, and would require the Conmlssion to
provide guidelines defining who is an outside member. Host
exchanges currently have rules which provide tor sons degree of
board diversification and the Commission has announced it will
nonitor governing board composition within the rule enforcenent
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r«vi«w proe«a*. H* favor having "public" vaBlMra on such boardm,
and ooold d«v*lop a broadar daflnltlon to Inclnd* groups, such «■
■arkat osars, alnca thay ara knowladgaabla about tha i naaiiilli lia
baing tradad aa wall as concamad with sarkat intagrlty.
Nhila a r*quira>ant (or a KinlauB percentage Of outaida
board — rtiara »ay add to tha public conddanc* In tha Industry,
tha ConalBaion ballavas a quota ayataa doas net aWaya acdiiava
tha daslrad raaulta. In a Juna 1985 raport, tha Conlaaion found
that tha perforDance of public dlractora sonatlBaa waa Ilvltad by
dlractora' sbsenteeism, fallura to prapara sufficiently, and
tailura to provida axpart aaslstanca. Thasa factors Bust also ba
racognlsad and consldarad before further restrictions concamlng
laoard ■aabarsblp bacons part of the atatuta or tha Cossission's
Telaaarkating Fraud
Tha Coasodlty Futures Isprova>ants Act of 19S9 would raquirs
tha Camffilssion to develop procaduraa to assure that non-hedging
futures and options custosers solicited by talephona for tha
first tlBS cannot trade on nawly opened accounts until thraa days
after signing tha account opening agreaaant. Ha ballava this
aaandaant Is net nacasssry since under currant Comniission
Regulations 1.55 and 33>7 no futures or coKaodlty options
transactions can occur lagslly until a flrst-tlBS cuatoawr
raoalvas « certified written riak diaclosure ststsaant, including
risk dlaclosurs language Bandatad by Ccmiaaion rogulatlona, the
custossr ackiKwlsdgaa in writing that ha haa received and
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understood th« disclosure atatuant, and tha broXar has In hand
tba slgnwl atataaMnt, which h« vust rataln.
Tb» Coiaiaalon suipports tha Idaa that raglstranta ba
•ducatad In tha purpma and funetlon of futuraa and options
■arksts and in the rulas and ragulatlona which thay aust obaarvs
to lagally trada in thaaa >arkata. Such a program ahould include
tha fiduciary raBponsibllltlas oC thosa in tha industry vho
handla custoaar aonay. It is aaaantial that all industry
participants undaratand tha signlticant sanctions thay taca If
thay abuaa tha aarkats and violata tha law.
Saglatration Disqualification
nia Conaodlty Puturas iR^rovaaants Act of 19S9 proposaa
■avaral aaandaants to tha ragiatratlon disqualifications sat
forth in Sactlon 8a of tha Act. Thaaa proposals aust ba
carafully avaluatad tor conslstancy with tha statutory
disqualification schama Congrass anactad in 1982. kt that tiaa
Congress gave applicants and registrants claar notlca of the
prlnazy standards ths CoimiBBlon would usa to evaluate their
fitnaas for initial or continued reglatration and granted tha
Coaalasion tlaxibla regulatory tools and authority to develop
innovative procedures to streamline and simplify it* ragietratlon
nia currant proposal raises concerns that it Is not fully
conaiatant with the logic that underlies the 1982 amendaenta.
Certain provlaions aay create uncertainty among appllcanta.
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r«giatranta and th* gancral public aa to tha atandarda tha
C^niaalon will apply in tta* raglatratlon contaxt. For axaMpla,
it an»aara that aapacta of tba propoaala craata ovarlapa batvaan
distinct catagorlaa of diLBqualifJicBtlon, whicA could incraaaa
uncartalnty about tha typa of conduct covarad by a
dlaquallCi cation. ni«a« ovarlapta also fall to raflect tha basic
diatlnctlon batwaan tha mora sarlous typaa of disqualifications
listad undar Sactlon 8a(2) and thosa liatad undar Saction 8a{3).
Ha ara also concamad about any aBandnent raquirlng tha
coBBiaaion to racognisa tha authority of othar regulatory bodies
to craate or apply excaptlona to tha diaqualificationa liatad In
Saction 8a. Such a provision will intarfar* with tha
CoHiisalon'B ability to rastrict such axcaptiona to thoaa which
protact tha public Intaraat. Hie proposal will »aka It Bora
difficult to assura that tha axcaptions to tha disqualifications
racognltad by tha CoBalsslon ara appllad in a consistent and fair
Psriod of Ksauthorlsatlon
Hiis is tha fourth raauthori cation of tha Commodity Futures
Trading CoBBiasion sinca tha CoBBlssion was craatad in 1974.
During thasa fiftaan yaars tha Cuturas industry has anjoyed
unprscedented growth. Itia ComBlsslon has davalopad Into a Mature
and abla regulator. He support your propoaal to Bake the
CoBKodlty Futures Trading COBBisaion a paEmanent agency. The
Biaoonoaptlon that the agency Bay soBehow disappear is one that
■ay arod* public confidence and should ba put to rest once and
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tor all. PacwuMnt autfaorl cation !■ consiatent with ragular and
activa Congrassional ovaralght o£ tha agancy vhich tha CoBmlaalon
bas alwaya aupportad.
I would lika to aubait for tha racord a briaf outllna (aaa
Appandiic) of our prograaa in daallng with 19Bt raauthorlzation
iaauaa and aaandventa.
I would ba plaaaad to anawar any quaationa tha Subcoaaittaa
■ay hava.
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«u— rv tn-«ii-«»m If port Ifaardlna
19B6 BMUtJiorlgation laauM and AMnd—nf
* In January 1987, th« CoMaisBlon vot*d to and th*
option* pilot prograa and to allow par>anant trading of ^tloni
on doaaatic fara product futuraa contracts and on physical
coaaodltlas. Riia action coaplatad ttia procaas bagun in 1961
wltb tha ra introduction of coaaodlty options trading on D.S.
* Tha Caaaiaalon complatad and publishad in Fabruary 1986
a aurvay of all tradars holding poaltiona In liveatock futures
and cations as of Karch 13, 1987. Tba Coniaslon found that,
a*ong thoaa aurvayad, no aingla tradar or group of tradars
doMinatad tha tuturas narkata. In fact, tha largast individual
ahara on aithar sida of any livastock futuras Barkata was about
six psrcant, and in both caaea the largast individual share was
bald by a coneercial livestock concern.
* In July 1987 the CoBOilesion clarified the hedging
definition (Rule 1.3<S)) to perelt inatitutlonsl user* of the
futures varkats to take certain positions that reduced overall
balance-sheet risk but bad previously appeared to fall outside of
tha traditional concept of hedging. In conjunction with the
clarification of tb* hedging definition, the Coiaission published
an interpretation of CFTC Rule 1.61 in Saptenber 1987 to perait
exchanges to grant exeeptiona froa certein exchange speculative
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position limit* in financial futuraa for certain risk nanagancnt
positions.
* In D«c*mb*r 19BT tha ComniaElon anendad Faderal
apeculativa poaition limits Cor soma agricultural markata in
rasponsa to £uturas industry concams that pravious lavals vera
too rastrictiva.
* In addition, tha Cooaisslon moditlad its aggregation
poltcY for positions of couaodity pools which have a common owner
but which are indapandently controlled. Tha exemption would
permit commodity pool operators to apply to the CommisBion tor a
higher speculative position limit on a case-by-case basis.
* Early in fiscal year 1988, tha General Accounting
Office (SAO) completed, with the Conaission's cooperation, its
mandated study of the cattle futures market. Hie CAO report
concluded! "The preponderance of the lnfor*atlon suggests...
these Markets are working fairly well and are serving the
traditional economic purpose of snhanclng price discovery and
facilitating risk shifting.... Exchange and CFTC regulation of
the cattle futures markets appears to be working well.
Haniipulatlon of tha cattle futures markets has nevar been proved,
and other violations have been detected at a lesser rate than in
other commodity futures markets."
* In February 1988, the Commission, with the assistance
of the National Futures Association, published and transmitted to
Congress its Leverage Survey Report. In November 198B, the
Commission forwardad to Congress its final report discussing the
amount of interest in the offer and sale of leverage contracts
and proposing changes to Commission rules to permit additional
commercial interests to enter the leverage business.
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TESTIMONY OF JOHN M. DAMQARD
PRESIDENT
R/TURES INDUSTRY ASSOCIATION
Mr. Chairman and rnamtMTs of tha Subcornnlttaa. my nwna ia John Darnoard. and I «n
here today Jrirny capacity as preskMm of ttwFutur«s<rKiustryA3sociatkxi(FIA). ThankytiuAx
the opportunity ra appaar tMfora you today on behalf at tha mambara o( the FIA.
The FIA la the national In
e aaaodatkxi of ttie commoctty ftjturaa and opilona trad
3 Is comprised of nnora thani 00 cf the largest fuluree
n oomrjealon merdiants' or "FCMa.* Thaytiandtomot
brokaraoallrTTia.Knawnas'kJiuresoornrisalonmerdiants'or'FCMa.' ThSytiandtomonthan
80 percent of the tranaacUons on Ifte U.S. luturasexchanoea. Our associate and mtamailonil
nyibers.ighkii number osyly. iOO. m a rnoredhertegroui). They induda al U.S. and many
foraiQn axchanQSS and claarlnohouaaa, law flrmS) accountlnQ Riiits, and users of if>a markets,
■uch Bi commerdai and mvestmeru banks, and pension, insurance and muttMl fund manaoars.
Although our meniMrahlp inckjdea al facets of the hJturea indutty. the FIA haa tta roota In he
brokerigecommunity.whlctilriksthatuturasmarketswHhitspuolicpeillcipants. AttrwFM,
our primary concern h to protect the intareets of ttieee who use and banan from our markets.
Today, the RA is ptaasad to offer Its support of H.R.28B8. Congressman (Mann Englsh.
Tom Cdaman, and Timothy Penny have introduced a bi that the FCM convnuntty betewaa can
' '" ' '-'X reforms that will usher futures iradkig into the 21st century. Wa share the view
embodied In the legiBlalion that sn improved audtt Irsi b the key to these reforms. An ai
tha can bs verifiao and that accurately raconstnjcts ths sequence of trading in a timety rrowMT
has been the goal of ttie U.S. ftitureecommunBy for the ensrei* years of tfieCFTC'saxisisnce.
Audit Trail apd Dual Trading
« newriy^CTMiad CFTC. ThapramlsaolthaCommocltyExchiHmAciisWwtthe
BKchangeawipoIca themselves and that the CFTCwH review the efUncy of these eftotta. K
hat long been the view of the FiA that without a vamWM audH trail, which accurately aoeounia
for awry trade, trie axchangas. the CFTC, and Indeed Congress ttself lack Iha tools necessary
to assure the public Ihet the meikstssre free from abuaa. wsbaleve that until a verffisbtoaudH
tral is in placa In every exchange, the Mures mdusiiY. the CFTC and Congress wl bs
vulnerable to puCfic skepticism - no ntatter how ilMoundad - about the iritegrity of the system.
The exchanges have made tremendous advances in their audi Irsl systems during the
last few years. That progress can be seen both In the CFTCniesnlarcamerH review* -
highlighted in a recant report by your Subcommittee's Inquiry team - as wel as in the sustained
growffi In the volume of futures trading. But there is mora work to do, and someUmes the last
mile is tfie most dfncult to traverse.
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~ after tha first year the legislation has been In affect, the exchartges must provide the
vedflablB time cif execution for every futures or options trade in increments no greater
tfian a mlr^jts.
The RA atronaly supports these amendments to Section 4 (g)(2) of the Act. We beiiave,
however, ttiat analyzing tne audit trail's efficacy end mploring new technologies to achieve
optimal enforcement or the CEA are paramount TTfis worit should be ongoing, and Congest
snould request yearly reports on its progress.
brokers atfflf joy^Wl* ^ f^^ "ylllSI' ^'^''^^^^i!'''?'''''?' ^^}^ If? ^"^^9*
volume c* over 7,000'
exchange's audit IrM
determines to be atlrtbulableto dual trading and where the audftraH is fully verifiable.
painfiily evident that the puMc inisge of futures nwltets and their members has been
adversely impaoed by the wideiy-helcf beiiet that dual trading in futures leads to custor
*' * The CUE'S SpadatCommrttee suggested that the exchanges ban dual tTBding in
«_..ij- — I,,-. Tk] '-' ~"?cl about 80 percent of all transaction on the CmE.
'mature, Hquid' mertcets. This would affect about 80 percent of all transaction c
Thus, both Congress and the Special Comminee recognized that while some abuses
may accompar^ dual trading, l^anning it altcMher might adversely affect the less liquid
markets. The RA has supported (his view wm tha important caveat tfiat,wfienever dual trading
is oannlttad. there sftould be adeouatessfeauerds in pbcs to assure the integrity of the maniet.
in exchange that will take action against tf>ose
Is.
The RA, therafbre, bellaves that H.R. 2869 correctly inks dual tradng to a more precise
audKtral. It is dWIouil.howavtr, tor CongrMSbilagialata whether certain markets are
suNdanhlEMd or whether ttMvjwMralwIkiuicMysd^^ We woukj prefer
that the Congress draci the CFTC to review the efflcacy of auch a Iqukjity test in particular.
■le believe there may be other conslderatiorw- quite ^art from he
.. j^ i_ -__j^|r,^ y^g, ig g„ jKfive, tquiO market- W
lonnanca of audit trail systems, the CFTC
o detect and prosecute trading abuses.
The CFTC currently is addressing dutf trading and has promised to report on economic
and otfwr aspects of tt« issue t)y September of this year. We respectful/ suggest that it is In
the best iraarest of customers snO tr» industry aMe to take a dose look at the CFTCs study
and otfiersundenway before acting definitively on dual trading. If after reviewino the
Commission's recommendations, the Committee finds that the Interest of the pul]4icci
has not been adequately addressed, the Committee could coroider addmonaileoislMiva
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arokf AModtfain*
TTw CFTC's roconvnandabont on broker assocMUons ara due ki AuQutt. We
recommend ihat the SubcorrwiineetakB into eooaidefitkyi the CFTC'arapon before llriafairiQ
legislaUve propoula In this area.
The Subcomrninee's Inqiiiy team hat locuMd on Ihe aoldMllon by a law finns of
ireont wiho. unaware of the ittks ol tradng futures and opdons, are enticed to become
customers ihrougtihigti-pressura telephone aondtatkma. In response, tha propoaed lagisU
includes a provhMm whteh requires tt^ CFTC to adopt new regulations to prolwil any parao
who has soHcited a cuuomer by telephone from antertna any orders lor three days after the
„ -,--r - menterlno any orders lor three days*
customer signs any contract end the prescribed risk disclosure statement opening the account
this three day 'cooling off period* would not apply to Mharthen the first account opened by a
customer wtth the sartw firm, or for accounts opened solely to 'hedge.'
support so ettons to remove them, waaraconcamed, however, that the languaoeifte
Subcommtttaa iaproposinDwi result rnore in fruatraiing tlie legitlrneie users of Mure* and
optionsttianinaamJnatlngmabadapplaa. TheregulatoiwihavadHDcultyindaAningwhatis
a first time sales solicitation, arid the wms wH hava a next to impossUe time supervising for
compllancswllh the rule. Large Ibms haw tddue they would be forced to hold al customer
trades for three days because ollha supan/laory probfams rala»d to comptarKe.
T^are Is a consUaratila body of Commission and Juddal precedents estatjishing that
the CommocBly Exchange Act and CFTC regulations can be used successfuly to prosecute
telemarketing fraud. Ahvady ttwre are in placa broad federal and salt-regulatcty prohibitions
against htah pressure tacttes and otfw fraudulent practices in the offer and sale of futures and
options. In adOtJon.custortMrs have successfully brought cases to obtain money damagee
tinder Section 14 of llw Commodity Exchange Act, the reparations section, and hen fled
arbHradon claims at the NaHortal Futures AssodaHon agdnsl salesmen and linns «rt» have
defrauded them using high pressure sales tactics. With the Subcommittee's permission, w« are
submHUng for the record a cocN of a latter from the CFTC to the Chairman of the House Energy
and Commerce Committee which annotates cases the CFTC's enforcemem dhislon has
successluly brought In both court and the administretive area against registrants Involved in
telsmwtieBng fraud. The letter eisolista a series of CFTCreparabora cases invoiving such
practices.
Unlike oltiers in the financial sarvkws area, futures professionals already provide apedflc
risk disctosure statements to ell futures and options customers, and these disclosures must be
acknowledged end retumed before a firm may lake a customer's trade. In most cases ttiis
procedure alone woukj provide customers with a cooling off period. Futures professional must
comply with NFA nies which regulate the content of ail communicalions t»tween NFA
members and the putMIc "Riese rules specifically prohitilt fraud, deceit and high pressure sales
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cKls and pose M pcMntld cusiorrws Is an eMctK* way to eSscotw high pressuTB tactlci and
takaactkxi. Thlin«tamihouk)baflnlargaderKJada()Mdbyo(harkiduwyseN-r»oulato>y
oTQanlzaiions ttM nava a responslbSiy m this ar«a, and w« boRmo 11 wi.
Th« RA wodd Dka to conUnua to wortt wWi tha Subcomnriiitae to help it tashlon a
proposal that Is apprapriaMy directed at those persona and firms on the periphery al the
IrxiuBlry who are usma unlawlul sales tacUcs.
The Subcommittae's proposal win permit the CFTC to request help trom and to
cooperate with ottier aoarKiea In ooraluoilng invMUotfiore, kKludlru undercover operetlart^
The $uiMO(THTi«ss tharstora Is rs(X)gnlzlria the dMIcuity of dstacUng all ■eo^
normal Jnyertgatory procedufee. The FIA supports the legal applntlonarauch undercover
ig rules which would require that persons of high
. . __pinBrycommliiees of the exchanges and the NFA. In
IS who are iikeiy to tw eieciod to the boards of the ewhanges
Industry tor the* business elhica and reflect wel on the indintry,
Pareot» aarvfrio in the leadsrstiip cf ssH reoMory oroanizatlorn are there to protect the puMc
participants In Via markets, arxl their dsdsens should not be open » question because of
reguinory probWms In their pasts.
The FIA also supports the requlrenwnt that dtedplinery committees tie composed of
persons who sre or a 'emerenttracino status* fnxn the rsspoixlenL This requirement appears
to be reaaonable, wNh the addUonal pmlso that an exchange be atila to put norvaxchange
' m such panslslnspecisi cases.
Whattiar govaming boards should be comprised o( U Isaet 20 percent pubic rrt
has already been decided by several exchanges which have opened msir boards to more
outside msmtiers. Our only caveat Is that puoHc members shoiid be sxpected to have a
working knowledge of futures marksts. The RA also has been concerned stnutirtcrsaaing the
actual reprssentatton of norvfloor intereets on exchange boards. To that end, we have asked
the Congress and ttie CFTC to encourage exchar>ges to have broad rapressntation on their
boards.
The FIA also Strongly supports; the Subcommittee's proposed changes tc
Hsglsfa'allon of Floor Traders
The proposal 10 register floor traders SO that ttwy receive ttw ssma kind Of FBI check
WKl backo^xjrid review as other Industry registrants also appears to be in the public interest,
and we fully support its enactment.
23-500 0-90-7
Dignz.dbvCoOgle
Several unlversAles, In some cases '
)d ethics tnMng and research
with generous support fromlndiatry leaders, have
raining arxf research programs, TnaRAreoogi^izasihachalBngeof
tralnkiginthitsrM. We My support the effort to increeee Industry
Kloa oTartd senslUvlW to atfical conslderatkyis involved in soidtlnq wvJ
rs' accounts and tredng In Uures markets, wfiettier for customers or
propnetaiy accotrts.
Whaittsr the tiXMei' o( the CFTCIs a real or parcalvad problBm, the FlA
houU take every ataprwcesaary to ghe the ConvTwaion perm '
approprialionsfloiiesfarigeOandir-- ' ' "
Inwtala any uncartaintias In the Comn
pennanent stahja, similar to the SecvN
for staHlly and continultv ol regulatory
Cornrass ahouU take every atap rwcesaary to glw th
.--.—iropriBlionsflaiiesfa-"™ — ""' ■
wtala any uncartaintiet
Mua, similar to the SecvWes and Exchange Commission, because M wH provide
le appropriaiionsltoirM forigeo arvll9Si and conwwnd the Subcommittee's
eirnlnala any uncertaintlas In the Cornmlaslon'g future. The CFTC ahoukj have
TTw CFTC has recommended lour prcMakxw that would:
IS Had m Fadaral coi#t based
- Permtt the CFTC to engage In cooperative enforcement efforts wtth foreign futures
The fHA can support the thrust of el four amendments.
HavMvar , the spacrflclaxiuma of al of H . a aSGS wanwds dosar review than wi
poeaWedurlngthettnewewerejilwtopreperethlstostlmony. T ' — ■--^-
Subcommlttee s permission to subrr* additional corrvnents ana auc
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Th* Honorabl* John D. Dlngall
rli> [ I Mil. Co^Bltta* on Bnargf and Co—ro*
U.S. Honaa of Rcprcaaiitatlvaa
2125 Raybnm Bonaa Offica Building
Waahlngton, D.C. 20515
Daar Mr. Chaimani
Thank you for your lattar of April 28, 19B9, advialng i
Subcommittea on Transportation and Bazaxdeua Materials
favorably reported H.R.1354. You alto noted that save:
expressed support for BmendnenEs to the bill that would avoid
needless overlapping regulations. The Comraission shares those
views. In our letter to you of April 24, 19B9, wa proposad an
amendment to exempt fcoRi the coverage of tha bill activitias
already regulated by tha Cognlaaion.
SouevsT, plsaa« b« BVauxed that va alio abara your concarn ovar
the problem of! -boiler room- inveatmont icama . In this regard,
we wish to emphasize at the outset that tha type of amendment we
support would not exempt such unscrupulous operations from the
reach of H.B. 1354. Our proposal is not a 'blanket exemption"
for all commodity-related Instroments. As atated in tha expla-
nation accompanying our April 24 latter, only those contracts and
tranaactions within ths CommiBsion' ■ exclusiva jurisdiction would
be exempted.
toi exanipla, parsons who aell unlawful off-exchange commodity
futursB contracts or who do not obtain a license as required by
tha Comaodity Exchange Act ("Act") do not operate within the
Conmlssion's exclusive jurisdiction. In such caaes, tha Act
explicitly provides that any other federal or state statute,
including one' like B.R. 13S4, Day be invoked against persons
engaged in this type of onlawful conduct.-^' He therefore bellava
^ Sn Section 12[a) of tha Act, tb* ao-oallad 'open aeaaon"
provislon. This aection was anactad in 1983 at the requeat of
(Foatnote Continuac
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that *n aaandnMiit to B.R. 1354 lik* tb«t w* h*v« proposed ia
fully aonal«t*nt with th« blll'a purpoaaa to oa«b*t t^lwiarfcotiag
frand and will «t th« atam tiaw avoid unnacaaaary r*gnlatezT
dnplication and conflict tor tboa* who do ^arat* vithin th«
Act 'a fr— work.
lat«d by tha Coraniaiion. Spaclf ically,
■ion'a rulBB contain aavaral bro&d antifraud provisions: Sactlon
4b of tha Act (futurea contracts); Saction 42 (coronodity trading
advica and pool oparatlona>; Sula 33.10 (axe hangs -traded Op-
tional; Xnla 3J.9 trada and daalar optioaajt Hula 30.09 (foraign
futaraa and optional I and Hula 31.3 (pcacioua aatala lavarag*
transactions .
With raqard to law anforcanMnti thara is a conaidarahla body of
Comnlaalon and judicial precedent BBtabllBhing that these provi-
aions dOva£ fraud in the telemarlieting of inatrunenta and aer-
vicas ragulated under the Act. The Conmiaaion's Enforcement
Division has ■uccesafully brought both court and adminiatrative
caaea against regiatranta involved in telemarketing fraud. 2.' 2n
addition, under Section 14 of the Act, cuatonera themselves may
(Footnote Continued
the Coinmlssion and was relied upon by tha North Anarlcan
5acuritias Adminietrators Association, rnc in drafting the Modal
Stats Commodity Code in 1965. The Code outlaws various forTns of
fraud and commodity' related transactions but exempts from its
coverage transactions within the Commission's exclusive
jurisdiction. Commission staff assisted NASAA in its drafting of
the Code and Commissioner Fowler C. West has appeared bafora
several state legislatures urging its passage He understand
that versions of the Model Code have now baen enacted in nine
atatas and ars awaiting tha Govaxnoz's algnaturs in two othazs.
2-^ aafi. e.g.. CFTC V. Bemth at al . . Civ. 66-6130 [S.D. Fla.
1980) {Section 4b); CFTg Vj. ChJlfHAth g»>°i"t>iiJ:ifi^ Cere.. Civ.
88-6058 (S.D. Fla. 1988) (Rule 33.10); CFTC i^ Comnodity
Fluctuations Svatems. Inc. . 83 Civ. 5909 {S.D.N.Y. 19S3) (Section
42); CFTC V. 'First National Monetary Corporation. 32 C 7707 [S.D.
111. 1983) fSection 4oli CFTC V. Multi-State Adviaoiv Corp.. 81
Civ. 2953 (D.N.J. 1981); In ^ha Mattel; of Multi-Btqte AdvlggrV
£201., CFTC Dkt. Mo. 82-4 (Section 4a); CFTC v. Multi-Nation^).
Holding Qorp. ■ Civ. 82-2173 (S.D.N.Y, 1982); In the Hatter of
Hnlti-Hational Holding Core.. CFTC Dkt. Ho. 83-5 (Section 42) !
and CFTC V. Trending Cvclea for Commodities . Inc. , Civ. No.
BO-'315 (5.D. Fla. 1980) (Section 4£). J
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bring raparatlons caaaa bafore tha Commlaalon to obtain nonsy
damagea for violationa of any of thei« provlaiona coromittad by
cagiatarad conniodity profaaaionala. Many of thaaa raparationa
caaaa bav« involvad talemarketlng fraud. -2' Similarly, Section 22
of tha Act providaa an axpraaa right of action in federal dia-
trlct court for cuatonara to aaek money damagaa for any violation
of tha Act, including tha antifraud proviaiona. Further, Section
ed of tha Act authorizaa atata officlala to bring caaaa in
fadaral diatcict court to en}oin fraudulent conduct or aaek Dionay
damagea oa behalf of thair defrauded citizens ■ Section tid alao
providaa that atata officiala nay proceed In atata court againat
Bloat claaaea of Conraiaaion registranta, epacificslly for viola-
tiona of tha antifraud pcoviaiona of the Act or Conmiaaion
Sales .1'
Induatry rulea and procedure! alio cover t*l«iiark*ting fraud.
The National Futuraa Aaaociation and all futurea axchangaa have
rulea which generally prohibit their raapactiv* Kanbaca froM
making fraudulent, decaitlul or high-pr*aaur« solicltationa of
cuatOBiarB to trade futurea or option eontrocta.A' The Covolaaion
■^ See, pan nay ^, Firat Commodity Corporation si BSBisa>
[Current Transfer Binder) Comm, Fut. L. Bep. (CCH) S 33,936 at
J4,279 (CPTC September 21, 1937) [Section 4b}: Toub ■?■ Apacha
Trading Corn. ■ [1986-1987 Tranafor Binder) Coaoii. Fut. L. Bep.
[CCB] 1 22,975 at 31,S54 {CFTC March 6, 1966) [Section 4b); Piakur
2. Hiftqrnational PreciouB Metala Corp.. [1984-1966 rranafer
Binder) Coram. Fut. L. Bap. (CCH) 1 22,493 at 30,164 (CFTC
January 2, l985)(Rule 31.3); Reed v. Sage Group. Inc. . [Current
Transfer Binder] Coram. Fut. L. Bep. (CCB) 1 23,943 at 34,29S
(CFTC October 14, 19e7)(Bule 33.10); Tavel v. International
frpdinq Group ■ Ltd. . [19B6-19B7 Transfer Binder) Comra. Fut. L.
Bep. (CCH) 5 23,722 at 33,867 (CFTC July 9, 1987), affirming
IftSfii S. international Trading Group. In£. , (1586-1987 Tronafer
Binder] Coram. Fut. L. Rep. [CCB) 1 23,199 at 32,524 (CFTC Auguat
12, 1986) (Rule 32.9).
i/ State officials Kair not proceed in elate ceort against
registered floor brottara or futures aasociationa
^^ See. National Futurea Aaaociation, Compliance Rule 2-29; Adwx
Coramoditiea Corporation, Rule 701; Chicago Board of Trade, Rule
506.00; Chicago Mercantile Bxchenge, Rulea 432 and 433; Chicago
Rice and Cotton Bxchanga, Rule 300.01; Coffee, Sugar t Cocoa
Exchange, Inc., Rule 1.13; Commodity Exchange, Inc., Rules 3.04
and 3.05; Kansaa City Board of Trade, Rule 1000.00; HidAmerica
Commodity Exchange, Rule 701; Minneapolis Grain Exchange, Rulea
TT5.00, and 1700.00; Haw Sork Cotton Exchange, Rule 9.01; Nev
(Footnote Continued) .
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aontinnally ■■•••■•■ mad z^eaammadt iMfzatwamatt to tli* affaa-
tlv«n*M of thaaa aalf-cagnlBtorj atandarda through Ita mla
•nforeaaant xavlawa of tha aalaa praetlca pronaaa which ara
-''-'-' ■ ' • blanr'-'
condact*d at aaob axohanga and tha HFA on • blannlal achadnla.
~'jiBlly, tha Act and Coaniaalon Rnlaa raqnlra tha axahanaaa and
wiatarad fntozaa aaaociatiena to provlda volnntar; arbltTatlon
otbar vioiatlona co^nlttad by axchanga or aaaoelation aai^ra.
toctlona 5a(Il} and 17(b|(10) of tha Acti 17 CFR Part ISO.
■• baliara tb« feragolng d«aonstrat*i that Um Act already
proridaa a co^rahanalva ragnlatory achaaa to prohibit and
cadcaaa talamarkating fraud that way occur in tha aollcitatlon of
CgaKiaaioD-raqnlatad inatruBanta. Wa truat that you will find
thia inforaatlon raaponiiva to tha concama ralsad in your lattax
*a th* Cownittaa continuaa its work on B.R.1394. W* «ppr*ci«t«
thia ^portanlty to cca»aant on this ijq^rtant lagialatlon and
bopa that yon and othaz Baabara of tha Comilttaa will ba abla to
aapport an aaandnaat of tha typa wa hava snggaatad. Plaaaa call
■• it you hav* any qnaatlona aboat tha vlawa wa bav* axpraaaad.
Sincazaly,
flon. Glann Bngliah
(footnota Continnad)
York Fntora* Bxabangat Inc., Ihilaa 351, 357 and 3SB| IMW Xorlc
MarcantUa Ixobang*, Rsl* a.53| and phiUdalphU Board of TT«d«,
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Jbl
National Qrain and F—6 Association
Statwntnl of the National Grain and Faad Aaaoclatlon
by Frank B«ur«kans
baforatha
SubcommKtaa wi Conaarvatfon, Cradll and Rural Dtvalopintnt
U.S. Housa of RapraaantaBvaa
id other iniill ctfiuBqcial hedfpi « friln prldni iad rlik Dutj
aitBiliyaibehdroflbeNiliiiiiilOnlnudFcsilAinUdootNaPA]. Myi
nhip of ihe Nfldmil Ortin uhI Feed Anadiilad edcofl^iuiei oxn Ihu 1.300 cor
PUT memtanhip ii compriicd of EVCTy mpntm at the |nlii ud tOtd loduiiriei - coi
IbocclfbiuiadaKiDiicriiiiDIiiQeilcconimiilitkaliiitindBdDiiibcieBictauiei. In die amiiii
rcpenedly ra it cffidEni ud viiUe mctedng uid riik minifcmeni meduniimi for t wide tmy of
The U. S. (nin indiulr]' It jnud of die rale ll played m Itie dendniinienl of cmKUlfilx famm
HiHteD, ti li pIcaicdvriihdieeiipuiikiiidiitbuiiiDi^nedicifaefDDiiEtiiidiiniy. HieNCVA
believet JI ha bcca i CDumicdvc, poitlm face during diU developomt mid BrQwdi |voccn- It 1i I
Wishlngton, D.C. 20005 • (202)783-2024
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ikiBi alw mln !■ nxiBi Ktulakm. WeaMdmanbditMibMdinnaunrlaartoaUlKni*-
iHtd by u ludifEiiilaii leinlMaT bodji. Owdig]K*n.CITChu|nFnalocvMlityni«falw
efilialwIrwUk iMmrim iiton a pufcm Huh h—tol iciim^ llMdiiB. R*ditiinn.<H
HoftbiCITC. WailB imim ■ niiw iiiili il -— t— i— ■>—
•fcncy. Ha liiiilplli|ii»1miiinlilliiin|iniiipl will coadaB
■lirtjFi VD IQ lavudpuy po»« to nvlawpiiiblBDinuiallidbaidDb □'TC^inflwlBw.liu
« Kdvliki to whkk ft ii hno^Ed.
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>. WaWUnlliilH
Rjuiuian by exduafM, Hlf-nfuliioiy vtiaizuiOBt wd ilM
ihe kII -Riuluvy rawun 1> n ba ntjmiiwl wlA conSdei
inf reuoiubly well, emyooa wllh Int
bi|heti dstita cf Inigirtay la ndlaf.
MrfplieiHI liediM ei» |b up BtmendBiHlT i» iMb. HtMy-Biited n
lad ps b; ill fM k anHribMu iwiinl|f 4o iba ttUckiKj cffunatt uikea
woEr.Aeiw DTdudndliit cwbeihiMliadclon wvcUluo by OTC uu
RR. aw wouMbM dm] Biding In iMftoiwhoie July inilum cxaali 7 JOO carniei* How-
ever, dwii would teiiminlier of Bxce^tkne to Itili nils. dTCaiuldcbneniiyBtlhe 7,000
cooncl level If Iba dial ndlfilbucruBdlziacuedvolMUlIy or wider bktidiiTnklL AIb.>
bn^icr could dual Hide If uithnlBd by hU cummer. Hoally, ibe UU would allow a UUni of Aa
dual trading ban for cuhangeifnUyloipicaniling Hide nddn|iyiKniic*p«bleefitCDDilrgediif
„Coogle
DotbifafibHd. At tte my nnnB. tflK
bsBbi aaU be oted dvbif brtitf opoBbii Bd dotlai periodi of Aa BwUaf iky , nH
u bs OMy bxvy wMi wida mliUHly la pricH.
WMk offOlDg as ipecUlc ptaldai OD ths innrlikiai of HJL Un ihu tn
Eu, m fuUy uppon [be Laiedl of ifaae pcDvlikiu u cdcouite t U^ leveJ of Hhks ud laB^rily In
Wc ipfffcdale Ibc opportuni^ (o [lucnE onr viewi ca CFTC m
[ipoit ud coofieiiiioii ihnugluul tfafl k^ilnivc pncctL ] would bo h^pyupequddDuyqua
„Coogle
KMUASOTY
ontlwpropoMd
Csmmsdlly Fulurai Improvamanli Act of 19SS
ID b* praMntKJ tMfor*
„Coogle
Chairrntn Englith and didingiMhad mwntara a
Rog«i Slovar, chairman ol Ih* •ichang*. and I vary much appraciata tha invitation M (fipaar
h«r« Mday to diacuM iTw Kanaa* Citf Board of Trada'a viaw* on your propaaaf to raauthoni*
iha Commodity Futurai Trading Commtiaian.
I am MIchaal Brauda, praaldani and ehM oracutlva offloar rf Vm axchanga,
Mr. Chairman, a mambar o( your alall viaHad Iha Kanaaa Oly Boaj^ o< Trad* on two occaalona
during Iha coinaa of your commitlaa*a worh. and 1 want you lo know that wa appraclaw Via
•pirit ol cooparalion ttial chaiaetariiad ihoaa viaila. Wa lall iha rnlant ol hii viail truly waa to
■•am a* much aa poaalbia about our oparatiana and our audit tr«i) in particular.
LM ma piafaca thaaa ramtrka with iha atatamani that tinea 1 )oln«d tha aichanga fiva and ■
hall yaan ago my oxparianca tiaa tsaan ll\al tt>a Commodity Futurai Trading Commiaak>n hai
dona an aiamplary job ol govarntng tha commoditiaa irtduitry Ihrough a vary chatlangkig pariod
in tha indualiy'a davalopnianl: ■ tima of plianomanal growth In trading voluma, in numbara of
proOucU Iradad and in Itw divarijty ot IntlrumanI* availabia lor trading, Tha racani
govarnmani invaatigation looming aa it > ovar Ihaia procaadlnga. I faal tt Imporlant run to loaa
light of Iha mammoth iab thai confront* Hia CFTC dadiy and thw auccMa with wNcti ihayVa
aecompliahad tha taak thua far.
Now. lat ma ipacificiaiiy addrasa iha provlik>ni ol tha raauthorizalion bill aa put forth by your
Parmanant Haauthoriiallon
TTia Kanaaa City Board of TrWa aupporta unaqulvocally ttia propocal to malia Ilia CFTC a
parmanant govammant agancy. The commodiliaa induilry haa maturad ovar tha put 10 yaar*
into a kay iMayar in tha inlamational riak managamant arana and iha CFTC haa provan Ittalf a
capabla and tough raguialor through Itwt aignincant pariod.
Tlta procaai of raauthoniation dietalad by Iha currant atructura cauaaa an unraaaonabia draki
on CFTC, induitiy and CongresalonaJ raiourcoi in Iha conlinuaJ affort to rajuaUfy tha MQ»nef*
axiatanca. Tha currant atructura alao hindara tha affaetivanaaa of tha Commiatlon by nuMng II
a political pawn praciaaly at Ihoaa crisis momanw whan hill Commission raaourcw ara naadad
To giva ttia Commission permanani italus aands tha clear message to i
aganclea and lo tha financial markals that Iha agancy hat tha lull Support Of Congraat. Tha naM
dacada prsmiset a new set of chaUengea lor the commodinas Industry bolh from wilhin our
borders and outaida Iham, and parmanant raauthorizalion craatas t firm four>dation from which
Iha Commitsion can face those challenges.
Dual Trading
Since tha news broke airlier this year ol the invetligaliont into tha Chteago commodity
mtrkatl. dual trading has become the banering ram ol those who would like to tea ttia Industry
conslrictad. Tha Kansas City Board at Trade would lilw lo use this opportunity to put forlti thai
dual trading, in and of llsalf. is nol a problem: dual trading is an accepWd, legitimate and
necessary component ol luturas trading, aspacially at smaller aichanges.
TTia kay lo dual trading lias m wttathar Iha aichanga In question haa tha appropriaM aysMms In
placa to detect dual trading abusaa. Thoaa procadurei may vary by exchange, deparvlirig on
tuch variablas at tha number of traders in a particular pil. trading volume in that pN and itM
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h tha •var-dianging m
. Wa al th* Kanaai City
r audit trail aurvalllanca
n •ichanpa*. bacauM wa racognlza Iha nasd to Innwata 1c
Dual txding haa t>aen tnotved thaaa many yaan In 1^ Trading pill iMcauaa il yiald* a
tignificani aconomic advanlaga. By Improving Iha liqijidily ol iha pit, dual trading nalpi lo
asaura aa narrow a tud-aik pric* apraad » poaaitila, with banafiti accruing to all participanta
in mat rnaihsl. A natural conaaquanca at raatricting dual trading la to raduca ttia aHiciancir of
Iha pit by conatrlcling Ihs population of brokari availabla to fill ordara. Thi* raducas pricing,
as wall a* aiaculion, alliciarwy. If not handlad with cara, taauictiotii on dual leading can
intanslly Iha vary problama tfiia committaa la trying to aolva and poaaWy cauaa a [aw mora.
Currant CFTC ragulaliona claarly datall tha raaponaiblUly of aidiangai lo iuruay. aiamina and
invaitigata thait markala to prolaet againal trading abuaaa, including thoaa that may raault
from djal trading. H ta our opinion that any axchanga Ihat can damonatrtla ItaaH capabia ol
fultililng that duty ahould ba aiiowad to conlinua lo dual trada. no mattar how larga daily
voluttw In a partlcular pn may ba, ConvarMly. any aichanga that cannot prova Itislt capabia
ahould not ba allovfad to dual trada. no mallar how low Ha dally voiuma.
Your commiltaa racognizaa that a kay to aflactlva monitoring of trading activity, inchiding dual
trading, ia through an affactlva audit trail. Wa agtaa with you. Tha Kanaaa City Board of Trada
wat tha firal axchanga lo raquira what wa caM 'liming lo tha minuta.' and wa practlcad such
in our pits long betora wa wera rsquirsd to do so. Our ayatam haa been recognized for its
effectiveneaa since itt impiamantation.
Nonathaleas, people who have not been directly Involved In the devalopmeni of auch timing
a of tha difficult nature of tha work involved. While the Kanaas
J to work toward the committae's propoaed one-yaar requirement
dard ar>d tha three-year requirement of a 30-Becond rule, we urga
« committee to allow tlia CFTC reaionabia flaiibilily in determining how and whan the
met. The challenge of the task will not ba clear until work haa begun.
ir asaoclaliona is similar to our opinion on dual trading. Broker aaasclations
are not a problem H an aichanae has tha mechanisms in place to detect
violations of trading rules. In fact, formal and inlonnal broker assoclalions may help the
markets by Improving trading accuracy and efficiency.
nestricting the type and degree of trading between members of a broker association is second
beat to having the procedures in place to delect any abuses aa they occur. The placement ol
restreliona also assumes that broker aasoeiationa are a formal business entity, when In fad
the majority of such assoclalions are quite informal and can very easily be camouflaged or
disbanded to circumvent raslrictive rules. To ba effectiva, any proposal dealing with broker
auociations should, at a minimum, define what a broker association ia and raquira thai graupa
meeting that description be registered as such with the appropriate eichanga.
Qoverning Boerds
Our exchange has no problem with your proposals to make members found guilty of certain
eichange violations inaligible to serve on governing boards and certain eichanga committea* or
disciplinary panels for a set period of time. Likewise, the eichange has no problem with having
30 pareeni of its board membara from outside Ihe exchange.
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Our •ichtng* also can tcc«pt iha provitiont u put forth in th* propoMl lo:
■■RMIuIra \rm aiiablwhrTwni of diiciplinaiv commniaat ai aacn aichanga ihai af* larga
snou(^ W incluc)* a majority in a calagory othar ttian ttiai of a parton baing triad.
--RaqUK* I'M CFTC 10 pu! inio placa ilriclar procadurea to rogulata tatopfion*
aolicitalion of comnnodity account*.
-Raquira tha CFTC to aataUlth atandardt to '•gitiar floor Iradara, artd
-RMIuirB r>*w raglalranla lo attand alhica training.
Th* K«n«w City Board of Trad* applaud* tha comminM'a iMoniniandaiion to maM Iha CFTC a
pamrnnant aBancy, iharaCy aanmg th* ragulaiory ton* n**d*d to carry th* fulurat induciry
Into Ih* 1»0*.
Th* aichang* alao raapacts tha commHlaa'a atMmpIa to prolaci th* public good by trying to
lagialat* agalnal polanlial trading abuaaa, apacKicaJly trom dual trading and brotwr
aaaociation*. How*var, tha Kansai City Board of Trad* laalt that Ihoaa iaaii**, aa ivalj aa th*
9*n*ral good of tfw invaating public, can baat b* aaivad by locualng sach •xchanga'a aftorta on
davaloping a comprahanaiva audH maehanlam la aaaM oul rula vMatara. Only thoaa aictwngaa
not abia lo maal a raasonabi* alandanl should b* rnad* lo confront Ih* conaaquancaa.
Th* U.S. commoditlat Induavy hu •»Ubli«n*d Haalf luccaaafLlly In tha Intamalianal llnancia)
mailwlplac*. As in any growth induatry. houmvor. ci
U.S. Induatry maala iha chaliangaa Ifial lia ahaad, bol
proposal modifiad 1c incluOa our auggastions provida* an accaplabla lrinia¥fOrk on ¥fhlch '
basa thoaa affona. Wa command tha commitlaa lor ila mrorti In drafting thia legislation.
Thanh you (or tha o(4>onunlly to appaar bar* today.
„Coogle
W^ New York Mercantile Exchange
StatoHUit of Z. ]
Chaliman oE tha Board of Dlrnctocs
■aw Tork Nercantila Ezchanga
B0f ottt tba
Onltod Statss Hovs* ot Bepres«ntattT«B
CoaaittMa on AQrleultuta
tt«« on Canaarration, Ctadlt and Sural Daralopnttat
He. Cbairman and Msnbeta of tha Connittaa and
Subcoicnittee. Hy nama la liou Guttnan and i am Chairnan of the
Board of Directors of the Mew York Mercantile Exchange. On
behalf of the Exchange, I want to thank you for the opportunity
to appear before this Subcoimlttee to present our viawa
concerning H.R. 2869 and tha reauthorisation of the CFTC.
It is abundantly clear that H.R. 2B69 aeeka to send a
message to the public that Congress intends to act swiftly and
firnly to rectify perceived defects in the regulation of future
markets. We do not dispute the value of this message. Although
we believe that allegations of abuse in our markets are more a
matter of perception than fact, it is undeniably in our interest
to ensure that public confidence in the integrity of the markets
is maintained.
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While wa luppott th« iMBaaga, as wall as tha concapt of
strengthaning tha regulatory syaten, we differ fundamentally as
to the means chosen to achieve those objectives. For the first
time, the bill aaaks to inpoae Congrsasional ntandatea in a level
of detail tiaditionally lesarved for tha CFTC and the exchanges
— the expects familiai with industry practice, cuatomar needs,
emerging technology and all of tha othet ptactlcal realities of
day-to-day life. Tba bill ignores many important dlffecancas
among the regulated markets and the customers that use tbem.
The net result, we believe, would be to weaken rather than
enhance the efficiency of the system. These weaknesses would be
exploited by our overseas competitors and, in tha final
analysis, the American public would be worse off under h.r. 2869
than it is today.
It is both premature and unnecessary to regulate with
the specificity contained In H.H. 2B69. The present regulatory
structure, with its flexibility, has allowed United States
markets to provide Internationally envied risk-shifting and
price discovery forums that have been of immeasurable value in
achieving price certainty and stability to farners. oil
producers and refiners, industry, the financial community and,
ultimately, consumers. The system works. Reaction to press
reports in January of a Justice Department Investigation into
commodity trading in Chicago demonstrates just that. Virtually
every commodity exchange In the cvuntrif has performed an
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extensive review of its own trading rul«s and practices ovar the
IsEt Biz months. Many constructive reconaandatlons for
requlatorr reform have been offered by the RYHEX Regulatory
Review Task Force and the special review connlttees formed by
other exchanges.
The essential conclusion of the VYHEX Task Force was
that the appropriate nethod to regulate against trade practice
violations was thcough rules designed to ptohiblt improper
conduct, an audit trail sufficient to recreate the sequence of
trading, surveillance and compliance systems that Identify trsde
practice violationa and a disciplinary process that both
punishes violators and serves to dater future violations. On
dual trading, the Task Force recognised that dual trading was
not a problem in itself. The Task Force, therefore, did not
recommend banning this otherwise beneficial practice merely
because of an apparent perception that it created a conflict of
interest.
Until studies determine with certainty that such an
action would not threaten the efficiency and liquidity of the
markets, ultimately harming the commercial and public
participants that the regulatory structure Is designed to
protect, the composition of the markets ahould not be tampered
with. Thus, the Task Force offered many reconmendations foe
strengthening the regulatory structure, but at the same time
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attamptad to ansuia that tha aarkats B«int«liwd tbair highly
teapected pricing capabllitias.
Ha raipactfully raguaat that Congress taica tha saaa
maasurad approach in its reauthorisatian o£ tha CFTC. On a
posltiva note, it sppaars that many of the provisions of H.R.
2B69 aca consistant with the tKKEX Task Force's ceconBandS'
tions. Wa baliava that they represent a reasonable effort at
fine-tuning tha Conaodity Exchange Act and systan of CFTC and
exchange ragulatlons that govern the industry. Our apaciflc
coranants on thoae provisions are contained in an addendum to
this testiiDony.
The dual trading and audit trail provisions of tha
bill, on tha other hand, seen to represent a "shoot first and
ask guestions later- approach. They place at risk the
efficiency and viability of out narkats. He are fearful of such
a method of legislation. Once the damage ia done to the
markets, it will be irreversible. Accordingly, ife respectfully
reguest that the Subconnil ttee reject those provisions of the
bill.
To briefly digreas, trading populations on conaodity
exchange floors are comprised of three groups of participants:
floor brokers who exclusively execute customer orders, floor
traders who serve exclusively aa narkat-maketa, abaorbing risk
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by trading for their otra account*, and ao-call«d 'dual traders'
who may both execute cuataoMt ordera and trade Cor their own
account on the same day. Theaa three components/ though not
necessarily comprised of equal numbers of traders, are the three
legs of the stool that support the open outcry auction market
system. That system, in turn, provides the most efficient
pricing system in the world. On an average day, there are
approximately 450 traders on the NYKEX floor, spread anong crude
oil, heating oil, gasoline, propane, platinum and palladium
futures trading and crude oil, heating oil and gasoline options
trading.
The liquidity provided to the markets by dual traders
varies depending on a wide range of circumstances. It varies
between commodities, times of the trading day and between
exchanges. In Hew York, for example, the limited number of
gualiCied floor traders makeB each individual's contribution to
the market more significant and less replaceable. In out Crude
Oil market, during the most active period, 65% of traders are
dual traders. They trade 35% of the total volume as
market -traders for their own account. They also provide a
significant amount of brokerage service for customer orders.
I am not going to suggest that if you cut the dual
trading leg from the stool that the stool will immediately
fall. What I am suggesting is that, in light of the vast amount
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□£ doBtatlc conaarc* that talics upon tba ■tabilltr of tba Btool
foe support, anr proposal that includes a provision for an
inmadiat« or contingent narket-wide termination of dual trading
should not tw adopted.
Prudence dictates that before such action is taken.
Congress nnist have a clear understanding with respect to eacb
individual market, how nuich of the liquidity provided by dual
traders would be lost if dual trading were eliminated and/or how
much of the brokerage capability would disappear if dual traders
chose to trade solely Cor their own accounts. Congress must
also have a clear understanding of the effects that such
fundamental market changes would hava on such things as bid/ask
spreads, the ability to execute large conaerclal custoMsi orders
with limited market impact, and the amooth and orderly flow of
customer orders through an already stretched, limited pool of
qualified floor brokers^ Studies by the CFTC and CBOT on these
subjects are already under way and others can b« expected to
begin soon.
At the present time, there is no evidence that dual
trading is an evil in itself. All that has been said is that
the practice creates the perception of a conflict of interest.
We submit that dual trading alone Is not a problem. Like other
potential conflicts of interest, it can be regulated through the
strict enforcement of rules designed to prevent the abuse of any
conflict that may arise.
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Pot rout tMn«fit, I would Ilk* to doicrltM Don that
syaten Motka, Including how aoaw of the reconowndatlona of th«
NVMEX Taak Fotca and provisions of H.K. 2869 might onhanco the
Hystem without putting its efCiclency at risk.
Th«r« are three primary methods by which a customer's
order can be taken advantage Of on the floor of an exchange.
The customer's broker can 'trade ahead* of that order, depriving
his customer of the beat market price, while raaerving that
benefit to himself. The broker can disclose his customer's
order to another, permitting that other parson to benefit at his
cuatoner's expense. And the broker can deprive hla customer of
a competitive market price by prearranging a trade or taking the
opposite side of the orders without the customer's permission.
Each of these practices Is exnlicltlv orohlblted br rules
cutrentlv In force at Bvery comnoditY Hxchanqe.
There are many ways to ensure that ttsders comply with
these rules. Begin with the principle that in handling customer
orders, floor brokers are fiduciariea. Accordingly, they owe
their customer the duties Of care and loyalty. These duties
represent much more than theoretical, ethical concepts; they are
part of the practical reality In the connoditles market. We
have many, many private attorneys general as customers in our
market. The energy markets, like many other commodities
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BaikAts In this counter, ate co«pti*«d prsdoainantlr o(
■ophiaticatMl, coBBaEcial participants. Including Integcated oil
conpanlai, producars and reflneca, aa wall aa larga invaataant
funds. Thesa partlcipanta actively aonitoc futures and cash
matket pclce noveaenta on a aoBent-br-noaant basis, through
Bcreens showing the HYHEX ticker, by uaing more than one broker
on the Exchange floor and by active consunlcation with upatalrs
traders throughout the industry.
They ate nore than ready to, and do, challenge the
price at which otdets ate filled on the floor if they believe
that they did not receive the best ultiaate execution. They
have the powec of a civil action as private attorneys general if
thelc broker has bteached his duties of cate and loyalty. But
they have luch greater power as ■ practical awttet -- the power
to move their business to a different broker, including a broBter
who does not dual trade;
The Exchange also has trade practice surveillance
programa to ensure compliance with its trading rules. These
piogrsms begin with the audit trail. The BYMEK audit trail la
created by a pit card system that requites each selling broker
to submit, on a ttanaaction-by-ttansaction basis, bard data Cor
each trade. Each trade la then Independently ti«e-stamped by an
Exchange official, and this time-stamp forms the basis Cot
sequencing the audit trail.
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It is the onlr audit trail HMcbanisin of Its kind,
providing tha most accurate, completa and tamper -resistaat
procedure for audit trail creation.
The pit card Bubmission procedure enables RYHEX to
continuouBly input all trades into its computer system
throughout the day, and display these trades on computer screens
located on the Exchange floor and in the Exchange's Conpllance
Department for on-line taview. From a self -regulatory
standpoint, we believe that same-day peer review and Compliance
Department scrutiny provide not only an effective audit traili
but also a significant deterrent to certain trade practice
SYHEX also uses trade Inforfflation from the pit cards to
construct a StceetbOOk — RVMEX's trade register. The
Streetbook provides a chronological trade seguence based upon
nlnute-by-minute exchange time-stamping of pit cards. With
advancements in computer technology, the Streetbook information
is available on interactive computers for selective Study and
review by the Compliance Department.
In addition, the Compliance Department employs computer
assisted surveillance tools to monitor trading. Most relevant
is the '1C/4C' program that is designed to detect potential
cases of "trading ahead.* The 1C/4C program identifies each
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Instanca In which a brok«r tr«d«s Coi his am aceaunt bafote oe
aCt«r axccutlng his custoniar-s oid«r, at a batter price than he
received for his customer. Since its inplenantatioa In August
19S8. the 1C/4C program has resulted in the opening of 19 Eornal
investigations, o( which five have led to disciplinary actions.
Three already have resulted in sanctions for floor trading
violations, while several others are still pending.
The (Inal step in the chain is an effective
disciplinary procedure to punish violators. NYNEX's Task Force
made several recommendations very sinllac to the coonittee
structure and publication of sanctions requlreaents contained in
H.R. 2869. In addition, the Task Force recommeoded special
training for disciplinary conilttee neadiers, and special
penalties for fraud and deceit involving customer orders, such
as the potential suspension of the privilege of executing
customer orders. HYHEX- believes that this regulatory Cramewock
of rules, audit trail, Bucvelllance/compllance and diacipline is
sufficient to deter, detect and punish trade practice violations.
If it Is not, or if any one of the components Is not up
to par, the CPTC already has the power to sanction an exchange.
We subnlt that the appropriate sanction is not a ban on dual
trading that would have unintended negative conaeguences on the
markets, but a sanction more traditionally ImpOBed through the
CFTC'B existing powers.
10
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Horeovac, the approach to dual trading in H.R. 28S9 la
overly aimpliatic. Pirat, voluna does not equal liquidity.
7000 contracta Id a market with a anall deliverable aupplr of
the underlying conraodity repceaanta a different level of
-liquidity* than 7,000 contracts in a market with a large
deliverable aupply where large traniactlons nay be neceasary to
hedge a aingla phyaical tranaaction. One of the key elamenta to
liquidity is the ability to execute a large order without
dlaruptlon to the market. ThuSi In a market auch aa crude oil,
where a 500 or 1000 lot order nay be necessary to hedge a single
transaction o£ 500,000 ot one nlllion battels of oil, the 7,000
contract volume threshold cannot possibly deaonstrate a liquid
market .
LikBHlse, the proposed volume threshold does not take
into account the differences in volume in different contract
months. Thus, a contract's total volune may be 7,000 contracts,
yet all months beyond the spot month may not be very liquid.
The proposed bill would eliminate the dual trader's
market -making capabilities fron all months, not just the
purportedly 'liquid* months. This problen is multiplied
geometrically for options markets where in each listed month
both puts and calls are traded for a series of strike piices.
AS the 7,000 contracts are spread among the various series of
puts and calls, the liquidity in each becomes less and the need
11
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for inccasiad nurket -making provided by dual ttad*ta ia aora
apparent.
Tha approach is ainvlr contiarr to tiaditlonal
selt-cegulation where the needs of particular markets can be
thoroughly addressed and sufficient flexibility maintained to
maximise all interests affected.
In sum, two proposals have been floated to addceaa the
perception problem associated with dual trading. RYMEX'S Board
of Directors met yesterday and would like to offer a third
proposal in which COMEX concurs in ptlnclpla. The two pending
pioposalB, offered by the proposed bill and by the Chicago
ezchanqes tie a market's privilege to have dual tradera to audit
trail accuracy and/or market trading volume. He aubmlt that
this is the wrong approach. If there is a lack of confidence ia
the ability to police tke markets to protect the public, then
strengthen that ability. The punishment of banning dual trading
will hurt market participanta, not help them. It will make
markets less efficient and drive up the cost of doing businesa.
For these reasons, NYHEX offers the following
alternative proposal:
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(a) CongresB shall naodat* that tha CPTC, with th«
full conaultatlOD of each exchange, ahall detecmine an
apptopriata standard for «ach azchangs, to «nsura tha accucacy
of that axchanga'B audit trail. The CPTC shall taka into
account the strengths and unique charactarlstlcs of each
system's method of audit trail craation.
(b) Tha Conaission. with tha full consultation of each
exchange, shall develop criteria to datemine Hhathar each
exchange is in compliance with its standard.
<c) To ensure that tha traders on tha floor of tha
exchange, who actually initiate the audit trail, are hald to tha
highest standards. Congress shall mandate that the Conmiasion,
through regulation, ahall raquira exchanges to adopt tulas
mandating each floor member to adhere to strict, objective
standards for audit trail accuracy. Tha exchange rules shall
provide specific and harsh sanctions for failure to comply,
including, ultimately, the loas of dual trading privileges
and/or suspension from membeTShlp.
He believe that this proposal, more than any we have
heard to data, moat directly confronts the issues at hand. All
bro)cars should ba held to tha highest standsrds in audit trail
creation accuracy. An accurate audit trail is the optimum means
to examine the trading of the individual for violations such as
trading ahead of cuatomer orders.
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Ond«T ttala proposal, Congcoaa Mill lovialktlvolr •n«ure
tbo hlghoat audit trail standards. Tba CPTC will retain Its
self -regulatory authority to ansura tbat the atandards ara
caisfully tailored to achieve Congress' goals while pieserving
the co«petiti«eness of the U.S. futures Markets. The exchanges
benefit by being penaitted to address the issue in a forthright
and direct ■annei. If an individual cannot adbeie to strict
audit trail cieation accuracy standardai the Individual should
be punished. Finally, and aost iapoitantly, with this piopoaal
and tbe aany other surveillsoce and coaplisnce iavroveaents that
ais being iBploaantedf the institution and the trading public
benefit fro* systatas capable of detecting trading abuses and by
retaining tbe aoat liquid and efficient futures Markets to
conduct tbalr hedging and price discovery. On top of that.
Congreaa will have ensured tbat each participant in the process
is Cully accountabiB foi the integrity of the systeai.
I thank you for your tiae and consideration, I welcoae
any questiona that you say have.
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l^lNew %(1( Mercanlile Exchange
Addendmi to
Statsnwnt of Z. Lou Guttman
ChairRMn of tho Board of Directors
R«w York Kercantil* Exchange
BBfoca tha
Unltad States House of Kapresentatives
Connittee on Agriculture
Subconmittee on Conservation,
Credit and Rural Daveloptaant
The Hew York Ketcantile Exchange CHYMEX*) respectfully
submits the following additional views on the provisions of H.R.
28e9.
SECTIOW 101 - DUAL TltADTlK;
RYHEX's position on dual trading is fully set forth in
the Statement. Dual trading is not Inherently evil. It allows
for additionsl flexibility in the marketplace, allowing exchange
members to service customers' needs and/oc provide liquidity as
the needs of the market change. Until studies can be completed
that determine what effect a restriction on dual trading will
have on market efficiency and liquidity, no such restriction
should be enacted.
The only problem with dual trading is that
the perception of a conflict of interest. We submit that the
proper way to deal with a perception problem is to ensure that
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no conflict can be abusad. Th* ptoper war is tbiough •CClcivat
rulei. an accural* audit trail, aggcasiiv* luiveillanc* and
compliance programa, and strong diaciplina. N« beliave that %
HYMEX haa thesB components in place and tbat they will be
further atrengthened through the adoption of the recoi^Mndat iona
of NYMEX'B Regulatorr Review Task Force and many of the other
proviaionB Of K.R. 2B69.
In addition, HYNEX cecoMaends that the following
additional measures be taken;
(a) Congress shall mandate tbat the CFTC, with the
full consultation of each exchange, shsll detenalne sn
appropriate standard for each exchange, to ensure the accuracy
of that exchange's audit trail. The CFTC shall take into
account the strengths and unique characteristics of esch
system's method of audit trail creation.
(b) The Connlssion, with the full consultation of each
exchange, shall develop criteria to determine whether each
exchange la In compliance with Its standard.
(c) To ensure that the traders on the floor of the
exchange, who actually Initiate the audit trail, are held to the
highest standards. Congress shall mandate that the Coonission,
through regulation, shall require exchanges to adopt rulea
mandating each floor member to adhere to strict, objective
standards for audit trail accuracy. The exchange rules shall
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PEOvide apacific and harsh Binctions for failure to conplr,
including, ultimately, tha loas of dual trading privileges
and/or suBpaosion from raai*b«rship.
Wa bellava that this proposal, mora than any we have
heard to date, most directly confront! the issues at hand. All
brokers should be held to the highest standards in audit trail
creation accuracy. An accurate audit trail Is the optiinum means
to examine the trading of the individual for violations such as
trading ahead of customer orders.
Under this proposal. Congress hIII legislatively ensure
the highest audit trail standards. Tha CFTC will retain its
self -regulatory authority to ensure that the standards are
carefully tailored to achieve Congress' goals while preserving
the conpetltiveneis of the U.S. futures markets. The exchanges
benefit by being permitted to addreas the issue in a fotthrigbt
and direct manner. If an individual cannot adhere to strict
audit trail creation accuracy standards, the individual should
be punished. Finally, and nost Importsntly, with this proposal
and the many other surveillance and compliance inprovenents that
are being invlemented, the inatitution and the trading public
benefit with systems capable of detecting trading abuses and by
retaining the most liquid and efficient futures siarkets to
conduct their hedging and price discovery. On top of that.
Congress will have ensured that each participant in the process
is fully accountable for the integrity of the system.
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SECTIQW 102 - TRADIMG AWMW »
At tnCMEX, mamlMcs of fotnal biokar affillationB, known
as Member Flrns, are already subject to ragulation. All trades
between or among them ace treated as ccoss-trades and nonitorad
as such. HYMEX believes that this trading restriction is
sufficient to prevent trade practice violations while still
permitting customers' business to be executed opposite the
mazlimun nunbec of willing counterparties to masimize the
customers' ability to participate in the narket.
RVMEX does not oppose legislation or regulation
requiring that broker affiliations be registered and their
trading monitored. However, HYNEX does not believe that
legislation limiting trading snong affiliated brokers should be
imposed until, first, the CPTC drafts a definition of
'affiliated broker' so that it is clear to whom any trading
restrictions would apply, and second, a study of the scopp and
use of affiliations is completed and a determination of the
necessity of additional trading restrictions Is made.
The CFTC is expected to convlete its study of broker
affiliations early this fall. Accordingly, legislation on this
subject should be deferred at least until this study la
completed.
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SeCTIOM 2D1 - AtlDIT TBAlt-B
RVMEX concurs in the naed for an accurate audit trail
capable of pemittlng th« Recreation of trade sequence. An
accurate audit trail Is a neceasarr component of an effective
compliance effort.
The tine frame for the audit trail, the method for
deternining compliance, and any sanction for non-compliance
should be left in the hands of the CFTC, to enable the strengths
and unique characteristics of audit trail creation mechanisna to
be accounted for .
NYMEX'a audit trail is created by the pit card
submission procedure — a procedure which requires
transaction-by-transaction sufanission to the Kzchsnqe of the
hard data used to create the audit trail. (The Escbange's audit
trail also has several other components to reconstruct trading
activity and detect Improper conduct, including order tickets,
transfer sheets and the Time and Sales Kepoit.) HYMEX believes
that the pit card system is the most effective mesns to create
an accurate, tamper-resistant audit trail, yet it is the most
burdensome on floor traders.
The pit card system records trsnsactions in the
After each transaction is executed on the
23-500 0 - 90 -
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floor of th« Bxch«n9«, th« aell«r is [«qulr*d to aitbatt to an
Ezchangs oCfiCial ■ pit card. Identifying the buying and selling
brokers, tbe cocnodity, nonth, quantity and price of the
transaction. Tha Eschanga official Imediataly tiiM-stanps all
pit carda upon receipt and that tine-stanp becomes the official
time of the trade.
In terms of audit trail accuracy, there ace several
banefita of the pit card aysten, all of which deriira fron an«
simple fact — pit card tines are real trade transaction times.
Pit card times are not Imputed by computer programs based on
assumptions and probabilities. They see not broker entries of
eiecution tinaa. They ate tina-clocked by Exchange officials,
independently recording the time of each transaction. Because
the pit card must be subaltted directly after a trade ezecutlon,
the ability of a broker to altar or amend that information
without alerting the Exchange and documenting the basis foe the
changa is eliminatad. Other systems permit brokers to retain,
review and create or ractaata their records foe a substantial
period after the transaction without detection.
The benefits of the pit card system bring with them
procedural difficulties in achieving the sane empirical
'accuracy' rates aa Other systems. Under the pit card system, a
trader must: <1) complete his trade, (2) write-up the pit card,
(3) submit it to an Exchange official, and <4} have it
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tima~Btamp«d, all within 60 ■•conds. To llIustEata: luppose a
brok«i has a nwEket otd*r to sell 100 contracts of crud« oil
futures for a custosnr. As he starts the process of execution,
he is sble to fill only 20 contracts with one broker at sn
initial pries snd, therefore, continues to offsr to execute the
balance of the order. Nithln noments, his offer Is tsken, in
pactisl filla of 20 lots each, by 4 other brckera. Asauining
that the process took lesa than one minute to coaplete the
execution of the customer order from the first partial fill
through the last, there is still a possibility to comply with
the one-minute time-stamping requirement. (Although the broker
could stop the execution process after the first psrtlal fill to
submit a pit card, this would be inefficient and might result In
significant economic harm to his customer.) At this point, the
broker must begin to mtitm pit cards and subait then to the
Exchange. Finally, still within the 60 second period, the
Exchsnge officisl must retrieve the card and tine-stamp it,
otherwise compliance (fith the one-minute standard technically
will not be achieved.
Although ireKEX believes this ia the most efficient
audit trail creation system, it is easy to see why compliance
with the one-minute standard is hardest. It is slso clesr why
the CPTC should be left the flexibility to determine whether a
30-second standard, at the risk of losing the benefits of the
pit card system, is an objective worth pursuing.
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HYIBX haa inv«stigat«d , and Mill contlnu* to
InvvBtlgata, the availabllitr of technologr that can inpt«v« tha
Bpaad and accuracy of th« procasa by which its audit trail is
created. He have exanlned the poaalbilitr of a hand-held
electronic pit card, but it la not technically feasible at this
tine. Congress must be confident that tho exchanges will
implemant electronic technology as it becomes availablB.
Howevet, it must leave the flexibility to the exchanges to
determine the type of technology and the timetable for
implementation that meet the trading practices and physical
facilitiea of each exchange.
secTiOB ana - Tttr.KHABgFTTiif; ntMm
HXMEX ezpreBBBS no view on Section 202 of the proposed
legialatlon.
SKCTIMI 203 - imDEHCOVEB OPBBATIOMB AMD EMFQRCEMEIIT
Under Sections S and 12 of the Connodity Exchange Act,
the CFTC already has the powers granted to it under Section 203
of the proposed legislation. Accordingly, this aapect of the
legislation is unnecessary.
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IRHEX's IMgulfltory R«vi«(f Task Forc« has recoi^Mnd«d
chang«s to tho RYKEX disciplinary conoittve structure virtually
identical to thoso containad in Section 304 of tb* bill. Theie
ar« two notable exceptlona. rirat. HVHBX would not allow its
staff nembeiB to serve on dlscipllnaiy connittees. Sscoiul,
rather than dividing disciplinary coonlttee members Into the two
categories of floor and non-floor, HYHEX would divide Ita
connittees Into the four categories that represent its
membership — futures comnlsgion merchants, comerclal trade
houses, floor brokers and floor traders. Under this aystem, a
majority of the connittee would still be comprised of OMmbera
from categories different from the respondent.
NYMEX's Regulatory Review Taak Force also reconnended
wider distribution of notlcea of sanctions involving serious
violations and that persons found to have comitted certain
offenses be prohibited from service on the Eschange'a
disciplinary connltteeB and Board of Directors. MYNEX would
work with the Conniaslon to develop appropriate regulations to
govern these matters.
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Bcaard of Diraetof
mniEX does not bellflva that Congceaa naeds to legislate
public participation on eschanga govarning bonds. PraseatlTi
ITYMBX bas thrae public directors on a 19 neDbai board. Choosing
the nost afficient meanB to run ■ cotporata organisation,
including the balanca batwaan tba detached views oC outaideis
and the hands-on and possible salf-interastad views of inaidera
should be left to the organisatione tbenselves.
SECTIQH 205 - BEOUIBED BBfllRTBATIQlt OF FLQOB TRADEBS
Nrnzx has no objection to Section 209 oC the proposed
legislation.
SECTIOM 206 - EHHAHCEWEWT OF HEC3TSTRATIOW BEOUiagMglfTIi
The only objection that nyMEX has to Section 206 of the
proposed legislation is the striking of the phrase 'Nitbin tan
years proceeding the filing of the application* In Sections
8a<3)(D) and <E) of the Act. mKEX believes that ten years Is a
sufficiently long period oE tlae to warrant the presupvtion o£
rehabilitation.
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227
secTicM 207 - mffOBcnmrr of civil mmmy PEMALTigg
mmEX aspresses no view on Section 207 of the proposad
legislation.
SECTIQH 20a - ZTHICS TRAIBIMG FOB HBaiSTRArTB
imiEX has no objection to Section 20B of the proposed
legislation, except to state that foe Exchange mambec
registrants, the training sessions should be adnlnistered by the
Exchange.
RYHEX already had an extensive broker training course
which includes a session on the legal and ethical
responsibilities of floor traders. HVMEX also requires all
Members to adhere to the Ethica Culdalinea for Wemberg of the
Mew York Mercantile Exchange, a copy of which is attached, that
was adopted last fall by the Exchange's Board oC Directors.
SECTIQH 209 - MATIOMWIDB SERVICE QF PROCESS AMD VEHUE
HYHEX Strenuously objects to the provisions of Section
209 of the proposed legislation insofar as it is unclear whether
an action involving both a contract market and any other persons
as defendants may be brought in any jurisdiction or must be
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btought In tlia Jurisdiction tibmtm tha contract marlMt Is
locst*d. Provided that clarifying language indicating the
latter Intent ia added, mCHEX irould have no objection to this
provisions.
gBCTIOM 301 - DEFIHITtOM OF FOREICM FtlTimBS AtlTHORITy
mCHEX expresses no view on Section 301 of the proposed
legislation.
SECTIOM 302 - SUBPOEMA AUTHQRITlf
mmsx expresses no view on Section 302 of the proposed
legislation.
SECTIOB 303 - CXMPERATIQM WITH FQHEIGIl PUTOBEB AIITHOBITIES
NYNEX exprsBsas no view on Section 303 of the proposed
legislation.
HYMEX expresses no view on Section 304 at the proposed
legislation.
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HmKX «zpi«sa*s no vlMf an S«ction 305 of th* piopos*d
legislation.
lYNEX expresses no view on Section 306 of the proposed
legislation.
SECTIOll 401 - AUTHQmZATlOM QF APPMPRIATIQIIB
MVHBX supports the petKanent reauthorlsstion of the
Connnodity Putuies Trading ConnisBion.
SECTIQM 402 - ErFECTIVE DATE
mniEX has no objection to Section 402 of the proposed
legislation.
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ETHICS 6UIDEUNES FOR MEMBERS
OF THE HEW YORK MERCAHTILE EXCHANGE
coiiilillim with ttw Ruland By-L«<nal the Eidwngc.
UK) with IM lam d New Y«* Stole uid Hv UniRd
SUM. Gtntnl pol>cv MUODnMi^iplyinB to (ll NVkCX
■ ne Exdwitc wtH KCh m (I'm *n<l puiuh i
member engaged m my praclKt whidi u uMthi
« <Ue^. ShouM the EKtwn«c diicovcr any bu
9 in iiivBti|attiia Biqi bt lo-
leipreUd by Slifl ■> an alIaii|N lo aOed IM tome or
oulconie ol an invotiption. The independeiKC •ml in-
legnly of the Contiliance Dcfiannail nqi be aiMiaetr
Department'i procedurei.or taka inue with any acUoa
„Coogle
iatmMieido(Mowii.«iltDKlWrlyiRlhaiHUy i"<o pmoml employmtM ivgotUtkmi with ■ UK
on*>hJI|B(ll>tii«ttiidon.'ninllreOofhiiitliliicliry member uiuil be diKloKi] by the Dinclor and UK
dut^ under Iiwloanre thai hit acltom meet the itAiid' menibertolhepreiidenl.aolhellheydono
penonaJ afUIn and the ilUIn (i< the corponHon. In h
Kua Ui queMkHii about hu duttei wHta the Prei-
I, Executive Vice Preiklent « Genera] Counael
, Mnvm ON IXCHAIMI »
ta-Ccn-
■ Acceptu^ Remrdi lor OtHcial Semcc iQlllee ii a way of giving back loi
dkantfe and Iti tnemben, and carri^ wim it a r^^nst-
- MkMwUii ComnMttn Acbant tor Ptnonal Cain biWj to avotd making deduom baaed onadMikiHt
• Oncting Stalt ESorU kr I>erKiaal Can or Fav« '^ *" ** '""'^ *^ "" £»*•"»• »"' •■ "■»■
prohibited in any farm. whMlKi the rrwanJ it direct or
with him in all
DllejitimKyloapracliKwWchtime- ^T"
rctuitinproniplandapprofiriateducl- |^,
M <4 hi> phyiical laciUbet; or on
Hl-being of the Exchange. It la never appropriate
4. Such inAuoKe may properly covial of p(
iscuuion.but when inlluence extendi to a it
■oial financial or buuneei mud. the di- latkimhip by nKing a particular way on a CanniaM.
A Floor Member director likewue cama great weight any potential conllici of Interest anxuig from hia duhea
used to let an example to protect the intefrily of the Fnpon«bilily1o bring that quotKjn to the full Qmmtt-
puhlic. However, it improperly may be uicd to intimi- lev or lo a Knior memtieT ol (he NYMEX atatl auch aa
date.uwell — loieekadvaMageouitradet.ortDDfIn the Piaidcnt. EttctiUvi Vice PiMident or General
impuiutytDottientobrei*thenile>. CommiaalDnahar- Counsel, for loolulwn. Relying on ipiorance ol die
„Coogle
„Coogle
TESTIHONV Of BBHHBTT J. CORN, PRESIDENT
COPPEE, SUGAR S COCOA EXCHANGE, BBPORE
SUBCOHHITTEE ON CONSERVATION, CREDIT AND RURAL DEVELOPHBNT
HOUSE COMMITTEE ON AGRICULTURE
July 18, 1989
Good afternoon, Hr. Chairman. Ky name is Bennett
J> Corn. I am the President of the Coffee, Sugar k Cocoa
Exchange in New York City.
Our Exchange, which has been in existence since
18S2, is the preeminent market in the world for trading
futures and options in coffee, sugar and cocoa. Our
contracts are heavily used by commercial interests engaged
in the production, exportation, distribution and
processing of these three commodities.
Over the years we have seen tremendous growth in
trading on our Exchange. In just three years, our total volume
has more than doubled, from 4,674,278 contracts in 19BS
to 10,019,664 contracts in 19B8. This growth represents a
solid vote of confidence from our market users. One of
the reasons for that confidence is that we have constantly
striven to maintain active, liquid markets, where trading
is conducted in accordance with rules and practices
designed to assure fair, orderly and competitive trading.
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2S4
Maintaining our pr««nin«nt position as an
international market has required us continually to
inprove the services and facilities we offer comercial
traders and public investors. As volume increases and as
technology advances, we have repeatedly reviewed our
situation and committed additional resources to the extent
necessary to meet both present and futures needs. For
example. In the early 1960's we installed a major computerized
information system to support our compliance program and our
market surveillance efforts, as well as the overall management
of the Exchange. This system was praised by the CPTC as being
state of the art at that time. Today* our needs have outgrown
its capabilities. Therefore, our Board of Hanagers last year
authorized the Exchange staff to develop whatever improvements
are necessary and budgeted the funds for the purpose. Barller
this year* the Board increased budgeting for computer egulpmenti
systems and facilities by approximately $5,000,000, which
represents an Increase in our combined capital and expense
budget of about one-third.
At the same time, in response to published
reports about Investigations of possible trading abuses in
the futures markets In Chicago and New York, our Board
appointed a special committee composed of members from all
of the trading sectors represented in our markets to
review all of our rules and practices, and all of our
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285
compliance procedures, with a view to Identifying possible
areas of inprovenent for raconmendatlon to the Board. The
report of that comnittee is expected to be presented to
the Board In September.
These actions are undertaken as a matter of
discharging our self-regulatory responsibility. However,
they are also undertaken as a matter of enlightened self-
interest. This Exchange operates with powerful competition
from eight rival exchanges overseas, most notably the London
Futures and Options Exchange, which actively trades futures
on coffee, sugar and cocoa. Ae I said earlier, our markets
enjoy very heavy participation by conmercial interests from
all over the world, but a majority of our market users also
trade on the London Exchange. It is very important for us to
maintain marketplaces of the highest quality, for if we do
not, it is a very simple matter for our largest customers
simply to take their business overseas.
The basic point is that we have the same goals as
this Subconunlttee. He have to. Our livelihood depends on
them.
We are very concerned, however, that in a
well-intentioned effort to benefit the trading public, the
Bill presently pending before this Subcommittee (H.R. 2B69)
will actually have the opposite effect. Unfortunately, in
its most Important provisions, the Bill proceeds from an
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236
unproven and, we believei incorrect premise. It then
attempts to solve a problem which has not been shown to
exist, and to do so in a way that could seriously damage
the U.S. futures markets instead of strengthening them.
Purthernore, we support granting the CFTC with
broad discretion to regulate the futures industry. Among^
other things, the commission should be free to take into
account differences among the exchanges when developing
regulatory standards. The Bill would have the opposite
effect, in that it would impose detailed requirenents on the
Commission that would erode its discretion.
Section 101 of the Bill would in effect ban dual
trading in markets having an average daily trading volune
of 7,000 contracts, unless the relevant exchange can show
that its audit trail satisfies requirements that may well
be impossible to meet. He would be affected in that at present
our sugar futures trade well over 7,000 contracts per dayi
while coffee and cocoa futures trades just under that atraunt.
'Dual trading" is not defined in the Bill, but we
take it to mean the practice whereby a floor broker trades
both for his own account and the accounts of customers
during the same trading day. While that practice might be
perceived to contain the potential for conflicts of interests,
the fact is that it is carefully regulated by CFTC and exchange
rules designed to protect the interests of the customers.
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217
There ar« instances where those cules are violatedr and we
take disciplinary action against those who are found guilty.
However, there has not yet been brought forward any evidence
to suggest that in fact the practice of dual trading is
actually a najor source of custoner abuse. To the contrary,
as the staff of this Subcommittee has already stated, dual
trading violations are relatively easy to detect) and, if the
practice were banned, those who are bent on illegally taking
advantage of their customers nay well resort to techniques
that are much more difficult to detect.
On the other hand, dual trading provides
important benefits to the market. We do not presume to
speak for other exchanges. However, we can state
categorically that dual trading plays an important role on
our Exchange. In the very brief time since the Bill was
introduced, we have not been able to study the matter in
any great depth. Nevertheless a quick, preliminary survey
indicates that in our sugar futures market, over SOI of
the floor traders are dual traders, and those dual traders
accounted for as much as 00% of the volume on the trading
days we reviewed. If dual trading were banned, there is
no way to say at this time what the effect would be. Soma
floor members would presumably opt only to trade for their
own accounts, while others would presumably trade only for
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custoners. Finallyf son« floor n«Hbers tuy find that It Is
not ocononlcally attractive to carry on only one business or
the othsr and accordingly withdraw altogether.
Whatever does happeni trading volume could be
significantly affected. That In turn could reduce liquidity,
which would be reflected in wider apreada between bids and
offers, and in a reduced ability of the market to absorb
price changes continuously and in an orderly manner. If
liquidity suffers, buyers will pay more and sellers will
receive less than they should. Public traders will be
disadvantaged. Commercials will incur higher costs, which of
course will be passed on to the consumers in the supemarkets.
In our case, the problem will be compounded by
the fact that if our markets lose liquidity to any significant
extent, market participants will find our foreign competitors
more attractive. If and to the extent they shift their
trading to the foreign exchanges, the problem will be compounded.
Liquidity is an extremely important feature in
the competition between our markets and those overseas.
The New York sugar futures market is regarded as having a
major advantage over its London rival precisely because we
have a large cadre of independent floor traders, which
London does not have. Indeed, just last year the London
Futures and Options Exchange held a reception In New York for
floor traders on our Exchange In an effort to entice them
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Another consequence of banning dual trading is that
more experienced floor nembers nay decide to trade for their
own accounts as locals, and only the less experienced will
continue to handle custoner business. This could lead to a
lower quality of execution for customers-
Please understand that I am not saying that all
of these dire consequences will occur if this Bill is
passed. What I an saying is that at this point no one can
be sure what may happen, and there Is no reason to take
the risk of haraing the markets In order to solve a problem
which has not been shown to exist. It Is premature to take
drastic action without having had an opportunity to identify
the problem and analyze the potential effects of that action.
The approach taken by the BUI is a little bit like firing
a revolver in a dark room merely because there la a suspicious
sound .
For all these reasons, we respectfully urge that
the dual trading ban be eliminated from the Bill. The CFTC
presently is conducting a thorough study of dual trading. The
GAO is conducting Its own study of the futures markets, and the
U.S. Attorney In Chicago has been reported to be conducting an
investigation of certain trade practices. It would make far
better sense to wait until the results of those studies and
that Investigation are released before deciding whether any'
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legislation ragarding dual trading is warrantadi and. if
so, what th« preciss nature o£ that legislation should be.
In any event, if the Congress concludes that the
U.S. trading public requires the abolition of dual trading,
then the conclusion should apply as much to trading on foreign
exchanges as on U.S. exchanges. In other words, if dual tradin;
is to be banned, then no one should be permitted to solicit or
accept orders from U.S. customers for execution on foreign exchi
that permit dual trading.
Those are our general observations regarding the
proposed ban on dual trading. In view of the very brief
period that has been available to study the Bill, we are
not in a position at this time to comment on its provisions
in full detail. However, there are a few specific points
which I shall take the liberty of calling to your attention.
First of all, the Bill establishes a threshold
trading level of 7,000 contracts at which the dual trading
ban would apply, but 'then gives the CPTC the power to
change that level in particular cases. There is no basia
for the 7,000 figure, which is completely arbitrary.
Determining an appropriate level requires the application
of expertise to a number of factors, such as the extent of
commercial utilization, the normal bid-asked spreads and
the average transaction size. If there is to be a threshold,
it should be set in the first Instance by the CFTC.
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Further, if ttiara is to be a threshold. It should
apply to each nonth, not to the entire contract, it nakae
no sense to ban dual trading in an Illiquid back nonth.
just because the volume in all months conblnad exceeds sons
predetemined level.
Among the exceptions from the proposed ban would
be trades to correct errors at the opening of the market.
There is no reason why the correcting of errors should be
limited to the opening. If a broker discovers an error
during the course of the day, he should be allowed to get
out of it as soon as possible. He should not be forced to
carry it overnight end thereby be at a risk of substantial
loss. This la particularly true In commodities such as
those traded on our Exchange, where there Is active trading
In foreign markets before our opening, and prices can move
significantly away from where our market closed the prsvious
day.
Another exception to the proposed dual trading
ban would be where a floor broker in affect has the consent
of his customer to engage in dual trading. Brokers typically
receive orders through a number of futures commission merchants,
which In turn may be acting on behalf of hundreds of customers.
In order to make a customer consent requirement manageable, the
burden should be on the customers to object to dual trading,
rather than requiring the floor brokers or the FCHs to solicit
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consents fro* th* cuat<»*rs. In otbar wordSf a floor
brokar should ba allowed to angaga in dual trading unless
a cuatonec directs otherwise. This could be done at tha time
an account is opened and at any tine thereafter.
In sddition, floor brokers generally have no direct
contact with the vast majority of custonars. The brokar is
selected by the PCM to whom the customer gives the order.
Accordingly, if a cuatouar directs that his orders nay not
be executed by a floor broker who also trades for his own accoui
the FCH will have the responsibility to place that custosar's
orders only with floor brokers who do not engage in dual trading
The Bill would direct the CFTC to exempt any
exchange from the dual trading ban if it can show that its
audit trail *(i) can detect any and all instances of trading
violations which tha C<»u>ission determines to ba attributable
to dual trading, and (ii) la fully verifiable.'
This Exchange has and continues to strive to make
enhancements to its Audit Trail System (ATS) to maintain a high
level of effective self-regulation. In that regard, the Exchan;
Compliance Department and systems staff have an on-going dialogi
to improve tha structure of our system. Wa monitor our ATS sys<
to sea that it is functioning effectively and assigning trana-
actlon times. He believe that we have an effective time
recording system in place, and we regularly review source
records .
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He b«ll«v* we have one of the taoat comprehensive
systems In place at any exchange to prevent the alteration or
fabrication of trading records. He collect trading cards
from members on the floor at the end of every half-hour
bracket period, and we maintain these collected trading ca^da
in a secure area where they are not available to unauthorized
persons. Accordingly) trading cards come into the Exchange's
possession frequently throughout the trading day and are
thereafter controlled to prevent alteration. Each of our
trading cards has sequentially prenumbered lines, and all
trading cards are sequentially prenumbered. This prenumbering
of lines and cards allows our compliance staff to monitor the
accuracy of traders' records and to verify the information
contained on those records against the Exchange's price change
register and original customer order tickets.
Hith respect to the sequencing of transactions, our
Compliance Department has standard reviews specifically designei
for the prompt detection of violations, and we have adequate
sanctions for violations of record keeping and reporting
requirements. Further, we monitor compliance with record
keeping and reporting rules in the course of any other standard
reviews conducted by the Compliance Department. Accordingly,
we believe we have adequate procedures to test the accuracy bf
source records and to prevent the alteration or fabrication
of source documents.
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In addition to having pr«numb«r«d s«qu«ntlal trading
cards on which all linaa ar« nunbsradi w« alao raqulra that
floor nanbara record all of the trading thay do (both for
thenaelvas and for cuatomars) in aequential ordar. Evary
trada axacutad by a mamber nuat be sequentially recorded on
his trading cards, whether it is for the nanber's own account,
for a housa account, or Cor a cuatomer. As a result, the
trading cards which we collect from our nenbara at the end of
every half-hour bracket period contain that membar's record
of all business he did at the ring in saquential order. The
docunanta anable us to reconstruct each individual menbar's
trading very accurately against the transactions occuring at
the ring, thereby providing us an excellant audit trail
capability. This enablea us to affectively police our dual
trading rulea and to detect and deter potential abusea.
It is important to note that our record-keeping
aysten differs fron many other axchangas. For esanplSf on
other axchangas, membars' tranaactiona for their own accounts are
recorded on trading carda, whlla custoiter transactions are aaraly
noted on trading tickets. Further, those exchangee require
■ambers to record their personal purchasaa on one aide of a card
and aales on another side of a card. Therefore, they do not have
a alngle record that shows all proprietary and custoaar trades
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While our audit trail is «xtran»ly effective, we
are concerned that the standards set forth In the Bill may
well be Impossibla to comply with. There is no aystem wa are
awara of In balng or on any drawing board that can detect
'any and all' instances of any violation. Furthermore, there
Is no indication whatsoever as to what it noans to require
that a system be 'fully verifiable.* The Bill is structured
so that an exchange would be banned from dual trading during
the period It takes for the CFTC to act on a petition for relief
— a period that could last months or even more. If the CPTC
eventually determines that the exchange has met Its burden,
there must then be a 90-day waiting period after the CPTC reports
its findings to Congress. Only then could the exchange
resume dual tradlngt but by that time, liquidity could already
have been lost, and the harm could already have been done.
There is no need for such a result. The exchanges should be
permitted to have dual trading unless and until the CPTC
determines that the f'equisite standards have not been met.
Section 201 of the Bill would require, among other
things, that every exchange must have the capability to time
the execution of all transactions within an Increment of one
minute by the end of one year, and within an Increment of 30
seconds by the end of three years.
Arriving at an appropriate standard for exchange
audit trails and developing a methodology to capture execution
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248
tines without unduly disrupting floor trading hav« been anong
the most difficult regulatory Issues the CPTC and the exchanges
have had to contend with. After years of study, debate and
controversy, the CFTC adopted a regulation that in effect
requires exchanges to record the time of execution of all
trades within increments of no more than one minute In length.
Each exchange is permitted to develop Its own system for meeting
the requirement. In compliance with this regulation, the
exchanges adopted a nupiber of different systems. Some use
manual recordation of times. Others use complex computer
logic to assign execution times. Our Exchange adopted one of
the computer-driven systems early in 19S8.
As an informal yardstick, the CFTC has stated that
it expects the systems to achieve an accuracy level of 90%.
Our system is still being tested in operation, with problems
being identified and corrected. He are confident that It
will meet the 90% standard In the near future, and we are
striving toward that goal.
In the meantime, what is most important for purposes
of monitoring our markets is that, under the systems and
procedures we presently have in effect, we can (and when
appropriate do) completely reconstruct a floor broker's trades,
in sequence, so that, for example, instances of dual trading
violations can be readily detected.
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It Is •xtr«Hely pr«Matur« to r«quir« at this tins
that th« timing incr«ments b» reduc«d from on« minut* to 30
seconds. In th« first placet there is no evidence to sugg«st
that the reduction would Improve an exchange's ability to
sequence Its trades to an extent that would significantly
improve its ability to nonitor trading activities. In
addition, there Is no indication as to the costs that may be
incurred, or the disruptions in trading that might result,
from going to a 30-8econd standard, and there has been no
analysis of whether those costs and disruptions are justified
by whatever benefits may be derived.
Section 201 also suffers from the fact that it
contains the starkest example of nicromanaging the CFTC in
the Bill, in that It lifts, almost verbatim, language out of
CFTC Regulation 1.35 and raises It to the status of a statutory
requirement, thereby depriving the CFTC of the flexibility to
amend its own regulation.
Section 102 of the Bill would make it unlawful for
one member of a broker association acting for a cuatoner account
to trade with another member of the same association trading
for his own account, and for any one member of an association
from effecting more than 25% of his own trades in any month
with another member of the same association.
First of all, I call your attention to the fact that
not every exchange recognizes the concept of broker associations.
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H* do not* if« hava rulsa r«gulating activitisa of brokara having
cartaln ralationshipa, but w« bellava tha natura of th« rulas
should depand on the particular ralationahlp. Thara ia nothing
wrong par aa with allowing ralatad brokara to trada with aach
other, whethar for customer accounts or thalr own accounts.
Tha objactiva should ba to anaura that all tradaa are opanly
offered and avallabla to avaryona In the pit or ringi and our
rulas «ra dasignad to that and.
Purthermora, wa ballava that a 35t linit, auch as is
proposed in tha Bill, would ba vary difficult for Meabars to aonJ
Anong other thlngSi whan a broker nakas a bid or oftar, there
is no indication as to whathar ha is acting for hia own
account or that of a customer. Tharafora, tha opposite broker
or trader has no way of knowing whathar tha 25) Unit would
ba appllcabla.
Hoat inportantlyi we ballava that whatever rules
are adopted should ba left to tha diacration of the exchanges.
He are not aware of any evidence to auggeat the need for
Congressional legislation In thla area.
Section 202 of tha Bill would provide that no one
who sollclta an account from a customer by telephone nay enter
an order for that account during a coollng-off period of
three days, with certain excaptlona. We assune that this
provision will be the subject of coMoent from others. Navetha-
leas, I would like to point out that the effect of thla provi-
sion could needlessly ba to prevent a customer of a lagitlnata
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brokftraga housa teom taking advantaga of an Invaatsant opportunity
In tha coMKodlty Barkatsi prlcas can Bova wary rapidlyi and
during tha thraa days a cuatoaar la ragulrad to cool off, ha
may mlas a good opportunity to aaka a profit. Such a custoaar
Is being punlahed bacausa of tha fact that aoaa hollar rooB
operatora taka advantage o£ thalr custoaara through high
preaaura sales tactics.
Ona othar obaarvation la that thara doaa not aaan to
be any basla for dlatlngulahlng U.S. futuraa and options fro*
other iRvaatmant products. If a coollng-offi period such as
this is adopted for tha protection of U.S. tradersi It ahould
apply as well to sacuritiasi foreign futuraa and all other
inatrumants that are sold for Investnant purpoaaa.
Sactlon 203 vould raqulra tha CPTC to 'continue'
to cooperate with appropriate Federal aganclea In conducting
investigations. Hhile cooperation with othar agencies is of
course dasirablai to mandate the Conaission to do what it is
already doing saens superfluous and unjustifiably demeaning
to the Conalssion.
Section 204 would require the CFTC to adopt
regulatlona requiring exchangee to have disciplinary conaitteeaf
specifying the coapositlon of those comnitteea and requiring
the establishment of a achadule of 'major violations,' tha
comalssion of which will render an individual ineligible for
service on the governing board or dlsolplinary cOaaltteee of
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any »xchang« or r«gist«r«d futuraa aaaoolation. In patt, this
provision la suparfluous, because the CFTC alraady haa (and
has long had) ragulatlons in place iraquiring disciplinary
connnittees and setting standards for their conposition. To
go into the kind of detail apacifiad in the Bill Is for
Congress to engage In mlcromanagement of the CoDBisslon to an
extent that is contrary to the entire concept of appointing
administrative agencies.
One provision of Section 204 would specifically
require that a majority of persons on a disciplinary coaniittM
must be of a different 'trading status* than the respondent
in any proceeding before the committee. Such a reguirenant
could also result In depriving a disciplinary panel of tha
expertise it should have in passing on questions that require
intimate familiarity with trade practices and standards. As
it happens, the Business Conduct Coanittee on our Exchange la
presently composed of three floor members and four non-Cloor
members, and It did not take any statutory or regulatory
requirement to produce that result. Rather, It was th« raault
of our applying our judgment as to what was appropriate for
our Exchange under all the circumstances. Each exchange
should be left to make its own decision In matters such as this
subject, of course, to CPTC oversight.
Section 204 would also require 30t of tha meabera
of every exchange board to be comprised of 'outside aaubers.'
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This seene lika another exanple of unnttceseary nicromanagcnant
of th« CfTC and th« exchanges. As It happens, our rules h«va
long provided for diversity In the membership of our Board,
Including public nembershlp. There Is no need for a statute
to require this.
If the Congress nevertheless decides that board
diversity should be mandated by lawi we suggest that, rather
than setting detailed requirements In the statutSi Congress
might consider the approach followed In the securities laws
for securities exchanges — • specifically In Section 6(b)(3) of
the Securities Exchange Act of 1934. which requires that each
securities exchange "assure a fair representation of its
members In the selection of its directors and administration
of Its affairs and provide that one or more directors shall
be representative of Issuers and investors and not be associated
with a member of the exchange, broker, or dealer." Presumably
the analogue to an "issuer" in the coomodities markets would
be a market useri such as a grower, manufacturer, processor
Section 204 of the Bill would require registration
of floor traders. We support this provision because it will
help the CPTC and the exchanges to keep persone with criminal
records and other undesirables out of our industry. He do
suggest, however, that the CFTC (and any registered national
futures association to which the CFTC delegates the registration
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function) b« «ncourag«d to adopt a t«nporairy registration
procadut*! so that properly quallCiad parsons srs not daprivad
oC the opportulty to function as floor traders during the
sonetlmes lengthy period that their applications Cor registration
are being processed.
Section 208 of the Bill would require ethics training
for all Conmission registrants. He strongly support the
concept of ethics training for Industry participants. Indeed>
our exchange and several of the other New York exchanges already
require an ethice course (or new members. On the other hand,
we bellve that unnecessary duplication oC requirements should
be avoided. He therefore suggest that the Bill be emended to
provide an exception (or persons who take suitable ethics
training under the auspices of a self -regulatory organisation.
Section 401 of the Bill provides for reauthorlsalton
of appropriations under the C<Nnnodlty Exchange Act Cor only
two years. He are disappointed that the period Is so short.
Ha believe that the CPTC has demonstrated that It Is entitled
to a permanent place in the U.S regulatory scheme. Over the
past years it has built up the expertise necesary to reconcile
the goal of protecting the public with the goal of accommodating
the reasonable needs of the businaes. Frequent reauthorlsatlons
divert the Comffllsslon Crom Its regulatory mission because of
the heavy demands that are placed on its modest resources
by the need to prepare Cor the hearings and to resj^nd to
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Congressional inqulri«a. Accocdlngly, w« urg« th«t the Bill
be amended to gcant the ConunisBlon psrnanent status.
He. Chairman, that concludes my testinony. I
appreciate the opportunity to testify before you today. If
you have any questioner 1 will be happy to ansver then if
I can, and to submit the ansvers later if I an not able to
provide them now.
Thank you.
23-500 0-90-9
D,gnz.dbvC00gle
Kr. Chairman, ■•Bbsrs of tha SubcoBBltt**, I «■ Robart
Fink, Chairman of th« Board of Commodity Exchanga, Inc.
(Comttx) . Comax la tha world'a moat activa matals futuraa markat
and ttaa fourth moat activa of all futuraa markata In tha Unltad
Stataa. Our axchanga providaa an arana for trading futuras
contracts on gold, ailvar, coppar and aluminum, and o|^iona on
gold, ailvar and coppar. Usara of our markata includa
apaculatora, coamarcial and industrial hadgara, and major
financial inatitutlons — both in tha V-,8. and abroad.
/
I am vary plaaaad to hava this opportunity to ahare
Comax'a vlava on tha Bngliah/Colasan bill, H.R. 2869.
Ha ara vary concamad about tha ai^roach that has baan
takan in tha bill. Particularly objactionobla is tha appaaranca
that Congrasa intands to daal with iasuea auch aa dual trading
and audit trail that are alraady subjacta of coaprehensiva
ragulation and to lagislata datails that should ba datarminad
through rulemaking by tha Commodity Futuraa Trading coamiaaion.
This couraa of dealing with futures Industry regulation aaems to
b* at odds with atatamants made by tha chief aponaora of tha
bill at their June 28 press conterenca and the provision in the
bill that is aimed at establlBhing tha Commission aa a parmanant
Independent regulatory agency.
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On Kay 30, 19B9, tha CFTC trannittcd « proposad
achadula of adalnlstr«tlv« actions to Clialiraan Laahy of tha
Sanata Coaaittaa on Agrlcultura, Nutrition, and Foraatry. Hia
Comdaalon statad that, aaong othar thinga. It would: propoaa
ragulatory ohangaa ragardlng audit trail* and dual trading, it
any ara warrantad, by SaptaiAar 19B9; publish lor public coisant
during tha 4th quartar of n '89 a proposal rula that will causa
axchangaa to bar, for an appropriata pariod of tl*a, thoaa
»e*bara with aignificant disciplinary racorda froM aarving on
sxchanga disciplinary and ovaraight pansla (a final rula la
axpactad by tha end of Dacaabar 1989); and coaplata tha
aaaassaant of tha infonution on brokar associations In August
1989, and than dataraina what ragulatory Inltiativaa, il any, ara
naadad. In addition, tha Conisaion has atatad that it Intands
to ravlaw tha adequacy of raprasantation on axchanga governing
boards aa part of its rule anforcaaant review proceas and to
recoaaand further action it tha boards ara found not ba be
broad-baaed.
He believe that the prudent courae to ba followed is to
allow tha Coaalsaion to proceed with its efforts on thasa issues
and develop an adainlstratlva record that can aerve aa a basis
for a raviaw by this 6u]»coaaitte* of those iasues. TharaCora, wa
do not support the sections of H.R. 2869 Which deal with dual
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trading (Ssctlon 101), audit trailB (Saction 201),
aaBociationa (Saction 102], and diaciplinary caaaittaas and
govamlng boarda (Saction 304} and baliava thay ahould ba
droppad Crtm tba bill at this tisa. If ttw SubcoMtittaa la
dlesatlBfied vlth tha avantual actlona taken by tha Coaalaaion
in thasa araaa. It can hold haaringa and taka whatavaz action
its daaH* naoaaaary at that tlaa. Tha pracadant of
congraaaional Involvaaant in tha handa-on regulation of thaae
■arKats, prior to CFTC action, la not a couraa that waa
contaaplatad Mhan tha CFTC waa aatabliabad and ia a couraa that
haa not B»«an followad to data.
During this raauthorlzatlon procaaa, tha SubcoaMlttaa
■ight Hora pr^^rly ask box tha CoBHisslon has dlscbarqad its
raqulatory ovarslqbt ras|?onslbilltlas uith raspact to its areas
of concam. In Coaax's viatr, comparative atatlatica daaling
witb tba sisa of tha axchange compliance staffs, expenditures on
coapllanca prograas, and *onatary sanctions against axchanga
■aabar* for a variety of trading abusas denionetrate Burprlsing
disparities «Kong the axchangas. Regulatory revlava parfonaad
by ttaa CFTC of the exchanges' coapllanca efforta aleo dlaclosa
differing degrees of coi^laitity and breadth of investigations
they conduct and of the violative acta uncovered and
sanctioned, it le difficult to understand how a single
regulatory aachanisa can expect to stride saoothly toward tba
goal of fair and honest trading when its tools of ■easuraaant
tolerate so »any standards of perf oraanca aaong its eoving
part*.
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In addition to th« foregoing, w« would also atrcss that
to proparly avaluata tha naad tor imw lagislation in tha araas
of dual trading and audit trail, tha kir auat ba claarad of
presumptions of tha lack of warkat participants' Intagrity.
Abaent tha ratnm of IndictMants or any otbar indication of
vrongdoing attributabla to dual trading and auggaativa of
inadequatQ audit traila, wa ballava that laglslatlva action,
partlcnjlsrly that alaad at rastrlcting dual trading, la
prawituT*. In fact, until Mor* la laamad of tha findings
raaulting troa thasa invasti gat ions, we cannot avan diacam
whathar tha types of conduct which are the subject of tha
invest igationa ware not already detected by the raspactiva
exchanges' survaillanca prograaa and sanctioned through their
disciplinary procasaas.
Finally, the Subcovvlttee should also be aware of the
Introspection that the industry has undergone since the
disclosure of the federal Investigations in Chicago and jfow
York. The Industry as a irtiola has engaged in a reevaluation of
existing practices, and tha exchanges have forsed advisory
panels to obtain guidance in this procaaa. Congressional
intervention before completion of this procsss will
significantly undenine the efforts of nusarous
well-intentioned, dedicated Individuals iriio are seeking tha sane
goal as this Subcomittaa — restoration of confidanca in tha
■arketplace through enhanced custoaar protections.
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DOAt. TBADtWC AMD MIPIT TBAILfi
Section 101 ot th* bill, in uaAitc*, would prohibit
dukl trading in any contract »ar)c«t whicb haa a dally avaraga
voliuH of 7,000 contracts or Mora. Tha bill axpraasly axaipta _
froa tha ban (i) apraad tradaa axacutad by a tloor brokar tor
hia own account, (11) trading by a floor brokar on tfaa opening
to corraot arrora aada In his account tha pravioua day, and
(ill) tradea axacutad by any brolcar trtioaa custoiMr apecifically
authoritas tha brokar to angaga in dual trading, nils saction
of tha bill also authorltas tha CFTC to axa^t an axcbanga frca
tha ban if tha axchanga daaonstratas to tha CFTC that it* audit
trail Is "fully varifiabla" and "can datact any and all
Inatancaa of trading violations irtiich tha Coanisslon dataralnas
to ba attributabla to dual trading."
In tandaa with tha dual trading prohibition, Saction
301 of tha bill would raqulra aach axcbanga to aaat tha
ona-ainuta trada axacutlon tiaa racordation raquiraaant within
ana yaar of enactaant of tha bill and a thirty-aacond trada
axacutlon tiae racordation raquiraaant within thrae yaara of
anactawnt. This section of the bill furthar diracts tha CFTC to
dataraine (i] whattaar tbasa aaasuras bava anablad rapid
reconstruct ion of an accurate, verifiable record of tranaaotiona
to provld* for affective rule anforcaaant and (11) whether use
of i^rovad tachnologias can iaprova tha accuracy of racordation
and aarkat reconstruction.
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CongrassBBD English stated at th« Jun* 28 press
conCaxanca at which tha bill was Initially dascribad that thass
provisions hava b««n proi^sad bacausa "nona of tha axchangas
hava raachad tha ona-ainuta standard" and, as a rasult,
datactlon of avary Instanca in which a dual trading floor brokar
•ngagas in trading abusas cannot Baa guarantaad.
Comax takas issua both with tha assmptions undarlying
this lagislation as wall as tha spacltic provisions aabodiad in
tha lagislation.
The threshold Issues which auat bs addressed by the
SubcoBBittee prior to passaga of any legislation are, first,
identification of the objectives of the legislation and, second,
a detaraination whether tbe BechanisBS prescribed by tha
legislation are the sost effective Beans of achieving these
objectives, in our view, adoption of tha proposed legislation
is inadvisable when both of these questions are answered.
It has been suggested that dual trading presents an
Inharant conflict of interest and poses an opportunity for abuse
by wrongdoers. Hhlla the objective of banning dual trading
a^ears to bs the eradication of potential trading abuse, we
balleve that tbe abolition of this type of trading would
allMinate only one type of abuse - direct frontrunning - which
is already unlawful, without affecting any other trade practices
that disadvantage customers. Each of the other (also currently
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prohibited) Bcthods of •ttacting sijillar rosults Buch a* th*
wittaboldlng ot cuatowar erdaxa and ttaa diacloaura of cuatoaar
ordara In axchanga for profit-aharing - indlract foxaa of
front-running - vould raiuin unaffactad by tba propeaad ban. In
fact, your own Su)»coanittaa Staff Dlractor has advlaad tba
aubcoaalttaa, during tha Hay 4 briaflng, that trading abuaea
will not ba curtailad as a raault of prohibiting dual trading
...(t]ber« ara only two trada violatlona
which a singla Individual can acco^llah
alona. Both of thoaa abuaaa can alao ba
acootq^liahad batwaan tvo or aora
indlvlduala.
Thaaa violatlona are trading ahaad of a
cuatoaar and taking a poaitlon againat a
cuatoBar .
Thaaa two violatlona whan axacutad by a
aingla paraon ara aaong tha aaaiaat to
dataet in an accurate audit trail. Thev
atlek out like a eor* r.hmh. (BBphaala
added.)
mua, tha abolition of dual trading will not further tha
cauae of cuatoaar protection, such a ban could, and probably
would, Bake detection of aoae abuaiva trading practlcea .aore
difficult to detect. Moreover, prohibiting or livlting dual
trading i^aas aarioua dlsadvantagaa to uaara of tha aarkata.
For exa^le, tha praaance of dual trader* in a trading
ring aivplies flexibility that enablea floor traders to respond
to changing aarlcet conditions, e.9.. providing iMwdlate
additional brokaraga capacity in a faat aarkat, thus enhancing
tha efficiency of tha aarkat. This flexibility would be lost if
dual trading were to be abolished.
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Dual tradsrs arc alao vlawad by aarkat us«r« who war*
intarvlawad bf tha BXchanga's Spacial Advlaory Panal aa providing
batter brokaraga aarvloaa bacauaa of thalr graatar trading
axpartis* and senaitivity to warkat f areas. Thay ara not vara
ordar fillara and hava thair ovn capital at riak in tha aarkat.
Tha Exchonga'a Panal has also baan adviaad through Intarvlawa of
tradars, brokaraga housaa and aarkat uaars that tha aB»olitlan of
dual trading is llkaly to inoraasa tha cost of brokaraga
In tba couraa of tbasa intarvlawa, all intairvlawaaa,
without axcaption, atatad that thay uaad (and tha substantial
■Bjority indicatad that thay sought out) dual tradars for tha
axacution of thair ordars, notwithstanding tha potential conflict
of Intarast dual trading prasanta. Nhlla not avary intsrviawaa
was praparad to andoraa dual trading unraaarvadly, not ana
intarviawaa articulatad tha viaw that tha diaadvantagas of dual
trading aaritad its abolition.
MoTaovar, and aast iaportantly, tha affact of dual
trading upon aarkat liquidity haa not yat baan fully atudiad. It
is iaparativa to dataraina tha affact of tha prasanoa of dual
tradars upon liquidity in aaeh Mrfcft prior to tha adoption of
rastrietions which «ay hava an Irravarsibla Intact upon tha
viability of our aarkata. HiaBa aarkata ara not tha saaa; aadi
baa its cwn spaoific cbaractariatlca.
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Th«aa tactora *r« all lBport:>nt to us*rB of our »BrlC«tB
and b«ar conaid«ration In waighing Uta »arlts ol curtailing dual
trading by legislation .
Ha ballava that it is inarguabla that an aftactiva audit
trail is a oomarston* to datactlon of trada practica abusss, of
which diract frontrunning ia only one. For that reason, tha
exchanges have coenlttad substantial rasourcaa, both in tenw ol
nanpower and dollara, to developing coeprehensiva Methods of
capturing trade data and analyzing tha data to facilitate
investigation of exchange aatabera' trading activities. As part
of the audit trail prograe, tha CFTC has sonitored our progress
and provided advice on how to ieprove these ayataBB, particularly
in tha area of surveillance, to better pertor> our obligations
with rsspect to the one-«inute standard currently aabodlad in
CFTC Regulation 1.35. In fact, tha CTTC has been actively
engeged In detemining the verlfiability of the date currently
collected, the extent to which abeance of data binders an
exchange's (or the CFTC'b) ability, to reconstruct aarket
activity and tha use to which the data is currently put. In
light of these ongoing efforta, it ia unclear lAiat objectives
this portion of Section 201 seelcs other than to reiterate the
■andates under which the exchanges and the CFTC have been
operating since 19B7.
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ni* second prong o( tttm audit txall ■•ction, which would
halve tha raquirad tiaa of racardatlon to thirty-seconda within
thraa yaara of anactaant of tha bill, has bean propoaed without
putting forth any eapirlcal evidence of tha potential banetita to
detection or tha feaaibillty of constructing the systama
neceaaary to capture this data. Absent evaluation of auch
information, wa believe the fiubcoaalttee would be acting
precipitously if It ware to adopt such an approach.
The third provision of tha audit trail section' of the
bill, Buthorlrlng tta« CFTC to exavpt exchanges fro* the dual
trading ban, is drafted so aabiguoualy aa to create a "Catch-22"
under the current regulatory structure. Since 19B7, the
Cotninl ssion baa been reviewing each exchange's audit trail program
to deteraina its efCectivenese in enabling adequate aarJcet
reconstruction. Its verlflablllty, and the extant to which It has
been Integrated Into an exchange's Burveillance program to detect
trading abuaaa. Understanding that even the most high-tech
system c^ppfttl capture every aingle Inatance of unlawful trading
(Buch as an iaolated one-contract trade executed one time), the
Commiaaion haa been developing trtiat. In Its expertise, ia a
standard of performance which, asaumedly, will apply to all
exchanges. Rather than continue to allow the Commission to
define the standards by which exchange audit trails are moat
appropriately measured, the bill appears to hold the Commission
(and resultantly, the exchanges) to what may be an unworKable
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Btandard, that of requiring th* d*v*lopBBnt at a tully varlfiabl*
aymt«B, capabla of catching all instances ot certain trading
aB»is*s. This result iq)raparly pre-^ipts the Cosalssion's
authority and may render the axeq^tion meaningless.
nie thrust ot our observations on the dual trading and
audit trail provlsione ot the bill ie easily distilled. He
believe that the only eftsctive aeans of coabating abuse of
custoaer orders ia to i^ileeent (1) Dechanlsns to capture data
tjiat enable tracking ot the tlou of all orders troa the tine of
placement through execution; <2) eeana of anelyting trading data
to detect patterns ot unlawful actlvityt (3) use of the data to
prosecute traders involved In unlawful activity; and (4)
iaposition of eubatantial diaciplinary sanctions against those .
adjudged to ti* rule violators. Absent any one of these four
aspecta of an exchange's obligations to the Investsent ctnaeunity,
customers will not be protected to the extent they ahould be.
The current provisions of the Commodity Exchange Act
mandate the performance of these obligations through rule
enforcement ravimra ot each exchange and subject the exchanges to
entorcsnent proceedings it they have failed to enforce their
rules. Including those pertaining to dual trading and audit
trail. Ae the Subcamnittee Is aware, enforcement proceedings oan
result in the revocation of e contract mBrlcet'a deaignatlon - a
atrong aanction In anyone's view. If an exchange is not
complying with its obligations, w* would el^ect that strong
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action would b* taken. Rather than supporting thla
' adainlstrativa procua, thia laglslation iaproparly diaadvantagaa
custoBara froN tha onsat - without any avidanca ol wrongdoing at
an exchanga - fay virtu* of a veasur* that is haralul to ttaoaa
aought to ba protactad by all partioipanta in tha regulatory
process. CongcasB should not be lagislating to cosbet a
perception) a negative perception altects the exchanges' buainaaa
and it is In their best intereat to coabat it, as they are doing.
Thia provision of tha bill ia further flawed in that its
focua ia diverted free the actual wrongdoers. For exavple, the
bank teller lAo aBbezzlea bank funda haa gained accesa to thoae
funda by virtue of hia anployaent. The corporate officer vbo
illegally profits frov bis non-public information gained that
infonutlon by virtue of hia aaployMent. In either caaa, whan the
arl>e is diaclosed, the perpetrator ia brought to justice. In
neither case is the bank or tha corporation closed for business.
If this bill is enacted, it will not be the trader 1^0
has illegally taken advantage of custoksr orders - tha violator -
trtio would ba aubjeoted to aanctions above and beyond those
currently available; rather, it is tha >arketplace that would be
restructured. Nobody, however, can speak with any degree of
certainty to tha affacta of that restructuring. It is «t beat
unwise, and potentially disastrous, to prooaed on thia path
without further study. Modem technology and international
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coBp«titiv« laal dapriv* you, *nd ua, of tli« liunixy of allowing
you to b» tfrong on thia iaaue, for liquidity onoa loat la alBoat
i rratr lavabla .
Clearly, no do not condona abuaiva trading practicaa.
Vm baliava, howevar, that tha axiating audit trail ayataaa
adaquataly dlacloaa trading abuaaa; that tha audit trail aysta**
will continua to ba iaprovad in an evolutionary Mannar aa naw or
l^rovad tachnologlaa bacoaa availoblai that tha induatry la
baco*ing convincad, aa Coaax haa baan for aavaral yaara, that an
effective aurveillance and coBpliance progra> is neoaaaary, and
banafita all concerned) and that the IncreNantal benefit to be
gained by Boving to « 30-seoond trade tiae recordation
requira>ant doea not justify the coats involved and could divert
efforta troB tha developsent of r*al-ti»e, on-line systeM*.
Hm tools are in place to deal with the abuses of dual
traders. It is up to the exchanges to demonstrate their
trillingnasa to iiqiose aerloue sanctions for serious violations
and tor the Coasiaslon to ensure that these efforts are
undertaken, if those coBvitBenta are not aade, the data
generated by the exchanges' audit traila are Barely so aany
aquigglea on a piece of paper. CoBOx has a long history
evidencing its commltaant to enforcing its trading rules, and the
Industry as a irtiole is now adopting a auch stronger regulatory
presence. Extensive studies have B>e«n undertakMi and will
continue to be coBslssioned for one slspla reason - It Is in our
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self-intarsat to do ao. Givan that aelf-intereat and our
expartlaa In vbat we do, we ahould ba allowed to aae theae
efforts through to fruition, ftt that point, your evaluation of
progress would be welcoked.
aaoKBt ASSOCIATIOIIg
Proposed Section 1D2 of the legislation would prohibit
aeabers of broker BBBooiationa froB executing ouataaer orders
opposite the personal accounta of aenbera of the association (or
the house account of the association) and would llait the aaount
of trading which could be done between aeabera of the aasocietion
(presuaably without regard to whether the trading is for their
own accounts or tor customers) to a fixed percentage <as percent)
of the associates' and the aasoclation's trading activity.
Assuning that a clear definition of "broker association" can be
devised, Coaex has no objection to adoption of a prohibition
against trading ousta*ers' orders (defined by CTTC regulations as
a type "4" trade) opposite house (defined by CFTC regulations as
a type "2" trade) or personal (defined by CFTC regulations as a
type "1" trade) accounts. In fact, Coeex has had such a rule in
place for seven years, treating this type of transaction as an
lq>ertiiSBible cross-trade.
The second part of this section of the bill, which
lleits trading between associated brolcers to a fixed percentage
of trades, poses serious problsMS to custoaer interests and
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should not b« adoptad. TIm typ* ot llaitAtion propoawd
' prttaiqipoBSB that thara ia alwaya autfloiant liquidity to anabla
th« axaeution of any ouatoaar ordar, ragardlaaa of tha alia of
ttia ordar or ttia dapth of tha Mirkat In tha contract month to
irtiich tha ordar appllaa. This aaausption is not borne out in all
MUrBtats or in all contract aontba, tharaby giving rlae to tha
poBBifallity that a brokar could not fill a custoaar ordar siaply
bacauaa ha had alraady tradad hia tixad allotaant of trodos
oppoaita othar aaatiara of hia aaaociation that day. For that
raaaon, wa ballare that no atatutory llaitation ahould ba placad
on tha axeoution of ouatoaar orders agalnat other custoaar
A Bora affaotlva approach to this issue would be
exchange -adopted rules requiring the registration of all
afflllationa on the exchange on which the group ia trading. Bach
exchange should then ba responsible as part of Its cmipliance
prograa (subject to CFTC review through Its rule anforceaent
prograae) to Monitor tha custover trades executed between
affiliated aaBiberB to sBBura that no unlawful activity haa bean
undertalEan. In light of the exchangea' already-atatad ooMaitBant
to pursuing this course, legislation of this nature is
PgRtOD QF RKMlTHORIZMIOll
Ha sunwrt a fraaework for rssiithorlsation that will
allow the coaaiBslon to effectively continue fulfilling its
responsibilitiaa. The exlatlng syste* ia a aignifioant drain c
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CFTC raBcnircaa anil delaya naaded changea and developKanU.
CongresBlonal ovaraight of tha agancy should ba ongoing and not
Blaply "glnned-up" for raauthori cation. Ukmriaa, tba CoMMiaslon
ahould aubvit racoHMndad lagialatlva ctiangas aa tba na«d ariaes
and not wait to praaant than in a raauthorisatlon packaga. At
thia point in tlMa, no on* is quastioning tha contlnuad axlstanca
of tha CFTC, and it should not be hald hostaga to a laborioua
raauthori cation procaas.
UHDERCQVER StntVEILL^MCE
Saction 203 of tha bill aMands tha CoBnodlty Exchange
Act to axprassly authorlsa tha ConniBBion to participata in
jolnt-tadaral agancy invastigations - a practice which baa baan
ongoing for years - and notes that these inveatigationa mmy
ancoepaaa "undercover operations." Absent any restrictions on
the CoMeiBBion'a inveatigative techniques or authority in the
current language of Section 8(a) at the Connodity Exchange Act,
this Bupplenentary provision 1b unnecessary.
GOVBRHIHG BOARDS ADD DISCIPLIMARV COMpTTEgp
Proposed Section 204 would (l) require that the board of
each exchange and the NPA include a fixed percentage of "outside
maabers" (as defined by the CFTC) i (3) require the CFTC to issue
regulations calling for the aatabllshBsnt of a systea of exchange
diaciplinary coaaittees; (3) require the CFTC to Ibbuc
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rcgulatloiw requiring axctuuiqca to aatabliBh and vaka publicly
availabla a achadula of its "aajor" vlolationai and (4) bar
wawbara of an excbang* trtio hava angagad in "aajor" (aa dafinad by
an axchanga) violationa of that axchanga'a rulaa Croa aarving on
that axchanga'a board or diaciplinary conaittaaa tor a pariod of
tiaa to be apacifiad by the Crrc.
&i Coanoaltlon of the Board
Purauant to by-law, tha Ca*ax Board of Govemora la
coBpriaad of aavan rapraaentatlvas of tha trading floor (tha
Floor Group), aavan representatlveB of futurea commission
■erchanta (the Commission Houae Group), aeven T-aprasentatives of
tha aatala trade (tha Trade Group), three non-aeabara , and a
■aMbar chairman elected by the full aaaberahip of the Sxchanga.
tha Matala trade (tha Trade Group), three non-a^ibara, and a
■aMbar chairman elected by the full membership of the sxchange.
Tha Exchanga'a intent in aatabliahing thla form of governance waa
to anaure diveraity of viewa during deliberations on all policy
iaauea, to provide for rapraaantatlon of all aactora of uaara of
our markets, and to obtain guidance from individnala unralatad to
tha Bxcbanga and its aaabara on mattara affecting the public
inter est.
In many exchanges' experience. It is often difficult to
solicit aervice by non-markat participants irtio will offar a
■ubatantlal dagree of indepandenca from tha laadarabip of tha
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■xchanga, who are willing to d«valop axpartia* ralavant to ttt*
iaaiMa at hand, and who ar* capabla of coMmltting tha tiaa nasded
to aaaiat in what ia often protracted dacialoraMking. For that
raaoon, w* baliava that tha daaignation of any fixad parcantage
of non-»^Db«r oeate on a board or coBnittea through lagielation
without ragard to tha difficultlea in obtaining "quality"
repraaentation la a alaguided intrualon into exchange corporate
attalra and is nerely an expedient nethod of desonstrating
representation of tha public Interaat without aubatance.
Ne would alao object to lagialation deaigned nerely to
aasure that pereona other than floor tradera (auch aa individuala
eaployed by wire or trade houaes) are rapraaented on governing
boarda. Nhlle wa believe that an exchange's dacisionaalcars must
represent all faceta of tha investment couMunity to assure that
' tha axchanga's deciaions are aada in good faith and that tha
public's intaraats are pronoted above thoaa of the Baaberahip,
tha actual coBpoaltion of a board should not ba a subject of
federal legislation. Instead, aa ia currently the eaBa,.th«
focua of oversight, whether by Congress or the CFTC, should
ba upon tha deciBions reached by an exchange's governors to
detenina whether the exchange has axerciaed its self- regulatory
responaibilitiea properly.
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Ai "— ™*H"i of DiaciTii*— ~ '•'— llrtlM
CoMMt talus ioBu* with tbm proposal vasting tba cftc
with authority to •stablish a atructura for axchange diaclpllnary
coaaittaaa aa wall aa with the Btataaaiita of ona of tha bill's
sponsors that a conClict axists trtian floor saabara pass judgaant
on thair colleaguas and that this "conflict laada to lanlancy".
First, it has bean Co»ax'a exparience that the floor
■wbara aaatad on our diaclpllnary coaBitteaa ara often tha
harahest critics of their paara, the aost expert at ferreting out
trading abuaea, and not at ell reluctant to aete out sanctions
that other aealMrs asy via* as harsh.
Second, while we agree that to fulfill Ita rule
enforceaent rasponsibilitias, tha SROa' disciplinary coaaittaas
should include aaalMrs of "groups" other than that of the
respondent (such as floor vs. off-floor neaberB) , we believe that
this issue of coaaittee coaposition, like that of board
co^OBition, is not a proper subject of federal legialation.
Siailar to our Board coaposition, by practice all
disciplinary coMaittaaa at Conax are coaprisad of rapraaantativaa
of each of our aeabership groups, and aeabers of adjudicatory
panels are appointed by tha Board with repraaentation of each of
these, as wall as tha non-aaaber groups. Notwithstanding our own
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adharanc* to this aystaa, tra ballava that apaclficatlon of tha
typaa of indlviduala aarvlng on dlaclpllnary connittaaa by
lagialatlon la an Inpropar intrualon Into exchangaa' gavacnanca
and arroneoualy locuaaa on tha appaaranca ol the dalibarating
body rathar than on tha resulta of Ita dalibarationa. Inataad,
as is already the casa, federal overaight ahould be concarnad
with the ustM ot an exchanga'a dlaclpllnary conalttaoa to
detaraine whether the exchange ia properly enforcing Its rules
and Is adequately sanctioning violators of those rules. To do
otherwise placaa for* over subatanca and diverts attention froa
the main thrust of oversight, which is the adequacy of the
exchanges' self -regulatory prograna.
As a technical natter, we further note that the specific
proposal calling for the astabllshxent of hearing panels conposed
of "a majority of parsons who are of a different trading status
than tha reapondent" (e.g., floor aeaber va. off-floor Baabar)
will require the establlshMant of aaparata hearing panela for
each case, tharafay rendering laore difficult thla exchange's
objective of davaloping consistent approaches to rule violations
and sanctiona within our diBolpllnary coBnlttesa. Thla result
Bust be anticipated if tha legialation ia adopted and serves to
undermine tha objective wa asau>a la sought by tha Subc^nittaa.
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£■ IM-nn-HMcatlnn for »nl» viol.tin™
Under our nil««, any Individual wbo has baan flnad by
Coaax in axcasa of fl.OOO is diaqualifiad from aarvica on tha
Kitohanga'B disciplinary conoiittaas tor a pariod of two (3) yaara
aftar tha aanctlon has baan isposed. It is our undaratanding
that othar axchangaa bava adoptad, or ara In tha prooaaa of
avaluatin? proposala to adopt, slailar disqualification
proviaiena for their disciplinary coaaittcas and/or governing
boards. In light of the likelihood that thla issue will be
resolved by all of the exchanges without legislation. In a aannar
best suited to each axchanga'a Intarpratatlons of its rules, it
is our view that thla provision of tha bill ia unnecessary.
CoBex aupporta the three-day "eooling-off" period for
f irst-tlsa speculative custoaere who have B»een solicited, by
tel^ione contained in section 202 . such a provision should not
be disruptive and should discourage sose of the telephona scut
operators. In the saiw vein, we have expressed our support for
the Telskarketing Fraud Prevention Act of 1969 pending before the
House Energy and Cosnerce convittee.
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CoBsx do«s not object to laglBlatlon tbat would require
the registration of floor traders, and Co>ax also does not object
to suppleBentation of the dlaquallflcatlon provisions currently
embodied in the CoMMdity Exchange Act, with the exception oC the
proposed insertion of language Into Section Ba(3) (k) of the Act
regarding "conduct inconsistent with just end equitable
principles of trade," since this type of violation 1* applied by
the exchanges without unilonity end does not address specKic
behavior sl*ilar to the other offenses envunerated In the
Commodity Exchange Act.
For several years, Coimx has required all new floor
trading aeabers to complete a floor practices trading course
adeinletered by th« Exchange to assure thet new Coaex floor
aevbars are fanlliar with their obligations on the trading floor.
This course currently Involves classroom Instruction (and
exanination) on floor trading rules such as open outcry, after
hours trading, cross-trading, prearranged trades, dual trading
and priority of orders.
Several month* ago, Comax began to explore the
possibility of incorporating ethics instruction Into our ongoing
training program or, alternately, joining with several other Hew
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York «icebang*B In >pon>orlng a joint prograa. M* ar« also
considarlng ajqwiidlng tha progra» to Involva all naw aitehanga
•nrollaaa and raquiring all currant Baabara to c^iplat« tha
atbioa caivQnant of tha coum. Willa w« do net ballav* that
fadoral lagialatlon ia raquirad to aaaura that this typo of
training la provldod to axohango kaabara, commx doaa not objaot
to tha propoaod provialon of tho bill which would call for tha
loouanco by tha CPTC of ragulatlona raquiring raglatranta to
partlclpata In auch training prograaa.
COWUBSIOII PBOPOSAM
Ha do not objoct to tho CoBaiaalon'a laglalatlva
propOBBla on (1) nationwide aarvica of procoaa; <3) intarnatlonal
oooporativa ontorcaBont attorts; (3) rajMvlng tha roqulrovont
that tha CPTC conaldor nat worth and ability to contlnua In
bualnaaa In dataralnlng tha aaount of a civil Bonatary panaltyt
and (4) providing for an autoaatlc auapanalon of raglatratlon and
a trading prohibition upon fallur* to pay a civil Monotary
(Actachaants follovO
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■■tloM Hal««d bv Crtuilii Provl«loM of H.H. 2868
Our analysis of tha languaga of tha Encrliah/Colaaan bill ralaaa
tha following quaationa. Givan tha lialtad aaount of tima va
bava bad to analysa tlia bill, this listing is not Intandad to
covar all potantial tachnlcal quaationa.
Mav Saction 4j (1) (A)— section 101 of tha bill— If thara ara
to ba critaria for modifyinct the voluma thrashold, shouldn't
thara be criteria for establishing the threshold 1 e the
7,000 contract provision? Can the Conialsaion ev«r determine
that the banning of dual trading created "undesirable price
volatility" or "unacceptable widening at bid-ask spreads"?
What are "undesirable price volatility" and "unacceptable
widaning of bid-ask spread"? What does "otherwise threatana
tha public interest" nean? Clarification of these tarwa ia
naadad if this provision ia to have any meaning without auob
clarification, it ia ii^osaibla to analyze the provision.
N«w Saction 4j (1) (B) (vii)— Saction 101 of tha bill— Hbo is
tha customer who aust axacuta ths wrlttan valvar of tha' dual
trading ban — is it tha FCH, tha ultiaata custonar, tha pool
operator, or aach pool participant? Is a valvar naadad from
aach and avary cuatomar?
Haw Saction *j (I) (D)— Saction 101 of tha bill— Tha critaria
for tha axa^ttion nay ba impossibla to satisfy, depending on
hov tha CFTC reads "attributabla to dual trading." What does
"fully varifiable" aaan? Ara thaaa criteria consistent with
the criteria contained in naw Saction 4g (2) B) iv} {a) that
look to the ability to "rapidly reconstruct an accurate,
verifiable racord of ' tha transactions executad..."
Hhat is tha rsason for delaying tha affectiveneas of such an
exception fron tha dual trading ban until the expiration of 90
daya after tha data of transnittal of a report to tha
congrassional agriculture cononitteee regarding the exemption?
Such a long period could destroy the utility of the provision.
Hew Section 4g (2] (B) {i}— Saction 201 of the bill— It appears
that tha tern "physical" in thia saction la intandad to ba "an
exchange foe physicals."
Naw Saction 4q — Saction 202 of the bill — Is there any raaaon
not to exaapt a custoMar who already has a co»modities account
with another fira?
Naw Saction 8c (6) (A) — Section 304 of the bill — What ia a
"schedule of Major violations"? Hhat ia the logic underlying
the requirsBsnt of public access to an exchange's schedule of
■ajor violations?
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COMEX Policy Staf—nt en Dual Tradlno and Audit Trails
Comiodlty Exchange, Inc. (COKEX) b«ll«v« thut th» Irontrunning ol
customer ordtra, vh*th«r p«rp«tr«t«d through dual trading or other
aaana, and th« davalopnant and us« oC acCurat« audit trail data an
«ach significant isauea daaarving of ragulatory attantion. TIm
n«xuB batwaen tha two iaauaa ia tha ability of an axchange'B audit
trail to datact trada practice abusaa, such aa frontrunning, and tb
willlngnafls of axchangaa to eanctlon ttioss ambars who hav« braadM
thalT fiduciary duty to tha public.
Tha r«quir«B«nts of audit trail coaplianc* sbeuld rast aquaraly en
tha shouldars of thosa dlractly cesponBlbla for tha accuracy of
trada tla* data — tha traders thenaelvea. Thareaftar, tha
rcBponalbility to uaa this data and to prosecuta wrongdoers becoMt
tha obligation of the exchanges. Unfortunately the provisions of
H.R. 2869 affecting dual trading and audit trail systeniB, as wall H
other proposals which would linlt the continuation of dual trading it
an exchange to tha denonstration by that exchange (rather than wdi
of its meabara) of its attainxant of specified audit trail accuraq
lavala, fall to follow this couraa. Instead th«B« prqpoaals
panaliia Market users aa well as all traders, svsn if a trader fuur
coaplias with an audit trail standard.
Dual trading BaXes Important contributions to tha Barketplaca
including increased liquidity, flexibility, and better execution of
cuatoner orders. Proposed restrictions on dual trading are likely
to have negative consequences for cur aarkata and tha service Ve
render to tha public without neasurable iBprovananta to aarkat
integrity. Therefore, dual trading, absent findings of illagal
activities by a trader, should be left intact.
Ha do balleva that an individual's dual trading privllegas should bt
subject to revocation if that trader has violated rules intended to
protect the sarketplace. For that reason COMEX supports a statutoiT
provision that would require tha CFTC to vandate that aach doasstic
futurss exchange establish a schedule of sanctions for any of its
Hsabars who violate the one-ninute audit, trail trading tiaa
recordation requirement, which auat include the suspansien of an !
•xchangs MSHbar's dual trading prlvilagas.
COMEX envisions this systaa working as follows. A ainlaua
acceptable level of compliance with the one-minute standard tor eacb
member of a domestic exchange would be established by tha CFTC.
Thereafter, each exchange would be required to subait to tha
coBBiiaaion a schedule of graduated sanctions which it Intends to
invoke against traders who fall to comply with the established
standard. Ho sanction schedule would be approved by the comelsaion
if it did not provide for the withdrawal of dual trading privileges
for any Individual who repeatedly fails to meet the standard, me
CFTC would then be expected to concentrate Ita oversight of the
exchange's audit trail programs and would be empowered to eanctlon
exchangee for their.to effectively enforce these provisions.
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Good «(t*moon Mr. Chainuin and ■■Bbara ol the
subcofflnittee I an Robert Isaacson, an Indapandant ooMBOdlty
Trading Advisor fron San Franciaco, California. I *m hara today
»m vice President of tha National Association of futuraa Trading
Advisora, known as NAFTA. NAFTA ia a national trade association
of opproxinately 150 companiea and Individuals who WAhage alHoat
$6 billion in investnents for thoir -clients Our membera ara
comBodity trading advisors and conmodlty pool oparatora. Thay
oparata or advlaa a substantial number ot the ooBModity pools and
■anagad accounta currently in ■xiatanc*.
and coHBOdlty pools provlds an
:ernative to direct BpecuLative trading by
.. iccordingly, HAFTA's neinberB are
substantial users of the exchanges on behalf of their customers,
Aa you can Bba, Kr. Chaiman, invsEtor confidence in the U.S.
XUtures markets ia aaaantial to tha contlnuad vitality and growth
o£ euE Industry.
NAFTA walcoMas this opportunity to share with tha Coaaittaa
tha experience of its »a«bars under the currant ragulatory
framework and to provide views Oft several Of the iasuaa ralaad in
H.R. 2869. Our coHsanta address three areas: 1) i^nunant
reauthorization of tha CFTC; 2} specific issues of concam to
futures investment xanagers; and 3) Hora ganaral points raised in
tha legislation.
First, Mr. Chairman, 1IK?TA anthuaiastically supports tha
proposal for permanent authorization of tha CFTC. In previous
testimony before this Committee HAPT* has supported measures
to extend the reauthorization period for the CFTC. He connend you
for your suggestion to place the CFTC ort the same permanent
footing as other federal agencies with slsilar responsibilities in
regulating financial marXetB. The history of the CFTC since its
creation in 1974 indicates a steady growth in staff expertise and
sophistication. The growth in the volume or trading on U.S.
exchanges during this period indicates increasing confidence in
these marXets, in part because of the regulatory framework which
distinguishes our aarkats from many foreign competitors.
Ha baliava the periodic reauthorization process drains
substantial CFTC staff resources and thereby detracts froB tha
ogancy'a ability to perfors its regulatory functions. Tha
banatits of tha the reauthorization process could, in our opinion,
be achiavad sore efficiently through periodic oversight hearings.
In addition, of course, the ability of Congress to conduct
invBstigations and hearings on specific topics of public
iiiportanca, such as the recent investigation of futures trade
practioas, would not b« iapairad.
* Principal, Cossodity Investaant Consultants, Ino., Nanlo Park,
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Our sAcend *r«a involva* Um unlqu* nlch* in tiM futuras
Industry occupied by NAFTA nembere. NAFTA aembcra organize and
operate coanodlty poola, aniS manage both pool and individuai
accounts. Co»»odlty pools resemble irvestnent conpanlBK, whila
the services rendered by connodity trading advisors substantially
resemble those at investment, advisors in the seuirities industry.
To the extant practicable, similar regulatory fraaeworks should
apply to both the futures, and securities industries, so that
neither set of investswit Managers receives a comp«tltive
advantage as a result ot dlaparitlss in the manner In which th«y
•re ragulatad.
This isme is particularly acuta for tUPTA's aaabara In tha
araa of publicly offered comjnodlty pools- These pools trada in
futures contracts and are subject to CFTC jurisdiction. Thay ara
typically ottarad in the fom of limited partnerships, however.
Tharefora, the SEC and state securities agencies also regulata
pools, since the limited partnership interest constitutes a
security. Consequently, a publicly offered commodity pool BUSt
satisfy tha regulations of the CPTC, SBC and of tha statea in
which the particular offering is to ba aada.
Ona highly unfortunate result of multiple ragulation has
been a staady increase In the size of prospectuses for publicly
offered funds and subsequent corresponding Increases in tha coats
of organizing such funds HAFTA s members believe that the length
and coaplexlty of disclosure is now so great that, in some cases.
Investors are literally overwhelmed ulth information. This
completely defeats the very purposa of disclosure. For these
reasons, HAFTA supports and coBmends the recent increase in
comaunlcation between the financial market regulators as
evidenced toy recant companion releases on the subject of
disclosures ralatad to publicly offered commodity pools.
HAFTA urgas both tha CFTC and SEC, for example, to explore
tha possibility of a two part prospectus requirement for publicly
offered conaodlty pools in the mannec currently permitted by the
SBC for investment companies. NAFTA believes a simplified
prospectus could nalce dlficiosures to prospective commodity pool
investors more meaningful, while a more detailed supporting
prospectus (comparable to what is now required to be provided to
all investors) could be made available on request to those
investors trtio desire additional information NAFTA suggests tha
Comlttae urge the CFTC to examine this area with a view to
proi^oslng streamlined and siaplltiad dlsclosuras for publicly
offerad OMmodity poola. This is an araa in which HAFTA beliavas
thara should ba greater parity batwaan coapating poolad invastaant
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Anothsr araa of particular concam to NAPTA'a »«a)MTB Is
that of speculative position limits and aggregation policlea.
These policies were initially promulgated prior to the developwant
of A oanaqed money sector In the futures industry. And they have
not been reconsidered Cor their Impact in Inhibiting the
development of the managed noney products, HAFTA Is aware several
large and extreaely auooessful conmodity trading advisors hove
increasingly turned to allocating funds to foreign markets in
order to avoid restrictions Imposed by speculative position limlta
which apply to U.S. markets but not to foreign markets. As
capital flees U.S. markets to lass regulated foreign markets the
consequences for the public and for the futures Induatry itself
become increasingly nagatiwo. potential investors could be hac»ed
because foreign markets typically have substantially fewer
customer safeguards. While no one believes U.S. oorkets should
compete with foreign markets by eliminating what are widely
recognized to be valuable customer protection measures, NAFTA
believes speculative position limits and aggregation policies
should be reviewed thoroughly for their continued efficacy. HAPT*
requests Congress to encourage the CFTC to continue the work it
began in this area when It recently Moditied torn* of Its rules
pertaining to aggregation.
Turning to specific provisions ol H.R. 2869, MAFTA does not
believe a prohibition oF dual trading is si^ropriate or necessary
at thia time. While KAFTA apprecietea that unspecified alleged
abuses have prompted the proposals to prohibit dual trading, we
believa substantial and valid reasons call for batter remedial
■teps. First, the prapasal would have several negative
consequences I
(1) Many of the Bost skillful brokers say choose to trade
entirely for themselves and no longer for customers
Because many aoney managers execute large orders for their
clients quality execution of trades Is particularly
important Hany NAFTA meubers devote substantial attention
to reviewing the quality of order fills and selecting the
brokers with whom they place orders It a ban on dual
trading were to convert brokers into traders, the ability
of our pembers to trade profitably for their customers
would be hampered.
(2) Such a ban would reduce the liquidity of the markets.
In soae cases, this would sake it more difficult to enter and to
exit positions for ouatosers; and
(3) It for any reason voluae ware to dacraaBe
significantly, a dual trading ban would reaalt in increases
in brokerage comisslon rates.
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NAFTA l>all«v«* dukl trading aheuld b« allowMl to oontlnu*,
■ubj*ct to dlBcloBurs to oufltoaars that • brolc«r intend* to trad*
fer hla awa account Exlatlng CFTC rsqulatlons requlrs just such
disclosure to prospective custoners of conaodlty trading advisors
■nd commodity pool operators. This dlBclosure would allow a
cuatOBcr to chooaa for himself without tha urkat having to auffar
the coata I hava just descrlbsd
Furtharaorc . wa believe incraaaad aorveillanoe by tba
aitchangaa and by the CFTC, along «ith technological deveiopnents
anhancing tha quality of audit trails, should moke all trade
practice abuses increasingly rare. KAFTA bslievea a prohibition
of dual trading should not be inpleaanted -until intemediate
alternative step* have been tested. The effects Of « dual trading
ban on market liquidity naada to be evaluated.
H.S. 2869 would require aitchang* and other aalf -regulatory
organization governing boards to include at leaat 10 percent
"non-m.ember" director*. NAPTA supports the concept of outside
directors on governing boards as a general principle. In fact,
tha MAPTA board of directors includes an outside director, even
though wa are a private trade association However KXtTA
believes no particular oerit exists in a fixed 20 percent
requirement. NAFTA believes the experience and knowledge of
individual governing board meabers, whether member or non-meeber,
are sore critical to sound decision-making and representation of
public interests than mandated percentages.
H.R. 2869 would impose a three-day 'cooling off period
between the time an account is opened for a tir*t-tlM* *p*culatlv*
cuatoaer trtto was solicited by telephone and the day on trttich thi*
cuatoaer aay make his first trade. First, I would point out that
telemarketing is not used to any significant degree by NAFTA
members. Nevertheless, in the interests of enhanced investor
confidence in our markets, we support the concept of audi a
coollng-off period NAFTA menbers are concerned, however, that it
would be extremely difficult to implement and police the proposal
contained in H.R. JSfid. For example, it is not clear to what
extent a brokerage firm could rely upon oral assurances from tha
cuatoaer that he vas not a first-time customsr. What types of
evidence would suffice to perait a broker to satisfy this gueatlon?
Finally, NAFTA has long supported the development of
ethical standards throughout the futures industry. In fact, MAFTA
views as one of its purposes the enhanceasnt of ethical standards
for trading advisors and pool operators and Intends to Include
■essiona in this area In Its future annual aeatings.
Our segment of tha futures Industry Is subject to a broad
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array of ragulatlon. COBBOdity trading advisors, eoHiodity pool
oparators, and thalr asaoclatad parsons ara raqulred to raqlater
with the HFA. Each of these associated persons aust first
BuccesaCully pass the National Coamodlty Futures Examination. The
HFA conducta regular audits of all NAFTA aenhers. Exhaustive
disclosure, r«cordke«plng and reporting regulations govern
coBBodlty trading advisors and pool operators, and pool operators
■ust provide annual audited financial stataBents to their
custoaers, the NFA and the cftc.
These regulations have been In place tor over a decade, and
continue to be suppleaented froa tlae to tine by NFA coapllance
rules covering areas such as promotional materials. NFA staff
also conduct periodic compliance audits. Comprehensive securities
regulations also govern pool operators and trading advisors.
NAFTA Bsmbera are thus subject to a very broad range of
compliance responsibilities. This regulatory framework Is
considerably broader in scope than that applicable to almost any
other CFTC registrants.
All of this leads HAFTA members to believe Bore vigorous
enforcement of existing futures Industry regulations may be mora
effective In preventing abuses than another regulatory layer of
■ethics' training. This is in large part due to NAPTA's concern
that serious problems must be very carefully considered in
developing any regulations to Impletient such a requirement. Would
this requirement create a financial hardahlp on individuals and
smaller firms, for example, by imposing travel to central
locations tor initial or refresher training sessions? For these
kinds of reasons, NAFTA urges extreme care in crafting any
regulations' and we commit our full assistance to the CPTC for
that purpose. In fact, NAFTA would undertake to provide any such
required training tor its members and would encourage Congress to
suggest such an approach for maBbars of NAFTA and other similar
trade associations.
Mr. Chairman, we appreciate the opportunity to present the
views of our Association. I will be happy to answer any questions
you may have.
„Coogle
NATIONAL ASSOCIATtON OF FUTUBEt T»APINO ADVISOtS
• OlHB Cl>«14M
■ by provlDlag fl*I<lbllltr In tfta li
■ncr and •eanaile uttlltr Bl tk> ■■:
„Coogle
NATIONAl AiSOCrATIOM Qf FUTUBEI THADING APVISOBS
VaiU. tit. OKtW-f. 6VWT th> iBDt
in ql.>ii urk
■ppaftrvd. irould Dfit r**lly htipi
■nklr, th* bralnr I
23-500 0-90-10
D,gnz.dbvC00gle
ATtONAL ASSOCIATIOM OF FUTURES TRADING ADVISORS
1<!Z^JC««(
„Coogle
COMMODITY FUTURES IMPROVEMENTS ACT OF
1989
THURSDAY, JULY 20, 1989
House op Repeesbntatives,
subcohmittee on consebvatign,
Credit, and Rural Devrlopmbnt,
committek of agriculture,
Washington, DC.
The subcommittee met, pursuant to notice, at 10:10 a.m. in room
1300, Longworth House Office Building, Hon. Glenn English (chair-
man of the subcommittee) presiding.
Present: Representatives Tallon, Penny, Nagle, Harris, Stagers,
Sarpalius, Long, Coleman, Morrison, Gunderson, Combest, Grandy,
and Holloway.
Also present: Representative E (Kika) de la Garza, chairmtm of
the committee, and Representatives Huckaby, Glickman, and
Jontz, members of the committee.
Staff present: Fred J. Clark, associate counsel; Willieun E. O'Con-
ner, Jr., assistant minority staff director; John E. Hogan, minority
counsel; Alice Devine, minority associate counsel; Glenda L.
Temple, clerk; Bill Cherry, Jsunes E. McDonald, James A. Davis,
Thomas H. Lederer, and David EHsersole.
OPENING STATEMENT OF HON. GLENN ENGLISH, A REPRESENTA-
TIVE IN CONGRESS FROM THE STATE OF OKLAHOMA
Mr. English. The committee will come to order.
This is the second day of hearings of the Commodity Futures Im-
provements Act of 1989. Tuesday's witness list included a wide
spectrum of the futures industry but today's list is even wider. It
includes a ffumer, a floor broker, and representatives of most other
parts of the industry. We will change the order of today's wit-
nesses. Late yesterday, officials from the Chicago Board of Trade
notified us that Mr. Mahlmann could answer questions about the
emei^ency order involving July soybeans if he could appear after
trading in the contract ends in Chicago. Trading ends at noon Chi-
C£igo time or 1 p.m. here. I know that many members of the sub-
committee want to get complete answers instead of the answers
they got on Tuesday. So I changed the schedule of witnesses. Mr.
MfOilmann will appear this afternoon.
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To help members of the subcommittee, we obtained the cash soy-
bean prices from the Agricultural Marketing Service at USDA and
arranged them in a table that includes the settlement price at the
Chicago Board of Trade. This is included in the material in front of
the members. I look forward to hearing today's
[The information follows:]
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'. Soyb«ans for
1989:
July
settle
15 day
Toledo
«in
IllinoiB
4em
phis
Kansas
City
6/30
3500
3500
3850
1450
4700
3600
2500
7/03
4050
4050
4350
2050
6200
4000
4650
7/05
7650
7650
7350
4850
8400
7400
7200
7/06
6500
6500
6350
3750
7500
6200
5900
7/07
6650
6650
6100
3600
6900
6400
4500
7/10
4350
4375
3850
lOSO
3350
3700
1300
7/11
2600
2600
2100
9450
2900
2500
1000
7/12
8650
8650
7850
6350
9450
7900
4300
7/13
9750
9750
9200
8100
0000
9700
0500
7/14
0350
0350
9550
9525
0850
1000
1300
7/17
7750
8000
7450
6725
8350
8400
8350
7/ IB
9550
9550
9350
8200
9200
9800
6
8400
„Coogle
Mr. Enoush. Now, Mr Coleman, for any opening remarkB.
Mr. CouMAN. I have no statement
Mr. Enoush. Mr. Tallon.
Mr. Tallon. I have nothing, Mr. Chairman.
Mr. Enoush. Mr. Combest.
Mr. CouBKBF. Nothing, Mr. Chairman.
Mr. English. Out flret witness today is Mr. Robert D. Joeeerand.
who is president of the National Cattlemen's Association.
Mr. Josserand, if you will come to the witness table we will be
happy to receive your testimony. Let me also say that, Mr. Josser-
and, you and all of our other witnesses today, if you would care to
summarize your written testimony, please feel tree to do so, and
your complete written testimony will be made a part of the record.
STATEMENT OF ROBERT D. JOSSERAND, PRESmENT, NAUONAL
CATTLEMEN'S ASSOCIATION, ACCOMPANIED BY ALAN SOBBA,
DIRECTOR, TAX AND CREDIT
Mr. JossBSAND. Thank you, Mr. Chairman.
As you have said, I am Bob Josserand from Herford, TX. I am a
cattle feeder; however, I am here today representing the Naticmal
Cattlemen's Association. I want you, Mr. Chairman, and tibe sub-
committee to know how much we appreciate the opportunity to ex-
press our views on this very critical issue as far as the cattle indus-
try is concerned.
I want to say right up front that our primary working relation-
ship is with the CME. Several years ago, we started a cooperative
venture in which our cattlemen were extremely concerned about
some of the attitudes toward the CME and some of the things that
were happening, and we started a joint project with them that has
been very successful, I think. We continue to work with them. We
think we have made some signiiicant improvements. 1 would like
also to thank the committee for moving in such a timely manner
on House bUl 2869.
I Eun going to be very brief, Mr. Chairman, and I will be very
happy to answer any questions the committee might have after-
wards. I am going to attempt to summarize. I am going to follow
the bill's titles. 'Title 1, limitation on certain trading practices —
dual trading. Very simply, the National Cattlemen's Association
supports the elimination of dual trading. We do not think under
the present monitoring system available on the floor that dual
trading is supportable by the exchange and simply because the pit
brokers' cards are submitted every 30 minutes and there is abso-
lutely no way to successfully monitor and audit trading.
We would also recommend, Mr. Chairman, that the elimination
of dual trading simply be across the boEu*d on all commodities. I
don't think it's feasible to eliminate dual trading in some pits and
not all. We would also like to surest that the elimination of dual
trading would probably do more to restore confidence by the ct^tle
industry in the futures meu'ket.
We would also like to support membership disclosure and elimi-
nation of dual trading for individual traders in banning members
of brokers' associations from trading for their personal accounts in
all exchange markets against orders executed by members of the
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same broker eissociation, r^Eirdless of profit-ehariiig firrangements.
Allowing dual trading to continue within broker groups but prohib-
iting it by individual traders is not fair and would put several
people at competitive disadvantage.
Title n, the enhancement of regulatory and enforcement activi-
ty— audit trails. One of the great concerns, Mr. Chairman, of our
industry is the audit trail. And we do not think today, given the
fEict that pit broker cards are bracketed into 30-minute s^ments
that the exchai^e can narrow the audit trail to make it meaning-
ful. We would like to recommend that increased audit procedures
to cross-match information on a pit broker's card with the broker-
age house, outside orders, be mandatory.
NCA also recommends increased research into the use of hand-
held electronic recording devices or other emerging technologv to
record pit brokers' transactions in lieu of the traditional hfind-held
pit broker cards. We also support the concept of separate time
brackets for market openings and closings. We feel that there is too
wide a trading range at the present time and we would like to see
a definite time bracket.
Closer and more frequent monitoring of positions held by rois-
tered commercial traders is recommended to assure that these posi-
tions are in fact bona fide hedged positions. Auditing procedures
may be requii-ed to establish that the commercial trsider in fact has
product or orders in the physical market that are being offset by
he^ed positions in the futures market.
The National Cattlemen's Association has been working quite
closely with CFTC Chairman Wendy Gramm; has urged their com-
plete and full cooperation with the ongoing FBI investigation. We
continue to participate and cooperate wherever possible so that the
public confidence in the integrity of the futures market is main-
tained.
The National Cattlemen's Association supports the concept of
self-regulation by the futures industry with continued strong over-
sight by CFTC. We feel that if the exchanges themselves will
adhere to the pentilties as proposed by the exchanges and will con-
tinue to monitor their own activities, with oversight by CFTC, that
it would be much stronger thfin additional people, additional regu*
lators from CFTC on the floor or in the pits. Strengthening self-dis-
cipline committees will help restore integrity to the market. We
would also urge that greater representation by nonfloor member-
ship is a necessary st«p. One item that we would like to see han-
dled in your bill, if possible, is the fact that we do require r^;istra-
tion of floor traders, or require some type of activity which will
give cattlemen and others increased confidence in floor brokers.
We also think that tied with the registration of floor traders
should be enhancement of registration requirements. We are not
sure that we totally have the lund of background checks and educa-
tion required for brokers. The concept of self-r^ulation with strong
CFTC oversight is supported by NCA. Without strict enforcement
of penalties, regulations lack the teeth to insure compliance with
self-imposed rules.
The integrity of self-r^ulation is directly tied to ethical stand-
ards. We would urge the committee to make sure that extensive
ethical training would be established both for the exchanges and
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the floor brokers. We would like to share just a few other com-
ments with you, Mr. Chairman.
We would recommend and support permanent authorization of
CFTC. We feel that this is long overdue. It would aUow the Com-
mission to redirect some of the funds and stafT that presently is ex-
pended to reiMur for reauthorization and would allow that staff and
ninds to be mriected towards its primary function.
We think that adequate numbers of highly trained, qualified, ex-
perienced personnel are central to the accomplishment of any mis-
sion. NCA supports CFTCs request for increased personnel and
fimding, whidi have been outstripped by growth in the futures in-
dustry during the recent years. One specific issue, periodic verifica-
tion of positions held by commercial traders as bona f!de hedges is
the t^pe of information that increased surveillance could create
and snould create.
The use of electronic systems in place of open outcry offers un-
limited advantages in recordkeeping, market surveillance, ease of
use, and opens opportunities for additional refinements. NCA
strongly encourages the exchange to implement electronic trading
systems during normal trading hours as an alternative to open
outcry.
We think that, while this is a long process and we appreciate
your efforts, we think that what you are doing will restore market
mtegrity in light of the recent investigation ^ establishing CFTC
as the futures regulatory agency, you will serve very much the
people in the country.
Mr. Chairman, National Cattlemen is certainly willing to asmst
you in any way that we can in this endeavor and I would be happy
to answer any questions should there be some.
Thank you.
[The prepared statement of Mr. Josserand appears at the conclu-
sion of the hearing.]
Mr. English. Thank you very much, Mr. Josserand. I appreciate
that.
Let me ask you with regeird to the state of confidence in the fu-
tures markets as far as the cattlemen of this country are ocm-
cemed, members of your association. Do they have a high level of
confidence in the int^rity of the market as it stands today?
Mr. Josserand. Mr. Chairman, I would have to say that certainly
the opinions are spUt. If you asked me for a percentage, I would
say probably half of our members do have that confidence; half
have some concern, particularly those who do not use the futures
as a price risk protection mecnanism, those who — I do not want
this to sound wrong — ^but those who are in rural areas that ^ust
simply do not have adequate communication on a daily basis; I
think those people have some concern about the int^^nty of the
market.
Mr. Engush. We hetird a great deal of concern expressed, of
course, from the industry itself shortly after it was announced in
Jtmuary that there had been a probe by the Justice Department,
that an undercover operation had been under way for several
months; and we seemed to find a great deal of interest within the
industry in trying to address any problems pertaining to queetions
of the int^rity of the market, to be willing to tighten up. As time
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has gone by and no one has been prosecuted; that seems to be less-
ening. Does that change anything, the fact that no one has been
indicted and prosecuted to dat«? Does that change the need, in
your opinion, for addressing the question of int^rity?
Mr. JossERAND. Absolutely not, Mr. Chairman. In fact, I think it
intensifies that need from the standpoint that in the countnr, the
general feeling is, you know, the investigation was announced, that
there would be indictments forthcoming fuid, as you say, nothing
has occurred. I think the country is saying why, when, and what
are we going to do about it; euid I think if Einything it intensifies
the efforts on your part.
Mr. English. Mr. Coleman.
Mr. CoLBMAN. Well, Mr. Josserand, your organization and the
Chicago Mercantile Exchange have entered into some advisory ca-
pacity; there's tui advisory board and so forth. Would you tell us a
little bit about the ongoing relationship that you all have set up
and how do you think those are proceeding?
Mr. Josserand. Yes, sir, Mr. Oaleman. We have had in the past 2
years a very good working relationship with the Chicago Mercan-
tile Exchange in that our members asked 3 years ago for a task
force to be appointed out of the National Cattlemen to really take
a look at the cattle futures cmd what they meant to the industry;
and within the framework of that task force and in the framework
of the recommendations that came out of that task force, we feel
like we have been at least ptuiially responsible for some significant
changes in the cattle futures; we feel like that we have had some
input and we do have nonvotii^ members serving on the live cattle
committee and the advisory committee; we do feel like we've had a
considerable amount of input into some significant changes, impor-
tant chfuiges as far as we were concerned. We have not gotten all
of the things that we thoi^ht would make the cattle futures a
better tool for us, items such as cash settlement, which we would
still like to see.
We also realize the difficulty in the use of cash settlements be-
cause of our pricing situation within the entire industry. We stUl
feel that that is a viable option down the road, but we also realize
that the industry has to solve its own price discovery system.
Our relationship with the Merc, I submit to you, is very good;
they have been very cooperative; we've worked with them. We still
have some chaises we would like to see made, but I think that's
possible, and I think they are open to input f^m the cattlemen.
Mr. Coleman. Well, I thank you.
Mr. English. Mr. Tallon.
Mr. Tallon. Mr. Chairmfm, thank you, and Mr. Josserand,
thank you for your testimony.
In looking back over it, of course, we heard you testify that you
support elimination of dual trading, period. Of course, Uie l^iala-
tion, the bill that hsis been introduced provides for dual trading
under certain circumstances. How would you feel if we included in
this legislation criminal penedties, if we provided for criminal pen-
alties within the l^islation for a trader that was trading ahead of
the customer? Do you feel like that should be included in the legis-
lation?
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Mr. JossBRAND. I think, Mr. Tallon, if you asked our members,
the int^rity of the exchanges is foremost and I think that our
membership would have no pr(d>lem with that type of activity.
Mr. Tallon. Thank you.
You seem to indicate the problem that you have with dual trad-
ing is wit^ the way the audit tredl is reconstructed. At the present
time, is there a possibility that with a tighter audit trail, a more
efficient audit trail that you could be conndent with dual trading?
What kind of changes would you recommend?
Mr. JossKRAND. I think No. 1 is that we do have to tighten up
the audit trail. I think our concern is simply the integrity when we
have dual trading and under present circumstances, I guess our
best option is the totfil elimination of dual trading. If, in fact, we
were comfortable and the country was comfortable with the audit
trail, then I think we might reconsider that.
Mr. Tallon. I think you said that maybe half of your members
had a problem with duEu trading, and maybe the other half did not,
and that probably the half that did not were people who didn't use
the market on an ongoing basis and maybe were not as close to the
mcu'ket and maybe mdn't communicate or have the means of com-
municating with the markets?
Mr. JossERAND. Mr. Tallon, what I think I said or hope I said
was that with regard to the futures market, about half of our mem-
bers had real questions about the use of them. I think as far as the
dual trading goes, you could say almost 100 percent ccF our member-
ship would recommend the elimination of dual trading under
present auditing procedures.
Mr. Tallon. And so the recommendation certainly would extend
to a ban on all dual trading, r^ardless of the smiount of volume in
contracts, no concern for liquidity; I mean, we just ou^t to ban
dual trading across the board?
Mr. J088ERAND. Mr. Tallon, we are very sympathetic to what the
ban on dual trsiding would do to liquidity in a particular contract.
We reeilize that there possibly can be some serious repercussions.
However, we think if we do not get the elimination of dual trEiding,
the repercussions A*om the questioning of the exchange and the fu-
tures contreict greatly outweigh the lost liquidity.
Mr. Tallon. Of course, we all understand there is nothing wrong
per se with dual trading; it's trading ahead of the customer, trad-
ing your own order before the customer's order, that's the real
problem here, and in my mind, smother concern that I have that
we've heard really very little about is when a futures merchant
gets an order, before it ever gets to the floor of the exchange, we
are very limited in how we monitor what happens to that order or
those orders, or those bundles of orders.
Has the Nationed Cattlemen's Association looked at that and do
you have concerns about how those orders are handled?
Mr. JossERAND. I'm sure that our task force, working with the
CMB, did look at that, Mr. Tallon, but I eun not knowledgeable
about that.
Mr. Tallon. Well, you understand that you can ban dual trading
on the floor, but there are so many things that can happen prior to
that order ever getting to the floor; ana I just have to question ^
maybe we can't see the forest for the trees.
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Thank you.
Mr. JossBRAND. Thank you, sir.
Mr. English. Mr. Combest.
Mr. Combest. Thank you, Mr. Chairman.
Mr. ChairmEin, Mr. Joeserand is a constituent of mine and only
at the last moment yestarday did he find out he would be deliver-
ing this testimony. I know how anxious he is, as soon as he leaves
here, to get back to West Texas, £ind from a personal experience of
both of UB loving West Texas, far be it from me to be the one that
would keep him from it. I have no questions. Bob, it was good to
lee yo!
Mr.,
Vlr. JossERAND. Thank you, Mr. Congressman.
Mr. English. Ms. Long.
Mb. Long. Thank you, Mr. Chairman.
It's nice to have you here today.
You have been talking about liquidity and dual trading and I
think that I am sensing ^m your — you haven't said this specifical-
ly— that the dutil trEiduig leaaa to liquidity, which leads to greater
market volatility, because you have people buying commoditieB
that you have no real use for in your case, cattle, their buying
cattle to resell and that's in a sense playing with the true forces of
the market. Is that what you are saying?
Mr. JossERAND. Well, I think our concern about dual trading is
one of fairness, one of the integrity of the market. I guess if you
looked at the cattlemen in general, there are those who do have
that concern about people trading in any futures market without
need of the product; but at this point in time, a discussion on dual
trading I think is one of fairness find is one of perception as much
as anything that things are being handled correctly and right and
that there is not misuse of the ability to dual trade.
I think more than anything I have to say that with the confi-
dence in the system, I think it's perception more than anything
else.
Ms. Long. Let me ask you another question along those same
lines. We tend to assume that liquidity is In and of itself good be-
cause it can keep a market active. Are you suggesting that liquidi-
ty has some negative aspects, that liquidity that results from
demand from buyers who have no real use for the commodity that
that is not necessarily good for the market?
Mr. JossERAND. Ms. Long, I Eim not trying to say one way or the
other.
I think as far as the position of the National Cattlemen, we cer-
tainly would encourage all of the liquidity we could get into a
market, even though we realize that it can cause some wild price
fluctuations once in a while. I think if you analyzed our member-
ship and particularly that segment which probably are not familiar
with the futures, you would find that they would be quite consist-
ent with the idea that maybe there is too much liquidity once in a
while.
Ms. Long. Thank you. I'm trying to, the same as you, I think,
assess the value of liquidity in the marketplace and am glad to
have your input. Thank you.
Mr. JossxRAND. Thank ^ou.
Mr. English. Mr. Hams.
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Mr. Harris. Thank you, Mr. Chairman.
One of the complaints or observations that I've had expressed to
me concerning the ban of dual trading is that this would drive the
markets overseas, euid I just wondered if jrou have any thoughts on
that?
Mr. JossEBAND. No, sir.
Mr. Harris. Because we certainly don't want to send any more
jobs overseas than we have already seen go. We would like to get
some back.
Mr. JossERAND. No, sir, I do not have any thoughts on that, and
I'm sure it has been looked at by our task force. I simply cannot
answer that. I do not know.
Mr. Harris. You would agree with me that that is a concern?
Mr. JossEBAND. I would agree witii you that we don't need to
transfer a lot more of our business overseas; yes, sir.
Mr. Harris. That's all I have, Mr. Chairman. It's good to see you
again.
Mr. E^NGUBH. Thank you very much, Mr. Harris.
Mr. Josserand, we appreciate your testimony very much.
Mr. Josserand. Thank you, Mr. Chairmfm.
Mr. English. Did you Imve a question, Mr. Coleman?
Mr. Coleman. If I might just meike a comment as a followup to
my colleague's question, on the other hand, if dual trading were
prohibited under certain circumstances, the int^rity of the mai^
kets in this country would be imquestioned, any problems that
might result from dual trading could be caught in a proper audit
trful under our proposal. When they exist for higher traded
volume, just the opposite probably woidd occur, would it not? The
people who wfmt to buy and sell cattle would want to come to the
United States, to make sure that they knew they were getting the
proper price and that there was no one taking advantage of their
position and so forth. So I would suggest that the bill and the
thrust of the bill would be very supportive of trying to retain and
enhance our markets as opposed to somehow driving your member-
ship, for example, away ftom our markets.
Mr. Josserand. I thmk you are right, Mr. Coleman. I cannot per^
ceive of it happening Emy other way.
Mr. Coleman. Thank you.
Mr. English. Thank you very much.
Mr. Josserand, we appreciate your testimony.
Mr. Josserand. Thank you, &b-. Chairman.
Mr. English. Our next witness is Mr. Leo Melamed, who is
chairman of the executive committee and special counsel to the
board, Chicago Mercantile Exchange in Chicago, and I believe he is
going to be Eiccompeuiied by Mr. William Brodsky, president and
chief executive officer, and I beUeve Mr. Jerrold Salzman will also,
outside counsel, will be accompanying him as well.
Leo, we want to welcome you here today and we appreciate you
coining down and testifying on this legislation. We are looking for-
ward to hearing your views.
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STATEMENT OF LEO MELAMED, CHAIRMAN OF THE EXECUTIVE
COMMITTEE AND SPECIAL COUNSEL TO THE BOARD, CHICAGO
MERCANTILE EXCHANGE, ACCOMPANIED BY WILLIAM J.
BRODSKY, PRESIDENT AND CHIEF EXECUTIVE OFFICER, AND
JERROLD E. SALZMAN, OUTSIDE COUNSEL
Mr. Melamzd. Thfink you, Mr, Chairman and members of the
subcommittee. I am pleased to be here and honored to represent
the Chicago MercantUe Exchange. I am here today with our presi-
dent, Mr. Brodsky, and genered counsel, Mr. Salzman.
I have extensive written testimony, Mr. Chfurman, that I would
like to submit for the record. At thus time, I merely would like to
make some opening remarks.
Mr. English. Without objection, so ordered.
Mr. Melamed. Thtrnk you.
Mr. Chairman, I wish to compliment you and the members of
this subcommittee on the investigative effort you have undertaken.
It is critical to the future of a very important indtistry. You should
recognize that the expeditious and for^right manner in which you
conducted the inquiry serves our industry very, very weU.
I am pleased that whatever help we were able to give you in the
process brought the investigation to a very expeditious point as we
sit here today. I surest that we move forward from here with a
legislative result and reauthorization.
I thank you for undertaking this effort in the manner you did.
I would like to offer a little historical overview on the Chicago
Mercantile Exchange because sometimes it gets lost in the shuffle.
It was on the floor of our exchange some 25 to 27 years ago when
this industry expanded in the direction that brought it prominence
and importance — financial futures.
Such instruments as futures contracts on foreign currencies. Eur-
odollars Emd Treasury-bills were created as a result of inventive
genius on the floor of our exchange. Those financial futures later
were so successful that they transformed our entire industry. That
led to instruments such as U.S. bonds futures, invented at the Chi-
cago Board of Trade and other financial futures contracts the
world over. The base of agriculture, which was the reason for these
markets in the first instance — and still is today — was expanded
into finance. It became so coveted an idea that every financial
center in the world today would like a piece of that action that
American genius invented. We are very proud of that, as you are.
After the 1987 stock market crash, there was a cry in the finan-
cial community that perhaps our futures markets might have been
a factor in that crash. And when we testified before Congress on
this issue, we urged Congress not to do Einything that might iigure
this American resource. We cautioned that if they did, tiie Ameri'
can financial fabric could be hurt in the process.
Indeed, there were those who wanted to wrest jurisdiction from
the Agriculture Committee and place it elsewhere. And we testified
and urged the Congress not to do so.
We were right. Today's hearing is evidence of our view, because
this committee has the expertise, the knowledge, the history of the
importance of our markets in the national economy.
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So, as we come before you today, I present that bit of history. I
Eim proud to be here and to be with you in an effort to make our
markets better, to serve not just the national interest but the world
interest We are a world market today, and everyone comes to our
doorstep. We want to provide liquid and eEEicient markets so that
no other markets in the world can wrest this American invention
away £rom us.
1 thank you, Mr. Chairman, for these brief opening remarks. I
am prepared to answer any questions you have.
\The prepeired statement of Mr. Melamed appears at the conclu-
sion of the hearing.]
Mr. EInglish. Thank you very much, Mr. Melamed, and I appre-
ciate your statement. I want to recognize the chairman of the full
committee, Chairman de la Garza, who has joined us.
Mr. Chairman, do you have any comments that you would care
to make, or would you care to lead us off in the questioning?
REMARKS OF HON. E (KIKA) de la GARZA, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF TEXAS
The Chairman. Mr. Chairman, just very briefly, I want to com-
mend you and members of the subcommittee for the very efHcient,
practical, and fair way that you have conducted the hearings on
the reauthorization of the CPTC and all of the other issues that are
before you.
I want to very much extend my appreciation to the industry for
the manner in which they have cooperated with us without excep-
tion, all s^ments of the industry. Your responsibility is to those
that you serve. We appreciate that. Our responsibili^ is to those
that we serve, including you and those you serve. So, we have a
mutual interest in seeing that the industry works hand-in-hand
with us for the farmers Euid all that benefit from what you do.
I wish to thank the industry for the excellent way they have co-
cn>erated with us. I wUl leave the time for questions to Uie rest of
the members of the subcommittee, Mr. Chainnan.
Thank you very much.
Mr. EifGLiSH. Thank you, Mr. Chairman. We appreciate it very
much.
Let me say, as we begin the questions, Leo, I do not suppose
there is anyone in the industry that is r^arded with more respect
as far as being a leader in innovation and a leader fis far as the
best interest of the futures industry is concerned than you ore. I
think your reputation is well known.
But I would like to read a little paragraph to you, a paragraph
that I know you are very familiar with because in a sense you wear
two hats. You wear the hat from the standpoint of doing what is in
the best interest of the futures industry and looking to the future
as to how we can best approach the problems that the industry
may have and, at the same time, you wear the hat of representing
the Chicago Mercantile Exchange, euid most times those hats coin-
cide find fit tc^ether very well.
In this particular instance, the pem^raph I want to point out
was contamed in a report from the Chicago Mercantile Exchange,
and this was issued on Wednesday, April 19, of this year. It is a
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report of the special committee to review the trading practi^s of
the board of governors, and it is signed by a very distinguished
group, of course including yourself, people who are highly respect-
ed including a former Chairman of the Commodity Futures Trad-
ing Commission.
It talks about the issue of dual trading, which I think we have
had a great deal of discussion about, and it goes through with
regard to the rationale for the position that was taken by this com-
mitt«e.
It states that, while it is valid — the good points for dual trading,
it has become painfully evident that the public image of the fu-
tures markets and their members has been adversely impacted by
the widely held belief that dual trading in the futures leads to cus>
tomer abuses. All past efforts to explain the rationale for the
CME's continued acceptance of dual trading have proved ineffec-
tive. Moreover, it has been ar^ed that, as tne transaction volume
grew, in the CME's major markets the need for dual trading to pro-
vide liquidity in those major miu'kets became a less imporUmt con-
sideration.
This was the justification for the proposal for a ban on dual trad-
ing. And I wanted to point this out because again I think it was a
veiy responsible act. I think that the committee put this together
and made an excellent recommendation, tind also that the provi-
sions dealing with dual trading contained in the legislation before
us here today were in fact modeled after those very recommenda-
tions by the CME as is the case with regeird to some of the other
features. Broker associations, for instance, is almost lifted directly
from the Chicago Mercantile Exchange.
So, that along with the fact that in some exchanges, there are
some contracts, the Standard and Poor's 500 contract that is traded
with CME, already contains a version of a ban. I believe 90 percent
of the trades that take place in that contract, dual trading is
banned, which is very close to what the estimate is as to what this
legislation would be as far as industrywide.
So, I guess that I was struck by the fact, on the one hand, it
seems that you are moving in a different direction than this com-
mittee reported, which you will remember in which you signed off
on, on April 19.
Would it be fair to say today that you are representing the Chi-
cago Mercantile Blxchange?
Mr. Melahed. That is correct.
Mr. English. And would it fdso be fair to say that the state-
ments that were made on April 19 were done by people who were
extremely knowledgeable in industry, people who certainly had the
best interest of the industry at heart, people who certainly would
not take any action whatsoever that would be harmful to the fu-
tures industry and what we are looking to forward in the future?
Mr. Melamed. Absolutely correct.
Mr. English. And let me also say that the question of driving
business offshore — this has been raised a couple or three times — it
would seem to me that the United States, as it stands now, certain-
ly with the exchanges that we have, all the exchanges I eun speak-
ing of, and with the regulations, with the systems that we have,
tiie big sellii^ point that the United States has and what is, I
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think, a strong case that can be made for attracting busineas to the
United States is the fact that we do protect the customer.
He is sure that he is going to be treated fairly, and that that in-
t^rity itself is a very, very big selling point. And anything that
strengthens that int^rity and allows us to point to higher stand-
ards, even gives us a better case to be made, as opposed to driving
businees ofbhore. Would you agree with that?
Mr. Melahid. I would agree.
Mr. English. Mr. Coleman.
Mr. CoLEBfAN. I, too, Leo, would thank you and the Merc for your
constructive proposals. And I think of all the players in the fiiturea
market, you all have responded in a very credible fashion. And as
the chairman has indicated, we have baaed some of our legislation
on the concepts and the recommendations of your blue-ribbon com-
mittee. At that time, they were only recommendations from your
committee, but they seemed to be closing some of the gaps.
I think that you recognize, that the board recognizes that credi-
bility is the issue here, and that we do not want anybody to ques-
tion the integrity or the credibility of these markets. We do not
want to drive people overseas. We want to retain them. We want
them to grow and prosper but within a context and framework so
everybody knows that what is happening is aboveboard, proper and
appropriate.
Having said that, you still differ with us to a certain extent on
the dual trading aspect. Your proposal is not exactly identical to
the one we have in the bill. And it is based upon an accuracy
record of 90 percent, I believe. Once you get to that level and verify
that level your proposal would allow duEd trading to occur. Is that
basically correct, with some exceptions?
Mr. Melaiied. That is right.
Mr. Coleman. What is the current accuracy record on your ex-
change?
Mr. Mblamed. It avereiges approximately 85 percent ex-
changewide.
Mr. Coleman. And how does that relate to 5 or 10 years ago?
Mr. Melaheo. It is exceedingly better than it wfis 10 years ago.
We did not have a Cl'K system to measure that accura^ rate.
CTR, as you know, is a result of a lot of work between the Qiicago
Board of Trade find Chicago Mercantile Exchange. It was imple-
mented at the behest of the CFTC about 2 yetirs ago and has been
given great credit because no other exchanges in the world — not
even the security exchanges — have a system that is as efficient and
as up-to-date as CTTR.
It can be made better and, obviously, that is our goal.
Mr. Coleman. Does the CFTC have a standard that it has given
you or goal to reach within a certain period of time?
Mr. Melamed. I do not know that we are on a set standard. I
think 90 percent has been sort of a genered goal that the industry
and the CFTC would like to strive for.
Mr. Coleman. Mr. Salzman, do you want to comment? Do you
know the answer to that question?
Mr. Sai^man. Ninety percent, I believe.
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Mr. CoLEMAM. I asked this of Chairman Gramm. The rule the
Commission is under is 100 percent accuracy, but nobody has at-
tained that. Is that true? Is that your understanding?
Mr. Melabied. Not my understanding. My understanding is that
the goal had been from the inception ^t about 90 percent was a
reasonable level of expectation tnat would give everyone the com-
fort level they are trying to achieve; 100 percent is d^fUcult unless
your trade is done on a computer.
As you know, we have plans for an Eifter-hours electronic trans-
action system that would indeed track an audit trail at 100 per-
cent, but that is without human beings. There are no humem
beings that can effectively do anything at the 100-percent level; but
computers can.
In electronic after-hours trciding we expect the audit trail to be
exactly what you suggest.
Mr. Salzman. I would just like to add, the standard that we are
looking at is 90 percent verifiably accurate. That does not mean
that we are not 100 percent accurate. It means that there are cei^
tain times assigned to trades that cannot be proved through other
evidence to be correct.
We think that a very substantial percentage of those trades that
are not "veritably" accurate are accurately timed.
Mr. COLEttAN. What would be those types of trades?
Mr. Salzman. The^^ would be trades where two or three prices
may have occurred within a short period of time, and where we do
not have a time stamp on one piece of paper that absolutely shows
tliat the trade was done at time one rather than time two, but we
have other reiisons to be confident that it was done at tame one
rather than time two. We do not count that as verifiably accurate.
Mr. CoLEfiiAN. Now our standard to allow dual trading is pretty
well set forth in the exemption which says that an audit trail
would have to be capable of detecting emy and all trading viola-
tions and is fully venJEiable. How does that differ from your propos-
al?
Mr. Mklamed. Well, fully verifiable is what I was referring to fis
a very difficult standard to achieve. While we expect that all sys-
tems can do better, no systems will ever be perfect. So, what we are
suf^esting is that we are going to try to aclueve a 90 percent verifi-
able standeird. At that point in time, we will have a comfort level
that ought to satisfy all reasonable requests in terms of verifiabil-
ity.
Mr. Coi^MAN. Can I go on, Mr. Chairman, or do you want to go
around again?
Mr. English. I think without question, we are going to go around
again because I have some additional questions. I am sure other
members wUl Eifterward.
Mr. Tallon.
Mr. Tallon. Mr. Chairman, thank you. And, Leo, thank you for
your testimony.
I think you said that your accuracy of your audit trail is about
85 percent overall average in all contracts. How long do you think
it would take you to reach 90 percent accuracy with the technolo-
gy? I mean, you would have to spend more money, I would assume,
on technology.
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Could that be done in 12 months, 15 months?
Mr. Melamed. Well, I believe we can do it rather quickly. I
would not want to label it within a couple of months, nor are we
talking in terms of many years. Some time within 1 year it can be
done, probably substantially less than 1 year.
The way to do it though is not just to throw money at it. Many of
the reforms that were suggested by the Special Committee To
Review Trading Practices that Chairman English has made refer-
ence to, are the reforms that have to be adopted — the hourly pick
up of the trading cards, special brackets at the opening and at the
close, lowering the half-hour bracket to a smaller increment <k
time like 15 minutes.
With few exceptions, the reforms recommended by the special
panel have been adopted by our board. These reforms will serve to
increase accuracy of the audit trail.
Mr. Tallon. Leo, would the system you have and improvements
in the system you have and doing everything you can do, how difiQ-
cult is it going to be to meet this bUl's requirement of detecting
any and all of these? Ceui you do it?
Mr. Mblamed. Any and all, I do not think so. If you had 100 pei^
cent veriflability, you would not detect any and all abuses because
people are people. I do not know of a system yet devised, in any
industry, anywhere in the world that can detect all abuses.
I do not believe our system and the people who work within it
are worse than anybody else, but I do not think you can detect 100
percent of anything anywhere.
Mr. Coleman. Where is dued trading banned in exchangee that
you would be competing with around the world?
Mr. Melambj). There is hardly eaiy ban on dual trading in the
United States or world financial markets. In the securities market
there certainly is no ban — the specialists on the New York Stock
Exchange are dual traders. The financial mtmager in cash markets,
be it currencies or be it bonds, be it any cash market, is a dual
trader.
I dare say that is true in the agricultural industry as well. It is
certainly true throu^out the world in all the forms and in all the
fincuicifd centers and all the futures exchanges. Throughout the
world there is a form of dual tradii^. It is not banned.
Now it is not always the same, but it is not banned.
Mr. Tallon. Leo, the specialists on the New York Stock Ex-
chfinge, those dual traders, how many of them are there?
Mr. Melamed. Mr. Brodsky.
Mr. Brodsky. I, of course, cannot speak for the New York Stock
Exchange, but basically on the New York Stock Exchange there
are about 1,300 members, and I would guess there are probably
about 500 members who are engaged full time as specialists. Aj^un,
I am giving you an estimate.
Of course, what is significant about the New York Stock Ex-
change's system is that a specialist has the sole franchise to toade a
particular product, where in our markets there is competition be-
tween floor traders Euid among floor traders. So, there are signifi-
cant differences, but in the pedicular case of the New York Stock
Exchange, the specialist maintains the only public limit order
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book, and has access to that book, and also has the right to trade
for his own account.
Of course, this has been a subject of review by other congression-
al committees for many decades.
Mr. Tallon. And how many traders, how many seats do you all
have on the Chic^o Mercantile Exchange?
Mr. Brodsky. We have approximately 2,700 seats on our ex~
chaise. So we have more thfin double the amount on the New
York Stock Exchange.
Mr. Tallon. And of those 2,700, do you have emy idea how many
of those people or what percentage of them are in dual trade?
Mr. Melamed. I would say we are talking about in the nature of
maybe 33, 40 percent.
Mr. Tallon. So 40 percent of 2,700, you have certainly got a lot
more specialists.
Mr. Melamed. I might be too high. It might be a lot less than
that. We have never taken the actual count. So, the rcmge of 40
percent might be far too high. It might be down to, say, 25 percent,
m that area.
Mr. Tallon. Well, today, if all of a sudden at 11 o'clock this
morning, none of those 2,700 floor brokers were allowed to dual
b'ade anymore, what kind of impact do you think it might have on
liquidity on your exchange?
Mr. Melamed. Well, that is the $64,000 question. I am afraid
that it is very difficult to answer except to say it would be dan^^
ous because dual traders provide a form of liquidity in certain pits.
Depending on the nature of the market, they provide a mainstay of
liquidity. It is not even. I mesm there are some msu-kets that need
it more than others.
But that is the danger in this delicate balance between the per-
ceived evil that dual trading might represent, which is a percep-
tion, and the reality of the liquidity they do provide, which is reaU-
ty. And in trying to balcmce the two, we are always very mindful of
the fact that if we go too much to one direction, we hurt the other
direction. You are talking perception versus reality.
Your question is right on the button, very important. I cannot
answer the question but to say that it is a dangerous kind of situa-
tion. We must be very carefiil not to injure whatever liquidity that
is provided by those traders.
Mr. Tallon. It might even possibly be catastrophic. If nobody
were edlowed at 11 o'clock this morning to dual trade anymore, 1h©
spread could become impossible and there would be no more liquid-
ity.
Mr. Melamed. I would not rule that out. That is one of the dan-
gers that we aire dealing with absolutely.
Mr. Tallon. Thank you. My time has expired, Mr. Chairman.
Mr. EbiGLiSH. Mr. Combest.
Mr. CoMBBST. Thank you, Mr. Chaimmn.
Mr. Melfuned, I need to replow a little ground here, and I apolo-
gize to my colleagues if I am the only one that is a little fuzzy on
this, but I need to try to make sure I Eun clear on what you are
saying.
In your testimony on page 18, reference to any and all instances
of trading violations and Uie requirements that the audit trail be
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fully verifiable, you say these are impossible standards. Perfection
is not attainable in the futures industry nor in any other. Detec-
tion of any and all instances of wrong-doing is an unreasonable
standard that can never be met.
Yet, I thought I heard you define that probability of reaching
that as very difficult in a question to Mr. Coleman.
Let me make it for sure. Is your testimony that you are saying
that detection of any and edl Euid the fully verifiable are impossi-
ble, you cannot attain it ever, period? Is that right?
Mr. Melambd. In the environment of open outciy, when humans
are the element being used to create the transaction, I am saying
yes to your question. It is impossible.
If you aie talking about the electronic or technological world
such as with computers, such as we are also suggesting to create, it
is not impossible. In fact, we will attain it.
Mr. CoMBEST. It was suggested by someone — and I apologize I
cannot recall who; I do not guess it really matters — that that tech-
nology is available today.
Mr. MELAHsn. In terms of computers, it is, yes. And we will use
it.
Mr. CoBiiBKffT. In follow-up to the chairman's initial questioning, I
want to be sure I am also clear on this issue, are you saying t£at
you would not be concerned — are you saying that if the bill in its
current form passes find becomes law, that you would not be con-
cerned about any loss of business offshore?
Mr. Melahed. No, I am not saying that.
If the bill passes in its current form and if we cannot comply
with the requirements and the standards set find if, in ikct, we
have taken away dual trading capability ^m a large s^ment of
our market participants, I am very much concerned with what will
happen to liquidity.
Our competitors are now worldwide as 1 said in the openii^ re-
marks. The Japanese just this Jime opened a market direct^ in
competition with the inventions of the Chicago Mercantile Ex-
change. As you know, the Japanese are very competent in what
they do.
I am very concerned that they can and will attempt to wreet
these markete from us. I am not at all saying that they cannot.
Even standing with us toe to toe, without any restrictions on our
mtu-ket, it is ^oing to be a difficult battle as it is. With restrictions
that might injure the liquidity base of our markete, then I say erne
of our hands is going to be tied behind our back. I do not want to
go into that kind of fight, cmd I know Congress would not want us
to.
Mr. CoMBEST. One of the caveats you said where you would be
concerned about loss of business was if we could not comply. If the
bill passes in ite current form, do you think that it is possible for
you to comply with it?
Mr. Melameo. Not with 100 percent.
Mr. CoMBEffT. Thank you.
Mr. Engush. Ms. Long.
Ms. Long. Thank you, Mr. Chairman.
I would like to talk a little bit more about liquidity. Liquidity up
to a point is good, but liquidity can be so great uiat it just ii
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the volatility in a market. We have been operatiiig I think a bit
under the assumption that, as long as we have dual trading, we
can increase liquidity, and by increasing Uquidity we have a more
efficient market, a better running market.
I would like to ask you: Do you believe that in the past there has
been at different points in time so much liquidity that it has led to
greater volatility in the market, and as a consequence problems
with tremendous price fluctuations?
Mr. Melamed- With all due respect, I know of no study from any
academic source that would suggest that liquidity creates volatility.
Just the opposite, in fact. Our experience and all academic studies
have shown that in markets that nave less liquidity, have more vol-
atility. Price gaps develop between the current price and the next
price simply because there are not enough bids and offers flowing
to that marketplace.
All studies would underscore the fact that liquidity lessons vola-
tility. The more hquidity you have, the thicker the market. The
thicker the market, the less volatility. That is not to say that vola-
tility cannot occur for a lot of other ffictors, and does, but not be-
cause of liquidity.
Ms. Long. But it can; once you get beyond sort of an optimal
point, it can do that. And what I am asking you is: Have you seen
that? And apparently from your response you have not seen that in
your experience.
Mr. Melamed. I have not seen it, nor do I believe the theory is
that it would occur beyond a certain point. As a matter of fact, all
theory I have seen suggests the opposite. The more liquidity, the
thicker the meirket, theless volatility.
Ms. Long. Up to a point, that is absolutely correct up to a point.
Mr. Melamed. I have not seen that point nor seen it in theory. I
hate to differ with you, but from my reading and m^ understand-
ing of what the meu-ket is, and from practical experience, there is
no particular point. It is just simply the more liquid a market, the
thicker it is.
As the gentleman who testified on behcilf of the NCA, Mr. Josser-
and, said that as far as he is concerned, the more Uquidity, the
better. Sometimes the view is that there is something wrot^ with
Uqxiidity. Actually, what that means is more bids and offers and
pEurticipants in the mtu-ket.
Ms. Long. But it depends upon— the reason you have participa-
tion in the market depends upon whether you have speculation
that is leading to liquidity, versus you have participation by people
who have an actual end use for the commodity. And all of those
variables are going to influence how positive liquidity is.
Mr. Melamed. The end-user of Uie meirket comd not survive
without the speculator because it is the speculator who takes the
risk. The perfect market where there is no speculator, you can find
in some pleices in the world, but they have no meu-ket. And you are
acquainted with those places.
We need the speculator. The speculator's bids and offers are no
different in the marketplace than is the end user's bid and offer.
The bid and offer is the same. It is called liquidity.
Ms. Long. But, of course, we need the speculator but we need to
have some kind of balance between speculation and end use of the
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commodity, and all of these things have to, in order for the market
to be fairly stable, be at some level of balance.
I think that what we are looking for here, and I would naanma
what you are looking for there, is a means of operating the ex-
changes so that we are close to that balance moet of the time.
I am trying to get from you — I think I am getting a pretty rea-
sonable assessment of where you stand and what you beheve —
what is a reeisonable level of liquidity, how much dual trading con-
tributes to that liquidity so that we can then determine, and I indi-
vidufijly can determine, under what circumstances dual trading is
in fact useful for the exchanges.
In your Eissessment, the more liquidity, the better. Is that a fair
assessment?
Mr. Melamed. That is correct.
Ms. Long. Thank you.
Mr. Melamed. I do not know other than that what to think be-
cause we have both theoretical and practical experience supporting
this. As ffir as the balance between speculation and commendal ac-
tivity, each market has a different balance. There is no particular
rule on that either.
Some markets that I am Eicquainted with that are very, very suc-
cessful have as high as a 95 percent factor of commeixnal activity
and only a 5 percent factor of speculative activity. On the other
hand, I know of markets that are also ver^, very successful that
have a 70 percent factor of speculative activity and a 30 percent
factor of commercial activity, and yet they too are succesBfol. And
everything in between those two extremes can find balance and
successful markets.
Tliere is no particular rule I know of that can tell us what the
optimum bahmce ought to be. The marketplace is the only one that
can determine that, and thank God that we have a system of firee
markets that allows the marketplace to seek that kind of leveL
I will say this. If the correct level is not achieved by the market
itself, that market will not exist and it will die, and many markets
do. But as long as the marketplace succeeds, then by definition I
think it has found a level of bfdance that fdlows the market to
exist.
Mr. Engush. Mr. Harris.
Mr. Harris. Thank you, Mr. Chairman.
Excuse me, Mr. Chairman. I promoted him. You know, I do not
think there is a person on the committee who does not want to see
that the integrity of the market is maintained, and I know that is
a concern of all of us as well as you. And I know I do not want to
see anything done that would drive the business overseas.
So I guess what I am asking you on the question of dual trading,
what recommendation would you make to us? 1 know that, for in-
stance, the cattlemen recommended an outright ban. Of course, our
bill is sort of a — it does not, it is not Em outright ban. It has got
some limitations on it. What would you recommend to do on that?
Mr. Melamed. Thank you, Congressman, for the opportunity to
respond to this important question. And in doing bo, 1 would like to
also refer to the chairman's question about the original proposal by
the specifd committee to ban dual trading in mature liquid mar-
kets.
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That same committee was reconvened recently when the CME's
internal committee proposed Ein Eiltemative to the special commit-
tee's ban on dual trtiding in mature, liquid mfirkets. The special
committee unanimously approved the internal committee's recom-
mendation and said that it was fully equivalent to their own rec-
ommendation.
In response to your question, the internal committee recognized,
as did the special committee, that a delicate balance exists between
the perception that dual trading might allow someone — and it is
true — to violate the rules— front-running, and so forth, etc, — versus
the liquidity dual trading provides.
How do you find that delicate balance? It is suggested that if we
could find a way to catch enough of those culprits that would use
dual trading to their own advantage and to the disadvemtage of a
pubhc customer, and if we could do that enough of the time to give
us the level of integrity that we seek, then we could preserve the
positive aspects of dual trading which is its liquidity. That level is
the 90 percent verifiability for the timing of trades through the
computerized trade reconstruction system.
And if we can sichieve 90 percent verifiability, it is felt that we
will catch the wrongdoer enough of the time that we can afford to
maintain the dual trading system. The special committee agreed
that this approEich was clearly adequate £md as good as their own
approach.
Those markets that cannot achieve the level of 90 percent verifi-
abihty will lose the right to dual trade.
Mr. Harkis. Thfmk you. Thank you, Mr. Chairman.
Mr. English. Mr. Staggers.
Mr. Staggers. Thank you, Mr. Chairmim.
Following up on Mr. Harris' question, the flaw in that would
seem to be that if we set a standard of 90 percent, then we are tell-
ing people as long as you only do 10 percent, you fu-e OK.
Is there another way we can do that as opposed to the "any" and
"all," language that is in the bill. And I think that is what Mr.
Harris was getting at, I think we are looking for ways to get
around the Emy" and "all," but if we say eis long as you work
toward the 10 percent, I realize that setting the standards -works
both ways. That is my question, if we say it is OK for 10 percent,
90 percent is a laudable goal, especially in today's society. But if we
do have the increfise in technology, I mean, why not have a goal of
100 percent and leave it to the discretion of the CFTC, or what-
ever?
Mr. Melamed. We are not saying that if we have 90 percent ver-
ifiability, the other 10 percent is OK. lliat clearly is not in our
intent and it is not the way this would work.
The 90 percent verifiability would be accomplished by a system
that can detect 90 percent of any untimed trades. The rest of the
system, however, is geared to detect anything within that other 10
percent. These trades may be timed correctly. Our Ll'K system
cannot, however, tell us this. AU our rules and the package of re-
forms is very very comprehensive. And we feel that with all these
rules together, our exchange will have a surveillance capability we
feel is second to none. "Hiere is one element we have recently
agreed to do, which I would like to explain if I could.
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Mr. EiHOLiBH. Sure.
Mr, Melamed. What we are suggesting ia that every morning,
the previous day's record of transactions be given to every membra"
of our exchange within an hour of the next day's opening so that
eadi of the 2,700 members of the exchange, most of whom are not
dual traderB, can act as poUcemen themselves. By examining the
record of the previous day's trades, they will be able to detect
whether any fimny trades occurred in their own pit, and come foi^
ward with supporting evidence.
As a matter of feict, many of our Banctions today are self-generat-
ed, as you know, by the exchange's floor membership. Thia has
never been done by any exchange, and it ia only made possible be-
cause computerized trade reconstruction — CTR — allows us the
luxury of quickly reconstructing the previous day's trades. We can
give our membeiB this important tool the next day as another self-
policing tool for that additional 10 percent. Indeed, we have many
many rules in place that will be more than enough to take care m
the other 10 percent, which may be timed correctly.
We are suggesting so comprehensive a package that I believe this
committee will be very pleased. I know our goals are the same. I
have no doubt that everyone of us has the same goal — to have our
markets the most efficient and with the highest integrity possible. I
commend you all, and of course the chairman, for movmg fonrard
in that direction.
Mr. Staggers. Following up once again with what Mr. Harris
said, I think I agree with you that our goals are similar, our search
for putting t^^ether some language which can accomplish that.
My undeiBtanding is the system that you have now could do
about 90 percent anyway. What 1 guess 1 am saying ia if we write
that into law, shouldn't we — 1 do not know what you mean by the
90 percent. I^iouldn't we have some flexibility to allow somebody
else to review this and to say, well, maybe next year, or 5 years
from now, you can do better; 95 might be the standard whitm we
want to achieve.
I agree that 100 percent of anything is very difficult to accom-
plish. And I see the point, but 1 am looking at it from a legislator's
standpoint of how we put t^ether something that is less than the
"any' and "all," of the 100 percent. Now, 1 am searching.
Mr. Melamed. 1 am too. I agree with you that we should always
try for better. Certainly 90 percent is the goal we have in finnt of
us at this moment. But what we suggested is that we give the
CFTC the authority to make the determination whether we have
achieved the 90 percent.
We do not want to be the umpire involved, because that certainly
would not be fair. We would like the umpire to be unbiased, one
with the capability to make that determination, and that is the
Commodity Futures Trading Commission.
Mi. Staggers. Thank you. Thank you, Mr. Chairman.
Mr. English. Thank you very much, Mr. Staggers.
Mr. Sarpalius.
Mr. Sarfauus. No queetions.
Mr. English. Mr. Holloway.
Mr. Holloway. Thank you very much.
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I know the testimony has been that undoubtedly the feeling out
in America is that dual trading has problems. I would like, just for
tiie record, for the two of you with both the Chicago Board and the
Chicago Mercantile, exactly what do your exchanges mean to this
country, to the city of Chicago? Knowing that we have been told
over and over of the problems that we are going to have with the
Japanese taking it over exactly in jobs and money, what do thrae
two exchanges mestn to our country, the city of Chicago?
Mr. Meluied. Thank you for the opportunity to respond.
To the city of Chicago and State of niinois, Chicago's four ex-
changes are the central economic engine in th^t area of the Mid-
west.
[The supplemental statement submitted by Mr. Melamed fol-
Iowb:]
More than 33,000 jolM are provided by the exchangee, their membere and the or-
ganizationB that provide services to them. Over 110,000 total indirect jobs can be at-
tributed to exchange economic activi^. More than Jll million vearl^ in proper^
taxes is paid on bufldingi that house the exchangee. Nearly $1 billion is spent annu-
ally on exchatuce-relatea goods and services in the Chicago area. Member firms have
an average of $4 billion on deposit in Chicago banks on a typical day.
Mr. Melamed. But those are not as important as the fact that
our markets are now so central to the financial fabric of this
Nation. I would like to relate an anecdote. After the 1987 crash, I
met with the heads of those financial firms in New York that are
at the top of the financial structure in this coimtry- One of those
gentlemen said to me that before you testify in Congrees to the
Banking Committee on these issues, remember that your markets
now are such a financial resource in this country, that we dare not
do anythii^ that would destroy or hurt them or drive them some-
where else, because they no longer are simply an out-of-the-way
little marketplace. They are now centrsd.
In fact, the Treasurer of the United States, Mr. Brady, called it
one market; the securities market, the futures market, and the op-
tions market are now one market. E^ach one of them is such an im-
portant element in the overall financial landscape that we cannot
exist without any one of them. And, of course, the rest of the world
would love to get their hands on our markets.
Mr. HoLLOWAY. Thank you. 1 mean, I know that we have to be
very careful. But I think we have to realize that if we make the
wrong move, we very likely could let the Japanese take another
one of the many industries they have taken away from us out of
our country.
I think we, as a committee, t hope we proceed cautiously. I am
not here to tell you that I totally understand the working of the
Chicago Board of Trade or the Chicago Mercantile. And I hope to
gain in knowledge as we go on to educate myself toward it. But I
just hope that we, as a committee, are very very carefiil with what
we do to our country as far as driving this abroad. Thank you.
Mr. Melamed. Thankyou.
The Chairman. Mr. Chairman, if I might have a question of Bdr.
Melamed, if you would.
I think you gave a very good, succinct, factual description of dual
tradii^. My perception is that the dual trader is not the problem,
but rather if you front run. Then the question I would like fbr you
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to address is if the front run may or may not be to the disadvan-
tage of a customer. What is the experience in that area? Just de-
tecting that someone bought for himself rather than for a custom-
er, gives UB numbers in a vacuum. You smd most of the witnesses
here are the experts. We deal mostly from theory rather than from
actual experience. We have to accept that and appreciate that. But
I would hope that we can put in the record a little more explana-
tion in the whys and wherefores and you address it in part.
Could you help us with that, Mr. Melamed?
Mr. Melahed. I would be pleased to, Mr. Chairman.
I want to say, first off, that our rules very explicitly label any
front running as a violation. Front running simply means that
when a broker has an order for a customer in hand, he dare not do
a trade for his own account ahead of that order for the customer.
That does not mean that when he violates that rule he automati-
cally ii^ures the customer. That has to be examined in a courtroom
or before a committee. Let's say the broker filled the order for the
customer and for himself at the same price and everybody got the
same price. Of course there was no injury involved. But the rule
had been violated just the same.
We look at that very, very strictly. In effect, you cannot and dare
not violate the rule of front running. We feel that dual trading
does give the opportunity for that kind of thing. That is why we
are here and talking about it.
But I must tell you, Mr. William T. Cheny, staff director, of this
subcommittee correctly stated to this committee that dual trading
is not inherently evil, that banning dual trading does not cure all
evil, and that there is nothing that cannot be done without dual
trading that can be done with dual trsiding.
In fact, he indicated that there are only two kinds of violations
that can occur because of dual trading: When a broker trades
ahead of a customer's order; and taking a position against a cus-
tomer. This kind of thing is one of the easiest abuses to detect. If
you ban it, all you are going to do is eillow that dual trader to find
a different way to violate. That violation is going to occur if he
chooses to violate. And we have to find him anyway.
So you are right in saying that to ban dual trading will not cure
the evil involved.
The Chairbian. The next item, Mr. Melamed. you mentioned
briefly the problems with the securities industry in New York. And
you mentioned your resources as to information.
Could you expand on that? I know that we heard that you were
supplying to the SBC information that they did not have readily at
hand.
Mr. Melamed. I could do it best by telling you this incident.
Mr. Nicholfis Brady, who is now Secretajr^ of Treasury, headed
the Presidential task force investigating The 1987 stodk loaxkBt
crash. When he visited our exchai^e within 1 week or so after the
crash, he sat down with us smd had a long list of the kind of infca-
mation that the committee he w£is heading would need in ito study.
He Eisked us how long it would be before we could give him our
response to this information, a lot of statistical information about
the trades that occurred during the week of October 19. We toM
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him that we have that information, and can give it to you before
you leave today.
He was Eistounded because the securities world was unable to
S' % it to him for weeks thereafter, months in some cases. Yet our
mputerized Trade Reconfitruction — CTR — system was such that
we were able to give it to him within days after the occurrence.
In fact, aa I au^eeted today, we SLre ready with a reconstructed
trade re^ster theday after. No other exchange I know of has that
capability in today's world; in the United States certainly.
The CHAiRBfAN. Would you also mention briefly your computer-
ized process, your GLOMEX operation?
Mr. Melamed. I would. What we recognized, Mr. Chairman, was
that the competition that we face with the Japanese and the Euro-
peans transcends our working day. Because, you know, the world
has now shrunk to a point that these competitive markets are ev-
erywhere. People do not wait until our markets open the next
morning to trade, to do their hedging, to do whatever they need.
In fact, it used to be we were all protected with a geographical
blanket that protected our markets from competition. It is no
longer true. So we decided that we must lesid our industry to create
an "after-hours" system. And the best system to create, we
thought, was electronic because that would work best for til 24
hours, the 16 hours that we are not physically open.
We went to the largest communications organization in the
world, Reuters, and with them created GIX)BEX, an "after-hours"
transfiction system that will be launched sometime later this year
or early next year. For the first time in history, we are leading the
financial service world to a 24-hour transaction system. And I must
say, everyone has followed our lead, including the securities world.
I notice the over-the-counter industry has moved in the same di-
rection. The security options industry has moved in the same direc-
tion. But it was our exchange that led the way. And recently, as
you know, the Chicago Board of Trade which created Uieir own
system of a similar nature and the Chicago Mercantile Exchange
have entered discussions to unify those two systems so that t(^&-
er we could present to the world a coBt«fRcient ^stem.
The Chairman. Thank you veiy much, Mr. Melamed, and let me
apolo&ze. I called your GIOBEX, GLOMEX. I have been working
on the Mexican foreign debt. And everything has been "mex" for
the last couple of weeks.
Mr. Melamed. I did not even notice that.
Mr. English. Thank you, Mr. Chairman.
Mr. Morrison.
Mr. M(HiiusoN. Thfuik you.
The capabilities of GLOBEX are exciting.
Is there a potential that it sets the stage for the incurBion of
fiilly computerized trading on into your normal trading dajr?
Mr. Melamed. I do not believe that that is likely in the foreseea-
ble future.
We have yet to prove to what extent liquidity can be generated
on a computer. We do not know that. We are experimenting. Now,
if you ask me what will it look like 20 years from now, I do not
know. But in the foreseeable future, I do not tiiink so. I believe
that the electronic Gfystem GLOBEX and AURORA, that we hope to
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launch in the near future, will succeed because it will dmend on
EUid key off the liquidity of open outcry that is created in me open
outcry fashion during our trading day.
That liquidity will work as the engine to succeed with the elec-
tronic market later.
Mr. MoEaisoN. But it will demonstrate a technology that if and
when the institution is ready to move in that direction, it could be
utilized as even a replacement for the current human involvement
in the pits.
Mr. Melamko. Theoretically. That is speculative, but theoretical-
ly you are, of course, correct. I merely say that I cannot foresee
uiat in a foreseeable timeframe.
Mr. Morrison. It would be interesting to see how the institution
responds. I think your approach to it is a superb combination.
I wanted to eisk about something that 1 do not believe anyone has
talked dtiout and that is off floor trading. It is not included in our
chairman's bill, and yet without knowing exactly what all was in-
volved in the FBI investigation, maybe a part of what th^ find
that reflects some problems out there.
Could you just give us an overview of your concerns with or how
off floor tradmg could be controlled, regulated, restricted?
Mr. Meiamed. Well, we clearly do not know what the invesUgar
tion will show. You are correct.
As a matter of fact, our beet advice is that not much of the inves-
tigation will in fact indicate a lot to do with dual trading. I mean,
there are violations involving taxes and there are other kinds of
customer cheating that do not have anything to do with dual trad-
ing. And there might be some off exchange things that we do not
know about, you are right.
Off exchait^e has always been a problem for the exchanges be-
cause we have no authority. In fact, some years back we went to
Congress, and t^ether, as you may recall, worked out the creation
of ue National Futures Association. The NFA is the authoritar over
(^-exchange matters, ordained by the CFTC to help the CFTC in
such areas as financial monitoring of ofif-exchangfe entities, that is
entities that are not members of exchange.
And so it is an area that we have some concern with, but we
have no authority over. The National Futures Association does an
extremely good job in monitoring some of that area. And the CFTC
has to do the rest.
Mr. MoRHiBON. You are coniforteble then that NFA and their
working relationship with the CFTC adequately covers that area?
Mr. Melamed. I must in all honesty advise you that I am biased,
since I am chairman of the NFA. Yes, I am comfortable and I be-
lieve the NFA does an excellent job, but it is very self-serving for
me to s^ BO.
Mr. Morrison. We love confidence around here. It is a product
that ia all too often in excess supply.
The Commodity Futures Trading Commission yesterday sort of
got beat up and 1 would like to, even though my time is up, just
ask one more simple question.
Your general observation working relationships between the ex-
changes as being essentially self-regulating and the CFTC. And as
we go through this process, do the dynamics need to be changed?
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Does the level of authority need to be changed? More of an editori-
al type question, I guess, thfin a specific one.
Mr. Mblamed. In our workings with the CFTC, although many of
our members et^oy when a Federsil Eigency gets beat up and ap-
plaud when that happens, I must say that we, as leaders of the ex-
change, have found the CFTC to be an exemplary agency. It is run
extremely well and does a very very efficient job.
As a matter of fact, we have a direct comparison that many of
our members do not because we deal with many Federal agencies,
not just the CFTC. And in almost every instance, I would say that
tJie CFTC comes out with higher marks than do other comparable
Federfd agencies. Our experience has been just the opposite. We
find the CFTC to be very professional.
As a matter of fact, we are, as you know, strongly in favor of per-
manent reauthorization for the CFTC. I believe the bill that the
chairman introduced also includes that provision, which we sup-
port.
Mr. Morrison. Thank you very much.
Thank you, Mr. Chairman.
Mr. English. Mr. Grandy.
Mr. Grandy. No questions.
Mr. English. Leo, I have some additionsil questions and I think
probably some of the other members will too.
I want to ask you to put on the hat that you were wearing on
April 19 when you signed the report. With r^ard to the provisions
dealing with dufd trading, I noticed in there uiat it bans dual trad-
ing in fill contract months that reach the level of mature liquidity.
I suppose the question comes in, and this would be determined by
the b<^rd of governors and based on market conditions and 80 on.
What is the definition by yourself of mature liquidity?
Mr. Melamed. Well, we use those words because there is no ob-
jective way in which to measure a mature liquid contriict. We used
them and indicated that it was up to the CME's board of governors.
This specifd committee, in its report, stated that the only way it
could make that judgment and feel comfortable about it is if they
allowed the market experts to make a determination on a case-by-
case basis which market is sufficiently mature and liquid to widi-
stand the hit it might get by losing some dual trading liquidity.
The special committee used the words mature liquidity with the
xmderstanding that you could not say catogorically which number
is right and which number is wrong. And they allowed the board to
make a determination market by market, in fact, contriict month
by contract month. That was their idea and that is how they pro-
ceeded.
Mr. English. And that basically is the provisions under the bill.
The bill sets a certain number. It provides and allows for the ex-
changes to come before the CFTC. The CFTC instead of the board
of governors then would be the one that would make that determi-
nation. So they are very similar in that manner as far ea where
the determination would ultimately end up, the CFTC on one hand,
the boEU*d of governors of the exchange on Uie other.
Mr. Melamed. We have no quarrel with the goal, eis we have
talked before, of your bill. Our difference is simpo' that we do not
believe that an absolute number is the way to approach this, be-
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cause we fear that and we do not feel that it is goiiig to work in a
practical way, that the CFTC will act in a timely maniiM'.
It might very well be, with all due respect to the CFTC. that Qm
will not act in a timely manner, because the system does not work
that way. By the time the illiquidity that has developed around a
given market has hurt that market, it is too late to change the re-
qtiirement. If we lower the requirement from 7,000 to 1,000 and the
market is already hurt by it, you cannot bring a market back
quickly.
And so, Eis in many things that are very sensitive, we feel you
cannot wade through a process that is, by its own nature, bureau-
cratic and will not work as kindly as is necessary. We do not want
to take that chance.
Mr. Enqush. But the point that we come down to though on the
issue of liquidity in discussing it with some of your members as
well as members from the other exchanges, it is my understanding
within the industry generally perceived when a contract hits the
level of 5,000 a day, it is generally considered to be mature liquid
contracts. Is that not true?
Mr. Melamed. I do not know that — I mean, these are opiniims
other than mine, but I do not know that there is such a number
that we could say. I know that some small markets are adequately
liquid at 5,000 and some are not; some are not liquid at 20,0W. It is
a question of whether the order flow is constant or at least is con-
sistent every day or every month during the course of the year.
Mr. English. But the basic issue that we are tolhing about here
though comes down to the question as to whether it would be, as
the proposal was originally intended, whether it would be the
board of governors of the exchange or whether it would be up to
the CFTC to determine whether a particular contract is a mature
liquid contract or not. Is that not true?
Mr. Melabied. You will note that when our internal committee
suggested a 90 percent verifiability threshold instead of mature
liquid, the special committee to which you are referring, unani-
mously accepted that as an adequate alternative to its own pn^xw-
al. They recognized that there is so delicate a balance between
trying to correct the perceived wrong and the loss of liquidity tlut
one cannot be so absolute. They felt that the 90 percent ven&dnl-
ity approach was as good and perhaps better.
Mr. English. It is my understan(Ung though that the recommen-
dation that you and the special committee made to the member^
ship met with a very strong rejection, opposition by the memb^
ship to those particular proposals. And that these were drafted in
place of those as a response to that strong opposition. Is that not
true?
Mr. Melamed. There were vocal objections, of course. There was
a segment that does not wemt any restriction on dual trading, of
course. But I do not know that was the vast majority.
The internal committee that wrote the substitute alternative and
presented it to the special committee, was composed of people that
clearly understood the problem. And no one pressured the special
committee to agree that what the internal committee sufS^iBted
was in every way as good as their own proposal.
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I do not believe it was in response to any nu^or objections from
our floor. There were some that objected, of course. There are ob-
jectors in every society or socifd structure. But that was not a pres-
sure that our internal committee bowed to.
Mr. English. Mr. Coleman.
Mr. Coleman. It has happened not just today but yesterday also
that we continually forget about the exemptions, exclusions, oppor-
tunities for flexibility both written in the bill and in your proposal.
We talk in stark contrast. We are either for dual trading or we
are against dual trading. Dual trading is going to dry up the mar-
kets or it is not going to drive things off-shore. We cannot talk in
terms of black and white, because your own proposal prohibits dual
trading. If I wanted to stop at that, it would be a rather unfair
characterization.
I think it is very unfair for people to suggest that the bill prohib-
its dual trading and stop at that, because we provide opportunities
to exempt exchanges from the prohibition, zmd you have addressed
those in your written testimony.
At the same time you prohibit duEil trsiding if a market does not
come up with a 90 percent standard.
Mr. Martinez. That's right.
Mr. CoLEHAN. So let's all be a little more forthcoming in how we
discuss these issues. What is it that we do not have in our bill
other than "any and aH" and the 100 percent verifiability — which
is your interpretation, and we understand that? Is it that we do not
provide enough flexibility to the Commission to deal with certain
problems? Your own proposal provides for the same exemptions,
written authorization of the dual trade, for example. We have the
spreELd issue. We have tried to address that. Do you have that?
What is it that is di^ereot about the two proposals other than
that we have a standard which is higher — but which could be modi-
fied. We are open to suggestions and modifications of some sort.
Is there really any substantial difference, Leo, in what we are
sayii^ Other than the degree, I guess, you are at 90, you may
think we are at 100.
Mr. Melamed. Well, other than the degree, of course. The ap-
proach is different because ours is based on a 90 percent verifiabu-
ity of timii^ of trades, and the proposal of the bill is based on a
volimie statistic. The volume statistic in itself is an arbitrary
number.
Mr. Coleman. As a threshold, but also it can be amended by the
Commission itself. They could set it at 300,000 contracts, and every-
body would be
Mr. Melameu. I doubt if they would because that is the point.
The Commission is not going to change the will of the Congress,
nor should it easily. You would not want that and I would not
want that. It would be a difficult process for the Commission to
ignore the suggested requirement of Congress. It always is a diffi-
cult proposition.
So in the kind of give and take that happens after such a bill
that has a number in it becomes law, it becomes almost near im-
possible to change the number. By ^e time the number is changed,
a given market has suffered and it will be too late to save.
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Mr. Coi^kiAN. In all due respect, if we were to take your lan-
guage and draft it into legislation, the 90 percent would be put into
law, EUid you would have the same impact, if a contract could not
reach that. True?
Mr. Melamsd. Yes, but it is not based on a volume statistic. It's
based on a statistic of verifiability of all the trades that occur.
liiere's one more element that our attorney would like to men-
tion. If I could ask him to with respect to the bill that I have not
touched on.
Mr. Salzman. If 1 could, I hope this isn't too technical, but some
of the exemptions are slightly troublesome, especially tiie one on
brokers who make errors. The bill seems to say that a broker who
makes an error must wait until the next morning's opening to
trade out of his error. The people we've talked to at the excbaogB
have said that it will make it utterly impossible to act as a broker
because the range of costs that could be involved in that are just so
enormous.
Everybody at our exchange, at least — everybody I've ever talked
to— agrees that a broker must be free to trade out of his error im-
mediately, otherwise the cost of brokerage, which is now between
$.75 and S1.50 or $1.75 either has to go to an infinite level or these
people will not act as brokers. There is just not enough money in it
to take those kinds of risks. They are taking |100,000 risks for $20.
Mr. Coleman. These are types of things which obvious^ can be
addressed and modified, and we respect and want and seek your ex-
pertise along these lines. So I think we are getting into some, as
you say, if not technical, at least some side-stream issues, and I
want to pursue a couple of the mainstream issues here, if I mi^^
This Bu^estion that we are going to force things ofbhore is a
real easy one. We heard that in 1986, in all due respect, in the last
reauthorization. It has not necessarily occurred.
The analogies to the securities markets, if we did not have an inr
sider trading violation of law, there would be some who would s^,
"If we have such a law £^ainst insider trading, we might be driving
all the securities offshore." I do not think anybody wants to elimi-
nate that s^ment of securities law because somehow To^o or
Taiwan or somebody might open up a market and allow inrider
trading.
We need to have the saf^aurds here, not just because we are
airaid of competition, that somebody else will have less safeguards,
as long as we do not destroy our markets. So all this driving off'
^ore Dusiness is an easy ai^ument which is difficult to suggest
that the answer is going to be more suspicion of our marketsTleeB
things nailed down, more perception problems that somehow this is
going to attract business.
Mr. Melamed. May I respond to the issue of ofiishore competi-
tion?
Mr. Coleman. Sure.
Mr. Melamed. That is not simply an imagined issue. I agree with
you that we want to have markets with integrity. Clearly, you are
right about that, but unmistakably the issue of offshore competi-
tion is vety serious.
From 100 percent of futures market share, in the last several
years, we have gone to 65 percent. If the auto industry or the mi-
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crochip industry are examples of what the Japanese can do to our
market share, those are serious competitive factors that we £is
Americans must understand Euid be very careflU with. While I do
agree with you entirely that our markets must maintain integrity,
we cannot afford to ignore the competitive issues that foreign mai^
kete do represent.
Mr. CoLEBiiAN. Have you seen any pull away in our T-bill mar-
kets by the Japanese?
Mr. Melamed. Which market?
Mr. CoLXUAN. Treasury or other credit markets?
Mr. Melahed. Absolutely.
Mr. Coleman. Would some of that be as a result of what, what
Mr. Melambd. The Japanese created markets that attract the
business we invented and are taking that business from us. That's
true in U.S. bonds, in Eurodollars, and they are now attemptii^ to
do 80 in currencies.
Mr. Coleman. But it has not been because of anythii^ that we
have slapped on from this committee or the high confidence that
you have voiced in the Commission, has it?
Mr. Melamed. On the contrary. Your committee has thus far
been very supportive and in full understanding of the value of this
industry. What we are simply afraid of is a change in direction.
Mr. Coleman. Let me ask one or two other questions, if I might
The issue of front nmning, Leo, hfis been brought up. Front run-
ning today is a violation of law because it is fraud. Is that not the
case?
Mr. Melamed. That's ri^t.
Mr. Coleman. So there should not be any question that it is al-
ready a violation or a wroi^ that is being looked for by the ex-
changes and by the Commission.
Mr. Melamed. That's correct.
Mr. CoLEiifAN. One final question about dual trading in the audit
trail. With GLOBEX going to a computerized trading system, you
have in fact constructed something that would change the terms of
our bill. Correct?
Mr. Melamed. On the contrary
Mr. Coleman. Is 100 percent verifiable?
Mr. Melamed. Yes, but in one respect, Mr. Coleman. It isn't pos-
sible to live within ^le bill because on the computer there should
be no ban on the dual trader at fill.
Mr. Coleman. That is correct because he would be found out.
Mr. Melamed. Yes, it's 100 percent verifiable.
Mr. Coleman. That is what we are saying.
Mr. Melamed. Exactly, so that your bill would not fit the com-
puter world at all because we shouldn't have any 7,000 or any re-
quirement.
Mr. Coleman. You would have met the exemptions, and the dual
trading would occur as you directly state. The problem with the
dual trader is if you traded ahead, he would be found out because
you had a system set up already.
Mr. Melamed. My suggestion only is this: In your bUl you might
wfmt to adjust the language that shows the difference between a
23-500 0 - 90 -
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computer-generated environment and a floor open outcry environ-
ment, if I might suggest that
Mr. Coleman. That is indeed the question, isn't it, open outciT?
Let me aak you a completely different question. We had some
testimony yesterday about basically the Clunese wall. In the con-
struction of the Chinese wall with a large broker like Merrill
Lynch trading for its own account and trading for customers, could
you tell us a little about how you look at that Chinese wall? You at
the exchange have the power to audit those now, correct?
Mr. MsLAHED. Yes.
Mr. Coleman. And any problems — have you seen any problems
with the breakdown of that Chinese wall, and would you explain
what that is for the record?
Mr. Melamed. Could I ask our attorney to try this one?
Mr. Coleman. Yes.
Mr. Salzman. We absolutely understand the problem, and we
have now created a surveillance tool, a computerized surveillance
tool to deal with it. We search the mfirket for large price move-
ments in short periods of time, and then look for aU orders entered
just before and after those moves, then we can trace those orders
back upstairs as well as the floor.
So given that tool, which our compliance people have now cre-
ated and which will be put into effect very shortly, we believe will
be competent to deal with upstairs abuses as well as floor abuses of
dual trading or trading ahead of customers. It's a pretty smart
idea, I think, and it works because we have the CTR system operat-
ing at this point.
Mr. Coleman. And the CFTC has not found any problems in re-
viewing your audit.
Mr. Salzman. The CFTC finds problems every time they review
us. It's part of their job. They give us a list of 8 or 10 correctionB
every oUier year, and they come back 1 year later to make sure we
have implemented them. We know that no matter what we do,
they are going to find 8 or 10 things we have to correct l^e next
year, and we expect it. It all helps build Leo's confidence.
Mr. Melamed. That's correct.
Mr. Eh4GLiSH. Mr. Tallon.
Mr. Tallon. Mr. Chairman, thank you. Anybody that wanted to
use a broker that was not a dual trader they could certainly have
an opportunity to use a broker that was not a dual trader or used
the Globex system which is a fiilly automated system. Is that not
true?
Mr. Melamed. That's true. In the present world, any customer
can direct his orders to a nondual trader if that's what he chooses.
Mr. Tallon. Ms. Long was asking some very good questions
about stebility and liquidity and its impact and efiiect on stability,
and I think your very good answer was that liquidity created sta-
bility in the mfirkete. In the l^islation that we have before us in
trying to define or determine a mature liquid contract with the
7,000 volume traded dfdly, would it be better in trying to define a
. mature liquid contract if that was a course that this committee is
going to go to — think about the bid-etsk spread on any contract
traded on zmy exchai^e?
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Mr. Melamed. There is no shorthand rule I know of for deter-
mining mature liquid. That's a hands-on kind of approach, feeling
the market, seeing the kind of bids and offers the market gets on a
daily basis over weeks and months by the people on the floor and
in the business and in the commercifu area of activity.
I don't know of any rules that can tell you bid-ask or otherwise.
Mr. Tallon. And again, I was not thinking about any strict
rules, but we have not really — for exemptions that Mr, doleman
talks about in the bill — we have not talked about the CFTC and li-
quidity period, but if we are talking about liquidity somehow I
think we have to look at the bid-ask spread rather than an arbi-
tral 7,000 contracts traded daily.
IV^. Melamed. Well, you're clearly right that the bid-ask spread
is an indicator of liouituty. A spread that is consistently small be-
tween the bid and offer is indicative of a much more liquid market
than is one that has a very big spread between the bid and o£fer.
'That was part of the Emswer that I gave Ms. Long in barms of price
gaps.
A large spread between the bid and offer will create large gaps of
trade between a price and the next price, and is indicative of a less
liquid market
Mr. Tallon. And a less mature liquid contract.
Mr. Melamed. Exactly.
Mr. Tallon. So, certainly that might be a way to determine li-
quidity in a contract on any exchange, in my mind, if that had to
be done by the CFTC to form what exemptions would be applicable.
Bill, how many traders on the Mercantile Exchange has the Jus-
tice Department ever prosecuted specifically for trading ahead of a
customer?
Mr. Brodsky. None to my knowledge, Mr. Tallon.
Mr. Tallon. BUt, if criminal penalties, msmdated criminal penal-
ties were written into this legislation for traders that were trading
ahead, what kind of impact do you think it would have on people
that are involved with dual trading? Would you want to comment
on that because that is certainly something that I have an interest
in and we have discussed?
Mr. Brodsky. Our view generally is that there is certain conduct
right now that is violative not only of our rules but of Federal law,
emd I don't think that there is any need to do anything further. My
counsel might be able to add to that, but I believe that our own
enforcement prc^am plus the oversight of the CFTC has had a
very important prophylactic effect over the last severfil years to
deter this type of conduct.
Mr. Salzman. I can only say that I saw the Justice Depeirtment's
reaction to the proposal. I know they are very nervous for fear that
somebody will interpret the change in law as if the previous boss
said there was no penalty. We have been cooperating as fully as we
can with the Justice Department, and we don't want to support
anything that they are against in this matter. I think we have to
leave it at that even though we understand what you're trying to
do and why it's important.
Mr. Tallon. And yet, the Justice Department has never brought
criminal charges against anybody for trading ahead of a customer,
and certainly if 1 were a dual trader, which I think can be very
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beneficial that to provide liquidity and eflicienQr to these markets,
I do not think tiiat I am going to think about uie — I am not going
to give much thou{^t at all to the illegal practice of front running
if that is a part of this legislation. That would be my view anyway.
I do not know I would want to deal with trade anymore.
Thank you.
Mr. English. Ms. Long.
Ms. Long. Thank you, Mr. Chairman. I would just simply like to
make the statement that right before a market crash you have a
high level of liquidity usually due to a high d^^ee of speculation,
and what we really need to fmd in this legislation, what we are
willing to do in this legislation is work toward r^ulations that
keep Uquidity at a healthy level and speculation at a healtli^ level.
Tiiankyou.
Mr. Engush. Mr. Grandy.
Mr. Grandy. Thank you, Mr. Chairman. I apologize to the cma-
mittee for being tardy this morning.
Mr. Melamed, 1 wanted to ask you your opinion of 8omethinf[. I
have looked at your testimony briefly and hoped to have some tune
to ask you about some of the things in it. But a couple of df^ ago.
Chairman Gramm was before us, and I asked her a question that
related to insider tradii^, and I asked her for her definition of it as
it relates to the commodity exchanges. The definition, at least to
this member, was not intelugible.
Can you tell me what insider trading is in your exchange and
how do you police it?
Mr. Melamed. Well, insider trading in the clfissic sense heia to do
with, say, knowledge of a corporate report by someone within a cor-
poration knowing the dividend report or how the coir^any is doing
or some special product that might be coming out. Those are the
classic cases of insider trading.
None of those exist in futures market because the product that is
being traded is not corporate-owned. The product that is b^ng
traded is everybody's product. Everybody knows the specifications
of the product. These specifications don't change. Everybody knows
what it is that is beii^ traded.
The onlv kind of insider trading that occurs in terms of futures
markets that come to mind is, for instance, the broker who has an
order in his hand from a customer. The broker knows what that
order is, and then deals for his own account because he understood
what that order from his customer might be. He has some roedal
information that nobody else has. We are very mindful of, and very
concerned about that kmd of thing.
But the other kind of insider trading that might oa;ur is if there
is a Federal report about a market, such as a market report on the
trade gap or something from the Labor Department on emplqy^
ment figures, or a cattle report that might be coming out. A Gov-
ernment employee might have that information beforehand, and
use that information to his own advantfige, sometimes in conjimc-
tion, say, with a broker. That would be the same kind of umae in-
formation you are talking about.
Mr. Grandy. And how do you prevent that?
Mr. Melamed. We prevent that, first of all, by having a strong
surveillance force that is cognizant of this kind of thing, especial^
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the first example I used of the trading ahead of the customer order.
We obviously have the ability to look at a brdcer's own personal
account to determine every trade he ever made in a given day, and
compeire it to when he received orders from a customer, and wheth-
er they were close in line or not.
Mr. Grandy. Well, let me Eisk you this. Several years ago, our
colleague Neal Smith introduced a bill, which never became law, to
prevent insider trading, and it reads as follows, and I would just
like you to comment on whether or not insider trading could be
banned statutorily.
Basically he is amending the Commodity Ebichange Act to say:
Aa used in this fiubeection, "insider" means any individual who has accesB to ma-
terial information not generally available to the public about preaent or anticipated
cash or futures trading or present or anticipated cash or futures podtiona for which
such individual is not a party in any commodity of any other persons where such
trading or positions are in amounts at or above Commission designated reporting
levels as specified pursuant to section 4(i) of this act
No insider ahall own, control, have a beneficial interest in or enter into any con-
tract or contract for future delivery in any such commodity on any contract market.
What is the problem with that language?
Mr. Meiamed. Well, the problem wi& that language is that it
doesn't attack the examples I gave you. What Representative
Smith has a problem with is that, for example, a grain company
knows it will be selling grtiin to a foreign body and puts on posi-
tions to protect itself with respect to those sales. Under the bill, the
grain company would not be allowed to hedge and protect itself.
This is true in cattle or in hogs or in other commodities. These
major commercials are using the special inside information they
have because they have done the sale, and our markets are exactly
for them to use under those very circumstances. They ought to be
hedging their forward needs in our market, and using that infor-
mation to their own advantage, because the advantage for them ia
that they can continue to make these sales.
The bill would prevent, in fact, the function that is very impor-
tant of our meurket.
[The supplemental statement submitted by Mr. Melamed fol-
lows:]
The bill would interfere with the effective operation of futures markets to the
overall harm of farmers and commercial market users. It would discourage everjr
professional market user from seeking the infbrmation necessary to allow the
market to fairly discover the appropriate price.
Considerable information about supply and demand in the marketplace is discov-
ered by the legitimate observation of buyers and sellers. The Smith bill would de-
stroy any incentive to acquire this information, to the extreme detriment of the
market.
Mr. Grandy. I understand that, I believe, to a point, but do I
hear you say that this amendment, this bill that iAi. Smith intro-
duced, I thmk, 6 years ago, would basically outlaw hedging for
large compeuiies?
Mr. Melamed. That's right.
Mr. Geandy. What about the small investor, what about the
small trader who would not have access to this information? Does
this prohibit him or does this in any sense give him a more even
position with his larger counterparts?
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Mr. Melamkd. The theory of markets — and we live within that
theory — is that the price structure of the market, the movement
itself, is indicative of what's going on in the market. Large com-
mercial buying obviously, or selling, puts a market up or down, and
the small investor has to have some understanding why it is going
up.
The information generally is available. It is very seldom that you
don't know after a period of 1 or 2 days who has been buying and
who has been selling as to why the market went up, and then you
can make certain assumptions eis to why that commercial activity
went on, and iisually those assumptions are correct.
So that I think the small investor is generally not so at the
mercy of not having the information because he has the informa-
tion of price movement.
Mr. Geandy. I see my time has expired, so I will not belabor this.
I understand the small investor has the information on price move-
ment, but usually after it is too late, and I, of course, am referring
to some of the problems that happened in the bean market last
week which had a very significant impact out in my area.
Mr. Chairman, thai^ you.
Mr. EInglish. Mr. Nagle.
Mr. Nagle. The proposals with r^ard to the disciplinary com-
mittee seems to have drawn the ire and hostility of most of the ex-
changes, but we have not really spent a lot of time talking about it
in here.
Could you elaborate a little bit on what your specific objectionB
fu% to the committee draft with regard to the disciplinary commit-
tee composition?
Mr. Melambd. Oiu- special committee, of which I was a member
and Mr. Brodsky was a member, made the original suggestion that
there should be an outside member with voting privileges on the
m^jor exchange disciplinary committees which will address iiiB
perception of clubbiness and closed room kind of decisionmaking.
We want to open up the process and show the world that indeed we
are not afraid of an outsider being present.
We have no objection with your recommendation in terma of the
committee structure.
Mr. Salzman. The only real problem — maybe it is a lack of un-
derstanding on our part — is the suggestion in the bill that the com-
mittee not have a mc^ority of people on it who are in the same
class of trader or same cleiss of person as the person being tried.
Nobody at the Merc really understood why that was necessary, aiul
we found that it would be counterproductive.
Our clearing house committee, which disciplines clearing mem-
bers, is made up of other clearing members because they are the
ones who understand the clearing operation. There hiss never
really been a sense that we were aweire of that anybody felt that
that was unfair or operated badly. Moreover, our committee that
punishes floor traders for trading abuses is metde up of other floor
traders, and generally they are the ones most eager to punish the
offending floor trader. There hasn't been any complaint about that.
Mr. Melamed. I didn't know you were rraerring to the composi-
tion in terms of peers. The peers are the ones that know the most
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about the rights and wrongs of a situation, and are best able to -
make ^e jui^ment.
Mr. Nagle. Let me yield to the chairman.
Mr. Enqlibh. I will be happy to clarify that since there seems to
be some (question about it.
The point that was made, and we did through the course of our
inquiry, complaints were made to me and to members of the staif
that basically it does become difficult for floor treiders and brokers
is if you are sitting there in the morning and you have to vote
against the guy and vote a stiff penalty on him and then turn
around in the £dtemoon and go out to do business with him.
That was the reason for the particular provision. The provision is
that you could go outside the exchange if you wished, but it should
be someone that does not have to mrectly do business with that
person day in and day out that should make the judgment. It also
says the mfgoritv, it does not say fill, and that is the reeison for it.
Mr. Nagle. Mx. Chairman, let me reclaim my time, let me ask
you a question maybe it is as much to the Chair as to the wibiess.
When we are borrowing or when we are restructuring th^e disci-
plinary committees, are we doing it on the basis that one pit will
not be— we are assuming that everybody on the committee is from
tiie same pit or are they from difTerent pits?
Mr. Melamed. They Eu*e from different pits, and that's a very
good point. I was going to respond in that fashion. Our committees
are, in fact, comprised of members from different trading pits. In
fact, we have a very healthy mix. If you are dealing with a viola-
tion that, for example, occurred in cattle, it's very likely that ihe
majority of those members will not be cattle members. We try to
structure the committee differently so that you avoid the very situ-
ation the chairman correctly indicates is difficult.
Mr. Nagle. Are the disciplinary bearings open to the public?
Mr. Melamed. The results of these hearings are public. We are
suggestii^ that one nonmember be on each of those disciplinary
committees. That would create an additional element of some out-
sider presence.
Mr. Nagle. Would there be a problem if they were open to the
public?
Mr. Melamed. There is a problem in terms of the legal necessi-
ties involved with the internal mechanisms of the exchange. I don't
think that there has ever been that kind of objection about the pro-
ceedings of OUT exchange. There has been objection that there
aren't outside members, and we are trying to correct that.
Mr. Nagle. What percentage of— what number of disciplinary ac-
tions did your committee take last yefu*? Did the various discipli-
naiy committees of your exchange tdte?
Mr. Melamed. I think the number is in the testimony, and I'm
going to try to find it. While it is being searched for, I will say that
it is probably a record we Eire very proud of in terms of how many
cases we instigated, emd how many peeple we peneilized.
There were a total of 217 penalties, 313 fines in 1986.
Mr. Nagle. Wait a minute, 217 penalties and 313 fines? What's
the difference?
Mr. Mblambd. Excuse me, the figure in 1986 was 33 participante
penalized, in 1987, it was 69, in 1988 it was up 105. The fines were
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$813,000 in 1986, $1,715,000 in 1987, $811,000 in 1988. In 1986, there
were no expulsions, in 1987, there were eight expulsions and in
1988, there were two expulsions. In 1986, there were suspenBiona of
238 business days, in 19S7, there were 12,392 business day suspen-
eions, and in 1988, 6,110 business days suspension.
Mr. Nagle. Two questions. It looks to me that the traders are
getting more dishonest as we go or we are getting better at detect-
ing them. We have gone from 43 to 69
Mr. Mklamed. Better detection.
Mr. Nagle. What is the nature of the abuses th^ are being
fined for, suspended?
Mr. Mklamsd. Well, a lot of them have to do with violations that
occur by virtue of getting ahead of the customer trade.
Mr. Nagle. Abusing the dual trading process?
Mr. Melambd. Abusing that. They have to do with doing some-
thing that takes away from a customer the rightful trade, not nec-
essarily getting ahead, but simply taking eidvEmtage in another way
not giving the customer the rightful trade that he ought to receive.
I am being given a following breakdown of our trades of the vio>
lations from l£e year 1986. It is in table 2 of the appendix to 1988,
and here are the following breakdowns, if I could.
Sixty-two were prearranged trading infractions; 15 were trading
opposite of customer infractions; 6 were a combination tradings; 14
were outside the exchange hour of pit trading; 3 were disclosing
orders; 6 were withholding orders; 1 was trading ahead of a custom-
er; and 5 were fictitious, what we would qualify fictitious trade.
Those are your statistics trom your committee.
Mr. Nagle. No. The curious thing is that we have 4,369 and 106.
How many of those people are still trading on the exchange, all of
them, except 10?
Mr. Meiamep. Well, those that were not expelled and are still
not under suspension, I don't know the exact statistics. But once
the suspension is over, and if they are not expelled, of course they
could go back to the floor.
Mr. Nagle. Is there a system on your exchange for — if I run a
stop sign once, it's a $10 fine; if I run it twice, it's a $20 fine; if I
run it the third time, you take away my privil^es? Is it graduated
here and time competitive?
Mr. Mklahed. Absolutely. Absolutely. And the fines are very,
very heavy, Congressman Nagle.
Aa you probaJttly know, our exchange penalties were at the
$250,000 limit before the recent structures recommended for every-
body. So we have been at a very, very high level, and in £act have
generated the laigeat bonds in the industry.
Mr. Nagle. Going beick to bring this full circle, with the indul-
gence of my chairman, you are eu^eeting — in your statement here
I thought you were a lot stronger about the committee's recommen-
dations than, I guess, your initial testimony.
You say we strongly oppose the imposition of composition re-
quirements on exchange of disciplinary committees. It would be
rash of Congress to mandate changes in the absence of a document-
ed failure of the current disciplinary committee system.
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You are saying, however, you fire willing to accept the require-
ment that, perhaps from us, that there be outside members on the
disciplinary committee?
Mr. Melahed. That's right. We recommended that ourselves.
Mr. Nagle. Is the problem with the elimination of the peer proc-
ess the lack of knowledge that would take place on the vEuious dis-
ciplinary committees?
Mr. Melamed. Again, the peer pressure?
Mr. Nagle. The peer knowledge. I mean if you're working in a
certain area, I mean if you're being judged by your peers, your
peers are more likely to quickly know that that in fact is a viola-
tion or an abuse?
Mr. Melamed. That's correct.
Mr. Nagle. Well, I thank the Chair for his indulgence.
Mr. English. Mr. Gunderson.
Mr. Gunderson. Thank you, Mr. Chairmfm.
Is it fair to say, having read your testimony, Mr. Melamed, that
you would favor just a simple straight reauthorization of present
law only makii^ it permanent?
Mr. Melamed. Well, we recommended many changes ihat we
will offer to the CFTC.
As far as reauthorization goes, we favor reauthorization.
Mr. Gunderson. I get the impression that you don't want any-
thing else in the statute, that what you really want us to do is
simply reauthorize present law and let any decisions that are made
be done by CFTC.
Mr. Melamed. Well, I don't know how that necessarily has to
work because we have made recommendations. I don't want to sug-
gest how that should happen. We expect our recommendations will
become law in one form or another, whether they take the form in
legislative action by you with an order to the CFTC, or whether
they take the form of CFTC directed to us. It won't matter much to
us.
Those are decisions I cannot make.
The permanence of the CFTC, if you refer to that, we would
like — we eigree with
Mr. Gunderson. I see that.
Mr. Melamed. Yes.
Mr. Gunderson. Are you confident that the FBI investigation
will not reveal any inadequate regulations by CFTC or fuiy inad-
equate legislation regarding the whole futures industry?
I mean are you confident that there's nothing in the investiga-
tion that will reveal a need for chtmge?
Mr. Melamed. I would not say that I'm confident because I have
no knowledge of what that will show. However, the little bit I have
beard, and it is not with confidence that I say so, would not give us
the indication that our surveillance system is not good.
Mr. Gunderson. And you don't anticipate anything from that in-
vestigation on the issue of dual trading?
Mr. Melamed. I don't know. But I don't think that that ts the
only focal point or that it will be a main focal point. I don't expect
that.
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Mr. GuNDERSON. The one area that I am concerned about, as we
look at a permanent reauthorization is the whole area of interna-
tional trading.
You mentioned in your testimony at length on Globex, et cetera.
Would you comment on Chairman Gramm's testimony earlier
where she had obviously advocated giving them the auUiority to
make investigations for foreign exchanges?
Would you believe that, as appropriate, No. 1, do you believe they
have the resources and expertise, No. 2, to do that? And I would
like you to be brief so I can pursue some questioning further.
Mr. Melamed. Well, to the degree we have to give the CITC the
authority to do this kind of investigation, because it often leads to
impact on our markets and our prices. We have to know that the
integrity on the playing field of our customers in foreign lands is
such that they are safe there as well. And the only way that can be
done is if the CFTC has some authority to do those kinds of investi-
gations.
Mr. GuNDEHSON. Can you give this committee any examples
where present r^ulations impede our competitive aJbility with
other exchanges, such as Tokyo, London, et cetera?
Mr. Melameh. Present regulations?
Well, the biggest problem we have faced is in authority to launch
a new instnunent. This requires authority from the CPTC that
goes through quite a protreicted period of review. And sometimes
requires even a nonveto by the SEC.
I will give you an example of the kind of thing we've run into
that has given me gray hairs.
It was with the Nikkei 225 stock index which represents the
Tokyo stock market. When Clayton Yeutter, who is presently Sec-
retary of Agriculture, weis president of our exchange, and I
achieved North American contract rights, with the owners of that
instrument, the Nihon Keizai Shimbun oi^anization of Japan we
wanted to laimch that instrument in our futures market in Chica-
go.
To do that, we applied to the CFTC. And we had to get a nonveto
from the SEC.
Four years went by before that was achieved. By then, the
Nikkei contract was listed in Tokyo and in Osaka. The stock index
futures market t>egan there. We still haven't listed it because we
lost the right timing and, to a degree, we lost the market.
Mr. GuNDERSON. How mimy of your traders also would partici-
pate in say the Tokyo, London, or any other foreign exchange?
Mr. Melamed. WeU, it would develop. I do know in the b^finning
it would be probably small. But it will develop over time, and that's
why you need the timing to institute the market so that it can in-
crease in use and development. But I don't know in absolute num-
bers.
Mr. Brodsky. I would supplement that by saying that the major
firms that belong to our exchange have joined the Tokyo Stock fc-
chfuige Emd the Osaka Stock Exchange so they could trade these
products. Because if they're offered there and not extend here,
they will participate over there.
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Many of the m^or investment banking firms and trading houses
of the United States beloi^ to the Tokyo Stock Exchai^te for that
reason.
Mr. GuNDERSON. Are there varyii^c degrees of standards for par-
ticipation today in one exchange, here say versus the foreign ex-
chal^e?
Mr. Brodsky. There are very differing standards and, in fact,
that's an area in terms of international trade policy that we have
been involved in. Because there's been what I would call some dis-
crimination against U.S. firms becoming members of of&hore ex-
changes, where we have not had similar barriers. That's an area
where we need the understEuiding and support of Congress.
Mr. GuNDERSON. All right. Thank you.
Thank you, Mr. Chairman.
Mr. English. Mr. Nagle has one question.
Mr. Nagle. Just one question for the record.
We were talking numbers of violations, you know, the 4,369.
How many members are there that trade on the exchanges in a
given year?
Mr. Meiamed. Oh, I would say on average, we have 2,700 mem-
bers, but not all of them, of course, trade. Many of them just own
the memberships and lease them out.
I would say there's an average of around 2,000 traders.
Mr. Nagle. You are hitting less than 1 percent with violation?
You're finding less than 1 percent violation by the traders per
year?
Mr. Melamed. That's right.
Mr. Nagle. I didn't want to leave the impression that everybody
on the exchange was engaged in hanky-panky or anything like
that.
Mr. Melamed. I thank you for straightening that out.
Mr. Nagle. I also did not say that nobody was engaged in viola-
tive conduct.
Mr. Melamed. Well, we know that too.
Mr. Nagle. Thank you.
Mr. English. Mr. Coleman.
Mr. Coleman. Let me Eisk briefly, Leo, questions about the S and
P 500 contract and your experiment to ban dual treiding from tliat
pit. That was Eind is a continuing experiment?
Mr. Melamed. Yes, it is.
Mr. Coleman. And the results, as you have put forward in the
report of the special committee, are such that it basically heisn't
htid an impact on the liquidity of the market.
Mr. Melamed. Well, let me explain a little bit about that.
We didn't actually ban dual trading in that pit. What we did was
exclude dual traders &om the top step where Uie order flow (nrnes.
Therefore, by doing that, if you want to be a broker on the top
step, you can't be a dual trader.
We know that most of the orders in the pit come from, through
the top step. We expect that somewhere at the 90-percent level
means that the brokers who handle these orders cannot trade for
their own account.
While we did stete that the impeict, we have not measured as a
result of the dual trading prohibiUon, we are not totally confident.
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because volume did fall precipitously since the time of the prohibi-
tion.
However, you will know that at the same timeframe, the 1987
stock crash occurred, and that too was a factor in reducing volume.
So it is difficult to make a concrete judgment how much effect
was from one thing and how much effect &t>m the other.
The experiment has given us Bome confidence but not total confi-
dence.
Mr. Coleman. Is it something that we would want to take a look
at as a possible legislative alternative to current bills and propos-
als?
Mr. Melamed. The top step exclusion is an old idiocfynciacy of
that market and isn't very transferrable to other markete. We con-
sidered that kind of thing ourselves and studied it. But it doesn't
work the same.
See, most markets have different idiosyncracies and the order
flow is different in each market. And so you really have to make
that applicability in a market by market basis.
Mr. Coleman. Thank you.
Mr. English. Thank you, Mr. Coleman.
Leo, I have only one other question to ask you.
In listening to what you said and looking at what you presented,
is it basically your perception that the difference between what the
bill is before us and what you're proposing is we're talking about
d^rees?
Mr. Melamed. We are talking about degrees and the approach.
Our approach is a standard of veriiiability. The approach being
submitted to us is a number of volume. That's a difference.
And then we're talking about whether you can do a complete 100
percent verifiability or some lesser reasonable number.
Yes, to a d^ree you're right. Our goals are certoinly the same.
The approach is somewhat different.
Mr. English. So basically we're t-jlVing about whether it's 90
percent or whether it's something higher than 90 percent. And the
question is: How do we determine this question of liquidity and
whether it should be done by volume or whether it be done by
some other mechanism, is that right?
Mr. Melamed. That's right.
Mr. English. All right. Thank you very much, Leo. I appreciate
your testimony.
Mr. Melamed. Thank you. I appreciate this opportunity. And I
thank you for your work today. I know that it has been a difBcult
job but a very good one you have done. And we commend you for
it.
Mr. English. Well, we wemt to keep working at it. You know,
the objective of this legislation is to mske sure Uiat we substantial-
ly raise the standards up to what we expect in the industry. I know
tliat'a an objective that you agree with. It's one that I think will
enhance the markets. It would certainly, I think, bring more confi-
dence as far as the public is concerned in the markets.
And I think that s where they go for everyone, and if s fiu* the
good of everyone.
Mr. Melamed. Our goal is common. Thank you.
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Mr. English. We are going to be looking forward to working
with you.
Mr. Mbiamed. Thank you.
Mr. Engush. Thank you.
Our next witness is Mr. Robert Wilmouth, president of the Na-
tional Futures Association.
STATEMENT OF ROBERT K. WILMOUTH. PRESIDENT, NATIONAL
FUTURES ASSOCIATION, ACCOMPANIED BY DAN ROTH, GENER-
AL COUNSEL, AND JEAN TIPPINS, VICE PRESIDENT IN CHARGE
OF ADMINISTRATION
Mr. Wilmouth. Thank you, Mr. Chairman.
And with your approved, I have two of my associates with me at
the table. On my right is Dan Roth, who is our general counsel,
and on my left is Jean Tippins who is our vice president in charge
of administration.
And we thank you for the opportunity to present our views this
afternoon.
As envisioned by Congress, NFA never intended to duplicate tuid
has not duplicated the regulatory efforts of the exchanges. That is,
the regulation on the exchange trading floors. Rather, our responsi*
bilities to protect the public begin well before and continue well
after the execution of a trade. Our members are the flnns and indi-
viduals that conduct futures business with the public.
Just quickly, our four primcu? responsibilities include the follow-
ing:
One, preventing unethical Arms and persons from entering or
conducting business in the futures industry. We do this by perform-
ing a screening and registration function on behalf of the CFTC;
Two, we try to assure that those who do conduct business in the
futures industry do so according to high ethical standards. They
must comply with the rules which we have developed and which
we strictly enforce to protect the public customer;
Three, we do provide through our extensive education pn^Euns
the information that can help the public make informed invest-
ment decisions or, depending on the individual, an informed deci-
sion not to invest in the futures market; and
Four, we have established a nationwide arbitration forum that
provides public customers with a fair, prompt, and inexpensive
means to resolve any disputes which may arise in connection with
the trading of futures contracts.
Our accomplishments in each of these areas since the last reau-
thorization of the CPFC are described in a report which we have
provided to each of you.
Now, certain proposed amendments to the act would directly
impact NFA in carrying out its responsibilities. And it is those on
which I would like to comment specifically today.
There are some others which do not directly impact NFA but, of
course, would have a profound impact on the futures industry, and
my comments on those areas are contained in my written t^itimo-
ny. But specifically to those that Eiffect NFA:
One is registration requirements. One of the best ways to protect
the public from unscrupulous firms and individuals is to keep those
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people out of the industry in the first place. NFA has boon han-
dling this job since October 1, 1985, when we assumed responsibil-
ity for denying, revoking, restricting, or conditioning registration
for all categories except floor brokers and leverage transaction
merchants.
We strongly support the proposed amendments which will not
only flne tune and tighten the fitness standards of the futures in-
dustiy, but would codify certain of the Commission's and NFA's
prior interpretations of the existing disqualification provisions and
resolve certain ambiguities in the act which NFA has encountered
over the past 4 years.
Furthermore, should floor traders, as your bill provides, be re-
quired to register under the act, we have the capability to perfimn
that activity.
On the subject of telemarketing fraud, the prevention of decep-
tive sales practices is precisely where NFA has focused its rule-
making and rule enforcement efforts. We believe this industry's
sales practice regulations are second to none in their comprehen-
siveness, effectiveness, and enforcement. Thus, while we welcome
any legislation which would help combat whatever small percent-
age of persons in our industry who engage in deceptive or high
pressure sales tactics, we have serious reservations as to whether
the proposed legislation would in fact have that effect.
The proposed rule could unduly be burdensome to the over^
whelming mf^ority of our members who are honest, legitimate
business persons. Correctly identifying which "first time" custon-
ers are solicited by phone could pose substantial problems of practi-
cality in the real world. In addition, there may be sophisticated in-
stitutionfd customers whose trading may not be exclusively hedg-
ing for whom this "protection" would be both unnecessary and po-
tentially harmful.
If there is any way to narrow the focus of this concept, to pin-
point the relative handful of unscrupulous firms, NFA could sup-
port the proposal imd, in fact, we do have some ideas which we
would like to present to the committee.
With respect to the issue of public representation on our board (rf
directors, our articles of incorporation have always provided for
public representation. Three of the 42 people on our board ere
elected as public representatives, and their varied backgrounds pro-
vide a wealth of industry, legislative, and eicademic perspectivee.
But we fdso have five other members whom we believe qualify as
public directors. Three of those represent commercial firms, and
the others represent commercial banking institutions. And th^
give us valuable extemtd insights and counsel.
So if we understand correctly, we are already in substantial com-
pliance with your requirement of 20 percent since 8 of our 42, or
roughly 19 percent of our seats, are covered by what we call pidilic
members.
The issue of disqualification standards to serve on NFA's board
of directors and disciplinary committees is one which we are cur^
rently considering, and we think it may well be appropriate to dis-
qualify from board or committee membership {>ersons who have
been found to have committed a major rule violation.
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We would caution the committee, however, that in detenuining
what cons^tutes m^or rule violation, the focus must not be on the
rule but on the violation. All of our compliance rules are designed
in one way or other to protect the public. The violation of any of
t^se rules could so undermine one's confidence in a person's judg-
ment that he should be disqualified from board membership.
Others, however, may only be technical in nature. And the best
way to determine a major rule violation is to focus not on the rule
that WEis violated, but on the sanction.
If that reflects the committee's intent, we certainly support the
proposed amendment.
We also agree with the committee that registrants should receive
adequate treiding concerning their ethical responsibilities to cus-
tomers. Toward that end, we have alreeidy made significant
changes in the National Commodity Futures exam. The content
has been changed to put greater emphasis on an understanding of
regulatory requirements, and the exam is graded not only on
market knowledge but equally so on regulatory knowledge.
And while these chEuiges have already improved the industry's
attention to ethics training, we fully support imy proposed amend-
ments which would focus even greater attention on this critical
area.
And, finally, NFA strongly supports the proposal to make the
CFTC a permsment EigenCT. This would ensure continuing congres-
sional oversight of the CFTC, it would eliminate ongoing uncertain-
ties about the agency's existence, and it would facilitate more effec*
tive use of the Commission's resources to relate futures markets.
The proposal is both welcome and long overdue.
Agfiin, we thank you for your attention, and we will be pleased
to answer any questions that you m^ht have, Mr. Chairman.
[The prepared statement of Mr. mlmouth appears at the conclu-
sion of the hearing.]
Mr. English. Thank you very much, Bob. I appreciate that.
There has been a good deal of discussion with regard to the ques-
tion of how we do the telephone solicitation. I know that this com-
mittee is not the only committee that has an interest and is con-
cerned about that. And we are looking for ways to strengthen that
particular aspect of it. The real question comes down even with the
3-day period that we have after a person is registered.
lliey file or apply with a firm. Even then we are concerned that
the unscrupulous may And a way to maneuver Eiround that par-
ticular aspect.
Do you have any specific suggestions as to how we might address
that?
Mr. WiLMOUTH. Well, we have several thoughts, and I might ask
Deui Roth, our general counsel, who has been looking at this, as we
thought that might be a possibility to discuss some of the ideas
that we do have. And we would like to present them later in detail
to you.
Mr. Roth. Just in general, I think the two points to be addressed
axe the effectiveness of the proposal and its unintended side efiects.
With respect to unintended side effects, just two points we would
note in passing, that we would be happy to discuss with staff at
greater length.
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We might be able to draw some compariaons from NFA'a own
"know your customer" rule. For instance, that rule, which has
proved a very effective enforcement tool for NFA, applies only to
customers that are natural persons and not to corporate customers
and, therefore, limits the scope of the people that are entitled to
the protection from that rule to those people that need it.
An^ investor sophisticated enough to incorporate is arguably so-
phisticated enough not to need the protection of NFA compliknce
rule 2-30. The same point might be made with respect to a pro-
posed telemarketing fraud provision.
Similarly, our nue requires members to gather certain informa-
tion from customers such as their net worth and nnmifll income
and BO forth. The rules makes very cleeu* so as not to he unduly
burdensome on our members, that our members can rely on the in-
formation provided to them by the customers, and have no due dili-
gence obligation to try to veri^ or corroborate that infonnation.
A similar type provision for this aspect of the bill rcttarding
whether a cummer is a first time customer and whether ne was
solicited by phone is something that might want to be considered.
In addition, we would like to talk with staff about possibly pursu-
ing tioB as a means of refining the supervision requiremente which
are already incorporated into CFTC rules and NFA rules. Clearly
what constitutes diligent supervision will vary from firm to firm
depending on the nature of the firm's business. For those firms
more actively engaged in retail sales, for those firms which have
past disciplinary histories, for those firms whose sales forces have
come from firms with disciplinary problems, it may well be appro-
priate to imprae upon those firms somewhat different provision re-
quirements. That might be a way to focus the attention of this pro-
vision.
Mr. EInglish. Mr. Roth, it sounds like that would be an area that
we would be very interested in so I hope that you will continue to
work on that and consult with both majority and minorily staff on
the subcommittee.
We are looking for a way of refining down that particular aspect
of the proposal. So that would be most helpful and. Bob, we would
appreciate that very much.
Mr. Coleman.
Mr. COLKBUN. Bob, let me ask you a question about your new
procedures to review promotional material for members.
I believe you have embarked on a pilot project or a program the
beginning of May in which people can run materials by an NFA
committee and get an approval based upon some facts, which
would have to be documented eventually.
You could give an overall approval, a disclaimer, and help basi-
cally your members who are tryii^ to conform to the appropriate
NFA rules.
If a company does that, comes to you and your review panel, and
you give them the approvftl, do they basically have a defense that
you can't come back later, having depended upon that approrol
and cite them? That's kind of like what we hear from constituents
with tbe mS. They get misinformation and the IRS says, <^ Tm
sorry, that was misinformation, even though the agency gave it
out.
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What ifi your position on that?
Mr. WiLMOUTH. Let me go into a little bit of background, if I can.
The question of what constitutes proper advertising and what
doesn't has been one that our members have been concerned about
because what they think they're doing is correct, and then we crane
along and we slap them with a fine, or we suspend them, or some-
thing like that
What we have attempted to do is to say to them, look, if you
submit your advertising to us in general, we will take a look at it,
and we will tell you whether or not we think it's going to comply
with our rule. We are going to do that within a period of 3 weeks,
and this is on a trial basis.
It would be my feeling that it would not necessarily, and I may
have to refer to legal counsel, would not necessarily exempt them
from any punishment from us if we found out later on that they
had twisted it.
But if somebody comes in and presents a piece of advertising and
we say that it looks OK, and it continues to be used in that exact
same format, I would think we would have a difficult time of prov-
ing that it was wrong if we had put our blessing, our stamp o£ ap-
proval on it.
But essentially it's just to give them a general overall approval
of the approach they're taking.
Mr. CoLBtCAN. OK. Now, previously, under the old methodology,
you would perhaps take what you might call a no action position.
You would not approve in a positive sense but you wouldn t disap-
prove?
Mr. WiLMOUTH. No. What we used to do before wtis to require
certain firms with whom we had a problem to submit their adver-
tising to us in advance. We made that a specific requirement. If we
did an investigation of a firm and we brought them to the atten-
tion of our business conduct committee because of the fraudulent
advertising that they were using, or the misleading advertising,
one of the sanctions might be you must submit that advertising to
us in advance, and they would have to do that. Otherwise, ttiey
would be in violation of our order.
And this was to make certain that any of those who were a prob-
lem in the past had an opportunity to come In end present new
material in advance and get kind of our imprimatur or blessing or
seal of approval, "Good Housekeeping" seal of approval in a wtiy.
Mr. CoLKMAN. Would you indeed give your approval, or would
you take a nonaction?
Mr. WiLMOUTH. No. We basically, if they submitted the advertis-
ing to us in accordance with our request, and we saw nottiing
wrong with it, we would let them go ahead and use that advertis-
ing.
Mr. Coleman. I see.
And what if it weis not a problem firm that didn't get a request
from you to submit this, what would be the normal course of the
firm?
Mr. WiLMOUTH. If we felt it was serious enough, we would bring
an action or a complaint against them, and bring it to the atten-
tion of our buBiness conduct committee.
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In meuiy cases, I must say that when we bring that to their at-
tention, they would stop using it immediately, and then there
would be no new cause to go after it because it would be an honest
misinterpretation of what they felt would be OK before we brought
it to their attention. Then they would refrain from using it.
Mr. Coleman. But previously if the firm had not hfia problems,
but had submitted something to you, you would have said
Mr. WiLMOUTH. We didn't have a pn^am like that
Mr. CoLEiiiAN. You didn't have a program?
Mr. WiLMOUTH. Until just recently. This is our new pilot pro-
gram
Mr. Coleman. So there was no way of doii^ it before?
Mr. WiLMOUTH. That's right.
Mr. Coleman. And no one would have said, well, the fact that we
are not going to approve this doesn't mean we are disapproving it
either?
Mr. WiufouTH. That's right. What we kind of felt as we got
alot^, and you have got to remember, NFA is a relatively new or-
ganization, it began in 1982, we tried to put out some interpretive
notices as to just exactly what we felt would be good or bad in a
particular area.
And I think advertising is a very difficult one to do. And scnne of
our members were effectively saying, we think that you're cracking
down on us when you really Bhouldn't be. That's why we have de-
vised this recent pn^etm.
I must fdso say that we spent a lot of time, particularly in our
etirly years, and still do, assisting a lot of our members in terms of
helping them not only set up books but also determining what is
and what isn't proper advertising or proper activities with the cus-
tomer.
Mr. CoLEBtAN. Thank you.
Mr. English. Well, thank you very much. Bob. I appreciate your
testimony and we are looking forward to working with you.
I think that one provision is an area that we can strengthen and
we look for the help NFA can do.
Mr. WiLMOUTH. I certainly will. We'll have something to you
next week. Thank you.
Mr. English. Let me also say that we have received letters com-
menting on this bill, and we expect to receive statements fit>m a
number of other organizations. Any statements, written statements
that are submitted to the subcommittee will be included as a pert
of our record.
[The prepared statement of Ms. Vogel appears at the conclusion
of the hearing.]
Mr. ENGLISH. We will now recess until 2 o'clock, when our next
witness will be Mr. Karsten Mahlmann who is with the Chicago
Board of Trade.
[Whereupon, at 12:55 p.m., the subcommittee recessed, to recon-
vene at 2 p.m., the same day.]
AFTERNOON SESSION
Mr. English. The subcommittee wilt be in order. Our next wit-
ness is Mr. Karsten Mahlmann, who is chairman of the Chicago
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Board of Trade, and I see that he has individuals accompanyli^;
him.
Mr. Mahlmann, we are going to let you introduce the gentlemen
that are with you.
STATEMENT OF KAR8TEN MAHLMANN, CHAIRMAN, CHICAGO
BOARD OF TRADE, ACCOMPANIED BY THOMAS DONOVAN,
PRESIDENT AND CHIEF EXECUTIVE OFFICER DONALD
ANDREW, MEMBER, EXECUTIVE COMMITTEE OF THE EX-
CHANGE; SCOTT EARLY, GENERAL COUNSEL OF THE EX-
CHANGE; FRED GREDE, VICE PRESIDENT IN CHARGE OF THE
OFFICE OF AUDITS AND INVESTIGATIONS
Mr. Mahlmann. Mr. Chairman, thank you very much for letting
us appear before your committee to address H.R. 2869. With me
this afternoon are, to my right, Mr. Thomas Donovan, president
and chief executive officer of the Chicago Board of Trade; next to
him, on the right, Mr. Donald Andrew, a member of the executive
committee of the exchange, a member of the board; next to my left,
Scott Early, general counsel of the exchange; next to him, Fred
Grede, vice-president of the exchange in cheoge of the office of
audits and investigations.
Mr. English. I want to repeat what I said earlier this momii^c.
Anyone testifying this afternoon and summarizing their testimony,
wiuiout objection their full and complete written testimony will be
made a part of the record.
Mr. Mahlmann. Thank you very much, Mr. Chairman.
Mr. English. So, we'll turn it to you.
Mr. Mahlmann. Mr. Chairman, I am here to present the views
of the Chicago Board of Trade on H.R. 2869, the Commodity Fu-
tures Improvements Act of 1989.
Among other things, this legislation metkes the CFTC a perma-
nent Government Eigency. The Chicago Bo{u*d of Trade endorses
that action. While we do not agree on everything with the CFTC at
all times, we respect the important role played by a mature and
expert agency in overseeing the self-regulatory scheme embodied in
the Commodity Exchange Act. The vote of confidence reflected in
H.R. 2869 for the CFTC is well-deserved.
Mr. Chairmfin, in sponsoring H.R. 2869, you indicated that you
wanted to promote both the int^frity of U.S. futures mtirkets tuid
our ability to compete with foreign markets. We share these objec-
tives, but disagree with how some of the provisions in H.R. 2869
would accompush them. We would like to propose alternative pro-
visions that would accomplish the same objective of elevating in-
dustry standards.
The Board of Trade is committed first and foremost to maintain-
ing the integrity of our markets. In the past week, we saw a dem-
onstration of the depths of our commitment. As you know, on July
11, the Chicago Board of Trade took emergency action to remove
the threat to an orderly liquidation of the July 1989 soybean fu-
tures contract. It took courage to take this action because we knew
we would be criticized by some, but we acted, nevertheless, because
of our commitment to preserving marketing integrity and because
strong, self-r^ulatory medicine was needed. As Secretary of Agri-
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culture Clayton Yeutter said, "The Board of Trade has nothing to
apoltwize for. Preventive medicine is better than curative medi-
cine.'
As this recent episode shows, the Board of Trade will not hesitate
to take decisive action when needed to maintain investor confi-
dence. We welcome further discussion on the soybean issue at the
conclusion of my testimony.
As a reflection of confidence in our markets, investors are par-
ticipating in futures mtu'kets at ever increiising levels. Over tibe
last 4 years, the Chicago Board of Trade volume has grown by 92
percent. During that eame time period, foreign futures exchange
volume increased by over 226 percent. Foreign countries are
waking up to futures trading and to economic and social benefits
that futures trading provides.
Even though U.S. futures industry volume has increased over the
last 4 years, market share has decreased by 10 percent. Foreign fu-
tures exchanges now account for 30 percent of total futures volume
for exchanges gained in market share exclusively at the expense of
U.S. futures markets.
U.S. exchanges do not have a monopoly on the products they
trade. The Board of Trades most active product, U.S. Treasury
Bonds, is now listed for trading in London, Sidney, Singapore, and
will be traded later this year by the Tokyo Stock Bxctumge. lie
Chicago Mercantile Exchange's most successfiil product, Eurodol*
lare, is traded in London, Singapore, emd now the Tokyo Financial
Futures Exchange. Our products and our success are the envy of
the world.
Why do we cite foreign competition? Many industries have come
before Congress to ask for protection from foreign competition. We
seek no such protection. We ask only that you not inhibit our abili-
ty to compete with these growing markets. The U.S. futures mar-
kets are already the most neavily regulated in the world.
We reo^nize the competition facing U.S. financial markets. In
the Far East, virtually unlimited capital is available. At the same
time, European countries are uniting economically to develop a
true common market in 1992. The European community recogaaeB
the formidable economic position of its international competitors,
and is tfiking steps to meet those challenges.
Faced vnth these trends, the U.S. futures industry has taken
measures to strengthen our markets in a cost efHcient way. In
today's environment, we are attempting to create a unified fi-ont to
manage our future direction.
The Chicago Board of Trade and the Chicago Mercantile Ex-
change recently announced that discussions would begin in an at-
tempt to unify Globex and Aurora, the computerized trading sys-
tems developed by each exchange. By creating a unified trading
system, we believe that we can lower the cost of doing business to
market participants, making us more competitive witn the rest of
the world.
The Chicago Board of Trade and the Chicago Mercantile Ex-
change recently also agreed to unify their electronic audit trail, tiie
Computerized Trade Reconstruction System, combining the best of
the Board of Trade system with the best of the CMKs approach,
creating the potential for an industrywide standard.
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In addition, the Board of Trade and the Mercantile Ebichange
have agreed to unify their existing computerized surveillance pro-
grams, CATS by the Mercantile Exchange, CTR Plus by the Board
of Trade.
The unified system will review 100 percent of trading activity at
both exchanges. No trade will escape the exchanges' computerized
microscope. As a result, both exchemges will operate a new and im-
proved audit trcul and surveillance to detect those trading viola-
tions that are attributable to dual trading as well as other types of
potentiaJ trading abuses.
Moreover, the subcommittee should not lose sight of the fact that
the existing Board of Trade audit trail and surveillance capabilities
already meets the highest standards. As U.S. Attorney Anton Valu-
kas has publicly stated, "They — the Board of Trade — have the re-
sources to identify trading practices in which fraud has occurred."
T^e Board of Trade has already passed new regulations in a
number of areas. Our audit trail is becoming tighter with new time
stamping systems and nEirrower timing reqmrements. Computer
surveillance has been uwraded. Surveillance personnel have been
increased by more than 30 percent in order to adequately handle
the task at hand. New rules and broker associations and opening
and closing procedures have been passed. Both the Board of Trade
and the Mercantile Exchange are implementing new technological
innovations, including the advent of electronic audit delivery ^s-
tems which will insure that customer orders have the most accu-
rate audit trail possible.
In summary, the Board of Trade already has taken steps to
insure enhanced customer confidence in our markets which will
strengthen our ability to provide liquid and fair trading markets to
the world.
As I mentioned earlier, we support many provisions in H.R. 2869.
We applaud the l^islation's primary objective to insure good,
clean, honest markets. However, we recommend that certain provi-
sions be modified in order to permit the efficient functioning of
U.S. futures markets to continue.
First, we oppose the provisions in H.R. 2869 that would ban dual
trading. We believe there is a way to preserve the benefits of dual
trading whUe also protecting agfunst a potential for abusive trad-
ing practices. This proposal eliminates the benefits of broker trad-
ing without considering the cost inherent in doing so. We strongly
recommend that a cost benefit analysis be prepared r^arding Uie
specifics of this proposal before it is legislated.
Mr. Chairman, I think we can all agree that dual trading, per se,
is not bad. In fact, dual trading contributes significantly to market
liquidity. What is bad is when brokers front run customer orders to
gain a financial advantage. To address that misconduct, the Board
of Trade and other exchanges have had rules on their books that
prohibit brokers from trEiding ahead of customer orders. Any
member violating that prohibition faces a full range of exchfuige-
imposed penalties from Substantial fines to expulsion.
Moreover, any approach to the topic of dual trading must be con-
sistent and comprehensive. This proposal only addresses floor trad-
ing. The Presidential task force on market mechanisms, known
commonly aa the Brady Commission, found that "the markets for
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stocks, stock index futures, and stock options are in fact one
market." Therefore, to address the dual trading question prnierly,
a review of all dual trading on exchange floors and off exchange
floors both in futures and securities as well as the ultimate diul
trader— the specialist — should be required. As currently provided,
this propoeal does not foster a level r^ulatory playing field. Off-
floor dual trading would permit eui FCM or its employees to front
run customer orders. Nothing in this proposal addressee this possi-
ble abuse.
Demonstrating another inconsistency in this proposal, the CFTC,
on Monday of this week, approved the trading of commodify
SWAPS without any Government oversight. SWAre are direct sub-
stitutes for futures contracts. Those who engage in commodity
SWAPS will be permitted to dual trade completely outside the rw-
ulatory oversight of the CFTC or of this committee. RR. 2869 wm
not touch this unr^ulated market where dual trading will occur
r^mlarly.
The proposal to ban dual trading will adversely affect the liquidi-
ty of futures markets, particularly so, agricultural markets, m in-
creasing the cost of doing business. The pricing impact on U.S. ag-
ricultural futures markets will also adversely impact the pricing oC
physical agricultund products traded in this country.
We recognize that H.R. 2869 includes certain exemptions from
dual trading prohibitions designed to permit flexihili^ for the
CI* 1*0 on a contract-by-contract basis. In effect, however, before the
CFTC can use these powers, the markets must be illiquid and po-
tentially irreparably harmed.
H.R. 2869 also exempts any Board of Trade from the trading pro>
hibition if its audit trail is nilly verifiable and can detect any and
all abuses. However laudable, this standard is unattainable m the
real world. The imposition of this perfect standard would bring our
business to a heilt. We believe that a more realistic approach would
be to exempt any Board of Trade from the dual trading ban if the
CFTC concludes that the Board of Trades audit trail and surveil-
lance systems provide for the effective detection of statutory and
r^ulatory prohibitions.
With respect to the audit trail proposal, we again find the otrieo-
tive of the bill's dreifters laudable. No exchange in the world has
demonstrated a greater commitment to the implementation and
usage of advanced technology in its audit trail svstem. In the ab-
sence of a definition of veritable, we believe a SO-second standard
should be a goal since it is not achievable with current technology.
We suggest a more flexible approach which would permit the ex-
changes to work with the CFTC to resesuch and develop technologi-
cal enhancements to the audit trail rather than l^islating stand-
ards.
Finally, with respect to make-up of disciplinary committees, the
current proposal, contraiy to the fundamental premise of our
system of justice would dictate that an accused member not be
tried by a jury of his peers. Disciplinary hearings are extremely se-
rious matters. This proposal severely ELpTects the rights of the indi*
viduals involved. As U.S. Attorney Anton Valukas recently stated,
"In my estimation, based on my own expertise in the area, the best
experte in the world concerning trading practices are the members
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of the Board of Trade." This statement was made while the allied
undercover investigation was supposedly going on.
In summary, Mr. Chairman, we CEin endorse many provisions in
this bill, but others may have serious and irreparable adverse
rcmiifications on the liquidity, pricing, and operation of U.S. fu-
tures markets.
We will be happy to work with this committee to develop effec-
tive legislation for the r^ulation of U.S. futures markets. We
share this committee's concern to uphold the integrity of our mar-
kets and maintain continued customer and investor confidence. We
must stress to this committee that the U.S. futures markets are the
best regulated in the world, and as such are the envy of our foreign
competitors. We cannot afford to hand our markets to those com-
petitors. Unless we are careful in the crafting of this bUl, we will
tilt the regulatory playing field in their direction.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Mahlmann appears at the con-
clusion of the hearing.]
Mr. English. Thank you very much, Mr. Mahhnann. I appreci-
ate that.
It would appear, in going through, I was taking note of the fact
that it would appear, with the exception of the disciplinary com-
mittee question, that the general disagreement— generally speak-
ing— the disagreement with this legislation has more to do with de-
grees than it does with regard to the objective iteelf, the question
how far can we go, how much can we accomplish.
Would you agree that that is the basis for the disagreement at
this point?
Mr. Mahlmann. Mr. Chairman, as I have stated in my written
testimony that I just read, we wholeheartedly agree with the goal
of the committee Emd with the proposal in the bill. It is a question
of degree and how do we get there without impacting the liquidity
of the marketplace, but at the same time detecting virtually all
abuses; "any and all," that's difficult.
Mr. English. Let me speak to that at this particular point. "Die
provision of "any and all ' is subject to definition. I think the real
question is the issue of whether this legislation is going to encour-
age through a carrot and stick approach, and many within in the
futures industry have stated that they thought that that approach
is a proper one, the question of how far can we go, what kind of
standards can we expect.
This subcommittee has not, and of course we will as we move
through the legislative process define exactly what that means. We
deeply appreciate and look forward to working with the Board of
Trade in reaching a definition that quite frankly is ambitious but
by the same token obtainable.
So, we do look forward to working with you on that, and we ap-
preciate the offer of helping us in that matter, and we will be call-
ing on you without question on that. So that is deeply appreciated.
Let me state that there have been a number of questions with
r^ard to the issue of the action taken last week by the Board of
Trade pertaining to soybeans. I have two questions. The first one is
the question given the existing situation in the market — in the soy-
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bean market— is it possible that the Board of Trade may have to
take some more action next month?
Mr. Mahlmann. Mr. Chairman, the Board of Trade, through ita
committees and through its staff in the office of audits and investi-
gationa is daily monitoring the August contract which is now the
nearby delivery month. I strongly hope, as the chairman of the ex-
change, that similar action will not be necessary.
Mr. Enoush. But it cannot be ruled out.
Mr. Mahluann. I cannot state that it will not be.
Mr. EbfOLiSH. OK, that is very good. I appreciate that.
The next question is one that we addressed to the CFTC when
Chairman Gramm appeared before us on Tuesday, and that gets
into the question of the decisions or the action that led up to this
decision and the involvement of the CFTC. As the law stands now,
of course the CFTC has the authority, should they disagree with
the action of the Board of Trade, to overrule that action, out there
is nothing in the law as it stands now for the CFTC to, in efibct,
respond in the affirmative unless they so desire.
Several members of this committee made the point, and I think
rather forcefully, that given the fact the CFTC was notified in ad-
vance of this decision being Emnounced that no statement, no re-
sponse is tantamount to approval, and I think there is a great deal
of interest in this subcommittee as to exactly what involvement tiie
CFTC had in the decision, and what was the interaction between
ihe exchange and the CFTC on finally reaching this decision.
Could you give us an overview of exactly, and in as much detail
as possible, what tiie interchange, the interrelationship was be-
tween the CFTC and the Board of Trade?
Mr. Mahlbiann. Mr. Chairman, if I am permitted to step back
for a moment in time, I will go back to approximately the first
week of June. We had just come through a May expiration that we
all were very happy that had got done by the skin of our teeth, but
it did get done without any emei^ncy.
E^ren through that time, we were in daily contact, and firom then
on forward, with r^ard to the July contract, we were in daily con-
tract with the Commodity Futures Trading Commission, both at
the staff level and from chairman to chairman, and there was inti-
mate dialog, going on into the emergency action that the Board of
Trade took from myself to Chairman Granmi on an almost daily
Mr. English. With this interaction, this daily contact I
you and the chairman and between other members of the Board of
Trade, and I assume other members of the staff of the CFFC, per-
haps other Commissioners, did the Board of Trade at any time
mfike fmy recommendations or did the CFTC make any recommen-
dations to the Board of Trade contrary to the decision that the
Board of Trade took?
Mr. Mahlmann. Mr. Chairman, the CFTC arrived independmt^
of the Board of Trade on the same day at the identical conclusion
that the Chicago Board of Trade Board arrived at in its special
board meeting of the afternoon of July 11. The CFTC, independent-
ly of the exchange, determined that there was a thriaat to orderly
liquidation of a contract, which is the same foundation that — and
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the same decision that the Board of Trade board arrived at on the
afternoon of July 11.
The actions that were then taken by the two parties vary to
some d^ree and are identical to another degree, if I may elabo-
rate.
Mr. English. Please do.
Mr. Mahlmann. The Commission in coming to the decision that
a threat of orderly liquidation existed came fco the conclusion that
it notified a single market participant that effective the close of 3
days before the expiration of the contract its anticipatory hedge ex-
emption from speculative limits would be revoked.
Putting it into plain english, it said the major market participant
on the long side, singly l^ himself had to come down to 3 million
bushels as of the close of the 18th. The Commission so notified the
market participant.
The Chicago Board of Trade board, on input and advice, and
seeking of help from the business conduct committee, addressed the
same issue on July 11 at 2:15 in the afternoon. The Chiceigo Board
of Trade board independently reached the conclusion that there
was a threat to the orderly liquidation of a contract, that if it was
not addressed could leeid to the potential default of the contract.
The Board of Trade boEird then, in its order, acted acrtss the
market, meaning market neutral, not against a single participant
but market neutral against fill market pEU*ticipant8 msofar as any-
body that held in excess of 3 million bushels, whether it weis hedge
or not, was not the deciding factor, was not a material factor. The
concern was orderly liquidation.
Therefore, anybody with positions in excess of 3 nullion bushels
had to reduce those positions in a gradual step way, 20 percent per
day, down to a figure of no more than 3 million bushels as of the
close of July 18.
The end position on July 18 in the Board of Trade's order and
the CFTC order are identical. The Board of Trade's order ^plied to
all market participants, whether long or short. The BoEird of
Trade's order incorporated gradual steps. The Board of Trade's
order was taken ever mindful of our obligation to have orderlv
markets, and particularly so, orderly liquidation, and it did not ad-
dress a single market participant.
The Board of Trade order, in its final step, at the expiration of
fibout 45 minutes ago, also included a provision that no market
participant could go off the board, meaning, have a position open
after the final bell of trfiding in excess of 1 million bushels.
But yes, both parties, regulator and the market, took independ-
ent actions along the same lines.
Mr. English. Mr. Coleman.
Mr. Coleman. I am going to go over the same ground a little bit
with you for emphasis. First of all, this intimate communication
that occurred between the Exchange and the Commission started
back in early June; correct?
Mr. Mahlmann. Congressman, it started before that on the May
contract. With regard to the July contract, in early June, yes.
Mr. Coleman. In early June. And was that primarily conducted
betvraen you as chairman and Dr. Gramm as chairman, or were
others involved?
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Mr. Mahlmann. The staff of our office of audits and investiga-
tions and the stafT of the Commiasion were as well in daily contact.
Mr. CoLKMAN. And during such periods of time, do you feel and
is there a confidentiality issue involved to the extent that you do
not share that information with others?
Mr. Mahlmann. There is very much a confidentiality issue in-
volved. Our office of audits and investigations is ever mindful of
that obligation that they have as staff members of the exchange,
and so am I as chairman.
Mr. CoLRBiAN. So I would take it that other than yourself, there
was no other board member who was involved with or familiar
with or was related to any information regarding this?
Mr. Mahlmann. The only piu-ticipants knowledgeable in the
dialog were the two gentlemen sitting to my left: General counsel
of the exchange and vice president of the audits and investigataons
department. No boEU*d membe'* was knowledgeable.
Mr. Coleman. I am sony? No?
Mr. Mahlmann. No board member was knowledgeable.
Mr. Coleman. Now, the CFTC — I am not sure what we are going
to call this. The CFTC informs a m^or participant, your statement
said: Was that through an informal proceeding, to your knowledge,
or was there an order issued? How would you characterize this
communication?
Mr. Mahlmann. They directed the mayor participant in writing
that his previously granted hedge exemption would be revoked for
the last 3 trading days of the July contract.
Mr. Coleman. Did they inform you of this action prior to ita
being taken?
Mr. Mahlkiann. No. They informed me after they had taken it.
Mr. Coleman. Had you been in discussion with them about a
possibility of some action being taken, eind weis this one of the al-
tematives that had been discussed?
Mr. Mahlmann. Congressman, we had been in daily discuasions
of what edtemative steps could be taken. They did not discuss what
they would do with me.
Mr. Coleman. Under the circumstances, and while this is an un-
usual circumstance, is it your feeling or is it your opinion that the
Commission was to give the excheinge the nrst right to move in
such a case? Or do you feel that you — I mean, who was waiting for
whom to move here? I guess that s the question.
Mr. Mahlmann. Congressmfui, I have to take you back to the
chronological event of now the last occurrence occurred. Withibi
the exchange, the monitoring of orderly markets, emd particular^
so the monitoring of an expiring futures contract, is delegated to
the business conduct committee. The business conduct committee is
a swom-in committee by oath to keep the secrecy of any item that
came before them on any issue, and they standardly go through the
procedure of recusal, and having been asked for a recusal if there
is luiy pEuty involved in a particulfu* commodity.
That committee has been continuously monitoring the July con-
tract. At various instances through the month of June and into
July did this committee call in market participante, both long and
short, and reminded them of their obligation to effect orderlyliqui*
dation of a futures contract. At the last meeting prior to the deci-
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sion, the business conduct committee instructed a major partici-
pant that, under its obligation to orderly liquidate positions, it
would have to do so on a daily basis in a reasonable fashion. And
the committee told the mayor market petrticipant — and this meet-
ing occurred on July 6 and was followed up by a letter of those in-
structions on July 7 — that the committee would deem 3 million
bushels a day reasonable liquidation.
The committee eJbo notined the major market participant if the
participant would not abide by the guideline and directive given to
it by the business conduct committee, the business conduct commit-
tee, seeing that it had no powers themselves to effect liquidation
within the rule structure, would have to present to the board the
CEise that they deemed emergency action in order to ensure orderly
liquidation would be necessary.
The business conduct committee monitored for 2 days the action
of the major participant, and when they did not find adherence to
the proposed guideUneB that they had given — meaning 3 million
per day liquidation — at that point the business conduct committee
recommended to the board to tfike emergency action.
Mr. Coleman. Well, my question is: Should there be some sort of
structured process by which the Commission on its own not only
could have but should have made these decisions emd acted prior to
what you have just related to me by the exchange?
Mr. Mahluamn. Congressman, I believe that the exchange, being
intimately involved in the marketplace and monitoring on a daily
basis, is a better judge of whether an emergency exists or not.
Mr. Coleman. And even though the Commission had concluded
the same thing, how did they conclude that, other than based upon
information that you gave them?
Mr. Mahlmann. Congressman, I can comment on the Board of
Trade's conclusions. I cannot comment on the CommisBion's conclu-
sions of how they Eurrived there.
Mr. Coleman. But any information that they received would
have had to have been relayed by you? Or how would they have
determined that?
Mr. Mahlbiiann. Congressman, I presume the Commission and
its stfifT also draws its knowledge from independent sources.
Mr. Coleman. And when we have an information letter, I guess
we will call it, from the CFTC that basically required this mQJor
market participant to do the same thing that you ordered them to
do: What is the difference as far as the effectiveness goes of what a
Government commission tells somebody to do — which apparently
tiiey were not paying attention to because you had to then follow
up with some sort of action on your own? Is that correct?
Mr. Mahlmann. The two fictions occurred independently of each
other on the same day.
Mr. Coleman. On the same day.
Mr. Mahlmann. Yes. But with respect to your comment on the
difference of the two actions, why did we have different actions, the
Board of Trade's action applied equally acnws the market. The
Board of Trade's action also incorporated a gradual day-by-day 20
percent reduction requirement The potential <^ the Commission's
action would have been that the nu^or market participant, out of
23 million bushels — and I can mention the figtue because it was
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stated in public court — might have elected to sell 20 million bush-
els on 1 day. I have no idea what that impact would have been on
the marketplace.
Mr. CoLEBiAN. Well, is this an informal rule as far as having the
participant know that they are going to have to liquidate iheii po-
sition? Is there an exchange rule, or is this an informal rule?
Mr. Mahlbiann. The Commission has its own rule, and the
Board of Trade has its right in its charter and bylaws under emer-
gency action.
Mr. Coleman. That is your authority?
Mr. Mahlmann. So both parties have the authority.
Mr. CoLEHAN. Yes. Well, the story in this morning's Wall Street
Joumfd characterizes this as a violation of an unwritten rule of tiie
Board of Trade. Is it, in fact, an unwritten rule, or is it a written
rule?
Mr. Mahlmann. The Wall Street Journal must be referring —
and I can only speculate on that — to the job awning which is the
only thing that the business conduct committee Cfin do. The Board
itself under rule 180 of our exchange has the emergency poweni
rule that can mandate market peirticipants what to do in order to
achieve orderly liquidation of a contract, which is in turn demand-
ed of us under the Commodity Exchange Act.
Mr. Coleman. All right. Thank you.
Mr. ENGLISH. Mr. Combest.
Mr. CoMBBST. No questions.
Mr. ENGLISH. Mr. Tallon.
Mr. Tallon. Mr. Chairman, thank you.
Mr. Mahlmann, I believe you testified that 100 percent audit
trail that would detect any and all abuses would be an imponibil-
ity for you to have in place, that kind of audit trail.
What is your accuracy rate with the audit trail that you have at
that Chicago Board of IVade now?
Mr. Mahlmann. The last CFTC review and substantial steps
have been taken since then indicate that the CFTC finds the Board
of Trade audit trail or the logic that leads to the Board of Trade
assignment of times in its audit trail that it could presume an 88
percent accuracy.
Mr. Tallon. The liquidity with the banning of dual trading when
a contract reaches a volume of 7,000 contracts on a daily basis, the
threat to liquidity which brings more stability to the market is cer-
tainly something I am concerned with.
Is this 7,000 volume in a contract? Why isn't that a mature
liquid contract when you reach the 7,000 volume?
Mr. Mahlmann. Congressman, I cannot tell you when a contract
is mature and when it is not mature. I have never heard any crite-
rion used on that before.
What we had proposed because we embraced the committee's
goal of getting to good clean, honest market that subetantially
detect virtually every abuse that there is. The exchange just ap-
proached, if it can offer that to the committee, would be that an
audit trail through computer technolt^y and surveillance systems
through computer technology that reach as a nearby soaL a 90
standard and then as additional technology becomes available that
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that goal be increased, that that be the measure rather then the
contract volume.
Contract volumes change. One contract can be liquid today, illiq-
uid tomorrow. We think that is a better implementation rather
than taking the liquidity which dual trading prevents out of a mar-
ketplace.
Mr. Tallom. You think you could reach a 90 percent iiccuracy
rate in 18 months?
Mr. Mahlhamn. I strongly believe so.
Mr. Tallon. You mentioned off-floor dual trading. I guess you
were talking about people like a futures merchant or brokerage
house receiving orders. Certainly in the securities market, certain-
ly specialists on the New York Stock Exchange. I believe you said
they were the ultimate dual trader in the things that we would
have jurisdiction over or direct the CFTC to look at.
What kind of job in just those areas like a futures merchant
where orders come into brokerage house, what kind of job has this
bill done in addressing any possible or potential abuse of dual triid-
ing?
Mr. Mahlhann. Congressman, it is my feelmg that this bill has
singled out on-exchange dual trading only. It has not addressed
dusJ trading if it is taken in the same vein as a broker trading for
himself and for his customer. That can occur off-exchange, that can
occur in the futures industry, that can occur on the securities in-
dustry, that can occur upstairs on private trading desks, and that
can occur on the New York Stock Exchange within the specialists,
and it can occur not only in the CFTC regulated industry, it can
occur in the SEC regulated industry.
So my view is that H.R. 2869 only addresses this on exchange
floors while leaving all the other industries untouched in its au&-
torial requirement, and I submit to this committee that would put
exchange floors on a tougher standard than either another indus-
try or any other part of the industry.
Mr. Tallon. Are you saying that maybe even a real estate
broker is a dual trader or an insurance agent or a banker?
Kb. Mahliiiann. They all can be.
Mr. Tallon. How many people do you have authorized to trade
on the Chicago Board of Trade now?
Mr. Mahlmann. Congressman, we have approximately 3,500
members.
Mr. Tallon. What percentage or how many of those 3,500 mem-
bers are actively participating or are quEilified dual traders?
Mr. Mahlhann. I cannot give you an accurate number on the
number of members. I can give you an estimation of preliminary
results of trading volume that occurs on our exchange that is done
by dual traders. As I indicated, it is preliminary, but it looks like it
could be as much as 20 percent of our volume of contritcts that are
traded on the exchange could be done by brokers that also trade
for their own account.
Mr. Tallon. To your knowledge, how many times has the Justice
Department brought criminal penalties against any floor triiderB
on the Chicago Board of Trade for specifically tramng ahead of a
customer?
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Mr. Mahucann. I would have to ask my general counsel because
I do not know of any.
He is not aware of any, either.
Mr. Tallon. How would you view this Iwislation if criminal pen-
alties were included in for trading ahead of a customer?
Mr. Mahlmann. Congreseman, the exchange right now has
within its rules a prohibition of trading ahead m a customer order.
I think it is up to this committee if it elects to include that into the
act. We have that as a rule already.
Mr. Tallon. Thank you. My time is up.
Mr. English. Ms. Long.
Ms. Long. Thank you, Mr. Chairman.
Mr. Mahlmann, in your testimony, you indicated that the C^TC
came to the same conclusion that you came to, that the board came
to at approximately the same time on July 11.
Why do you think that the board is better equipped to identify a
potential emergency or real emergency and then to fbUow throuc^
with the execution of an emergency order — better equipped than
theCFTC?
Mr. Mahlmann. The board and its staff are living within the
market place everyday. The Board <^ Trade staff is monitoring all
the activity of every market participant, particularly so in an ex-
piring option. The business conduct committee is in constant con-
tact with the office of audits and investigations of our staif, and I
think their expertise — that is their livelihood — lends them a better
insight or a better feeling or a better knowledge and prognostica-
tion of whether we have a potential default on our contract or not
or whether we have right now a potential, very upeet liquidation
process in the contract.
I feel strongly that the members of the exchange that are part of
that committee to monitor that, who have been delegated to do so
are the best equipped to do so. They come out of the industi^.
Ms. Long. How do you address the concern regarding olqectivify
that the CFTC is a more objective body than the board?
Mr. Mahlmann. As I indicated before, there is a requirement,
every business conduct committee member has to adhere to an
oath of secrecy, every business conduct committee member is asked
prior to any meeting whether he has an involvement in a particu-
mr contract if that is up for discussion. He is asked to recuse him-
self, and I believe every business conduct committee member as
well as every board member who goes through the same procedure
£md has to (£sclose whether there is a conflict of interest.
I think that is established beforehand so that you have absolute
impartiality. I think it occurred in this insUmce. I can state for this
committee that the opening question that I ask eveiy board
member when they came to the deliberation — when they were
called for that meeting before the issue of the day was put before
them, before any proposal was discussed, the opemng question was,
"Do you own or control any July bean futures?
One party answered in the amrmative. Iliat party was inmiedi-
ately recused. The rest of the board members in attendance all an-
swered in the negative.
In addition, prior to going into the board meeting, throu^ the
office of audits and investigation, did I know, and as the only party
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that knew whether anybody had any July bean position as of the
close of Monday night. And in addition going into the board meet-
ing, I was the only party that knew that the CFTC was arriving at
an independent decision that orderly liquidation was jeopardized
before I asked the question of every board member whether they
had a position or not.
Mr. Nagle. Would the gentlelady yield?
On the question of the conflict, could I just simply ask for my
own education. You indicated you inquired of the board members
whether or not they had any interest, any, to quote you, "owned or
controlled any positions in July soybeans," I tun curious to know
whether or not the members of your board would have an interest
or serve on the board of any other company who h^ a position on
July SOTbean futures?
Mr. Mahlmann. The question that I asked, do you own or con-
trol, and if they Einswered either of those parts with no or both of
those parts no
Mr. Nagle. Did any of the members present in the room that
voted on the decision hold a position with any of the companies or
brokerage houses or agencies that would have had a position of
July soybean futures? I mean, for exEunpIe, do you have any
member serving on your board who is also a member of CfU'gill, the
board of directors of Cargill? That type of situation? 1 am not
saying that they do, 1 am just inquiring.
Mr. Mahlmann. I said every member that weis there answered
in the negative when I asked mm do you own or control. If you are
representative of a futures commission house and you luive custom-
ers potentially, he did not own or control the position of those cus-
tomers that may clear through you as a futures commission house.
That is not a disqualification standard.
Mr. Nagle. That is my question. You mean I could serve on the
board and make this decision and also be a member of a brokerage
house who had customers that had positions that would be adverse-
ly affected or enhanced by the decision that I was going to vote on?
Mr. Mahlmann. That is correct.
Mr. English. The gentlelady's time hfis expired. The gentleman
is next to be recognized, but I think we better go vote. Maybe the
gentleman would like to rec<^nize the lady in case she has anotiier
question since her time expired.
Ms. Long. No, thank you, Mr. Chairman.
Mr. English. Thank you very much. We will recess for this vote.
[Recess taken.]
Mr. English. The meeting will come to order. Mr. Nagle.
Mr. Nagle. How many members are there on the board?
Mr. Mahlmann. Twenty-four.
Mr. Nagle. Is Hal T. Hanson a member of the board?
Mr. Mahlmann. Yes, he is.
Mr. Nagle. And he is the president of Cargill Co.?
Mr. Mahlmann. He is president of Cargill Investor Services.
Mr. Naqle. Is tliat a corporation or a close corporate relationship
to Cargill itself?
Mr. Mahlmann. I do not know the exact corporate relationship
to Cargill.
Mr. Nagle. Anybody there know?
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Mr. Gridk. I believe it is 100 percent owned 1^ Cargill.
Mr, Naolb. Silas L. Hathiaa, Sr. — is he a member of the board?
Mr. Mahuiann. Yee, he is.
Mr. Nagu. Let me be fair. First of all did Mr. Hanson recuse
himself from the vote?
Mr. Mahlbiann. No, he did not.
Mr. Nagle. Silas L. Hathias, Sr. — is he a member of the board?
Mr. Mahlmann. Yea, he is.
Mr. Naols. I have him aa the director of grain operations. Gen-
eralMUlfi?
Mr. Mahlmann. I presume that is his correct title.
Mr. Nagle. Did he recuse himself from the board?
Mr. Mahlbiann. No, he did not.
Mr. Nagle. It would appear to me that there were a number vS
people — who recused themselves?
Mr. Mahlbiann. One local trader that had 1 minute open posi-
tion on a spread basis between the Mid-America Commodity Ex-
change and the Board of Trade. He recused himself.
Mr. Nagle. Donald G. Andrew is a member?
Mr. Mahlmann. Yes, he is.
Mr. Nagle. And he is the senior vice president with Shearson-
Lehman and Hutton?
Mr. Mahlmann. Yes, he is.
Mr. Nagle. John F. Benjamin, senior vice president for DrenI
and Bumham?
Mr. Mahlbiann. Yes, he is.
Mr. Nagle. Gary K. Biefelt— he is with Biefelt and Co.?
Mr. Mahlmann. Yes, he is.
Mr. Nagle. It looks to me like people who work for Shearson-
Lehman, Drexel, and Bumham, Biefelt and Co., Index Futures
Corp. Group, Inc., Hollander and Ferhagen — I believe it is— Seay
and Thomas, Heinweiber, General Mills, Solomon Brothers, Hager
Green Co., Triple Nickel Trading Co. — all of these people's compa-
nies would have been affected if they held positions by the decision
that the board took; would that be fctir?
Mr. Mahlmann. Congressman, as I indicated before, my opening
question was: Do you own or control? And all of those gentlemrai
answered in the negative, except one as I indicated in prior testi-
mony.
Mr. Nagle. But you did not ask the question: Are you employed
by someone who owns or controls?
Mr. Mahlbiann. No, I did not ask that question.
Mr. Nagle. So if you go back to the qiiestion I immediately
stated previously, people who made this decision were people who
worked for companies, if those companies held the position in the
July futures who would have been adversely affected or enhanced
by the decision that the board would take?
Mr. Mahlbiann. All of those gentlemen made the statement I
have no conflict of interest in deliberating the issue.
Mr. Nagle. I will ask the question Eigain. People who had enor
Sloyment with companies that if they held futures positions on the
uly soybeans, they would have been enhanced or diminished hy
the action of the board, voted on the decision that was taken by the
board that day; is that not true?
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Mr. Mahlmamn. No, that is not true.
Mr. Nagle. Then I guess if you are working for Cat^l, and your
company does not have any — or to be precise, if you worked for a
company that is 100 percent owned by Cargill — and I do not mean
to pick on Cargill because I have a statement from them here I will
get into — but if you work for a company that is 100 percent owned
by Cargill, and Cargill could not fill its July futures position, that
would not be on the Boeird of Trade regardless of conflict?
Mr. Mahlmann. I do not understand the question, Congressman.
Mr. Naole. If you are an employer it is good to benefit by the
decision you made. Would that not nave been a conflict?
Mr. Mahlmann. I thuik we have to go back again to the original
question I asked. Do you own or control, and that was einswered in
the n^ative by each participant.
Mr. Nagle. But you did not ask the question, are you employed
by someone who owns or controls?
Mr. Mahlmann. No, I did not ask that question.
Mr. Nagle. Nor did you ask the question, or are you associated
with an investment house whose customers own or control?
Mr. Mahlmann. No, I did not ask that question either.
Mr. Nagle. Tell me why working for someone who had a position
would not have been a conflict to meike this extraordinary decision
that the board made?
Mr. Mahlmann. If 1 pick on my fellow board member Don
Andrew who happens to be the vice president of Shearson that you
mentioned. Shearson may have customers in July beans, but he
neither owns or controls any portion of those accounts and as a
bofird member he can, because he has no conflict of interest and
his customers may both be long and short and he may not know
who they all are and what they have in positions. He is in a posi-
tion to make by his expertise as a member of the exchange wittiout
conflict that he can make a decision.
Mr. Nagle. The question I asked, I think, frankly, saying it is
not a conflict does not define the fact that tiiere is a troublesome
aspect to the board members that made the decision on behalf of
companies for which they were employed whose interest may have
been impacted by the decision that they were about to render.
Who won and who lost as a result of the order?
Mr. Mahlmann. I do not think there is one party that won; I do
not think there is one party that lost. The order that was estab-
lished was equal across the marketplace. It applied to both longs
and shorts.
Mr. Nagle. You would not disagree with me that Ferruzzi lost
big?
Mr. Mahlmann. I would disagree with you.
Mr. Nagle. Please tell me why?
Mr. Mahlmann. I would first make a statement that the whole
marketplace in itself won by the exchange taking firm, independ-
ent action that there is no party by themselves that on either side
of the marketplace that can be influencing the market.
Mr. Nagle. I do not mean to quarrel, but let me refine it. Then
who suffered a financial loss as a result of the board's action?
Would Ferruzzi be one of those people that suffered an immediate
n^ative financial impact as a result of that?
23-500 0 - 90 -
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Mr. Mahlmann. Conffreflsman, we are alflo in a potential lawsuit
that ifi atill pending before Judge Zagle in Federal court in Chicago
waiting for amendments. I cannot make a comment right now
whether Pernizzi lost monev or not lost money.
Mr. Nagle. Can you tell me whether or not Ferrum is suing
you?
Mr. Mahlmann. They are suing us.
Mr. Naglb. Can I draw a fair conclusion, although you oould not
tell me that if they are suing you they are probably not very
happy?
Mr. Mahlmann. I presume you can draw that conclusion.
Mr. Nagle. How much are they suing you for?
Mr. Mahlmann. It has not been Bpecined. They have been givoi
a date by which time they can amend their lawsuit.
Mr. Naglb. Could you provide for the committee a list of those
individuals and organizations and business entities and corpora-
tions and brokerage houses that benefited financially hy the deci-
sion of the boeutl, and those that suffered a negative impact as a
result of the decision of the board?
Mr. Mahlmann. Congressman, I cannot provide that list to you
because I cannot quantify who won and who lost
Mr. Nagle. The board does not have the resources or the inibr^
mation or the capability to generate that type of information?
Mr. Mahlmann. Congressman, I do not have IJiat information
nor does the board.
Mr. Nagle. Incredible.
Mr. English. Mr. Gunderson.
Mr. GuNDBBSON. Thank you, Mr. Chairman. Just one quick
follow-up question in r^ard to Mr. Neigle's questioning. Mr.
Andrew, when the question was asked whether you own or wmtrol,
the answer was in the negative. Are you or is any other member of
the board aware to the extent to which your company controlled
when decisions like this were made?
Mr. Andrew. I cannot speak for the other companies. I know in
my own particulfir case, I am not privy to, in my position, I am the
mfmeiger of the floor of the execution of the orders. I am not in-
volved with the individual accounts and what their positions are,
so I answered the question.
Mr. Gunderson. Is there some kind of confidentiality require-
ment at a time a decision is made and announced whidi prevents,
what we would call lead information or inside advantage?
Mr. Andrew. Yes, there is. I wear two hats. One is the Board <tf
Trade hat and the other is with the Shearson-Lehman-Hutton, and
they do not overlap. They fu:e separate issues and I personal^
make it a point that I do not get involved into the position wbere I
would have to compromise my position with the Board of Trade. So
they are both separate.
Mr. Gunderson. Let me change the focus of the question a bit,
because one of the issues that I think presents the greatest chal-
lenge to us in the reauthorization and the preparation for the
future, espededly if we do this in terms of a permanent authoriza-
tion is the whole issue of international exchange or regulation. You
indicate in your testimony that there has been a foreign futures ex-
change that now accounts for 30 percent of the total futures
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volume. I assume you mean volume here, or do you mean volume
worldwide?
Mr. Mahlmann. International volume.
Mr. GuNDERSON. What percent of that is American participation
do you believe?
Mr. Mahlmann. I can answer that for the Board of Trade. I
cannot answer that for all exchanges. The Board of Trade domesti-
cally in the U.S. industry last yefu* represented about 4S.5 percent
of uie industry volume. That was after 4 years of unprecedented
growth, cumulatively about 92 percent that the Board of Trade had
grown over one 4-year span or the most recent 4-year span. During
the Sfune 4-year span with that kind of a growth figure, the Board
of Trade's international market trade, meaning of total futures
volume worldwide, declined from about 37 to 33 percent.
Mr. GuNDERSON. Can you give me your insight as to whether you
believe that was a Ifick of particular products on your exchange or
isBuee on your exchange aa opposed to how much of that might be
the result of competitive disadvantage due to r^ulation? Can you
give me some insight on the two?
Mr. Mahlmann. It is part of both. Congressman. As I indicated
in my testimony, for instance, the U.S. Treasury debt instrument is
probably the most worldwide spread held instrument substantially
in Asia as well as in Europe. Euroj>e already is treuling a U.S.
Treasury bond contract on the London Futures Exchange. Tokyo
intends to bring it up this fedl. Both ends are trying to make an
end road in what used to be solely our product.
Mr. GuNDERSON. To what degree can you blame that on r^;ula>
tion? And if so, can you be specific as to the regulations now in
effect which you believe put the American exchanges at a competi-
tive disadvantage?
Mr. Mahlmann. I can give you a recap of a very recent conver-
sation with one of the governors of the Bank of England. And we
talked about the legislative environment and I told him that in the
foreseeable future, I would have to come before this committee to
talk about dual trading, and the gentleman said, in London we call
it single capacity tmd we used to be on that standard. But we recog-
nize that the eidded capitfil that dual capacity can bring to a mar-
ketplace is very much wemted because it creates a better depth and
liquidity in the marketplace. It creates closer bid and ask spreads,
and it appears to me that we are going the opposite way than the
U.S. industry is going.
Mr. GuNDERSON. Do you know of any foreign exchange that bans
dual trading or regulates it?
Mr. Mahlmann. I do not know of any. There may be some, but I
do not know of any.
Mr. GuNnEESON. I guess my time is up. Thank you, Mr. Chair-
Mr. English. Thank you, Mr. Gunderson. I have noticed there
that the chairman of the full committee has joined us. Chairman
de la Garza. Mr. Chairman, do you have cmy conmients or ques-
tions?
The Chairman. Thank you, Mr. Chairman. 1 will yield my time
to the members of the subcommittee.
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Mr. English. Thank you very much, Mr. Chairman. And we also
have the chairman of the Wheat, Soybeans, and Feed Grains Sub-
committee. He has something of interest on the soybean issue, I un-
derstand. Chairman Glickman, I would be happy to recognize you
for fuiy questions you may have?
Mr. Glickman. Thank you, Mr. Chairman, for allowing me to be
here. I wont to ask you how can a nuyor participant in ^e market
acquire such a large position as Femizzi apparently did — how do
you monitor that to determine if they are in fact possessed of a le-
gitimate hedging position. For example, I understand that the spec
limits on soybeetns was what?
Mr. Mahlmann. Three million bushels per month.
Mr. Glickman. Three million bushels per month and at least it
was reported that Femizzi stated in Federal court — they had a
long position equivalent to 23 million bushels of soybeans. And ac-
cording to the Wall Street Journal today, this company is at war
with you. I am not sure who declared war against whom, but I
guess what concerns me is that how do you make a Intimate de-
termination as to whether a comfuny is a legitimate hedger? And
do you consider a company tiiat is at war with you a Intimate
hedger on your market?
Mr. Mahlmann. Congressmcm, no comment on the war. On the
other part of the question, Femizzi company and its affiliated ochu-
panies are wholly owned companies, meaning Central Soya process-
ing companies as one of them collectively go to the CFTC to seek
an exemptive status from the speculative limits and the CFTC
greuits a hedge exemption to commercuJ market participantB. And
under the exemptive procedures, the CFTC approved the hedge ex-
emptions for the Femizzi companies.
Mr. Glickman. So not only did you approve it, but CPTC ap-
proved it, right?
Mr. Mahuhann. Congressman, it is not in the Board of Trade's
purview to approve hedge exemptions for grains. We requested that
approved process on an emergency basis during the early part of
June. We have it on an emergency basis for approximately another
45 days, but the approval to establish these positions was dtme to
the best of my knowledge prior to us having this hedge ezemptive
procedure approval ourselves for a very short limited time, and the
positions that we are talking about were approved under the Com-
mission's hedge exemption.
Mr. Guckman. OK, just so I am clear because I am getting ccm-
fused now. Who gave Femizzi a hedge exemption to go above 3 mil-
lion bushels of soybeans?
Mr. Mahlmann. The Commission.
Mr. Glickman. When did they do that?
Mr. Mahlmann. I do not know a date.
Mr. Guckman. Is it monitored continuously?
Mr. Mahlmann. Congressman, you would have to ask the CPTC
because this is hedge exemption granting which is totally delisted
to the Commission. This is for grtiins.
Mr. Guckman. Let me move off of this one for a moment. In
your statement you state that no trade will escape the exchange's
computerized microscope. That is a quotation from your statement
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1
Does that mean that you will be able to determine with absolute
precision who is dual trading?
Mr. Mahlmann. It means that we are, under our surveillance
microscope, auditing and reviewing 100 percent of every trade that
occurs. Can we under that determine who trades for t£eir own ac-
count and for its customer orders? Yes, we can.
Mr. GuCKMAN. Will you be able to? See the implication of your
statement is that you will be able to determine with pretty much
an Ed»olute certainty who is dual treiding, who is not, and then
make the appropriate judgment. Is that a fair assertion?
Mr. Mahlmann. That is a correct assertion.
Mr. GucKMAN. At the current time, can you determine who is
dual trading?
Mr. Mahlmann. Yes, we can.
Mr. GucKMAN. Do you know how many traders are, in fact, trad-
ing for their own accoimts, as well as for customer's accounts right
now?
Mr. Mahlmann. I do not have the number, but I may be able to
rive you the number of our membership. No, I do not have it
Mr. Glickman. I think that would be useful. Let me just ask you
a couple of other quick things. SWAPS, you make the point that
the CFTC has basically approved SWAP trading in kind of an un-
r^istered feishion, bo you can have dual trading on SWAPS. Are
you recommending that we in fact r^ulate SWAPS as futures?
Mr. Mahlmann. I strongly recommend, first of all, that SWAPS
be declared futures contracts. And that they fail under this com-
mittee's jurisdiction euid under the jurisdiction of the Oinunission.
So the emswer is yes all the way through.
Mr. Glickman. The final question goes to the number of— let me
just mention one quick thing. I think the point of Mr. Nagle's ques-
tion about — did any of the people who were on your board work for
other companies that might have had positions — I think it refers to
the fact that it was clear that a decision by the bo£u*d to close out
these long positions would result in a significant reduction in the
market price — soybeans?
Mr. Mahlmann. No, it was not clear. The order of the board ap-
plied to both long and short hedgers that had in excess of 3 million
bushels. It therefore affected also parties that had to cover short
positions.
Mr. GucKMAN. Once a hedge exemption is granted, do you ever
monitor the position of a hedger to determine how big the position
gets?
Mr. Mahlmann. We monitor positions constantly.
Mr. Guckman. Thank you, Mr. Chairman.
Mr. English. Thank you. Mr. Coleman.
Mr. Coleman. Let me ask a question about the spec limits that
CPTC provided an exemption on in this particular case; is that cor-
rect?
Mr. Mahlkiann. That is correct.
Mr. Coleman. The usual limit is 3 million bushels?
Mr. Mahlmann. That is the speculative position limit that any
one speculator in the United States can hold in a sin^e contract
month.
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Mr. C^LEBCAN. Unless th^ receive some sort of an exemption
from the Commission?
Mr. Mahlmann. That is correct.
Mr. Coi^BfAN. You know when they received this exemption?
Mr. Mahlmann. No, I do not.
Mr. Coi^MAN. Were you knowledgeable of this exemption?
Mr. Mahlmann. Yes, we were.
Mr. Coi^MAN. You were informed or you just heard about it? Did
the Commission inform you?
Mr. Mahluann. The Commission did not formally inform us.
They were permitted to carry that position.
Mr. Coleman. Do you think that there should be some sort of
rule or requirement tjiat you be notified of that?
Mr. MahlBiIANN. Congressman, I think the Board of Trade
action, as I indicated before to Congressman Glickman from
Kansas, was that the Board of Trade in emeigencjr action request-
ed to have the jurisdiction over agricultural spec limits. We did so
in early June. We got permission or our requ^ was granted on an
emergency basis and will expire roughly in 45 days. Yes, the ex-
change felt strongly that the exemptive procedure should also be
within the hand of the exchange.
Mr. Coleman. I am sorry I had to step out of the room, I did not
hear what you were saying.
Mr. Maiojaann. I am sorry.
Mr. Coleman. I am glad you mentioned it. So the CFTC granted
you some extraordinary emergency
Mr. Mahlmann. Only under our emergency request were we
granted the exemptive procedure as an exchange, but I strongly be-
lieve we should have that power concurrently with the Commis-
sion.
Mr. Coleman. How common is it to receive one of these exemp-
tions from the Commission?
Mr. Mahlmann. Any commercial user showing justifiable reascm
of why they would have to exceed the speculative limits can go to
the Commission and get approval.
Mr. Coleman. Is it not common knowledge that the amount of
available soyl>eans was considerably less than 23 million budidfl?
Mr. Mahuiann. It stipulated in cart that the amount of dsliver-
able supplies within the deliverable contract area attributable to
the futures contract on the Board of Treide was approximately 10 to
12 million bushels which were predominantly ovmed by the same
party that owned the futures contract.
Mr. Coleman. Knowing this as a fact, not as a judgment, the
CFTC allowed this exemption to occur knowing that the contracts
could not be fulfilled. Is this an unusual conclusion that one would
draw if one knew the supply and knew the position to allow an ex-
emption?
Mr. Mahlmann. I think the answer would be no, because nor-
mally you would expect orderly liquidation of the contract.
Mr. Coleman. Let me ask a line of questions about the recusinK
from the discussion that the board of directors had on July 11, and
ask you that if a company has a large position apparently as one
did and in a market like this, is it generally known on the floor
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that this is occurring? Is this exemption that was granted by the
Commission a matter of public record?
Mr. Mahlkiann. It is not a matter of public record.
Mr. Coleman. But generally speaking, do people sense and pick
up the action that there is such a position being held? Would you
say this was common knowledge?
Mr. Mahlmann. By coffee shop talk, I would presume so.
Mr. Coleman. And people on the floor would definitely fall into
that category?
Mr. Mahumann. I would think so.
Mr. Coleman. So my question would be — and I am not suggest-
ing that there is or was any wrongdoing — as we look at self-regula-
tion and the questions that one reuses with the potential conflict of
interest, this was common knowledge that people could benefit one
way or another having this knowledge, notwithstanding that they
may have emswered your question about having an interest or con-
trol on a particular date. Leading up to that date people could
have, because of this common knowledge, participated in the mar-
kets in some fashion that would have benefited themselves. Is that
possible?
Mr. Mahlmann. Congressman, I do not understand the conflict. I
can make one statement. The only one, the sole member of the
board, other than the president who is a nonvoting member, that
knew about the propo^ that may go to the board for discussion
without knowing how it would come out was myself.
Mr. Coleman. I understand that. But it is possible that people
not only on the board but other people who were traders could
have — with this understanding of what was going on in the mar-
kets— obviously tried to benefit from it or r^uc^ their exposure
in the weeks leading up to a decision on July 11?
Mr. Mahlmann. Congressmfm, I cannot comment on traders
that react to rumors fmd take positions on the rumors.
Mr. Coleman. Is there any reason why members of the board of
directors would be in any better position to gain or to lose than any
other person who was on the floor?
Mr. Mahlmann. No. Absolutely not.
Mr. Coleman. And in this pfuticulfu* question, since the CFTC
had already made a concurrent decision, even absence the boEird
making a decision, the effectiveness of that decision would have
been the same in this particular instance. If CFTC had not taken
that action then there may have been more reason to feel that a
conflict of interest that one may have worked for an employer who
held a position would have been more meanii^ul. This particular
case was less so probably because the Commission had made a simi-
lar decision.
Mr. Mahlmann. Now the CFTC came to the same conclusion as
the board, but there existed a problem in the orderly liquidation of
a contract. The two entities came to that conclusion independent of
each other.
Mr. English. Mr. Nagle.
Mr. Nagle. I want to go beick again. Mr. Andrew, you are a
senior vice president with Shearson-Lehman and Hutton, Inc.?
Mr. Andrew. That is correct.
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v»
Mr. Naqlb. Was Shearaon-Lehman and Hutbni giving advice to
customers as to whether it would be prudent or not in May and
June to invest in July soybeans? Does your company give tiiat kind
of advice?
Mr. Andrew. I am sorry, I did not hear the question. Let me see
if I hit it. Does my company give advice to buy or sell July soy-
beans?
Mr. Naqlb. Yes.
Mr. Andbew. They give advice on the soybean market It could
be July, November or any, yes.
Mr. Naqu. Would the same be true for Drexel, Bumham, and
Lambert? Would they render basically in the industry the same
kind of advice that July futures are a good buy or July fiituree are
a bad buy?
Mr. Andrew. Generically, most of the firms will have analysts in
beans and they are given recommendations to buy and sell for all
markets. When I say all markets, I mean all markets, not just aoy-
beans but grains and fdso with soybeans, July, old crop, new crt^
that type of thing.
Mr. Naole. Would it be fair to say that Shearson-Lehman would
have custmners who would have been affected by the dedsimi that
the board took on, I believe, it was July 11?
Mr. Andrew. I do not know what the Shearson positicms were,
the customers positions were. I assume tiiat they could have heeai
on both sides. So I do not know, some could be winners and some
could be losers.
Mr. Nagle. Could the same be said for Drexel, Bumham and
Lambert?
Mr. Andrew. I really cannot speak for Drexel.
Mr. Nagle. The boaird is composed of 24 members. How many of
them are independent members or public members?
Mr. Mahlmann. We have three nomnembers, meaning non-
members of the exchange on our board. That is from the general
public. There are three members who are members of the exchange
but are members from outside of Chicago. They are nonresident
members. There are eight members and members of the exchange
who are currently principals or officers of Futures Commiseion
Merchants. There are six directors whose principal occupation in
life is being brokers on the exchtuige. And there are three members
whose principal activity is to trade for their own account. In addi-
tion to that you have the president who is a nonvoting member of
the board.
Mr. Nagle. Can you obtain and supply to the committee the
open positions of all participants in the July contracts of soybeans
at the end of each day from July 11, to last night?
Mr. Mahlmann. Congressman, under proper subpena, we will be
very happy to supply the committee with the records (^ anybody in
the marketplace on July 11.
Mr. Nagle. And can you obtain and supply to the committee the
trades by all participants for each day fitim July 12 through noon
today?
Mr. Mahlmann. Under the proper subpoena, we can supply that
to the committee.
Mr. Enqush. Would the gentleman yield?
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Mr. Nagu. I would yield to the chairman.
Mr. E^NGusH. On thm particular point, it may be more proper for
any requests that are made to be made through the CFTC. Tlie law
is quite clear as to the committee's ri{;ht to information. And as I
understand it, the CFTC then has the ri{;ht and access to all the
information that is in question. So as opposed to the conunittee
going directly to an exchange, it may be more proper for us to go
through the CFTC and perhaps the committee might want to get
tt^ether and discuss what information — let me say this. There is
already a request before the CFTC, and it is my understanding that
this subcommittee will be supplied certain information. Perhaps we
should review that information and determine if we need any addi-
tional information, but some of it is along the lines you are talking
about, Mr. Nagle.
Mr. Nagle. I would like to make that a formal request of the
committee, but I will defer until we have a chance to talk, Mr.
Chairman. But I think probably, I would like to make a formal
motion, if necessary.
Mr. English. Thank you very much.
Mr. Nagle. When Dr. Gramm was here, I am almost certain and
I will have to review her testimoi^ precisely, but I am almost cer>
tain that she told me that the CFTC did nothing when informed of
the board's decision, except thank you for the information. I am
just dead certain. I am quoting from a newspaper article that
Mr. EInglish. What paper?
Mr. Nagle. The Journal of Commerce quotes her at the hearing
as saying, as to the House Agriculture subcommittee hearing on re-
authorization of the CFTC about her reaction to CBT's notice. She
said, "she thanked them for the information." I thought your testi-
mony today was as if the CFTC took an independent step or action
other than just simply thanking you. Your testimony is that they —
what did they do?
Mr. Mahlmann. Congressman, the Commission took independent
action vis-a-vis one market participEuit by revoking the hedge ex-
emption of that market participant, effective the close July 18
which in effect meant that that market participant had to liquidate
whatever they had open, single market participant, up to and in*
elusive July 18, down to 3 million bushels.
Mr. Nagle. So if the committee were told that CFTC did nothing,
that testimony would have not been consistent with your recollec-
tion?
Mr. Mahlmann. The CFTC took their own independent action.
The Board of Trade did its own independent action. We communi-
cated those actions to each other.
Mr. Nagle. With the indulgence of the Chair, you started moni-
toring this in May as a board?
Mr. Mahlmann. The July contract was started to be monitored
last week of May, first week of June, after the May contract had
gone off the board.
Mr. Nagle. Did you monitor it every day?
Mr. Mahlmann. On a daily basis.
Mr. Nagle. And the price continued to rise?
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Mr. Mahuiann. I do not recall any price movement in particu-
lar during the time from May on forwani. It was irrespective of the
price movement. We monitored open poeitions every day.
Mr. Naole. I guess I am curious. Would you agree that there was
an upward trend in the price on July soybean futures between
Mr. Mahlmann. I do not recall the prices, Congressman.
Mr. Nagle. Could you supply that to me?
Mr. Mahlmann. Yes, we can.
Mr. Naglk. The question I want to know is: Why did you wait 80
late before you finally took the Eiction?
Mr. MAmJMANN. Congressman, you etre most reluctant as an
overseer of orderly markets to declare that there is an emergennr.
And you hope that all market participants will live within their ob-
ligation to affect orderly liquidation. Emergencies are only taken
as a Ifist resort.
Mr. Nagle. I would characterize and I would ask you to assume
for the purposes of my question. The characterization of this ap-
pears to be an attempt at marketpleice manipulation by one of the
market participants.
I wont you to make that assimiption. Do you anticipate at the
CBOT that in the future you will see more (^ this type of market
manipulation activity or to put the question neutral, more of this
type of market conduct?
Mr. Mahlmann. I cannot comment or would I even speculate
whether there would be more mcinipulation. I cannot comment on
any potential allegation of manipulation to begin with. All I cem
say is that the procedures in the May contract by job owning Uie
market participemts, both long and short, got us a reasonaSle—
even though only by the skin of our teeth, orderly liquidation. That
saune syBtem failed in July. Therefore, the emergency action.
Mr. Nagle. Are we going to see more of these in me future?
Mr. Mahlmann. That is speculative and I hope not.
Mr. Nagle. I hope not too. In terms of the reauthorization of the
CPTC, are there any steps this committee could take to see that
perhaps you can act expeditiously when confronted with this s^ua-
tion or the CFTC can act expeditiously when conft*onted with this
situation, assuming that it does reoccur?
Mr. Mahlmann. We strongly hope it does not reoccur. And that
the action that we took is strong enough to the participating WOTld
whether long or short, that the Board of Trade will not stand for a
single party pushing the marketplace in total around.
Mr. Nagle. You do not have to answer this today, but you are
not requesting any additionid tools to deal with this situation
should it reoccur?
Mr. Mahlmann. Could you repeat the question, please?
Mr. Nagle. I am trying to get the sense of direction of how we
can deal with these things in the future, if they do happen, and I
share your hope that they do not. And I am asking you whether or
not you think that in the process of our reauthorization, there are
any additional tools that either you or the CFTC should have lesis-
lauvely?
Mr. Mahlmann. Coi^ressmim, as I indicated before, I think the
exchange would tike to have cojurisdiction over the exemptive proc-
ess of speculative limits, but otiier than that, I think there are good
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checks and balances in place between the self-regulatory environ-
ment of the exchai^e and the regulatory environment of the Com-
mission.
Mr. Nagle. Is the exchange, the Board of Trade given any con-
sideration in light of the composition of the board and this situa-
tion specificEilIy? Is the board given any consideration to expanding
its public membership?
Mr. Mahlmamn. We have given it consideration.
Mr. Nagle. That narrows it down, for or eigainst it?
Mr. Mahlmann. I would be speculating right now as a single
member of the board. But it would be my idea to expand the board
by one nonpublic director. I mean, public director.
Mr. Nagle. Thank you, Mr. Chairman.
Mr. English. Thank you very much, Mr. Nagle. Mr. HoUoway.
Mr. Holloway. No questions. Mr. Mahlmann, I want to thank
Cvery much for your appeeirftnce before the subcommittee. It
been very helpful find I think that without question, the infoi^
mation that you provided concerning the soybeetn situation is most
helpful as well. That is a subject of great interest and particularly
this subcommittee has taken note of fuid I think it certainly has
gotten the attention of a lot of members of this subcommittee that
tiie question of the involvement of the CFTC. I think we were led
to believe on Tuesday that the situation occurred differently than
what you told us and we plan to look into that veiy carefully and
further. So 1 am sure we will have an explanation mim the Chair-
man of the CFTC. Thank you very much.
Mr. Mahlmann. Mr. Chairman, I would like to thank you for
scheduling us after the expiration of July futures and I would like
to thank the staff that worked diligently and has been very much
available to have dialog with. Thank you very much.
Mr. English. We are looking forward to continued dialog, and as
I said as we talked about earlier, as far as the legislation is con-
cerned, I think we are talking about degrees in many areas. And
we are looking forward to resolvii^ those matter. Thank you very
much.
Our next witness is James Lindau who is president of the Minne-
apolis Grain Exchange in Minneapolis, Minnesota. Mr. Lindau, we
appreciate your coming and I know that you have been waiting
very patiently and we are looking forward to your testimony. As I
told our other witnesses if you would care to summeuize your testi-
mony, please feel free to do so, and without objection it will be
made a part of the record.
STATEMENT OF JAMES H. LINDAU, PRESIDENT, MINNEAPOLIS
GRAIN EXCHANGE
Mr. Lindau. Thank you very much, Mr. Chairman. I must say
this has been an interesting day. I am James Lindau, president of
the Minneapolis Grain Exchange. I am delighted to have this op-
portunity to talk to you. There are a lot of things that are on the
table before us that are very important. I am going to try to re-
strict myself to a very few.
The Minneapolis Grain Exchange was established in 1881. It is
an active cash greiin trading center and maintains futures con-
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tracts and options on Hard Red Spring wheat and contracts only on
White wheat, oats, and high fructose com syrup.
I note that representatives from several other exchanges have al-
reewhr testified before this committee in connection with this year's
CFTC reauthorization. Let me hmit my remarks to the issues of
major concern to the Minneapolis Grain Bxchan^.
First, a general comment. I am a newcomer m representing an
exchange in a setting such as this, but I am ffuniliar with business
and government. I spent 23 years with a compeuiy that will remain
unnamed, as a manager of grain trading and a feed ingredient
trading business, and 11 years as mayor of the third largest aty of
Minnesota.
The futures industry today with all its size, strength, and variety
owes much of its growth and credibility to the action of this com-
mittee in 1974. In that year you crafted l^islation to create an ex-
clusive, independent r^ulator to regulate the Nation's futures
markets. The child of that legislation, the Commodity Futures
Trading Commission, has done a good job under difficult circum-
stances. However, we are concerned that parts of this bill serve to
revive the 1974 mandate and put micromanagement of some as-
pects of the industry in the Congress and out of the expert regula-
tors. One must question whether this is either good tni^ess or
good government.
Specifically, dual trading is essential to preserving liquidity in
our futures markets. Dual traders are involved in everv aspect of
futures trading at the Minneapolis Grain Exchange. They cannot
be separated from trading in the current option, or spreading
against deferred options, and permit retention of any semblance (^
liquidity.
If di^onesty springs from dual trading, we must increase our
vigilance to prevent it, even though there is no evidence of dishon-
est dual trading at the Minneapolis Grain E^xchange. IF dishonest
dual treiding springs from highly liquid, eictive futures markets, let
us identify and punish the dishonest traders, but let us not, in the
process, destroy the futures markets. These markets have provided
the best, and often the only source of pricing informaoon and
margin protection dating back almost to the Civu War.
Technology is reaching the point that very accurate, timely audit
information is available to help identify those traders who mif^t
try, unfairly, to do better than their trading skill alone mij^t
permit. At the Minneapolis Grstin Exchange, we believe that our
audit program provides a satisfactoiy means by which to verify the
timing data submitted to the clearinghouse and to detect inaccu-
rate or missing trade data on source documents.
In this regard, the Commission, during its 198S rule enforcement
review of ttie Minneapolis Grain Exchange, found that the ex-
change'e I-minute timing system was extremely accurate. The
CPTC stated, "The exchange a overall accura(^ rate was 96.8 per-
cent." We believe that an accuracy rate of 90 percent or greater
may be a proj>er target, and will, of course, continue to soive to
maintain a high level of performance in this area. I will add paren-
thetically that our goal is certainly higher than that.
Let me take 1 minute to congratulate Mr. Cherry and his staff
on their professionalism. We were visited at the Minneapolis Qr^
,,C,oogk
Elxchange by Mr. McDonald who was competent and thorough. It is
our view that the fruitfi of this long, detailed Investigation should
be fully used by the committee as pail of its responsibilities to
overview the CFTC. In the main, the CFTC has more than enough
statutory authority in the areas of so-called dual tratUng, audit
trail and composition oC boards at exchangee. I think it is entirely
appropriate for this committee to review the record of the CFTC on
these issues. It would be risky to incorporate your concern into
statutory mandates.
[The prepared statement of Mr. Lindau appears at the conclusion
of the hearing.]
Mr. Engush. Theuik you very much, Mr. Lindau. From what I
know of the exchange out of Minneapolis, you do not have a single
contract that would fall under the provisions of this legislation, do
you?
Mr. Lindau. That is correct, sir.
Mr. English. So it has no impact on you whatsoever?
Mr. Lindau. At the present time, we have no contract that would
reach the limit that you have established. Obviously, we hope that
that becomes a problem.
Mr. Eh^GLiSH. But you have a long way to go?
Mr. Lindau. I cem say that with confidence. We have a loi^ way
to go.
Mr. English. With r^ard to the point that you made with more
than enough statutory authority. I would wholeheartedly agree
with you. CFTC does have more than enough statutory authority.
And one of the problems we have is that when we find an agency
that is not using the authority that they are provided, we have two
choices. One, we can attempt to address that problem, namely
through legislation, or we can simply accept the fact that that
agency chooses not to act. And in this particular case of this l^is-
lation, we have chosen to act where we see the failure of the CFTC
to act. It certainly is not the desire of the members of this subcom-
mittee or the full committee or the Congress to have to take this
action. We would much prefer to sit bade and say, gosh you guys
are doing a great job and we are thrilled about it Euid go merrily on
our way past the reauthorization.
That is not the case. We have some problems that we are facing.
We have an investigation underway by the Justice Department
that is well documented. You have just heeuxl much of the contro-
versy with regard to decisions that are being made. We have evi-
dent involvement by the Commission. We had Chairman Gramm
come before this committee and leading this committee to bel^ve
that the CPTC was nothing more than a casual observer who re-
ceived information.
We do not have much choice. If, in fact, we are going to demand
higher standards. That is the real issue we are t^ftlbing about is
whether we are going to demand higher standards. Then we have
to take that action. We are soUciting and hoping to work with the
exchanges. We want to work with you, and as I mentioned, the
Board of Trade and earlier this morning, the Chicago Mercantile
Exchange, the New York Exchange, Kansas City, in trying to de-
velop what those standards should be and the best way to reach
those standards.
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We have had the Futures Industry Aaaociation testifying that
they agree with us that a carrot and stick approach is necosHaiy if
we are going to achieve those goals. That is basically what this W
istation contains. It holds out a carrot, but there is also a stick. We
recognize that with your audit treiil and the system that you have,
you are among the top exchanges in the country as far as being
able to monitor and make certain that you know when any type en
wrongdoing takes place, emd we want to push other exchanges to
reach those goals.
Mr. LiNDAU. Mr. Chairman, yours is not an enviable task. I agree
that it is diHicult to accomplish. I think you should take some ctnn-
fort and confidence in the fact that every exchemge who has spo^n
here this morning shares your goal of creating a more honest, more
reliable marketplace. So in that, we can all work t<%ether.
Mr. English. I appreciate that very much and we are looking
forward to your suggestions and your thoughts. And I am hopeful
that in the next few days that we will firmly eetabluA and detail
what those standards wfll be. So thank you ver^ much. Mr. Tallon.
Mr. Tallon. Thank you, Mr. Chairman. I thmk you told us that
^ou do not have any contracts on your exchange that would Call
mto 7,000 contracts a day being traded and therefore come under
certain restrictions, but with your audit trail and the technology
you are using, are you able to have 100 percent audit trail that can
detect any and all abuses? Can you do that?
Mr. LiNDAu. Mr. Chairman Euid Mr. Tallon, as I indicated in my
remarks, we had at the last cmalysis a 96.8 percent accuracy rat^
100 percent would be difficult in only one respect. We time our
trading cards to the minute. If there happen to be 1, 2, ot 3 trades
in that same minute by the same trader, we may not be able to be
100 percent accurate, out we think that even at 96.8 percent, we
are pretty close to perfect.
Mr. Tallon. And perfection is pretty difficult to achieve, is it
not?
Mr. LiNDAu. Of course, it is. It can only be a goal. One of the
restrictive factors is the cost of getting to that point of perfection.
As an exchange, we can only do what we can afford to do. We are
pleased that that has got us to 96.8 percent.
Mr. Tallon. Wait 1 minute. Do you believe that if cost was no
problem that you could get to an absolute 100 percent witii any
and all abuses?
Mr. LiNDAU. Mr. Chairman and Mr. Tallon, if costs were no
factor, we probably could find a person to stemd by each one of our
60 or 70 traders in the pit all day and go home with them at nic^t
to make sure the trades were honest.
Mr. Tallon. From a practical standpoint, I certainly agree with
the chairman that with his carrot ana stick approacl^ but maybe
his stick is too loi^. I do not know. Thank you.
Mr. English. Mr. HoUoway.
Mr. Hollow AY. We appreciate you bearing with us with the long
day we have had. I am sure that you have had interest in the hear^
ing as well as we have. I just basically say with dual trading do
you ^t many letters in or my perception oif what America feels is
that it is evil. Do you get many letters to the exchange a
or questioning you about dual trading?
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Mr. LiNDAU. Mr. Chairman and CoDgressman Holloway, we have
not had any cards or letters dealing with dual trading. As a matter
of fact, the number of customer complaints that we get is very
small. Ours is principeilly a commercial market. Dual trading has
not become a household word.
Mr. Holloway. I have no further questions, Mr. Chairman.
Mr. English. Thank you very much, Mr. Lindau. I appreciate
your testimony very much.
Mr. Lindau. Thank you for giving me the opportunity.
Mr. English. And as I said, we will be looking forward to work-
ing with you.
Our next witness is Dr. Sanford Grossman who is with Princeton
University, Princeton, New Jersey.
Dr. Grossman.
STATEMENT OF SANFORD J. GROSSMAN, PROFESSOR,
DEPARTMENT OF ECONOMICS, PRINCETON UNIVERSITY
Mr. Grossman. Thank you for inviting me. I tim a professor of
finance. I have been a professor of finance at Princeton University
of Chicago, University of Pennsylvania, and Stanford University. I
have worked for the Board of Governors of the Federal Reserve.
My reseeirch over the last 15 or so years is involved in the study of
futures and securities markets with special attention to the deter-
minants of market liquidity and price discovery. My current re-
search involves studying dual trading, as well as the mathematics
of transactions, cost avoidance, and securities in futures markets. I
have worked for the New York Stock Exchange, Katz and Bachs
study of program trading. And I have recently completed the theo-
retical part of my study of dual treiding for the Chicago Board of
Trade.
I would like to if I could summarize the results of that part of
the study for you. Some of this is going to sound, I am airaid overly
academic, but that is where I come from.
From my point of view dual trading is said to occur when an
entity sometimes trades as a broker for customers, find at other
times trades -for its own account. I found that dual trading is quite
pervasive throughout the U.S. securities and futures markets, as
well as in financial and commodity markets throughout the world.
The pervasiveness of dual trading is due to the fact that many of
the skills and facilities required to be a good broker are also neces-
sary to be a good trader.
Dual trading increases the supply of both brokers and floor trad-
ers because a dual trader can earn income from two activities to
cover his cost of training, his exchange seat, and time spent on the
floor. He has less idle time and facilities when he can switch ^m
the activity in low demand to the activity in high demand.
I should just mention that as a professor, this notion that you
can be spending your time on two d^erent activities and be a dual
trader is very common in my business, the professor business,
where we both do teaching and we do research. And there is some
overlap between the skills required to be a good teacher and the
skills required to be a good researcher, and when we do not spend
our time teaching, we switch and do research and sometimes if you
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do research for too long you get a headache Eind you prefer to do
some teaching. So this notion that your skills in trading that one
has can be used for two activities is something that every research
professor is familiar with.
Returning to dual trading, I found that dufil trading has both a
direct and mdirect effect on the quality of customer services. The
direct effect is an increase in the quality and quanti^ of brokers.
T^ fact that dual trading increases the supply of brokers means
the ctistomer has more brokers to choose from and at a lower ^irice.
Furthermore, using a broker who is a good trader means hi^ier
quality execution for customers.
The indirect effect of dual trading derives from the increase in
the liquidity of the market caused Inr the increase in the number of
market makers. Parties who trade for their own account by bui
at a low ^ce and selling at a high price serve a market nuu_
function. Thus, the abihty for Em entity to use its facilities for pro-
prietary trading results in an increased presence of market makers
on the floor at times when their services are most needed. More
traders standing ready to trade make for a more liquid market
with smoother price changes.
In order to aid in a comparative analysis of dual trading I distin-
guish two types of dual tradli^. The first type called simultaneous
dual trfiding occiu^ when a firm trades as a principal for its own
account, Emd an agent for its customer in the same transaction.
This ty|>e of dual trading is prevalent in securities markets, curren-
cy and interest rate swap markets, and the fixed income market
As a matter of fact most member firms of the New York Stock
Exchange call themselves broker-dealers. These stock exchange
firms sometimes act as brokers, trading for customers as broken,
and other times trade for their house or proprietary account. Every
major firm that you have ever heard of that trades stock, trades (or
its house account and it also trades for customers.
But it does something even more extreme than that. Sometimes
it does bo^ at the same time by taking the opposite position ot a
customer treuisaction, crossing that transaction, for example, on
the floor of the New York Stock Exchange. I heard it said today
that speciahste are dual traders in the New York Stock E^hange,
but that is an understatement. E)very major firm that is a m^nber
firm of the exchange both trades for its own account and tractes for
customers. Simult^eous dual trading does not take place in- fu-
tures markets in the sense that firms do not simultaneously take
the other side or their own customers trades.
The second type of dual trading which is something that occuza
in our futures markets is what I call consecutive dual trading, and
this occurs when a firm trades for customers as an agent and at
other times trades for its own account as a principal, but the firm
does not do both in the same transaction. Consecutive dual trading
occurs in futures mfu'kets, as well £is in edl of the markets in whiw
there is simultaneous dual trading.
Dual trading plays a particularly important role in futures mar-
kets as contrasted with securities markets. The fact that all trad-
ing in futures takes pUtce on the exchange floor and that sinread
trading is an important part of hedging strat^es make the skills
of a trader more necessary for a good futures broker. The immedia-
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cy required by the futures markets makes liquidity more impor-
tant, and therefore makes a larger supply of market makers more
critical than it would be in a securities market.
There are three types of brokerage services that I have identified
that the customer needs. The first service called search involves
searching for the parties who are interested in being on the other
aide of the trade, that is the contra-side, the contra-party to the
trade. The second service called timing involves obtaining and proc-
essii^ information to determine how long to wait for the arrival of
the most advantageous contra-party while being exposed to the risk
of Eui adverse price move. The third service bargaining involves ac-
tively bargaining Eunong available contra-parties to obtain the best
price.
A securities broker can use his skills and sales force to prear-
range trades upstairs. Upstairs search in securities markets is
ofien an effective substitute for the downstairs working of an order
where timing and bargaining skiUs are needed. A futures broker
cannot prearrange trades upstairs. The brokerage firm cannot sub-
stitute search skills for trading skills. The order must be worked on
the exchange floor. The floor broker must have the ability to trade
in such a way on the floor of the exchiuige that he brings the other
side of the trade to the floor at a good price for his customer.
Therefore, floor trading skills are relatively more important in the
fiitures market than in the securities market.
Further, much futures trading involves spreads where a custom*
er wants to buy and sell two or more contracts simultaneously for
a guaranteed net price. The customer's broker can execute the
spread by trading with a local on the floor, or the broker can exe-
cute the individual l^s of the spread consecutively. The latter will
be in the best interest of his customer if the broker is a skilled
trader, since by trading each 1^ himself, the broker avoids paying
the local a premium for the risk in trading the spread. Such spread
trading is inherently risky to a broker, since Eifter he execute one
1^ of the spread his customer can hold him to a price for the other
1^ of the spread, which the broker may find impossible to Eichieve
if the price moves after he does the first leg. This aspect of futures
trades as well as the relatively high underlying price volatility in
many futures contracts increase the trading skills burden on a fu-
tures floor broker relative to that of a securities floor broker.
Futures trading customers often have a high demand for immedi-
acy because they are trading to hedge an underlying spot market
position. The fact that immediacy of trade execution is extremely
important to futures customers implies that they will have a great-
er demfind for market makers than will be the case in markets
where the cost of delayed execution is smaller. A commodity
hedger bears great risk if he does not do his fiitures trade immedi-
ately. This risk may force him to trade using a market order, for
example, to sell immediately to the highest bidder currently avail-
able. If there are few market makers, then he will receive a rela-
tively low price, that is, his trade will have a high market impact.
Thus, futures markets have a great demand for traders who in
effect serve a market making fiinction. The institution of dual trad-
ing permits this demand to be met at low cost.
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Mr. English. Dr. Groesman, we have a vote on the floor, we are
going to have to make, so we will be back here just shortly. We will
have to break for that vote. I am sorry.
[Elecess taken.]
Mr. English. Dr. Grossman, I am sorry about the vote. We get
into these interruptions here as part of our committee process.
Please continue with your statement. As I mentioned before, if you
care to summarize any of your statement, please feel fi^ee to do so.
It will be meide part of the record.
Mr. Grossman. Yes, I am just about finished. In concluding, dual
trading increases the supply of the types of customer services
which are relatively most demanded by futures customers. Ehial
trading is prevalent in the securities market, both on the floor and
off the trading floor. Institutional securities trades are often prear-
ranged off the floor, and this lessens the burden of securitiee floor
brokers. It would be quite peculiar to eliminate dual trading for Ai-
tures and maintain it for securities where the dual trading by floor
brokerB is less important. The elimination of dufd trading from f^i-
tures markets will harm customers by reducing the quabty of bro-
kers who do customer business. The beet traders will trade for
their own account, leaving customers with broken who are lees
skiUed traders.
Bv preventing traders from acting as brokers, the elimination of
dual trading will reduce the number of floor traders and thus
reduce market liquidity. Foreign markets will gain an «lvantage
over U.S. markets causing large customers to leave U.S. markets,
and these U.S. markets will therefore lose liquidity. Therefore,
there are small customers who remain and they are the ones who
are unable to trade overseas, will be most adversely afHected by the
loss of liquidity in U.S. markets. Spot metrkets, such as grains and
the U.S. Treasury bond market will be adversely affected by the
loss of liquidity m futures markets, and spot prices will become
more volatile. Finedly, customers will lose the freedom of choice
they now have to pick either a broker who trades for his own ac-
count, or to pick a broker who trades exclusively for customers.
That is sort of the end of my formal statement. I would just like
to give you one example of what goes on on the floor to make srou
get a feel for what the difficulty is of trading futures sometimes
and why futures traders really need a skilled broker. A skilled
broker is somebody who is a good trader. Sometimes you have a sit-
uation where the commodi^ or the spread that is to be bought, the
bid is $1 and the offer is $1.10. That is a 10-percent sprecu. Now
the customer gives his order to the broker. It could be a market
order. If the broker is lazy or very risk adverse, he might just lift
the offer to $1.10. Maybe if the broker is energetic and feels likes
working hard and takmg some risks, he might bid $1.09 or $1.06 in
the hope he can get it somewhat cheaper for his customer. Now in
bidding $1.05, he of course runs the risk the market will move
away from him before he is ever able to get the trade done for luB
customer. So there is a lot of pressure on a broker itbout how hard
to bargain and how long to wait.
A good broker has to have all the skills of a good trader to give
bis customer good service. I have listened to a lot of the testbnony
today emd h^trd about abuses and front running and things tiiat
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definitely sound terrible to me, but there is one abuse tliat hae not
been mentioned which I think economically is at least as great sig-
nificance, and that is the abuse of a lazy good for nothing broker
who does not act by front running adversely to you, but just does
not give you a good fill. He goes in and you tell him I have a lai^
size to buy, get me a good price. And he has a big deck; he is very
busy; he has a lot of orders to do. He asks what is the market
People give him a very wide spread, as I said, the locals or whoever
is there gives him a spread of $1 to $1.10 find rather than bargain-
ing with them and aiding with them effectively and yelling and
working very hard to work this order, he goes to the $1.10 find says
done. And he has cost his customer perhaps 10 cents. Maybe if he
had worked harder, he could have got it for $1, instead of $1,10.
There is a notion that when you give your broker an order, the
broker is away from you on the floor and you cannot see how hard
he is working that order creates a kind of an abuse of laziness and
bad fills, which I think is very significant. And I think, institutions
that encourage good traders to Income brokers and dual trading is
such, the institution of dual trading does encourage good traders to
become good brokers and do customer business as opposed to leav-
ing customer business, really lessens what I call the bad fill abuse.
I think in trying to regulate these markets, you should keep in
mind that one of the biggest abuses in any principal agent rela^on-
ehip is laziness on the part of the agent and these brokers are
s^nts find anything that can be done to increase competition
among brokers by increasing the broker population through allow-
ing dual trading is something that will give the customer a tool to
deal with lazy brokers and help the customer get better fills.
That is all of my informal remarks.
[The prepared statement of Mr. Grossman appecus at the conclu-
sion of the hearing.]
Mr. E)ngli8h. Thank you very much, Dr. Grossman. I appreciate
that. I Eun not sure there is much that this subcommittee can do
about legislation on leiziness. That is an area we have not had a
great deal of success with in the past. There has been once or twice
that Congress, I think, has attempted to legislate in that area and
it haa not worked out well at £dl. It is my understanding that you
have been employed by the Chicago Bocud of Trade to carry out
comprehensive empirical study on dual trading; is that correct?
Mr. Grossman. Yes.
Mr. English. Also, it is my understanding you were employed by
the Chicago Board of Trade earlier to cany out a study with r^ard
to the proposed 1-minute time bracketing r^ulations and you put
out this booklet; is that correct?
Mr. Grossman. That looks like a reprint of an article published
in the Journal of Futures Markets. It is a reprint of a scholarly
journal article.
Mr. English. Right. You were also employed by the Chicago
Board of Trade to can? out that study; is that correct?
Mr. Grossman. 1 think the study that I did for the Chicago
Board of Trade led to that paper. I am not sure they commiseure,
but there is definitely a relationship, yes.
Mr. English. So you were employ«l to do that. I noticed in this
article booklet that it states, "The frequency of dual trading is
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itself low." And then in another point in there you state, "The fre-
quency of dual trading are worth emphasizing or the low frequen-
cies of dual trading are worth emphasizing." Given that fact, how
can dual trading be as vital as it is, since you stated back in 1986,
it rarely occurred?
Mr. Grossman. I think, if I remember the context of that is that
we were at that time concerned about front running abuses, and
that what we did is we studied a particular time bracket. In a pai>
ticular bracket, we did not And very many instances where a dual
trader had both traded for a customer and traded for his own ac-
count. That does not mean that across other brackets that particu-
lar individual did not switch from becoming a trader, a broker, to a
trader who is a proprietary trader.
Mr. English. I guess the point that I am making thou^ is that
here on one hand you state back in 1986 that this is sometUng
that is a low frequency situation. It is something that does not
occur that often. If that is the case, I do not understand then why
it can be such a big deal this year. The other part of it is that from
your testimony, you are talking about a theoretical overview. Does
that mean that it haa little feict and a lot of rhetoric when we talk
about the question of dued trading on your study?
Mr. Grossman. At the moment I have not yet done the empirical
part of the study. I have finished outlining the work that needs to
be done for the empirical. I do not believe there is any rhetoric
here. It is an outline that is a theoretical framework used to pro-
vide a guidance as to what should be sought for in the data. Let me
just emphasize agEiin and with respect to your previous remark
about the low frequency of dual trading, what we said was that the
dual trading has a low frequency in a particular bracket But a
given individual who trades in a particular bracket only for him-
self may in another bracket trade only for customers.
The terms that we have used in the paper that you were quoting)
even though that individual across two brackets had en^iged in a
lot of dual trading in the sense that in bracket one, he had traded
only for himself, and in bracket two, he had traded only for cus-
tomers, in each bracket he had tretded only for himself or only for
customers. So on a bracket-per-bracket basis, there was not a great
incidence of dual trading, but across the whole day there may well
have been a large incidence of dual trading. It is the fact that there
is not a lot of dual trading within a particular bracket that lessens
the occasions where front running abuses can occur,
Mr. English. I believe you also stated in ihe pamphlet that a 1-
minute bracketing would constitute regulatory overkill.
Mr. Grossman. Ib that a quote?
Mr. English. We would be happy to give you the page number, if
you would like for us to dig it up for you.
Mr. Gbossman. No, I do not remember. I am just asking, are you
quoting?
Mr. English. No, it is not a direct quote, but that is tiie context.
Mr. Grossman. I think what we had done at the time was look at
the costs emd benefits of the proposed r^ulation and we had used
facts to meeisure those costs, to estimate those costs and facts on
dual trading to estimate those benefits. And we have found at that
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time that the facts were such that t^e costs seem to be higher than
the benefits.
Mr. English. And given the fact and certainly given your testi-
mony here today, before you had done the study that you theoreti-
cally alreeidy support the concept of dual trading. You seem to
have some very definite ideas before you had done the study with
regard to that. And also given the fact that you have been retained
by the Chicago Board of Trade which also supports dual trading,
can ^ou tell us that we are going to receive an objective study on
this issue?
Mr. Grossman. You should understand that I thought everybody
agreed, correct me if I am wrong, that ^ere are potential benefits
to dual trading?
Mr. E^NGLiSH. No, that is not the question. Let me make the
point. I do not wemt you taking off on another angle because basi-
cally what we are coming down to, on one hand you come here, you
testified you are very strongly in support of dual trading. Two, you
have been employed b^ a firm that strongly supports dual trading,
and three, you are telhng ub you are going to do a study.
It is hard for me to understand how you could have an objective
study when you have already reached the conclusion. I do not un-
derstand. I am certainly not a Ph.D. and I do not go around doing
studies, but it was always my understanding whenever you con-
ducted these studies, you are supposed to be somewhat objective
and you are supposed to go and try to learn an euiswer, not know-
ing the answer before you went in and then try to prove that it is
right.
Mr. Geosshan. Even though you are not a Ph.D., I should be ar-
ticulate enough to be able to explain to you what I am doing and
why I am doing it, and I hope you will allow me to do so. This
study and the outliiie that I have given you discusses the benefits
of dual trading and how you measure those benefits and where you
should look for those benefits. There may well be coste to dual trad-
ing and those costs have to do with the abuses that are eissociated
with duel trading. What 1 think needs to be done to come to an
appropriate economic cost benefit analysis is to think of where you
would look for the benefits and measure the magnitude of those
benefits.
What I have set out to you is where I would look for those bene-
fits. Now the actual numerical magnitude of those benefite are not
something one is predisposed toward, they may turn out to be eco-
nomically negligible. And if certain evidence arises that the ^uses
are not economicidly n^ligible in terms of their costs, then though
I have elucidated where tiiose benefits are, the fact that they are
sufficiently small relative to the cost would mean that we should
restrict dual trading.
So the mere fact that one has from a theoretical point of view
said where the benefits would be sought after, does not mean Uiat
one is predisposed to the economic, numerical magnitiules of those
benefits. I am certainly not so predisposed and I could not off the
top of my head even give you a ballpark guess In doUars as to what
the magnitude of those benefits are. 1 should mention to you that
there are no studies of dual tradii^. There are no studies of the
benefits of dual tretding or the cost c^ dual trading. I think this ia a
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completely new area and I would urge you to allow studies to go
forth to measure the economic quantity of dollar values involved to
get a notion of what the costs and benefits are of the quantitiee
being r^ulated.
Mr. English. I am not the one who is paying for it. You would
have to talk to the folks who are paying for the study. Thank you
vB]^ much. Dr. Grossman. We appreciate your testimony.
"nie next witness is Mr. Warren Lebeck ^m the National Grain
Trade Council here in Washington, DC. Mr. Lebeck, we want to
welcome you here today. And as we have told our other witnesses,
if you would care to summarize your testimony, the written testi-
mony will be made a part of the record.
STATEMENT OF WARREN LEBECK, ON BEHALF OF THE
NATIONAL GRAIN TRADE COUNCIL
Mr. Lebeck. Thank you very much. Well, I am not even going to
summarize my testimony. We have submitted a copy for the record,
but after being briefed on Tuesday's hearings, I gatiier that you
have heard several times what is in the statement and I do not
think that it needs to be repeated, as long as it is in the record. But
as a consequence I was advised that the conmiittee might be better
served and more interested on comments or questions that it had
raised Tuesday, especially on parts of section 101, and with your
permission, Mr. Chairmeui, and respectfully hoping only to be help-
ful, I would like to give some personal views based on years of m-
servation of this business at close hand.
And I think eis you know, and maybe not many people in the
room know for me this is deja vu. I do not know tmt this is tbe
same chair that I sat in, but it is the same place I sat in 16 years
ago, and at that time there were questions about why did soybeans
go to $12.90 a bushel? You have not heard any f>rices lilra that
today. And why did the Board of Trtide say liquidation only in July
futures?
So I have been there and I might say almost reluctantly, I am
here again. But just a few views of 35 years of observing ^turee
trading. Banning dual trading at any level means that choices will
have to be made and the very real fear is that the best, most com-
petent members will either choose to trade for their own accounts
or only for customers who sign releases. And I am going to get to
that a little later.
It seems to me that in most instances traders would opt to trade
for their own account if they had or if they wanted to have a posi-
tion. I would hate under those circumstances to be a floor manager
tnecause I would have to spend every morning up until that bell
rang at 9:30 finding out who is going to fill orders today and who is
not going to fill orders today, and I have to wonder if that is the
way to assure customers of the b^t possible service. If thrae was a
monumental news item — Gorbachev deposed, a shooting war some-
where— would traders want to broker or trade and I tmnk most of
them would want to trade with monumental news aiuj that leaves
you with who is going to fill the order then.
I am talking about customer releases which is one of the things
that is in your bUl. A dual trading broker would be limited tofifi-
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ing orders only from customers who had signed releases. Some
large commercials have indicated to me that they would sign re-
leases. They already use brokers who trade and they know they
can trust them. They have confidence in their floor personnel to
see that their orders are filled fairly. And since this type of custom-
er generally provides brokers with the most business, the most
orders, and gives them the opportunity to trftde, there would be
where your best, most competent people would be, leaving smaller
commercial houses with less competent brokers.
I do not believe that commission houses would s^ blanket re-
leases. I do not think their attorneys would let them. They would
insist that each customer decide which type of broker he or she
wants executing orders. In the view of the publicity in this pro-
posed legislation, it would be my guess zind that is all it could be
obviously, most public customers would not sign releases. And thus,
commission houses would have to Hnd bo^ types of brokers be-
cause they had both types of customers.
Referring to Commission discretion, even with the Commission
given the discretion in your bill, it still would be a time-consuming
affair. That is just the nature of Government and requiring reports
to a congressioned committee, while I understand it, I believe in it,
I do not think there is saiy doubt it would make the CFTC extreme-
ly cautious. And this is in no way a criticism of the CFTC or of the
requirement, it is just a fact that such a requirement invites bu-
reaucratic caution, and that could be to the detriment of the
market.
I know there has been a lot of talk here today, especially by the
Congresswoman from Indiana, worrying about liquidity and trying
to determine what is and what is not a liquid market. I do go back
16 years to the soybean meu'ket zind from personal observation, Mr.
Chairman, there were times when between trades there was more
than 5 cents and yet there were a lot of activity in those particular
markets.
The council does feel strongly about the issue of dual trading be-
cause as commercial users of futures markets, our members do not
have the luxury of being able to stay out of the markets. They
must be able to be buyers and sellers of futures contracts during
every minute that the futures markets are open. The economic
beneiEit of additional liquidity is difficult to measure, but it is real
and cannot be refuted. Section 101 would force the unknown cost of
doing without it onto the commercial users of the market. This
would raise costs not only for market users, but for fill who
produce, use, or consume grain, in short all of us. It seems clear to
the council that the cost of this supposed remedy greatly exceeds
any perceived benefits.
And also it seems to me, Mr. Chairman, that we have talked
about, I think, you have mentioned severed times today, the stick
and the carrot, there is an old saying that if you really want to get
someone or something's attention that a 2 by 4 appropriately ap-
plied does the job very well. It is my feeling that the 2 by 4's that
have been wielded by Tony Valukas and by this committee have
done just exactly that. They have gotten the attention of the ex-
chemges. And I think that was dramatically illustrated by the testi-
mony here today. And it would be my hope that there C£ui be some
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compromise to allow the audit trails to do the job. I think that in
all casefl it is better to use medicine rather than surgery. You can
always keep surgery as an alternative.
The efficiency of our futures markets must be preserved and en-
hanced. The council urges you to keep an eye toweird what greater
contributions American futures markets can provide our country.
This very committee continues to ^apple with the issues of price
risks in the production of U.S. commodities. As production deci-
sions continue to move toweird marketdriven from Govemmentr
driven, the classic risk-shifting functions of futures markets will
become increasingly attractive.
I do appreciate the opportunity to be here, and having had some
experience with a couple of times when there was liquidation only,
if there are any questions, I will do my best.
[The prepar^ statement of Mr. Lebeck appears at the conclusion
of the hearing.]
Mr. English. Thank you very much, Mr. Lebeck. I appreciate
that. Several exchanges are part of your Council, are they not?
Mr. Lebbck. Yes, sir.
Mr. English. So you are very familiar with that aspect of the
trade. Of the involvement that you have had, you mentioned the
public sector or you were talking about the public individuals, I
think, trading, eis opposed to grain companies and others that may
be looking for various reasons to become involved. What percent-
£^e of the trade is made up of those individuals that simply may be
cattlemen or a farmer or whatever that may be hedging, say in the
Board of Trade? You are familiar with the Board of Trade, I know.
Mr. Lkbeck. The last figure I heard on farmer participation, pro-
ducer pcuiicipation in the grain markets, and I have to confesB, as
you know I have not been that active in the last few years, was it
ranged probably between 6 and 10 percent. I think tiiat the
chances are probably pretty good that that has increased but I
would not think it had increased a significant amount.
Mr. English. You think it has increased?
Mr. Lebeck. Yes, sir; I do.
Mr. English. I was looking at the contracts that we have and
ptu^icularly the big ones. For instance, now on the Board of Trade,
the big contract that is being traded is not wheat or com or soy-
beans even, basically the big ones £u*e T bonds.
Mr. Lbbbck. My answer was producers, meaning farmers in the
agricultural markets.
Mr. English. But we are talking about the entire business on an
expanse.
Mr. Lebbck. I would have no way of answering that. That would
have to come ftom the Chicago Board of Trade.
Mr. English. OK, but coming with these big numbers, 296,000
contracts being traded on an average each day, as opposed to sf^
13,000 for wheat or 37,000 for com, or even 44,000 for soybeans.
Probably it has shrunk up considerably since the time you were
talking about, has it not?
Mr. Lebbck. Are you saying that the agricultural volume is not
as great?
Mr. EInglish. Or Euiy individufds such as that. Whenever you
have these new contracts that have come on the exchange, big con-
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tracts, huge trades taking place, high volumes of trades taking
place every day. That the percentage of those individuals, if it was
back during the time you were talking about, 5 or 10 percent on
the agricultural contracts, if we are talking about the entire ex-
change itself, that has probably shrunk down would it be fair to
say less than 2 percent, do you speculate?
Mr. Lebeck. If you back me into a comer, I would agree with
Mr. Lebeck. My figure was the number of fanners who were
using the markets as opposed to how much their volume was com-
pared to the total volume.
Mr. English. Right. Well, I agree with that But whenever we
talk about the question of dual trading, what we are talking are
mature liquid contracts. And say on the Board of Trade, T bonds
are definitely mature liquid contracts, would you not agree?
Mr. Lebeck. Yea, I would agree. And I am very very happy that I
happened to be president of the exchange when that contract came
out.
Mr. English. Great, and I am happy too.
Mr. Lebeck. I have just been handed a note which reminds me of
something I should know better than the person who handed me
the note. NFA transaction fees which apply to nonmembers of ex-
changes Emd that does not mean just individuals, but any non-
members, range in the mid-20 percent.
Mr. English. But that would be farms and whatever it may be.
Mr. Lebeck. It could well be pools and firms, not just individuals,
yes.
Mr. English. That does not give us a very good feel for what we
are talking about. The ■other point that I wanted to go down to, to
bring me around to that is basically what we are saying the people
who are trading on the exchanges — the m^ority — are big compa-
nies. With regard to grains, we are talking about the big compa-
nies. We are talking about Cargill, Bunge and whoever may be
wanting for whatever reason hedge or maybe even speculate the
markets, correct?
Mr. Lebeck. Yes.
Mr. English. OK, given that and you made this statement with
regard to a dual trader is really trusted. They trust that broker on
the floor?
Mr. Lebeck. Yes, sir.
Mr. English. Well that is a different story than what we got
irom those companies. Those companies tell us, well we do not do
that. We do not trust them.
Mr. Lebeck. That surprises me because the ones I have talked to,
including one of the firms you nfuned, have told me that they
would B^ releases for all their brokers.
Mr. Polish. They would indeed. And the reason that they
would is because they have their own people on the floor. They
have their own people looking over the shoiuder of that broker and
they have their own surveillance system. In other words, they have
their own built-in protection.
Mr. Lebeck. I mentioned that in my statement.
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Mr. English. But that being the case, it is not the question of
whether they trust the broker, what they are doing is they are
trusting their surveillance system that they personally have put in
place, correct?
Mr. Lebeck. For whatever reason, they trust their broker.
Mr. English. But whenever we are talking about these individ-
uals, they do not have the surveillance system. They do not have
somebody there to look over their shoulder. We had the gentleman
here from the Minneapolis Grain Exchange. He was asked the
question, could we have 100 percent perfect system. He said, yes,
you stick somebody with each one of those brokers looking over his
shoulder, yes, we could costwise. And that to a great extent, not to-
tally, but to a great extent is what large companies have done and
that is the reason they have built-in the protection themselvea. Is
that not true?
Mr. Lebeck. Yes.
Mr. English. And then the other thing, we get down to the ques-
tion of dual trading. It was said we have the gentleman who was
hired by the Board of Trade, Dr. Grossmfin, and Dr. Grossman's ac-
count here stating, there is not that much dual trading taking
place. So when we start talking about the markets moving <m
shore and when we start talkii^ about the impact that this is
going to have on markets, the huge Impact, and then we come in
and Gnd, according to the professor who did the study back in 1986,
and he is stating that the frequency of dual trading is itself low. I
guess it starts kind of neirrowing this thing down and makes you
wonder if we may be splitting hairs on a number of these issues.
It appears to me as I mentioned earlier, if what we are really
talking about here, taking away a lot of the rhetoric, we are talk-
ing about degrees. How much of the standard ftre we going to
have? How much are we going to strengthen that standard? And I
know in talking to you that you support a higher standard.
Mr. Lebeck. Absolutely.
Mr. English. So I just want to say, I think it is important for us
to go through and to bring a little bit of this out and should point
out that what we are looking for is the overall public. It is the in-
t^rity of that system that I think that makes it so successful and
makes it so appealing to people not only in this country, but from
overseas. We just want to build just a shade more inte^ty into it.
Mr. Lebeck. I do not think anybody I heard today would disagree
with that. I would mfike a couple of comments. Back in my d^re, I
got in trouble periodically by having that attitude, sir. There nave
been — I know the Board of Trade and I think the Merc — ^both have
had studies on how much of their volume is done by dual traders
and the amounts that I recall just ofFhand run fl*om 20 percent on
up. So I realize what is great and small. I do not know what the
professor — I do not understand these Ph.0'5 too well like ytjta,
means by great or small, but I think that the volumes do run in
those ranges.
Mr. English. I think we heard 20 percent being used today.
Mr. Lebeck. Did we not hear that today?
Mr. English. Yes, the 20 percent was brought up. Mi^ybe the
Board of Trade ought to check with the professor in what it i
by low. I think that is a good point.
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Mr. Lebeck, we are going to look forward to working with you. I
know we have already talked about some of these areas and we feel
tiiat you all can help us a great deal, and given the experience that
you have had. And I know that you are very interested in seeing
stronger standards. We are going to be looking forward to working
with you.
Mr. Lebeck. As you are, and I thank you.
Mr. Bnolish. I appreciate your testimony. Thfink you very much.
Mr. Jontz, we have a panel up next. I am going to let you lead
off by introducing one of our witnesses, if you would, one of your
constituents?
Mr. JoNTZ. Thank you very much, Mr. Chairman. I am delighted
to have the opportunity to do that. Mr. Chairman, I know you have
conducted very extensive hearings today and earher this week, and
you have heard from the president of t^e exchfinges, find you have
heard from academics, and you have heard from a lot of different
perspectives.
I am glad to welcome a constituent from my district who repre-
sents a very important perspective to all of us find that is the local
country elevator and farmer. I think it is important that we hear
from them too. So I am delighted to introduce to you John Fre-
drickson who is a partner in Kentland Elevator and Supply in
Kentland and Newton County in my district. I have represented
Newton County in one capacity or another for 15 years, and I know
that Mr. Fredrickson brings to us today a very important perspec-
tive, and I believe the other witnesses on this panel do also.
I want to conclude my comments, Mr. Chairman, by thanking
you agftin for the tremendous effort you have put into these hear-
ing, and even though I am no longer a member of your subcom-
mittee, I am going to be following your lead very closely and I
know that you have done a very thorough and comprehensive job
with these hearings. And I thfink you very much for allowing me
to sit in this afternoon for just a little bit of the testimony.
Mr. English. Delighted to have you back and feel free to come
by any time. It is always a pleasure to have you with us, and Mr.
FVedrickson, the very high recommendation that you got and I
want to introduce our other witnesses who have equally high cre-
dentials. Mr. Dave Danker who is from Perryville, MifBouri. I be-
lieve, Mr. Coleman, I am not sure you are from his district are
you?
Mr. Danker. Congressman Emerson's.
Mr. English. Congressman Emerson's district, OK. And we have
Mr. Joseph Kane, who is floor broker with the Chicago Board of
Trade. Mr. Kane, we are happy to have you here today, and Mr.
Ralph Weems, who is a former president, American Soybeem AsBO-
ciation from West Point, Mississippi. Mr. Weems, we are happy to
have you, and Mr. Fredrickson, we will let you start off our testi-
mony. And as we have told our other witnesses, if you would care
to summarize your testimony, your written testimony will be made
a part of the record.
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STATEMENT OF JOHN L. FREDRICKSON, PARTNER. KENIUUID
ELEVATOR AND SUPPLY, INC.
Mr. FREDRICKSON. Thank you. Chairman English and also thank
you Congreflsman Jontz for the introduction. As Congreesman
Jontz introduced me, I am a partner in Kentland Elevator and
Supply, a country elevator located in Northwest, Indiana. I have
been involved in the management of grain elevators for over 20
years, and involved in the ownership of this present facility for the
past 11 years. I also own and operate a small fEum, serve as an offi-
cer of our State grain and feed association, and serve as director of
an insurance company.
The firm I represent is an independently owned elevator with
three locations. The primary business of our country elevator is
purchasing grain from area farmers and reselling it to grain proo-
essors, grain exporters, livestock, and poultry feeders.
When we purchase grain from a farmer, we are at risk in the
marketplace until we have sold the grain. We may choose to sell
the grain through a user for immediate delivery, or we may choose
to keep the grain in one of our storeige facilities to sell at a lat^
time, it we choose to store the grain, we must transfer the market
risk to someone else immediately. This is accomplished by hedging
the grain in the futures mEU*ket at the Chicago Board of Trade. We
place an order to sell futures contracts for the amount of grain we
have purchased. When we decide it is no longer economically fsasi-
ble to hold the gritin, the futures portion of this transaction is
oflset by buying ftitures contracts at the same time the cash grain
is sold. Our elevator's margin is the selling basis, lees the buying
basis.
The execution of the futures orders is a critical component of the
transaction. It must be completed at the best possible price and ex-
ecuted very promptly. The liquidity and flexibility provided by dual
traders who can trade for their own account as well as execute cus-
tomer orders, is a contributing factor for our country elevator to
provide the best price at the lowest cost.
Sometimes we may determine that it is not economic to sell the
cash grain as the futures expiration approaches and decide to roll
the hedge forward to a deferred contract month. This transaction is
called a spread, since it involves the simultaneous purchase and
sale of futures contracts in different months. Successful executiim
of a spread trade is obtained by utilizing an experienced dual
trader who can 1^ into the position by executing one side of the
trade when futures prices for that contract are more favorable. He
may not be able to obtain the desired price from the other leg <^
the spread, but may place it in his own account at possibly a slight
loss in order to satisfy the customer and keep his business. The
ability of the dual trader to obtain favorable prices for spread
treides helps increase the liquidity in relatively less deferred con-
tract months, and results in more accurate indications to market
participants of the cost of carrying commodities.
The banning of dual trading could increase transaction costa for
our elevator by widening bids and offers due to less pit participB-
tion. This increased cost will cause either a reduction in our return
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on investment, or most importantly a reduction in prices paid to
farmers by our firm.
Dual trading increases the supply of both brokers and floor trad-
ers because a dual trader can earn income from two sources to
cover cost of training, an exchange seat, and time spent on the
floor. Dual trading encourages greater competition between bro-
kers, thus keeping commission costs down. If duEil trading is
banned, the best brokers will trade for their own account, decreas-
ing the number of brokers available to execute orders for our eleva-
tor. Thia will reduce the liquidity of the marketplace, thus making
it more difficult to have our orders executed promptly at the
market.
Dual trading is voluntary on the part of customers; customers
can now prohibit their brokers from dual trading if tiiey choose.
Additionally, U.S. futures exchanges are engaged in a continuing
process of improving their market surveillance systems. If abuses
can be curbed through adequate surveillance, there is no reason to
eliminate the practice like dual trading which contributes to the li-
quidity for which American markets are known.
Simply stated the ideal l^islation would preserve dual treiding
while ensuring the exchanges bear the responsibilities for detecting
its possible abuse. I strongly urge Congress to eveduate the pros
emd cons of dual trading before making a final decision on this
vital issue. Your decision will effect the entire agricultural indus-
try, as well as the future of our markets.
rnie prepared statement of Mr. Fredrickson appears at the con-
clusion of the hearing.]
Mr. English. Thank you, Mr. Fredrickson. Mr. Danker.
STATEMENT OF DAVE DANKER. VICE PRESIDENT AND GENERAL
MANAGER, BUCHHEIT GRAIN, INC.
Mr. Danker. Chairman English and members of the committee,
my name is Dave Danker, and I am the vice president and general
manager of Buchheit Grain, Inc., located in Perryville, Rfiesouri.
Buchheit Grain is a small, family owned feed, grain, and general
merchandise business founded in 1934.
My purpose in coming here to speak to you today is to attempt to
explain how we use the futures markets, in pzirticularly the spread
market to effectively manage our business, and how that relates to
one of the subjects your committee is reviewing, that is, dual trad-
ing. We have approximately 1,250,000 bushels of space in two dif-
ferent locations. In order to survive as a grain merchant, we must
fill all of our space at harvest find hopefully handle 60 to 70 per-
cent of that volume once again after hfu^est.
In order to manage this need in a business-like manner, it is im-
perative that we prespread our space and the volume of grain that
we hope to handle post-harvest. A brief example of prespreading
would be a simultaneous purchasing of 10,000 bushels of December
com futures while selling 10,000 of March com futures. As the
com is purchased from farmers during October, we would simply
sell the December com futures. This would automatically Bpreeid
the purchase out to the March futures position.
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Freepreading is an inexact science, but aa one gains experience,
it becomes easier to establish reasonable goals and achieve them.
We like to enter our spread orders prior to the time the contract
actually trades. Oftentimes this results in getting a good fill that
may never be available at any other time during tM marketing
cycle. Quite often, due to poor liquidity in those distant contract
months, our broker has to 1^ a wread m order to have it filled. Bv
l^ging the spread, the broker first takes one side of the spread,
then fOls the other side as soon as he is able.
During the time elapsed between the execution of both legs of
the spread, the broker assumes the risk of not getting the spread
filled at or above my order. If he fails to accomplish that flQ ami
ends up trading the spread at a lesser amount, the loes is for his
account. The broker's ability to dual trade gives him an opportuni-
ty to offset these losses by trading for his own account througlunit
uie day. I feel that this will make spread brokers more willing to
take chances in order to get their customers the beet possible fill,
thereby maintaining their reputation and position in the market-
place.
I had a personid experience with this situation last winter that I
would like to share with you. Last January, I b^;an planting for
the 1989-1990 marketing year. I budgeted the purchase of 200,000
bushels of soybeans at harvest. And I estimated that we oouLd buy
at harvest, store, and later resell soybean, if we could get our No-
vember/March spreads set at 17 cents per bushel or bettor. I called
my trading firm and entered a broker to spread 200 November/
March soybeans at 17 cents or better. A few days after the March
contract first came on the board, my spread got filled at 19 cents.
Given what I know about spread conditions at that time, I have to
assume that the trade was l^ged.
And I realize that not all trades have such a happy ending, but I
believe it illustrates my point that if you trade through a broker-
age firm that does the job in policing and controlling the trading
activities of the brokers that it uses, you can get good honest fills.
It seems to me that if one is knowledge^le al^ut tiie current con-
ditions of the market, offers spreads, options and some futures
transactions at a given level or better, he will obtain the fill he
wants.
The key to obtaining these fills is in prior evaluation of the qual-
ity of broker that you choose to deal with and in the existence of
surveillance systems that detect and deter abuse. The issue is not
whether the broker dual trades. The reed issue is whetiier or not
there are adequate monitoring systems in place to detect cases
where the practice of dual trading is abused.
In summary, I would like to stress that 1 feel the current system
of allowing brokers to both fill orders and take ri^u for their own
account, provides a more liquid meu'ket, and most pnAeUy a more
aggressive trader. The system, aa it exists, has provided us with the
structure to build a successful small business. I would like to en-
courage you to provide a means for protecting and improving the
integrity of the current system of dual trading rather Uian^hang-
ing something that, in my mind, already works. Thank you.
fThe prepared stetement of Mr. Danker appears at the conclu-
sion of the hetuTng.]
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Mr. English. Thank you, Mr. Danker. Mr. Weems.
STATEMENT OF RALPH WEEMS, FARMER, FORMER PRESIDENT,
AMERICAN SOYBEAN ASSOCIATION
Mr. Weems. Thank you, Mr. Chairman and Mr. Colemeui said
members of this subcommittee. I am a feirmer from West Point,
Mississippi. I believe I am the only farmer we have had here today.
But I have been involved with soybeans for 30 years. I have been
associated with the Mississippi Soybean Association for 22 of those
years, and I worked my way up to the presidency of the American
Soybean Association in 1984. I should briefly depart from this and
say that the views that I am expressing today are mine and not
necessarily those of ASA.
I became eissociated with the CBOT through the agricultural ad-
visory committee in 1984. I was elected chairman of that ag adviso-
ry committee in 198S and the chairmanship of that committee car-
ried with it a 3-year term on the board of directors as a public di-
rector, a seat that I held until February 1988.
While I was at the Chics^o Board of Trade as an outside director,
several CEiaes came before the board at that time, one which I vivid-
ly remember and would like to call to your attention at this time.
It had to do with a trader who was suspected of outside — not out-
side tradii^ — but front running and this was naturally very inter-
esting to me Eis a farmer to see how a fellow director would ap-
proach this thing with me as an outsider on their group. But, sir, it
wEis my opinion and I hold that opinion to this day, that those gen-
tlemen took that hearing to the deepest part of their heart and
that they did their dead level best to do what weis supposed to be
done at that particular time.
The board's decision on that case was explosion. I said then zmd I
repeat now, that I wish every farmer in America could have been
there that day and seen what happened. Because I think it would
increase the confidence in our msirket system enormously. I have,
as I stated, had tremendous confidence in the board and I still have
that confidence today. Thank you, sir.
Mr. Engush. Thank you Mr. Weems. Mr. Kane.
STATEMENT OF JOSEPH J. KANE, FLOOR BROKER, CHICAGO
BOARD OF TRADE
Mr. Kane. Chairman English, Mr. Coleman, and Mr. Jontz, first
I would like to thank you very much. Ralph said he thinks he was
the only farmer here. I know I am the only floor broker trader
here. My name is Joseph Kane. I am a member of the Chicago
Trade since 1952. I have also been a member of numerous other ex-
changes, including Chicago Mercantile Exchange and the New
York Coffee and Sugar Exchange. For 7 years, I was the director of
the Chicago Board of Trade and served on most of the major com-
mittees of the exchange, including the business conduct and the
floor governor's committee. In fact, in 1968, I wets the chfdrman of
the reorganization committee of the exchange that was responsible
for introducing public members to our board of directors, also out
of town directors to our board of directors, and creating the floor
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Kovemor'B committee which has the primary responsibility for po-
licing the conduct of our members on the exchange floor.
I was bom, raised, find educated in Chicago and I am the father
of eight children. Many of my children have worked in one capac-
ity or another in the futures business. I have been at the Board of
Trade so long that I can say that I knew the grandfathers of two of
our present directors. I say this for a reason and I h<^ it wiU
become apparent.
I know the Board of Trade's rules, customs, and practices. I have
seen those rules, customs, and practices evolve. I have also seen the
competition for business which exists on the floor and the solid eth-
ical standards which are upheld by most members combined as a
potent force for the protection of the customer.
Nevertheless, I know that this subcommittee is concerned about
the practice of dual trading. I believe I am in a good position to
discuss this practice and the results which govern this practice be-
cause throughout my 37 years as a floor broker, I have also rou-
tinely traded for my own account. Over the years, I have given a
lot of thought to dual trading. In 1975, 1 was coauthor of a study on
that topic which formed part of the report of the chairman of the
advisory committee on the regulation of contract markets and self-
r^ulatory associations of which I was a member. As you remem-
ber, when the CFTC was formed, there were four groups formed to
aid from the industry. I was privileged to be a member of one Of
those groups.
In that report, we came to the conclusion that dual trading was a
majoi ingredient in the liquidity of our markets and that its elimi-
nation would impair that liquidity without conferring any measure
able benefits on the public. We recommended tiiat dual tradm^ be
preserved, but that rules be adopted which clearly prohibit a
broker from buying or selling for his own account while holding
orders for others at the market price at the eame time. We also
recommended that surveillance systems be unproved, so that the
exchanges in conjunction with the CFTC could ensure that abuses
of that and other practices were detected and pimi^ied.
I believe our recommendations were valid then and that the last
14 years have vividly demonstrated their validity. In the interven-
ing years, our markets have enjoyed unprecedented growth in
volume and liquidity, making them the envy of the wond. At the
same time, the Chicago Board of Trade and other exchanges have
adopted strfiightforward rules to maike the misuse of dual trading,
that is, trading ahead of the customer order, a trade practice vic4a-
tion.
And moat important of all, over the last 10 years, and in particu-
lar the last 5 years, the exchanges have taken strides unimaginable
in 1975 to create and implement effective surveUlance systems &»*
detecting all trading abuses, including trading ahead. In particular,
the computerized audit trail codeaigned by the Chicago Board of
Trade and the Chicago Mercantile Exchange has demonstrated a
detection and deterrence capability offered by no other financial
metrkets in the world. At least that was the view expressed by
Nicholas Brady as head of the Presidential task force which stud-
ied the 1987 stock market crash which was alluded to by Mr. Me-
tamed this morning in his testimony.
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I do not pretend to speak for the entire floor broker community,
but I know if I conducted a survey of the many manv responflible
floor brokers whom I work with each day or whom I know Eux>und
Uie various exchanges in the country, they would want to stress for
you the following points. First, they would like to tell you that you
would take away a nu^or means of servicing their customers if you
t^ce away the dual trading privilege from the broker, as in the
manner that it was just outlmed to you. Dual trading aUows the
floor broker to go after the best fill for his customer, knowing the
broker has the flexibility, if necessary, to trade out of resultant
losing positions through lus personal account whenever the oppor-
tunity arises.
Second, they would tell you they support the fidoption of the
best, most comprehensive surveillance system devisable as a means
of protecting themselves as well as their customers. That is an im-
portant point tiut a good surveillance system protects the broker,
as well as the customer.
The message I would leave with you is simple. We have the best
most liquid markets in the world. I am not an economist, but I be-
lieve the rational review of the economic literature available on
the subject will lead to the conclusion that dual trading has con-
tributed to the unrivaled success of our markets. In copying every
aspect of our market formula in an effort to win business from us,
fore^ markets have also copied us in permitting dual trading.
The foreign markets do not have our surveillance capability. They
do not have the know-how and they do not have the commitment
to eliminate trading abuses and the perception that abuses exist.
Let us use our know-how and our commitment to keep U.S. mar<
kets in their preeminent position. With your help, we can preserve
our liquidity, and elII of the factors that contribute to it, including
dual trading, while reinforcing the int^rity for which we must be
equally well known.
As a little adjunct, I would like to say that I think that I have
showed you that for more than 20 years, our goals have been the
same. I do not speak for anyone but mys^, but like the exchanges,
my goal has been to try to be of help in this instance, and I hope
tbAt I have been of some help today.
fThe prepared statement of Mr. Kane appears at the conclusion
of the hearing.]
Mr. EhfGLiSH. Thank you very much. I appreciate that, Mr. Kane.
One thing that I guess puzzles me a little bit, Mr. Kane, is this par-
ticular l^islation we are looking at has a provision in it that says,
anyone — any of these three gentlemen — who does not care whether
their broker is involved in dual trading or not, all they have to do
is sign a paper saying, I recognize my broker is involved in dual
tradmg. It is fine with me, give him my blessing. Approve him.
That is it.
We have had testimony today — I mentioned Dr. Grossman, but
we will go back to the earlier testimony — that some 20 percent of
the trades may have dual trading involved. So we are talking about
any contract, any particular contract that we are talking about,
and let us assume that we go with the 20 percent. Then we fit into
the question that any customer who so wishes or does not care
whether his broker is involved in dual trading signs off for it.
23-500 0 - 90 -
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We have also heard that the nuuority of the busineae on any con-
tract is going to be firms, grain companies, and so on and so forth,
and they have their own people looking over their shoulder. I guess
after you fit all of that together, it is hard for me to understand,
how this is going to have that kind of m^or impact on any con-
tract, I do not care what it is. Because if in fact you gentlemen are
representative and you do not care or you support dual trading, ev-
erybody signs off. 'niough there is no impact, is there? Is that not
true, Mr. Kane?
Mr. Kane. I think that you have one segment of an industry
here that would sign off perhaps on this situation, but I think Blr.
Lebeck brought up an important point in his earlier testimony. Al-
though the commodity head of a particular futures commission
merchant may be perfectly willing to sign off or to solicit his cus-
tomers' opinions, I am not sure that their legal department — and I
am not an attorney — would allow that to happen.
Mr. English. Let me point out though, the model that we are fol-
lowing comes from the Chicago Mercantile Exchange. That is
where it comes from. That is where that provision comee from.
Their lawyer does not seem to have a problem with it. He does not
seem to have any difficulty with it. The thing that I wonder about,
we were talking earlier about with Mr. Lebeck, the Chicago Board
of Trade today may have less than 2 percent — I am probably being
too generous, maybe even less than 1 percent, maybe even less
than one-half of 1 percent — of their trade represented by gentle-
men like we have here, whether it be farmers or whatever, a veiy
very small percentage.
We have then the contracts, the trading that is taking place on
these contracts are by firms, big firms. If they do not have any
problem with dual trading, fine with me. ThCT sign off. They have
their own people there. They run their own business. So I do not
understand where all these people are going to be driven away
from this metrket because we have the provision that sayB timt
folks that do not want their particular broker involved in dual
trading have a right to say so, and — our right to refuse to give that
approval.
How much business are we going to lose because of that, Mr.
Kane? How much business would you lose? How many of your cus-
tomers that you have, do you feel would not sign that paper fi^o*
you?
Mr. Kane. I do not have any idea how many would or would not
sign because I have a business that is both commercial and retail
business. And the retail business would be in jeopeirdy because of
what I brought up before. And I think that woidd be the important
aspect personally that I would look at in that r^ard. It would f(m»
me to make a decision.
Mr. English. What kind of decision are you going to have to
make?
Mr. Kane. I would have to make a decision whether or not I
would remain a broker or whether I would become a trader.
Mr. English. Why?
Mr. Kane. Because if 50 percent or more of my income were to
be displaced
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Mr. EInolish. If you have all of these customers out there and it
seems to me, everything I have heard of you, Mr. Kane, you are a
very reputable person, one who has an excellent reputaUon. I am
sure that over uie years you have built up an awful lot of satisfied
customers. Do you think that just simply because, hey, folks, cus-
tomers, I am involved in dual trading. Most of them already know
it, do they not?
Mr. Kane. Yes.
Mr. English. And if they know that, how many of them do you
think
Mr. Kane. I jumped to a conclusion. May I define a customer in
my mind?
Mr. English. Sure.
Mr. Kane. A customer in my mind has a twofold aspect. A cus-
tomer in my mind may be a futures commission merchant and
then the ultimate customer would be the customer of the fiituree
commission merchant. The relative retail customer of that futures
commission merchant would not know necessari^ who this order is
going to. He would judge it on the basis of the futures commission
merchant. That is where the difference
Mr. E^NGLiSH. It is liis money. Should he not have the right to
make that decision?
Mr. Kane. Oh, yes. He has that right — right now.
Mr. English. How does he have that right? He can tell ihai com-
mission merchant, I do not want anybody that is involved in the
dual trading carrying out my order, and how does he fmd out for
sure that that is done?
Mr. Kane. I do not know how he finds out.
Mr. English. That is the problem we are into. The thing that
comes down. As I said, here we are talking about 20 percent of the
business. And then we are talking about narrowing that on down —
the Ifick of omiidence that I sense in the industry about getting
customers to sign that paper is frankly surprising. I felt that most
brokers, most people in industry would be very confident that tiie
customers fire satisfied, the customers are happy. You gentlemen
here seem very satisfied with the arrangements that you have with
whoever your brokers are. You seem to me to be the kind of gentle-
men that would sign that paper. Would not you three? Any one of
you who would not sign it?
Mr. Dankes. Yes, f would, sir, and I think our d^ree of satisfac*
tion has come over years of education and experience with a par-
ticular broker, and our confidence is built up probably more so in
the futures commission merchant.
Mr. English. So you do not know who your broker is, do you?
Mr. Dankeb. I do not know, but we have the ability to watch our
trades as they are entered and see how they are filled.
Mr. English. How do you do that?
Mr. Danker. We have up to the second quotatiom on our screen.
Mr. English. But you do not know whether this guy that is out
there — you do not know who this broker is? You do not know what
he is doing?
Mr. Danker. No.
Mr. English. So if he in fact traded ahead of you and he was not
picked up on the audit trail, you would never know it would you?
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Mr. Dankkb. No, sir. But I would know what kind of fill I got,
where the market was at when I placed the order.
Mr. English. But you do not uiow whether you were cheated or
not?
Mr. Danker. A fraction of a cent, probably not, sir.
Mr. Bnoubh. The question I am coming down to, to you it does
not matter? You are willing to sign off?
Mr. Danker. Yes.
Bfr. Bnolish. Do you think the overwhelming nuyority of the
people that are in your business would feel the same way?
Mr. Danker. Yes, I believe so.
Mr. English. OK, what is the fear? If you end up with 75 pei^
cent of the people in the business that are willing to sign that dip,
and we end up now that is 20 percent of the business that is in-
volved in dual trading fill to^tner, so you have 75 percent of 20
percent. And the other individuals, that does not mean that th^
are leaving the market, they toe simply saying, hey, I want a guy
out there who is not involved in duftl trading. I mean they are
going to be in there trading. Their business is not Roinf away. Now
where is the threat? Can you tell me that, Mr. Danker?
Mr. Danker. I do not Know, sir. I am not in a position to talk
about the technicalities of the futures market I only know the ex-
perience irom my end.
Mr. English. But would this satisfy your concerns then? You are
able to have your trader— he is able to continue to do busineaa just
like he is today. Does that not take care of vour pn^lem?
Mr. Danker. Yes, sir. I think you would see an instance maybe
where the people that did not sign off would though would get— the
better traders are going to choose to trade for their own account.
Mr. English. Well, that is iine, but that is their choice, right?
Mr. Danker. Yes.
Mr. English. They may see it another way. They may decide,
hey, I am concerned. I do not know who this guy is that is a broker
for me. I do not want some guy that is dealing for himself. That is
their decision, right?
Mr. Danker. Yes.
Mr. English. Mr. Fredrickson, does that take care of your prob-
lem?
Mr. Fredrickson. Yes. Of course, any time we take away brokers
or whoever it might be in the marketplace, we do reduce competi-
tion.
Mr. English. How do we take away a broker?
Mr. Fredrickson. In other words, we eliminate the people that
will be dual trading.
Mr. ENGLISH. I do not understand how we would do that. If we
had Mr. Kane here. Mr. Kane has been in the businefls fbr some
time. He has a lot of customers. Mr. Danker has people that he has
faith in. They are not going to desert these people. You have said
yourself you are going to sign off. In the case of Mr. Danker, he has
brokers doing his business that he does not even know. But he has
confidence in the firm that he uses to have the right people, l^t
is fine; that is great. He signs off on that.
Thj^ are certainly going to be able to continue to do dual trad-
ing. What we are going to have evidently, if you gentlemen are any
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kind of representatives, is a very small percentage out here that
said, until we get a better 83rBtem, until we can feel confident that
we are going to be able to deal with this problem, I just as soon
have somebttly who is not involved in dual trading. And there is
going to be somebody to pick up that business. That is the Ameri-
can way, is it not? Where there is a need, there is going to be some-
body out there. So why deny them their chance.
I guess what I am coming down to is it seems to me that we have
taken care of your need. We are not running Mr. Kane out of busi-
ness. Mr. Kane can continue to do dual trade. He may have some
people who do not wiint him to dual treide. Maybe he has people
staged up because of his good reputation that just love to — you do
not have any of those, you take fdl comers, do you, Mr. Kane?
Mr. Kanb. No, I do not take all comers, but I will be glad to take
any business that you might have.
Mr. Enoush. ok, but see my point is that the l^islation does
not ban dual trading, that is the whole point. It takes care of those
people who are happy with their brokers and do not care if he is
involved in dual trading, end give them their opportunity to do so.
It takes caxe of those people who do, who are concerned about it. It
gives them a chance.
It probably is going to develop a new market. You Eu*e going to
have some folks out there, say, hey, I think I can go out there and
pick up these people who are concerned, azid I will make more
money doing that than I am being involved in dual trading. We
have an aw&l lot of traders out there that Eire not involved in dual
trading; is that not right, Mr. Kane? They are simply traders.
Mr. Kane. They are simply traders, certainly.
Mr. English. So they may pick up a little business. We are not
losing anybody on this thing. And eis far aa the liquidity in the
market, we are going to find there is very little chance because
that customer stUl has the need, no matter whether you are using
a broker or trader. He still has the need and he is still going to be
involved.
So the thing we have come down to is, I recognize that folks do
not like to change. You know, if you have a good deal and it is
working fine, well that is great. What we are saying, find I think
the excSianges Eigree with me, is that we are pushing. We wemt to
see a little higher standard. We want to see them do a little better.
We have a little more faith in them. We think they can do better.
And as I said, we are using a little bit of a carrot and stick.
Mr. Weenis, I did not ask you, does that pretty much take care of
your needs too?
Mr. Weems. Yes, sir. It would take care of most of the farmers'
needs. I see nothing wrong with it. It may take away a little of Mr.
Kane's business, but may& he will get some more.
Mr. Enoush. He may do better. The thing that we are coming
down to, that is what we are going to try to address, £md we do not
want to do anything that is going to be harmful to the market. We
built an awful lot of safeguards in this system. Mr. Kane.
Mr. Kans. Mr. Chairman, may I address two things that I think
are important in this area?
Mr. English. Sure.
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Mr. Kane. One, it probably would have an impact on the young
men or jrouns women who are starting in the busineae ^m the
standpoint of being brokers. It would probably have impact on
those people. I do not want to expound on it. It is 6 o'clock and
that — but if anybody on the staff would like to talk about it, I
think that would be important. Let us leave it at that one.
Mr. English. We would like to visit with you emd take that into
account. We sure would.
Mr. Kane. I think there are a few impediments.
Bifr. English. Mr. Coleman, do you have any questions? Bfr.
JOQtZ.
Mr. JoNTZ. Mr. Chairman, let me say thanks to each of the wit-
nesses for their statemeat. And I wonder, Mr. Chairman, if it
would be out of line if I took advantage of the opportunity to a^
Mr. Fredrickson for his observations and his perspective of country
elevator about the recent soybeans futures controvert with the
Chicago Board?
Mr. EInolish. That subject has come up toda^, so feel ftee.
Mr. JoNTz. Mr. Fredrickson, what is this gomg to mean for farm
income and what effect is this going to have in the long term on
bean prices, and what perspective do you think the Congress ought
to take with regard to this matter?
Mr. Fredrickson. Well, I might say that as we have all heard
today, the Chicago Board of Trade did take action. The^ are b^ng
highly criticized by some people in the marketplace and in the
public for the action they did ^ke. However, if they had not taken
action and the consequences had developed, they would have been
severely criticized for not making the move that they did. Quite
frankly, I do not feel that this has had a severe imjMict on the price
of soybeans over the long pull. Temporarily, yes. On the days that
there was a lai^e liquidation of these contracts, the July contract,
for example, toifiiy beana were down severely.
However, when we get into this situation the exchange or the
speculator is always the culprit. However, I think ^wut 1 year ago
when we had the drought situation, and soybeems futures reached
$10 a bushel, I did not hear any criticism of the exchange or the
speculate. I, as a hedger, had problems meeting my margin calls
those days because of the grain that I had hedged.
Mr. JoNiz. Do any other members of this panel want to tackle
that question while you are here?
Mr. Wbems. Mr. Jontz, I do not want you to take this too lightly,
but I think the general rain that they hiad in the Midwest over the
last week probw>l][ had more to impact the price of ftiturea soy-
beans than the action that the Chicago Board of Trade took. And I
come from a place where we are up to here in rain right now.
Mr. Jontz. Let me thank you again for your testimony to the
committee.
Mr. English. Thank you veiy much, Mr. Jontz. I appreciate that,
and I want to thank you gentlemen. And as I said, if you got any
other ideas, suggestions or whatever — Mr. Kane, I am glad that
you came downTi will tell you it is a great help to us, and I kmiw
that you have a lot of your colleagues back in Chicago that are ap-
prehensive with regard to this le^lation, but just tell them that
we are working with the exchanges, with U*l<3, with everyone
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else, and we want to try to get this to the point that what we are
searehing for is that we are going to est^lish a standard. It is
going to be a little higher than we are right now, but we wEuit to
make sure it is reachable, obtainable, find we will encourage every-
body to move in that direction, and we want to make this whole
system workable.
Mr. Kane. Mr. Chairman, as I told you, I feel that we have
common goals. And I thfmk you for the opportunity to be here
today. It has been very short notice on my part. I had not prepttred
as much as I would like, emd I know the time constraints involved,
but I thank you for the opportunity. We have the very same goals.
I think the surveillance system will be improved because it is im-
measurably improved, as some of the people from the CFTC who
have been there from the beginning will tell you, and some of your
own staff perhaps. And it eunazes me because I have not been in-
volved intimately with these things over the years.
But I thfuik you very much for the opportunity, and I would like
to take this opportunity to thank a Mr. O'Conner whom I have
never met until today from your staff. I call him on occaBions to
find out some information about what is going on and he is most
helpful. I met him for the first time today.
Mr. English. Do not say too much, he will be wanting a raise
next. Be careful with that phrase.
Mr. Kane. Well, he would not be unique in that spot.
Mr. English. That is true. I want to thank you very much, Mr.
Kane, and if you get any other ideas or any of your colleagues in
Chicago get any ide£is, we would be hapi^ to hear them. Thank you
very much.
We will recess, subject to the call of the Chair.
[Whereupon, at 6:20 p.m., the subconamittee adjourned, subject to
the call of the Chair.]
[Material submitted for inclusion in the record follows:]
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d Kucal D*t«lo(iMat
4 ■■■ocim«a*.
• Mttl* MCOOlAtlOrU
„Coogle
t (paaif Icatlens . Today, tta* HCA and tb* Oileago Maiaaatil* Biahang*
nua wnklna Co achlan algnldeant tmpiovaBanta In clia cattla fntuna
maiKl yeu (ec aovlng teniaEd In a tlaaly Banmr alth It
EOduction of H.n. 28C9, Ttw Coanodity ruturva l^rova
trong blacory of acclvlty on CTTC taauthociiation and
our comBnci today vlll addraaa tba bill cUlas ■• Incioducad:
cltl* I - uxraxzcm ea a>mM vawna tMcncu
fs«»i T.-fcittwiy — KQj^ aupporta alijiination of dual trading, currantlr, bcokara^
„Coogle
NU is ayifwtMtic to cUlM thtt dUiiMtiaB s( diul tcadlsq ewld i«AtM
n tiiilwj In tarn contiacc wiBtha. M tnt* tlM, hsiim*c. It la Mlt*««d
Clca. rioducac csnildanoa la pacaKntnt to thali eontlniMd >»• e( tba
•^■•"-II "-~1T "— ^M n* lr(i>" «..~.i.n~..— »..>.ii> eontlilanea In futur**
urhaca eou14 ba IncrauM by diaclgaun of btokar ■aaDClatlon ■anCwrtliip. NCft
o(lt ihailng aiearnwinta. Ulowlot
a but profiiblting It by indlTldoal
svlng tM audit trail ttn eutalte papai ulll b* nlatl'
■aaad audit pcgcaduraa to ereaa-aatoh iafeiaatlOB oa • pit bcskac'a ca
or othBc anarslng tachnoleglaa to cacord pit bzokar trauactlon* In tin
of tha traditional hand cacoidad pit bioMc caida.
HCA HuppOEtd tha concapt of aaparata tljaa braekata Coc aackat opadlo^ ai^
clofllnga. DpanlAcr and cloala^ of tEading aaaalona oftan hava a wlda tradlBg
ara battai tban foe outalda oidaia. Statiittoal pEobabilltiaa oC aqual
flllad on tba epan and closa.
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Srlog of pO*ltleD*
■M by lagliund
• peilttoos in la i
paitlclpatlon by CTK
, Jujdlcing prooKtuiva nay ba K*quic»d ti
i_ud_>BiaiaMMt~HC» e
aatad dlraetly iilch CTTC
■ publicly uuiounotd. CoDtiqutd ecMparktlea ukd
tlwT Innitlgstlng ■gwiclv* irlll Incruaa p(d>lla
: *t'^**i> o" IoumI lisisoo
""flltllj ainnij— Hr*
-rvgulatlon ^
iBlghc by th* CTTC. Strict adb
Wilo Trading Fzutica*
lora aaanlngful tban incraaaiog tba ni
nOB-*loor 1
a goTamlng boarda a
laclpllniEy ccua
„Coogle
okai* ■» i^itlMt* nil
liif mai\l -' '•' — ' 1lnn«i rmilTl— "- MooaipC et Mlf ngalsClen alUi atro^
cnc eni(t«lit 1( lupponad by acft. Vlcliaut nrlet —farmint af paultlM,
TcgulattoB lack* tha taath to aBaun csavHanea vltb aalt-li^aaad culaa.
■C* aivpsR* CM Mloptlao s( ttadlng guldallnaa fsE rula tlslaEloDa aa
2, MooBd sttanaa - ii^LaleB.
1. rlrac sfCanaa - Thirty ilaya anapanataa of all Bi^iarBhip pilvllavaa;
3. Tilted otfanaa - ona ]r«ai
a cs^ilctlDg any naJoE nils Tiolacioo o
iBtagrltT of aalf-raffBlaticA la dliwitly
d ta athleal atandaids. tnaoaiira achica tnlnlog ■
„Coogle
■CM e( Its funds CD ■ccaapllsh tb* •ipwxlsd tasks ■■ oui
quaca nuabars of highly Cralnad, qualltlad, axparlaDesd p>
oconplialMMit of any Bilssion. MC* supporta CTTC raquasts
1 and funding, irtilch tiava baan eutstrlppsd by gnxtb In tha tutuiai lodustcy
acant yHrs. On on* apseiflc Issua, pailodlc niltlcstlon at pesltleni Iwld
n that l»o[«a**d
alsctronlc syitaoa In plica of *opsn oucsEy* ottaTi unllmltad
cordltaaplns naiJiet sunslLlsnca, aaas of uaa, and opan* oppoxtunlcla*
aflDVHnc of i:;o^>utarliad Trada Mconst ruction. HCX sctongly
xchanosB to ii^laavnt alactronia trading ayscans during noiaal
an alcamatlT* to "opsn outcry" as tbss* tschnologiaa baccoa cafinad
naElcac participant*. Mtumlng narkat iat*9rity, in light at tha racant
innstlgstlon, and aatabllshlng CTTC as Um (utuns lagulatory agaacy ara sought
aToryena.
Hr. Chainaan, NC* is villing to assist yau as this pEocas* aOTaa fonard.
■ill aagarly •atartala vaascians.
„Coogle
LEO HBLAMED
F TBS KXECmiVI
AHD SPECIAL COUNSEL TO THE BOABD
BEFORE TBE
U.S. HOUSE or REFRE5EXTATXTES
CGMIITTKS OH JUaaCDLHUSB, mmilTIOH JUn> FCnXSTBX
SOBCOHNITTEE OK C0M8SRVATI0N, CSZDIT UD KOaU, mVELOR
JOLT 20, 1989
Hr. Cbalzaan, munbcTS of tb* i
Lao Halaaad. I aa Chalrnan of tho EiMcnitivs Ctnnitt** and
Spacial Coun>«l to tb« Bo&rd of Gov*mors of tlia Oilcago
Harcantil* Exchang« (CHE) . Acconpanylng ■• is Wllliaa J.
Brodsky, ovir Prasidvnt and Chlaf Exacutiv* Officar. W*
valCOMe this oppoz-tunlCy to appaar batora you today and to
offar our cooaanta on tha Coasodlty Putnraa D^iravaaant Act
of 1989 {tha "Bill") ■
Ha Hava davotad subatantial attantlon to tlia propoaad
Bill and hava praparad a datallad analyais, lAlch la appandad
to our taatlmony. That Bill claarly daKonstratea that this
Conmittea has worked dlligantly and vary quickly to luidar—
atand tha major iaauaa confronting tha futuras industry. In
many raspacts, tha aponsors hava propoaad lagislativa raaolu-
tions of thoaa issuas which ara substantlBlly similar to tha
rulas that hava baan adopted or are in tha procaas of baing
adopted by the industry.
Evan whara tha industry approach to tha issuaa diffara
from tha solution that would be imposed by tha Bill, tha CKE
and tha Bill's sponsors share tha aams basic goals: Na both
want to Insure tha Integrity of our markets and bolster
public confidence in that integrity. . However, tha C3tE and
the other exchanges are beholden to yet another principle;
those basic goals must be pursued in light of tha need to
maintain efficient and competitive markets.
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Th* U.S. futiuras industry is not immun* from ttim
chall«nga of «ither donwstlc or foreign competition. If U.S.
futures markets c*as« to efficiently perform their risk
transference function, both domestic over-the-counter oarkats
and off-shore futures markets will immediately fill the void.
Neither of those competitors is subject to comparable regu-
lation.
The challenge now is to resolve any concerns about the
industry's ability to detect and prosecute customer abuse
without, in the process. Impairing the Industry. The media
reports of undercover investigations in Oiicago and New York
impose tremendous pressures on all of us to take soma
dramatic action. He loiow that the industry is prepared to
act and that our response will be both timely and effective.
He differ with the approach of the proposed Bill,
however, in that we do not find the need for Congress to
modify its well-proved policy at requiring affective self-
regulation subject to oversight by the Commodity Futures
Trading Commission (CFTC) . Moreover, a policy that shifts to
dependency en the lagialative process is unlikely to be
effective when it attempts to address the details of every
The Bill's sponsors obviously considered this problem
and chose to deal with it by giving the CPTC power to over-
turn the provisions of the Bill if in practice they prove
destructive. This "escape clause" approach will have diffi-
culty in application. First, that remedy does not operate
until after the damage has occurred: the industry may never
recover. A market lost will not be regained. Second, it is
not practical to expect prompt curative action from a federal
agency subject both' to the usual bureaucratic constraints and
by a requirement that it certify to Congress that no harm
will ever occur because of its negation of a legislated
prohibition. Inaction is the more likely result.
The current situation is reminiscent of an incident that
occurred during the early days at the audit trail debate.
One prominent regulator came to observe the trading pits so
that ha could suggest improvements to our audit trail . He
watched for several hours, and agreed that the propensity for
heavy order flow during periods of highest volatility made it
impossible for the broker to accurately time record every
trade while he executed the orders in a manner which served
the best interests of his customer. The regulator had a
categorical solution, "slow dowi the trading." he ordered.
He was correct. If we had imposed a limit on the speed
at which we allowed prices to move and the number of execu-
tions that could be done each period, we could have achieved
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a p«rf»ct: audit trail and aliainat«d tb* pOMibillty of aoat
trading abuaaa. Of couraa, in aucb a casa parfcction would
b« achiavad at th« coat oC daatructlon oC tha aarkat and Its
unlvaraally acknewladgad banaCita. That kind of parf action
1« aynbollc of tha aarkata In Ruasla.
Tba D.S. futuraa industry haa bad an outstanding racord
at growth, innovation and aarvica to its custoaars. niat
history was aada possibla l»acausa tha advlca of that regu-
lator waa rajactad in favor of Congrass ' a datarvlnatlon to
aat goals and standards of parforBanca rathar than attavpt to
subst ituta Its bus inass j udgaxant for that of aiqtariancad
nanagara and axparts on tha intrloacias of tha futuraa
Barkat. Tha consaquanca of that long-standing laglalativa
dacialon is a auccassful and usaful Industry that la cantarad
in tha Dnitsd Statas . Thara is no coaparabla f avorabla
raoord for cantrallzad govanoMntal aicro-plannlng for
buainass. nia Bastsm Bloc is atark tastivony to tha
bankruptcy of that abroach.
Tha history of this industry provldas a claar racord of
raaponslbla Intarplay batwaan tha Congrass, tha CTTC and tba
axchangaa . Hhan tba axchangas hava baan alow to achlava
approprlata goals and atandarda , tha Congrass and tba CTTC
hava appliad tba nacasaary praaaura. Tba rasult of that
prasBura, in avary casa, has baan to catalysa tha industry to
act and to craata ■yataaa that achlava tha goals without
angaglng aithar Congrass or tha CPTC in tha datailad aanaga-
aant of a highly tacbnical and rapidly changing buainaaa.
Tlaa and tiaa again, aalf -regulation has provad tha bast
satbod to raacb tba goals of sarkat afficiancy and intagrlty.
7or inatanca , in raaponaa to tba CPTC ■ a raqulra*ant that
axchangas tiaa transactiona to tha naarast minuta, tha CXE
callad on tba conaidarabla axparlanea and avpartiaa that its
■snbars had accunulatad in yaars of actual trading. Dia aa
invastad substantial subb in avaluating tachnologias and tha
altamativa aanual racordatlon tachniquas . Tha on took
account of its spacial naads, aassivs businass flowa, and th*
actual configuration of Its trading pits.
Tha OtB undar stood that a solution basad solaly on
rsqulring brokars and tradars to nanually racord transaction
tlnas would b« inadaquata and would potentially cost futuraa
market cuatoaara such mora in terma of greatly lessened
market afficiancy than any benefit they would likely derive.
Inataad, tha CHE, in conjunction with tha Chicago Board of
Trade, developed a Computariaed Trade Reconstruction (Cnt)
ayaten, of which tha two primary benefits are minisal Barkat
disruption and prinary reliance on information subiiltted froa
sources other than tha objacta of survalllanca.
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Through laprovomants In the CTR systen, CHE's suzveill-
snCB ays'twn has continuously evolved to detect a wide ranc|» .
of trade practice abuses and to Impute transaction tiaes at a
verifiable accuracy rate of 85% (as measured by the CFTC in
our last review) . OfE Compliance Department staff continu-
ally facilitate the evolution of this system to keep pace
with new trading stratsgiss as they develop.
It would be extremely difficult, or perhaps impossible,
for the Congress or the CFTC to ma)ce decisions at this
detailed level. He expect that Implementation of furtHer
•nhancenents euggested by the Special Committee to Review
Trading Practices will increase the accuracy rate to veil
over 90t. I will outline these enhancements later in my
testimony .
Another recent instance in which the CHE Independently
initiated raforas in fulfillment of its self -regulatory role
occurred with regard to the OfE's then-most popular market,
the SfiP 500 Stock Index futures contract. As a result of
this process, the entire transaction system for the Stp SOO
futures contract was examined and revised. In what aaounted
to a dramatic break with status quo, dual trading was effec-
tively banned from the CKE equity futures contract by the
adoption of the so-callad "Top Step" rule which affected
approximately 90% of public transections in that marScet.
Also in 1987, the CHE took a series of strong actions to
enhance the effectiveness of its rule enforcement program.
It hired, trained and placed Compliance Department staff in
the trading pits on a full-time basis. The jobs of these
investigators includes making obeervatlons that might
discover improper conduct as well as following up on lead*
generated by the computerized portion of the surveillance
He enacted stringent rules requiring registration of
broker associations and imposed limitations on their ability
to trade between their members. He also created several
programs to monitor compliance with these new rules and
empowered a committee to enforce then.
At the same time, the CHE greatly expanded the power of
its Compliance Department. All members are required to
submit to a tape recorded interview upon request. Members
are required to produce requested books and records within
thirty days or face charges of a major rule violation. A
panel of experts was created to serve as consultants to
Compliance Department staff in respect to esoteric or newly
developed trading practices and schemes.
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As anotb«r part of th«B« r*forms, w* «nact«d s mach
bar char penalty structura and adoptad a strict anforcaaant
policy. Tha poaltiva rsaulta of thaaa actions vara avidanead
at thia Subcomittaa ' a last briaf Inq aaaalon on Juna 28 ,
1989, whan an InvaatigaCor for thia Subcomnittaa taatiCiad
that tha (XS laviad total finsa of ovar $2.5 million, auapan-
dad Maabarahip privilagas a total of 18 , 502 buainasa days,
and axpallad 10 Exchange mambara in 1987 and 1988.
Ha ballava that tha abova actions, which wara takan
Indapandantly of any ragulaCory raquirenant, ara racant and
atrong tastamanta to tha affactivanaaa of our aalf-racfulatery
aystaa, aa wall as tha wisdon of delagating tha discrafcion
taspacting tha nathods to ba us ad to meat rula anforcaaant
goals to tha exchanges thenaalvea.
Diacloaura that tha FBI was conducting an invaatigation
of futuras trader* activities on the Chicago and New York
exchanges does not altar any of tha foregoing. While tbis
investigation may result in legal action against sons of our
■SBbara, it will not negate tha fact that tha CKE survaill-
ance systas is affective and has an outstanding record, nor
will it cast a doubt on the value and efCactiveness of ths
self -regulatory process. Indeed, no surveillance system is
fool-proof, nor is any industry coupletaly free fros its
share of wrongdoers. Neverthslass , the vast sajority of CKE
nevbers are law-abiding and its ayatea of aurvaillanca second
The CKE continued its eicesplary self -regulatory role In
response to the FBI investigation. within a week after
disclosure of the investigation in January, 1989, we
desonstrated our willingness Co conduct a thorough self-
axasination of all trading practices. Toward this end, a
Special Conmlttee to Review Trading Practices was formd.
The Special Comnittee was cosprised of five public and
industry participants as well as four Exchange officiala.
This Comilttee held lengthy hearings to receive testimony
froB scores of witnesses froB all strata of tha Industry. In
addition, scholarly works on narket eCflclenCy were
consulted. This Congressional Subcoimittee was Informed of
the recommendations announced by tha Special Committee.
Aa this Subcommittee also knows , recently these racom-
sendations were reviewed by a series of six internal CHE
committees comprised of a wide spectrum of CUE members. Tha
six internal committees — Dual Trading, Broker Associatlona
and Verbal Orders, Trading Surveillance, Discipllnai:;
Practices, CTR Enhancements, and Admission Requirements —
have presented their recommendations to tha CHE Board of
Governors which is now in the process of examining the
recommendations .
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As a ramult of this process, tile wide-ranging and
coBprehensive changes reconmended by the Spsclal Cammlttee
have, in most instances, been accepted. In Boms cases, the
tXB Internal aeuber comaittee lessened the recommendations,
but in other Instances, recommended even further aeasures or
equivalent or better altemativee to govern the area identi-
fied as a possible source of abuse by the Special Committe«.
The Board will now have an opportunity to review the package
of reconendations . No doubt those roc omaendat ions between
the Special Ccmnittee and the internal committee that are the
same or similar will be endorsed. In those cases where the
Board considers the recommendations of the Special Comaittee
were lessened, the rationale at the internal committee will
be carefully scrutinized in order to determine whether such
lesser recommendations should be accepted. After Board
consideration, those trading practice modifications which
will have a substantial impact will be offered to the
membership for ratification.
The following discussion of the issues raised by this
Congressional Subcommittee incorporetes the recmnendations
of the six Internal CHE review committees based on the recom-
mendations of the Special Comaittee. nieir contribution In
terms of insight and institutional knowledge is Invaluable
and afflras the value of self -regulation.
The ban on dual trading is the provision of the Bill
most likely to draw public attention and delaate. The
prohibition springs froa the conviction that the public's
perception of dual trading in futures markets is strongly
negative and the understanding that dual traders can prefer
their own interests to the interests of their customers in
clear violation of their duty. We have not found widespread
concern about dual trading among the aost substantial users
of our markets. And, while we agree that dual traders are in
a position to abuse their trust, the evidence so far
accumulated does not suggest that dual trading is the
principal culprit.
In our opinion, it is a serious mlstaka to require
across-the-board restrictions on dual trading in all markets
which have reached a daily average volume of 7,000 contracts
as provided by the Futures and Options Regulatory improve-
ments Act of 1989. (Although the Bill uses the phrase
"contract market" to compute the 7,000 contract threshold, we
assume the Subcommittee really intended to apply the
threshold to any contract month instead of all contract
months combined. It is clear that no purpose consistent with
the goal of the legislation would bs served by rsfusing to
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racognlza th* raallty that •ach contract Bontt) i* a aaparat*
market. It 1> coaaian for tha voluaa lavals b*tw*an ■oon-tO'-
•xplra BonthB and back nontha to vary widaly.) A prohibition
bas*d on an arbitrary avsraga daily laval oC trada baara no
ralationahip to tba purpoaa sought to ba accaaplisbad.
Horaovar a slngla number cannot raaliatlcally be applied
aorosa the board where marlcets and market conditions are so
varied.
The recooaendations by the Special Committee to R«v1«h
Trading Practicas to prohibit dual trading in mature, liquid
contract month* reflected a compromlae between the poeltiva
contribution of dual trading and its negative aspects and
psrcaptlons. In its rationale, the Special Committee
recognized that dual trading la not inherently evil and
"pervades financial markata, including cash markets, and the
firms that deal for customers on those markets." It also
recognized "that the practice of dual trading is a critical
element insuring futures market liquidity."
When the internal CHE Dual Trading Committee ravi«w«d
the foregoing recommendation, it concluded that the Special
Committee ' s solution with respect to dual trading could bm
improved. If a methodology could be found that would
sufficiently guard against those who would abuse dual trying
while retaining the positive contribution of dual trading to
liquidity, the CHE markets would be better served. Purtbsr-
mora, the internal Dual Trading Committee datanined that a
res[>onsible and effective industry standard respecting the
conditions under which dual trading would be permitted would
better serve the long-run intereata of the industry. Accor-
dingly, the internal Committee on Dual Trading i ei iiiiimsiiiTsil
the adoption of the following proposal subject to its accep-
tance by the CME Board of Governors, Congress and the CFTC.
(In the event its proposal is found unacceptable. It
recommended that the CHE resume consideration oC ths Spaclml
Committee's recommendation.)
Dual trading will be allowed in any contract month in
which the CFTC determines that the cnt system prbducss an
audit trial of transactions that is verifiably accurate to
the nearest minuta at a 90% rata. If a contract month fails
to meet that standard, then dual trading shall be prohibited
with exceptions as proposed by the Spscial Committee, to witi
(1) brokers who hava been given specific written authori-
zation from every public customer for whom the broker fills
orders; (2) brokers who are filling orders for other members
of the Exchange; and (3) brokers who predominantly fill
spread orders.
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and to the seie-ragulatory capabiliti«« oE th« Exchange that
will b* inplementad aa a conaequanca of this rafora procesa.
Staff waa satisfied that it could adequately enforce all
rules respecting dual trading violations in any contract
Bonth vhera the 90t accuracy level is mat. Staff also felt
that tha reference to the cfTC to authenticate conpliance
with the 90% level assured the substance of the program.
It is important to note that on July 11, 19B9, the dual
trading proposal of the CHE's internal conaittee was
presented for review to the special Committee to Review
Trading Practices. The Special Comaittee accepted the
internal comnittee ' s recommendations as a fully adequate
response to the pros and cons of dual trading. In its
deliberations, the Special Comnittee took note that the
balance between the contribution of dual trading to liquidity
and the perceived dangers to customers is axtrassly delicate.
Accordingly, the Special committee unanimously agreed that
the CHE ' s internal comaittae ■ s proposal is fully equivalent
to its own original recomnendation.
Tha goal to reconstruct trading with a fully-verifiable
audit trail which accurately reflects the sequence and time
of trades so that all trading abuses are detectable is
aanmendabla, but unrealistic. The timetable which has been -
set to Beet the requirements of 1-minute, 30-second and, in
five years, real-time trade recordation ignores the physical
realities of open outcry trading. There are no indications
that technology will develop at a pace sufficient to make
meating these requirements possible in an open outcry market.
The important issue here is not whether you can achieve
an abstractly perfect audit trail, but whether we can perfect
a surveillance and punishment system that ia highly effective
in detecting and deterring trading abuses on the exchange
floor. Surely you are all aware that no amount of money,
effort or good faith can deter or discover and punish each
and every rule violation.
We have not absolutely prevented our members and
clearing members from violating our rules, CFTC Regulations
or the law. During 1987 and 1988 the OIK opened 260 trade
practice investigations and secured convictions oC 188
individuals. A large portion of these investigations and
prosecutions were a direct result of information provided by
our internal computerized surveillance system and floor
monitors (23%) and by information provided by member and non-
member informants (77%) . The fines imposed by the CME in
respect of such trade practice prosecutions since January I,
1987, total 33,479,925.
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H« Butelt that these rmsults ar« a cImu: Indication of
tb« CME ' ■ strict ruia anf orcaawnt pol icy . Thay ara tha
raault o£ a tough atanca against violators, ona that
coaparas favorably with any othar Cuturas axchanga in tha
nation. Hor can It ba arguad that thasa rasults sisply i^ly
that thara ara nora violators at our Exchange than at other
exchanges. Such a cynical view Has no basis in fact and runs
contrary to logic which dictates that trade practices and
ethics of sesbers on all exchanges tand to be siailar.
Hhila these raw statistics respecting investigations and
convictions ara Ij^rassive tastiaony to tha past efforts of
the CHE and its CoBplianca Dapartaant, thay only tall but
half of tha story. A true assaasBant of a survelllanca
aystatt requires that violations ba graded according to tbair
potential for han to custoaers, the sarlcat, and other
■aabers. nie first priority of the CHE and its survelllanca
systs* has baan to protect tha public cuataaers of its
Markets. Our aost intense efforts and tha bulk at our
resources have been devoted to the protection of public
Ha believe that our current systeas have bean highly
affective in deterring, dataoting and punishing rule viola-
tions that injure public custoaers of our markets. Ha are
awara, however, that thara hava baan a nuaber of technical
violations that hava not injured custoaars that have gone
undetected and unpunished, in particular, everyone connected
with auction aarkets is aware that there 14 a certain aaount
of trading that continues after tha final ball . Tha news-
papers hava had a field day with allegations about tha
horrors of "curb" trading. It is a technical violation and
wa do devota effort to preventing it, but it is not at tha
top of our list of enforcement priorities.
The open outcry systaa baa In the past and continues to
aeet tha aandata of the Coaaodity Exchange Act to contract
markets to prewide op«n and coapetltlva aarkets. It deaon-
strates its efficiency every day. The unique chemiatry of
open outcry has operated to aake our aarkets soae of tha aost
liquid in tha world. Other countries hava atteapted to
aaulata this systea because of this vary quality. Our
custoaers have denonstrated thair overwhelming confidanca in
and support of our open outcry systaa by their trading
decisions . Voluae this year at the CHE has increased by
alaost 40% over last year.
Tha alternative which we believe was intended to ba
furthered by this proposal is electronic trading. While wa
are in the forefront of developing an after-hour electronic
system, we are convinced that electronic trading will not
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Th« stat«d goal of th* audit trail proposal is to assure
custaDBE-a that U.S. futures markatB are honest. Rather than
helping U.S. exchanges to compete for business, this proposal
will actually cripple these markets by overburdening
participants to the extant that it will be nearly inpossible
for then to function efficiently, thereby destroying the
liquidity that made then successful in the first place. It
is well-lwiown in the futures industry that the success of a
market often depends on which of the conpating markets
attracts the most volume at the outset.
Instead of the above requirements, we believe that each
exchange should be strongly urged to improve its surveillance
and compliance trail systems. He believe it should be within
the purview of each exchange to determine these enhancements
but strongly recommend adoption of the CKE's CTS systea for
purposes of improving the verifiable accuracy oC trade tiaing
in order to reach the standard required to be able to detect
abuses which may be associated with dual trading.
The CHE'S internal review committees have recommended
the following enhancements to our audit trail and
surveillance systens;
Report matched trade information on the trading
floor for self -policing purposes. In addition to
the information recommended to be displayed by the
Special Committee, the CKE review committee also
recommended that customer type indicator and order
type indicator information be included.
Increase floor surveillance staff to provide
greater coverage of all trading areas, particularly
during market openings and closes and during
periods of unusually active or volatile markets.
Conduct a study of the affecCiveneas i
surveillance for specific trading
inveatigations on the trading floor.
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Instltut* opanlng and closing bracket indicators to
diatinguiah tradas occurring during th»a« brla£ and
activa parloda froa othar tradaa which occur during
tha firat and last halC-hours of trading.
Raqulra tha plclc-up of tradijig cards froa aaabars
avary two hours. If audit trail iaprovaaant goals
ara not aat vithln six nonths, raqulra that trading
cards ba plckad up on an hourly basis. Currantly,
trading cards ara collactad twlca dally.
Currantly,
Mr ordars by
Raquira floor brokara and tradara to dasignata
apraad tradaa.
In ordar to Inprova trada timing, raqulra that
ordar typ« Inforaatlon ba subalttad for all nen-
parsonal tradaa.
BBOKEB AS30CIATI0WS
nia CHE racognizad that brolcer aasoclatlona parfora a
valuabla rola in our marlcats, but can ba a aachanisa to
facilltata trada practlca abuaas.
Tha CXB Instltutsd a systaa of bro>car association
ragistratlon ovar flva yaars ago and Implaaantad trading
raatrlctlona among broker association asBbara mora than two
yaars ago.
Tha CHE's Special Coaalttaa to Savlav Trading Practices
recoamandod and our internal Committee on Broker Associations
has approved a similar set of Exchange restrictions on broker
associations. Trading for a personal or proprietary account
against a custoaer ordar will be prohibited among association
members. customer^to- customer order trading raetrlctiona
will be maintained at 25t of an association member's total
volume In that contract.
PERIOD OF HgADTHORIZATTOH
We strongly support the proposal to establish tha CTtC
as a peraanent agency. He agree that this will allow a aora
efficient allocation of agency resources and aore
concentrated efforts towards industry regulation.
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mrogRCOCTH SmwrnTT-TAWrW
N* agr«e th«t undercover murveillanc* nay h«lp to d«t*r
and deCecC abucas. Howcvar, we strongly oppose undercover
Invaatlgations that saek to indue* wrongdoing in order to
force the wrongdoer to testify against others who may be the
real targets of investigators.
gOVKHHlMC! nnaona
The CH£ internal Connittee on Disciplinary Practices
endorses the Special Committee's recommendation that members
who have bean convicted of a major offense be barred from
serving on a disciplinary committee for a period of five
years. In addition, it is also recommended that members
convicted of minor rule violations be barred from disci-
plinary committee aeabership for three years.
our Exchange has always anlisted public and industry
governors to s*rv« on our Board. This was the result of our
judgment that this was an advisable business practice. Th*
composition of its governing board is a business decision
which exchanges arrive at for competitive reasons . This is
another area that should be left to the discretion of the
individual exchanges. It is not appropriate in this context
for congress to substitute its business judgment for the
judgment of the institutions that are actually competing.
TEtam^KgTTHe FRAPP
He agree with the testimony that this subcommittee has
received that telemarketing fraud in the futures industry
occurs in only a vary small percentage (less than It] of all
transactions. He believe that where these practices do
occur, they have a disproportionate negative reflection on
the industry as a whole and must be prevented to the extent
possible without hindering legitimate retail trading.
Currently, the industry must comply with an extensive
set of rules respecting sales practlcea that have been
adopted by the CFTC and the National Futures Association. In
addition, the cftc has recently directed that each exchange
develop additional procedures for assuring that sales
practice audit and investigative programs adequately address
the issue of detecting abusive oral sales representation.
The CHE, for example, has decided that its Compliance staff
will pose as customers over the telephone In attempting to
ascertain which firms are engaging in fraudulent or high-
pressure oral sales solicitations.
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proposal ia attuq^in? to >olv«, but without tb* accoiqiBnylng
r»conUM«plng burdww that will b« placod on firs* to
daaonatrst* eoaplianc* with tha ragulation.
DISCIPLmABT CQIO.T1TKM
W« strongly oppo** tha lapoaltion of coiq^sition
raqulraaanta on axchanga dlaciplinary coamittaas. Tha OtE'a
Spaclal CoMBittaa alraady baa aada a thoughtful racoaaan-
dation on this aubjact which haa bsan ratiflad by tha
internal CoBBittaa on Disciplinary Practicss.
It would ba rash of Congrasa to mandata changa in tha
abaanca of a docuaantad failura of tha currant disciplinary
coaaittaa syaCan. As tha tastimony haard by this
Subco^ittsa at its last brisfing sassion baars out, tha
CHE'S and othar axcbangaa' diaclplinary coBvittaas act
fairly. At tha CHE, aany aataguards ara in placa to pravent
a saabar who has a financial intarast in tha adjudicatad
matter froa hearing a caae. Alao, dalibarationa ara
conducted confidentially, so that a aanbar need not Caar
retribution for his dacialon.
The CHE'S internal conmittea on Disciplinary Practices
baa andoraad tha Spaclal Coaaittea ' a proposal to add one
luiowledgeabla non~naabar to each Exchange disciplinary
coaaittaa panel. This proposal haa b«an structured to retain
the trading axpertiaa nacasaary to a connittee dalibaratlng
possible trading practice abuaea while injecting iapartlal
participation by a )cnowledgeabIe outaidar. Wb balieva that,
in our caaa, this is tha bast remedy for the parcalvad
problea that disciplinary coaaittaas have a bias in favor of
Exchange nembera against non-meabers or show favor It isa to
influantial aeabara. However, wa believe that this i»
another area in which each exchange should axercisa its
discration.
Rowavar, if some regulatory raquireaanta in thla ares
are daeaad abaolutely neceasary, tha CFTC ia in a far better
position than Congress to act if change ia neceaaary. The
CFTC already haa the toola necessary to do this.
HBGTSTRATIOMS
The CHE'S Special Coaaittee recoaaanded and tha oa
internal coanittaa on Adaission Baqulraaents has approved a
propoaal whereby floor tradera would be required to ragiatar
as floor brokers in order to get FBI fingerprint checks.
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ETHICS TRAIMIHG
Til* CHE ' s Special Conmlttes rf coHfflcnded, and th* CHE
internal Conmitta* on Adnlsiion Haquiranents has ratlflad, a
manda'tary athlca program for naw and axlsting mambars which
vould ancoMpaas trading rules, fadaral and adniniatratlve
aanctiona Cor rula violations and thair ethical responsi-
bllltiaa thareunder. in addition. It 1> balng racanmanded
that OUT aaabara ba rauindad of thair ethical rasponsiblli-
tlaa pariodically.
GLQBHX
Allow ma now to digress a bit Cron the foregoing
discussion relating to floor practices. Indeed, if tbe
aaotional impact of the dual trading issue or the other
issues relating to floor practices were not of auch
overriding momant, my testimony would havs begun, rather than
ended, with a ramlnder that the CHE has spent the batter part
of the last two years creating and implementing its global
alactronlc trading systaa ~~ GLOBEX.
The CHE and Sautars Limited are developing GLOBEX as an
electronic comaunications network and order matching system
that can be used by members of an exchange to trade its
futures and options . contracts during the boura that the
exchange's trading floor is closed. GLOBEX will allow
transactions in futures, options, and selected foreign
financial instruments to be executed from anywhera in the
world, instantly, and with financial integrity.
It Is of Immediate concam to us that the Bill falls to
acknowledge tha existence of electronic trading systems which
guarantee perfect audit trails. The prohibitions that are
attached to pit trading are equally attached to trading on
the electronic system. Again, wa are confident that this is
the product of the time pressure under which the Bill was
prepared. Ho matter what form Sections 101 and 102 take,
they need to exclude trading on electronic systems with
inherently perfect audit trails.
That much is obvious, but tha creation of GLOBEX by the
CHE and of ADSOR& by the Chicago Board of Trade has a
significance that seems to have been all but overlooked whan
the philosophy of the BUI was formulated. It is absolutely
and unequivocally clear that the exchanges were at the fore-
front of a monumental innovation with enormous regulatory and
far-reaching business consequences. The exchanges moved to
implement better audit trails and to afford thair customers
markets of unquestionable Integrity without threat of legis-
lative action, without administrative spurring, and without
the prodding of tha U.S. Attorney. He acted because we were
14
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drlvan by co«p«titlon, h«d tb* courag* to B»k« bard d*cl-
■lona, and vrm abla to nova without awaiting aitbar a
laglalativa or adniniatrativa initiativa.
Tha CKE concludad that Cba Boat inportant trand
aff acting sacurltia* BBTkata and capital foraation la tha
accalaration toward intamational aarlcata. Capital aevaa
acroaa national boundaria* with incraaalng aaaa, raflacting
both anhancad oppartunltiaa and aophistication on tha part of
Invaatora to aiqploit tha opportunitlaa. Tha CHE 'a initial
reaction to thia trand waa to davalop Coraign currancy and
Eurodollar futuraa and optlona. Koat racantly, tha davalop-
oant of GLOBEX acknowladgaa that tha nachaniaa of trading
naada to Cit tha intamational conaunity as aaaalaaaly aa tha
inaCrumanta tradad.
stepa to kaap our aconoay in a (position to B>anafit froM
this trend nust ba mada today, or tha Unitad stataa any losa
Its placa oC pra-aainanca in tha world capital aarkats.
Prlvata U.S. Ciras hava daaonstratad an ability to Bova
quickly and affactlvaly in tbia anviroraMnt, but ragulatory
burdana should ba addrassad promptly.
Trading can ba dona in London or Tokyo aa aasily aa in
Chicago or Haw York. In tha laat five years, naw futuraa
axchangaa have opanad or been announced in London , Paris ,
Hong Kong , Sydnay , Toronto , S ingapore , Nev Zaaland , Brazil ,
Osaka, Zurich, Tokyo, Dublin, Frankfurt. Every financial
canter knows tha value of integrating actual or pessibla
movaaent of London's FT5E 100 and Tokyo's NIKKEI indicaa aa
harbingers of the daya' ssp 500 aoveaent.
Regulation of aecuritiaa and futures markets inter-
nationally has shown little consistency across national
boundaries. While regulation should be adequate, great care
must be taken that our ragulationa do not place unnecessary
conatralnts on the n.S. aecuritiaa and futures industries.
Many inatruments are traded at aeveral different locations
around the world, and regulatory Inequities could cbase tJ.S>
business to foreign markets.
The Chicago Hercantile Exchange ia firmly coanitted to
meeting its self -regulatory responsibilities. We b«lieve
that our record of achievenenta in this area is well
documented . In addition , we bel leve that the process by
which we are examining tha entire scope of our trading rules
in a very thorough and thoughtful manner maeta the bluest
goals of self-regulation.
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He recognize that our custamars have intsraate in market
integrity, efficiency and liquidity and we take oux abliga-
tlons to safeguard these intaresta very aeriously. Through
the exaaination of our rule enforceaent syatem, we have
aought to structure recomiBendations to further market inte-
grity with a minimum of market disruption. He beliave that
only by allowing U.S. futures axchangas to determine markaC-
•fficlent neasuraa to meet their self -regulatory
responaibilitias will tha V.S. futures industry continue to
an joy its pre-aminant role among all futures markota
worldwide .
I would like to thank this Subcommittee again for the
opportunity to aoBaent on these very wide-ranging proposals.
Of necessity, my conmants have bean long and technical in
nature. I would be pleased to answer any questions you may
have.
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a>e. lai. PtKl TradlM
Th« dirvctlon to Zb» CFTC to 1b>u« rsTulatlons to ban
dual trading In certain circuaatancas fails to account for
tha claar diffarencas batvaan plt-baaad trading and trading
dona by naana of an alactronic ordar axacution ayataa auch aa
ttaa CKB'a CLOBEX. SLOBBX doaa not aaka usa of floor brokars
who oparata in an analogou* fa ah ion with tba pit-baaad
ayataKi howavar, siany SLOBEX taminal oparatora aay hold
floor broXar ragiatration. Ha aubait that tha lagialation
naada to ba radraftad to diatinguiah anong trading ayatau.
In our opinion, a dual trading ban basad on an arbitrary
numerical threshold la inappropriata . Tha theory underlying
tha legislation la that volume atruataa to liquidity and
tharafora a significant voluna laval guarantees tha liquidity
necassary to ban dual trading without adverse aarlcat ia^MCt.
Tha rationale underlying such a principle is faulty.
Liquidity cannot be aeasured solely in terms of average
volume, taut rather in tarma of the ability of tbe aarkat
throughout tha trading day to allov the pronpt execution of
orders without causing undue price gaps-
Reliance solely on a voIu»e nunber fails to talM Into
account the distinct and highly relevant variables among
markets. If ordar flow to a particular market is even and of
a relatively uniform size, than a contract aonth that
averages 7 , OOO contracts per day may be sufficiently
developed so that a ban on dual trading will have only a
alight impact. However, if a market has the opposite
characteristics, namely uneven order flow and widely
disparately sized orders, then 7,000 contracts per day is ao
Indication that the contract can survive the elimination of
dual trading. Simply atatad, each market has Its own
Idiosyncracies . Svery contract market — soybeans, cattle,
gold, Interaat rates, oil, cocoa — • has a distinct user
community of coDmercial hedgers with different volume needs
that change over time. There is no uniform appropriate
volume threahold that transfers from commodity to commodity
or exchange to exchange.
The Bill applies the volume threshold to the "contract
market" aa an entirety, ignoring tha different circumstances
of various "contract months." Thus, if the active month
tradea e,SOO contracts par day and an Inactive month trades
500 and only has two brokers and two local traders, the Bill
would bar dual trading across the board and severely restrict
competition in the less active month.
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Th« Bill also aata forth an unworkable tes? Cor th* CFTC
to increas* or decrease the thceshold trading level. The
CFTC ia called upon to determine that the prohibition against
dual trading "createa undesirable price volatility, widening
of the bid-aak spread, or otherwise threatens the public
intarcst." It is highly unlikely that the CFTC can or would
devote the reaourcea to perfecting a test that will be able
to isolate the impact of dual trading in this context. That
being the case, this language encouragea litigation on any
occasion the CFTC would diverge from the artificial
thraahold.
Th* Bill ' s exemption from th* prohibition on dual
trading baaed on the aoundneas of the audit trail is correct
in concept but imperfectly applied. The Bill requirea that
th* audit trail "detect any and all Instancas of trading
violations" and further requirea that the audit trail be
"fully verifiable. " These are impossible atandarda.
Perfection is not attainable in the futures industry nor any
other. Detection of "any and all" instancea of wrongdoing is
an unreasonable standard that can never be met.
Tbe exemptions are not complete . There is good reason
to allow a member on the floor to give hia order to any
broker he chooses, including a broker who trades for hia own
account. There is no reason to require the formality of a
written fora in order to permit thia practice. Th* restric-
tion of a broker's ability to trade out of his errora to the
next day ' s opening is disastrous . A broker who makes an
error muat be free to immediately trade out of the position.
No one could afford to act aa a broker if required to hold
positions assumed in error until the next day'a opening.
The exemption for spread brokers is insufficient. The
exemption ia needed to protect spread brokers that attempt to
fill an order and complete only one aide of the spread. That
position then belongs to the broker. If spread brokera war*
unabl* to "leg on" by buying one side at a tinie in the hope
of then getting the reat of th* spread, c-uatomers would
suffer serious conseguencea .
Sec. 102. Trading Unnnfj MMit>^ra pf pyo^er ^aoeiationa
He commend the purpoae of this section, which is to
clarify that just as it is wrong for an individual floor
broker to "front-run" or in any method abuse a customer trade
by dual trading, then the same should be prohibited for
broker associatlona . However, the legislative language sets
forth serious unintended consequences.
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■acb as GLOBEX. C«rt«ln ■■Mtwrs of m brekar «ssocl*tlon,
on* trkdlng Cor a eu«tcn«r, anothar trading for hia oim
account, could In fact taka opi^alta aldaa of a transaction,
and unbaknownat to thaaaalvas ba automatically aatchad In tb«
CL08ZX syataa. Whlla thay ara.aaabara oC an aaaociatlon, im
wronqdolng can occur In th* CLOBEX aystaa which la totally
nautral to who la aatchad In tradaa, rathar It doas it en a
prlca and tiaa saquanca baals.
Further, tha Bill would lapoaa an artificial lagialatad
parcantaga point aa an approprlata tr ana action thraahold
prohibition. The objection la not that tha 2S% la Inappro-
prlata, but rather that It is Inadvlaable to put In place
any parcentag* in law. The Clexibllity to detaraina an
appraprlata percentage threahold should exist so that it can
ba relaxed , or aad* aore stringent , as conditions warrant .
The Bill should set forth tha purpose to ba accoapllahad, and
direct tha CFTC to require tha exchangas to adopt appropriate
rulaa to aeet that goal. This would provide for tha Clexi-
bllity to deal with tha changes in technology, and to
conaldar tha benaflta extant with broker aaaoclatl ona ,
specifically tha coabination of greater capitalization, and a
continuing long-ten coaaitaant to tha brokerage fausinass.
TTTIJ TT. MltMieiBnOfT OF BBajTATOBV AgPTtfTT) KH
See, aoi. Jmdit Trail.
Our principal objactlon to this ssction is that it
deaanda a result without reference to tha value of that
result and the consaquancas of achieving it. The goal la a
verifiable audit trail effective In deterring and datscting
abuses. Mandating thirty-second tlae accuracy within three
years is not the way to that end. The CFTC should bs allowed
to dateralne an acceptable threshold of verlflabiilty, and we
should recognize it nay change over tiae.
Section 201 ahould thua delate aec. 20l(a> C) (B) (11) (b) .
Sec. 30l<b) requiring that "every contract Barket"
coaplles with tbs spsclfically delineated audit trail
ragulrsBsnts as a condition of dssignatlon Is over broad.
Tha language would apparently rsquirs either Imeed lately
ceasing all futures trading until each exchange deaonstrated
that it is in coBplianca, or require the CFTC to so aasert
coapllanca. The CFTC has the current authority to revoke any
contract aarket daaignatlon If It finds surveillance
inconsistent with tha Act.
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SW=i 302. T«tT>»tljKi Fraud
Sec. 202(a) should b« raviaed to direct the CFTC to
accowplisb approprlst* regulations and sat forth the custoaer
peotactlon goals.
aws. 303. ondereovr Operations and Bnf«»'^— «<<•
This language is redundant. This is aade clear by th«
phrase "the Coamission ahaii eontinua" the prscioe authority
this section delineates. The CFTC has the authority to
cooperate uith appropriate Federal agencies and has done so.
All cnc aBploysas ara prohibited from trading tutures
contracts, wbich 1b appropriate, and thus it does not have,
nor should it have, the ability to conduct undercover
investigations. That Is the purview of the FBI, and
obviously that is the status of the current law.
Thus Sec. 203 should be stricXen. Any discussion of
undercover operations, and the CoimisBion's cooperation with
saae, can be part of legislative report language.
See, ao*. Self-regulatorv Oraanization DlaclpHnm-y
^^^«■^1■^■— and Covemlno Board*
The CFTC has the authority to conduct a rule-«aking on
the structure of disciplinary comolttees. That is the
appropriate nethod for determining what, if any, iaproveaents
are necessary. nie Bill atteapt at committee restructuring
la based on a premise that is without evidence; i.e., that
the current disciplinary structure is flawed. Further, Bill
language requiring that staff aembers of the exchange serve
on disciplinary comgittees is a serious error. CHE staff are
eaployees of the Exchange and should not be the judges of the
members. Further, the requirement that the coaaittee be
composed of a majority of persons of a different trading
status than the respondent is totally unwarranted and
unworkable. Henbecs are traders, and virtually all
disciplinary committees, by their nature, involve aenbers -
disciplining members who are of the same trading status.
Committees should be coaposed of experts who understand their
responaibility to ensure markets are honest.
The CFTC presently has the power to effectively
establish and adainlster a rule enforcement program. The CHE
and other exchanges currently publish accurate descriptions
of the context that was the basis of a rule violation. These
are proainently posted outside of the trading floor. There
is no evidence that what constitutes a aajor violation la
unknown.
23-500 0-90-14
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Psnalty guld*lln«B for rul« violations involvlnq
financial injury to public cuaCoaars ara importairt. TtM CHE
Spacial CoBuittaa raconaandad savara panaltiaa, including
suspanaion of Bavbarship privilagaa and aicpulaion. Whan
naabarahip haa baan auapandad, tha individual ia unabla to
aarva on disciplinary or govamlng commitcaaa of tha
axchanga, and thus tha laglalativa languaga ia radundant.
Tha racownandation of a lagialatad cart a in parcantaga
for tha nunbar of outaida govarnors for a board la
inapproprlata. Tbla ia a buainasa judgaant. Corporata
govarnanca diacuaaiona today oftan urga a broadar
rapraaantation of outaida diractora and/or a concoaltant
liait to tha numbar of officara on a board of diractora.
Hovavar, just as thara ia no statutory raquirenant on this
undar tha sacuritiaa lava, nor should thara ba undar tha
C.E.A.
Sac. 2Q5. Raquirad Baaiatration of Flc»r Tfadara
He andorsa tha concapt of raglstaring floor tradars.
Tha principal purpoaa for doing so is to obtain tha FBI
fingarprint chack halpful to anhanca a thorough background
raviaw of tha individual trader. Hovavar, tha Bill languaga
specificity cauaas concern. By axavpla, the Bill's
definition of " floor trader" could ba nisconatruad in a
SLOBEX-AOSORA electronic trading schaaa. In short,
regulatory flexibility for "floor trader" registration would
be batter Bccoaplished under rula-aaXlng.
wa oppoaa
instituting unnai
Wa andoraa aac. 205(a) furthering the applicable
exaaption of contract aarkats, claaringhouaa , floor brokers,
or floor tradera from the appropriate axai^tion of
jurisdiction by the states.
aining appropriate
See. 20«. Rnhancanant of Raoiatration PTMriBMltl
TbM CHE generally agraea that registration raguiraaanta
should ba tightened, but rafara you to tha tastiaony of
Robert K. Hilwouth, Preaident, National Puturea Association,
on this topic . The HFA haa , ainca 1935 , assuaed tba
registration raaponaibilitiaa for tha futuraa induatry.
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a*c. a07. enforcCTMrt: of civil Mywy PiialtlBa
H« endors* aBandlng tha Act to d«lat* the raqulreiMnt
that financial considaratlons of th« violator and his ability
to continue in businaa* naad not be part oC the consideration
for assessing tha fin«, restricting penalties solely to the
gravity of the violation. However, we question the
appropriateness of a aers fifteen day period for
accoMplishing full paynent. This has vestiges of imprisoning
delators fcr inability to pay. Accepting the iaportance of
racslving full payment and interest thereon, flexibility for
procedures to ensure that payment can be accomplished would
seam more sensible. The same analysis applies to the thirty
day requirement subsequent to appeals. We endorse the
concept of expanded efforts toward collection for those who
fail to pay, but believe the tine frame for accomplishing
payment should be significantly broadened; e.g., six months,
with interest to comMence accruing after fifteen days.
See. 20H. Ethics Training tor Reaiatranta
a rule-BBklng on establishing ethics
3^^t;. 299. Wat^onwlde Service of Proceaa and Venue
we endorse this jurisdictional broadening.
TTTLE Til. AaSISTAMCB TO PORBIGW FnTORES AOTHaRITIgS
Ha andorsa the following sections, recognizing the
globalization of futures trading, and the need for
cooperation among regulatory counterparts;
SSSi
Ssc^
in*.
He endorse this section requiring cooperation. However,
we note that the CFTC is only required to "consider" whether
reciprocal cooperation exists, when it determines whether or
not to provide assistance, and further to only "consider"
whether the request would prejudice the public interest to
the United States. The CFTC is in a better position than an
exchange to evaluate this language.
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S«c. 301. Daflnitlon of Foreign Futureg Authority
H« andaraa th« r«quir*B«nt tlMt tb* CFTC not b*
ooiqMllAd to dlaclos* «ny inConution obtalnad froa a foralgn
futures authority. Hovavar, wa baliova th« Bill's axcaptions
to this diacloaura protaction ara too broad • Na would
raatrict discloaura to axclusivaly adainistratlva or judicial
procaadinga, racalvarship or bankruptcy procaadinga to which
tba CFTC haa a right to appaar . Rowavar , wa rarn— ami
liHlting >uch diacloaura to a congrasaional procaading.
Violationa of confidantiality in congraaaional procaadinga
ara unCortunataly a wall-known fact, and that poaalbllity
could Inhibit foralgn futuraa authoritlas fron cooparatlng.
Ha andoraa thaaa proviaions.
tTTTX TV. XimWItTZATTmi QF APPHOPBIATIOWS I MTKCTTV* Itt'PK
a«c- ^Ol- Autherlaatian of Anpronriationa
Ha aupport tha provlaion waking tha CFTC a paraanant
agancy on full aquivalant status with tha SEC. Wa aupport
this provision which dlscontlnuas tha thra* or four yaar
raautlwr 1 z atl on .
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TESTIMONY OF ROBERT K. WIU40UTH
PRESIDENT
NATIONAL FUTURES ASSOCIATION
BEFORE THE HOUSE AGRICULTURE SUBCOMMITTEE
Oil CONSERVATION, CREDIT, AND RURAL DEVELOPMENT
RE: H.R. 2869
I. IMTRODOCTIOM
My nam« Is Robert K. HilKouth and I an tiia Prasident of
National Futures Association. HFA wslconcs this opportunity to
prassnt its viaws on tha proposed lagislatlon pandinq before this
ConiBittae. Tha laauas involvad ara both complex and important.
Congress must once again perfom a difficult balancing act. On
the one hand. Congress oust provide sufficient regulation to
ensure the fairness of and public confidence in U.S. futures
markets. On the other hand. Congress must avoid unduly burden-
some regulations which could impair the afflclency and usefulness
of those narkets and erode the position of U.S. markets in an
evermore competitive global marketplace.
From its unique position in the regulatory structure of
the industry, HFA may have a somewhat different perspective than
soma of those who will testify before you. As envisioned by
Congress and implemented by our Board, KFA was never intended to
duplicate, and has not duplicated, tha regulatory efforts of the
exchanges. NFA's authority, therefore, focuses not on exchange
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trading floor*, but on all otli«r «sp«cts o£ it* Msabmra' daallngt
vlth th* public. HFA's pri«arr rasponaibilltiM includat
developing and enforcing custOHvr protaction rulaa to
•nsura that M««b«r« obsarv* tha hi^iaat poaaibla
•thical atandards in thalr buaineas and salas prae-
ticas ;
pravanting unathical firas and individual* froa antar-
ing th* industry by parforalng tha ragiatratlon func-
tion on bahair of tha CoaBlaaion;
protactlng custoaar* by aducating thea about tha
futuraa aarkata and thair riaka ao that custoaera can
■aka fully inforaad invast>ant daciaion*; and
providing customars with an arbitration forua which
provides a fair, proapt and Inaxpanalv* saana of
resolving disputes.
UFA'S accoBpliahaents in each of these areas since the
laat raauthorlsation hava baan detailed in a lengthy report va
have previously provided to each of you. The Executive Suiwary
of that report is attached to ny written autaaiasion.
Certain of the proposed aaandaanta to tha Act that you
are considering would directly i^act UFA in carrying out our
regulatory responsibilities. I would Ilka to coaaent on those
proposals with soae specific observations. Other issues you are
dealing with aay not directly lopact HFA but could have a pro-
found impact on the futures industry. On those issues HFA is a
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v«ry lnt«r«st«d bystander and I would offer more general observa-
tlone on those points.
II. DUAL TRADIKG/AUDIT TRAILS
TWO ol these issues which do not directly concern hfa
involve dual trading and audit trails. Audit trails do not
directly affect HFA since we do not operate a oarlcstplace. I
would only note in passing that in considering whether to reijuire
further improvements to exchange audit trails. Congress must not
lose sight of the progress which has already been made In this
area. The trade reconstruction capacity of the exchanges is now
vastly superior to what it was just a few short years ago, and in
most contract months the exchanges can reconstruct trading
activity with 90% accuracy. That is not to say that further
improvements should not be made. But the one thing which the
various investigations Into the October 19ST crash proved con-
clusively was that the audit trails In the futures marlcete set
the standards for other markets to match.
With respect to dual trading, I suppose the only
statement that everyone would agree with is that this issue is
extraordinarily complex. Hone can deny that public confidence In
the U.S. futures markets is critical to the continuing success of
those markets. That public confidence is based on both the
integrity end efficiency of those merkets.
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ni* integrity of thos* aarkats ha* b**n cillad into
qiMstion by soa* b*cau>« th« practice of dual trading can craata
tha appaarane* of custoaer abuaa. And whan you are dealing with
public confidence, appearancea can be aa laqportant aa r*ality>
However, in deciding whether to Baintain public confidence by
regulating the practice of dual trading, Congreas auat aova with
great caution.
Public confidence ia iaportant to th* aarketa but no
■ore ao than market efficiency, mat efficiency dependa on tb«
liquidity offered by U.S. futurea aarketa, liquidity which is tha
envy of all of our world coapetitora. Dual trading aakaa an
ii^ortant contribution to that liquidity and any legislative
action which conld affect aarlcat liquidity, the cornerstone of
our efficient aarkets, should be a.ppTO»eb»d with great cautimi.
Thia ia particularly true In trying to design a solution irtiieb
would apply not juat to one contract or to one axchanga but on ut
industrywide basis. A second point to consider is how tha
concema over potential abuaaa in dual trading can be addreaaad
through liqiroved audit traila. Aa thia bill racognlzaa, the
better th* audit trail to detect actual abuaaa, tba lasa the
public concern over potential abuses and the less the need for a
ban on dual trading. The bill provides that th* ban on dual
trading would be lifted irtien an exchange's trade reconstruction
is loot accurate. But given the liq^ortance of dual trading to
the efficiency of our aarketa and the inevitability of huaan
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error. Congress must consider whether a trade reconstruction
standard of absolute perfection is More denandinq than necessary
and, pertiaps, unobtainable.
The issuss are difficult, the stakes are high and
Congress should take great care to hear all of the interested
parties, learn all of the relevant facta and consider all of the
possible ramifications before taXlng any final action.
III. REGISTRATIOM REQ^IIREMEI^T9
one of the best ways to protect the public from
unscrupulous firms and Individuals is to keep those people out of
the industry in the first place. That Is the job that NFA has
been handling since October 1, 1985, when it assunad respon-
sibility for denying, revoking, restricting or conditioning
registration for all categories except floor brokers and leverage
transaction aerchants. NFA has done that job by applying the
tvio-tlered system of disqualifications from registration which
Congress established in 1982. Sections 8a<2) and aa(3) of the
Act have proved to be effective tools in maintaining the high
fitness standards of the futures industry, but H7A agrees with
the Committee that those provisions can bo fine-tuned and
improved. HFA strongly supports the proposed anendments.
In general, the proposed amendments will tighten the
fitness standards of the futures Industry. At the same time, the
suggested anendments retain the critical distinction between the
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mar* agrsgious dlsquallticatlona sat forth In SacCion Sa(2) of
the Act and the lass serious disqualifications sat forth in
Sactlon 8a(3) of th« Act.
Th« proposad aMandaiants would also codify certain of
th* Connisslon's and HFA's prior intsrpratations of the existing
disqualification provisions and would rasolv* certain anbiguitias
In the Act which NFA has ancounterad over the past few years.
To suminariza, it is NPA's view that the proposed
anendmants to the disqualification provisions of the Act will
strengthen the fitness standards of the futures industry, promote
fairness and unifomity of treatment among similarly situated
applicants and registrants and further serve to streamline and
simplify registration disqualification proceedings. A more
detailed analysis of HFA's supftort of the proposed amendments is
set forth below.
Section Baf2WCUiil of the Act
At the present, Section Sa(2} (C) (il) of the Act pro-
vides, in pertinent part, that a parson is disqualified from
registration if he is permanently or temporarily enjoined
from "engaging in or continuing any activity involving any
transaction in or advice concerning contracts of sale of a
commodity for future delivery. ., or concerning securities."
The language used in Section Ba(2) (C) (11) is rather broad.
Theoretically, Section 8a(2)(C](ii] of the Act disqualifies
a person or firm which Is enjoined from simply engaging in
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certain futures or securities recordkeeping violations.
Further, this Section of the Act arguably disqualifies from
registration persons and firms who, though subject to a
permanent injunction involving securities, nevertheless
obtained or retained registration troM the Securities
Exchange Comolsslon, the National Association of Securities
Dealers or a state securities commission, which Initiated
the injunctive action.
At the sane tine. Section aa[2) (C) (ii) of the Act is
perhaps too narrowly drafted. It covers only Injunctions
involving futures or securities. As currently written.
Section 8a(2)(C)(ii) does not Include injunctions which,
although not involving futures or securities, nevertheless
involve serious wrongdoing. For example, state insurance or
state gambling coBmissioners may obtain court orders enjoin-
ing wrongful conduct. However, such injunctive orders are
not covered currently by Section 8a(2)(C)(ii} of the Act.
HFA favors the proposed amendments to this provision
which encompass the most serious types of injunctions,
regardless of whether such injunctions Involve futures or
securities, such as those involving theft, fraud, fraudulent
conversion, misappropriation of funds, securities or prop-
erty, false pretenses and deception of custoir.ers. nFA also
supports the proposed amendments which explicitly create an
exception for injunctions which are not deemed to constitut.a
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disqualificatiiona tzom raqlatratlon by the ragulatory agency
which initiiatad tha Injunctive action. HFA anticipat«B that
If thaaa propoaed aaandaants ara adoptad, it will ba abl« to
concantrata Ita efforta and rasourcaa on aora sarioua
injunctiona, rather than Bp«nd tima on »attara which ara of
a dS ■int»ia natura or which tha primary ragulator did not
rwgard as constituting a disqualification froa ragiatration.
Saetion 8«faWD> of tha Act
At prsaant. Section Sa(2)(D) of tha Act providaa that
certain typea of aerioua felony convictlona within the lost
ten years qualify aa diaqualiflcations fro* registration.
HFA agrees with the CoBvlttae. that Section 6a(2) (D) (iii) o£
the Act can be strengthened by including felonies which
involve dacaption of cuatoaera. In HFA'a view, such felon-
ies bear directly on a person's fitness for registration.
K7A also favors awending Section ea(2)(I»(iv) of the
Act to include serious felony offenses under other sections
of titles 18 and 26 of the United States Coda. Virtually
every criminal federal case involving commodities or securi-
ties includes violations of one or more of the fallowing
federal criminal statutes which are not currently included
in Section aa(3)(D)<iv) of the Act:
1) le U.S.c. s 1001 [false statenents) ;
2) IB U.S.C. S 371 (conspiracy) ;
3) 26 U.S.C. ff 7201 and 7206 (tax evasion and tax f raud) ;
4) 18 U.S.C. S 1S03 (obstruction of justice] ;
5) IS U.S.C. f 1623 (perjury);
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6) 18 u.s.c. f 2314 (int«rstat« transportation of stolen
property) ; and
7) IB U.S.C. ss 1961-1963 (rackeCacrin?) .
KFA cantenplatas that Section 8a(2)(D)(iv} will b* sig-
nificantly Btrengthanad it thasa cerious Cslony convictions
are added to the list of disqualifying offanses.
Sactlon Ba(2WBl of tha Act
Section aa[2)[E) of the Act currently disqualifi«B
persons who havs been found to have violated certain serious
provisions of a nunber of specified federal and state
statutes and the regulations, rules or orders thereunder.
The Coimiisslon has indicated in an interpretive notice that,
as currently dratted. Section 8a(2) (E) may be interpreted to
authorize the Conunission to affect the registration of a
parson subject bo findings described In such Section, which
are made In a proceeding initiated by a private party either
in a court of law or In a reparations natter. The Conmis-
slon has indicated, however, that such private litigation is
Intended priaarily to provide restitution to the customer
and Is not intended to be punitive in nature. Thus, the
Commission has decided that it may be inappropriate to use
findings in such proceedings to affect the registration of
any person under Section 8a(2) (E) of the Act. However, the
Coamission has made It clear that such findings may be used
to Initiate a disguallCicatlon procaadlng under Section
Sa(3) (K] of the Act. Sfifi Appendix A to Part 3 of tha
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CoHilsslon Ragulationa, 1 Coaa. Put. L. Rap. 13330L at 3346
(1984).
NFA mupparta tha propoaad aaandManta to Saction
8a(3>(B) which would codify tha Coaaiaaion'a intarprativa
atataaant on thla Saction. nta propoaad aaandBanta rastrict
this Saction 's applicability to adalnlatrativa procaadinga
brought Bay tha Co^laalon, or any Cadaral, atata or othar
govamaantal body. HPA alao aupporta aaandlng Saction
8a(3>(K} to Includa vlolatlona of tha Rackataar Influancad
and Corrupt Organlsatlona Act ("RICO"}. HFA aharaa tha
Coaaittaa'a viaw that vlolatlona of RICO ara aa aarioua. If
not aora ao, than certain of the vlolatlona of the atatutea
currently enuaeratad in Saction Sa(3) (E) .
Purtheraore, HFA favora amending thla Section to
include vlolatlona which involve decai^lon of cuatoaera.
Thla language, which tracks the propoaad oKendaent to
Saction 8a(2) (D) (ill) of the Act, would encoapaaa violations
which bear directly on a person's fitness for registration,
but which aay tall outside the paraaatars of Saction
ea(3)(E} of tha Act as currently drafted.
Section BafZlfSl of tha Act
Section 8a(2)(G) of th« Act dlsquallfias troa ragistra-
tlon any parson who willfully aakaa any falaa or alaleading
stataaant or oaittad to atata any aatarlal fact in hla
registration application with raspact to aattara aat forth
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in Sactlons aa(2] (A) through (F) of th* Act. HPA supports
th« propoB«d amendMents to this Section which would dis-
qualify any psrson who aaXas any willful ■atsrisl ovlasion '
or aislsading statsmsnt conc«mlng any disqualification
und«r slthsr Section 8a(2} or Section 8a(3) of the Act.
It is wall-«stabliah«d that MFA's fitness deteraina-
tions depand, in part, on full disclosure of all material
information. HFA agrees that it is highly inappropriate to
allow an applicant to obtain a temporary license or for a
registrant to remain registered, trtio has failed to disclose
the fact that he may be subject to a statutory disqualifica-
tion. The inappropr lateness of allowing a deceptive person
to obtain or' retain registration does not lessen because he
may be subject to a Section Sa(3] rather than a Section
Ba[3) disqualification. NFA believes that Congress can
undersc'ore the importance of full disclosure on registration
applications and amendments tharato by adopting the proposed
HFA also supports the proposed amendments which make it
clear that omissions and misleading statements in updates to
registration applications will disqualify a parson from
registration.
Section Ba(3WDl of tl^e Acft;
Section 8a(3](D) of the Act disqualifleB from registra-
tion persons convicted of felonies other than tha type
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specitiad in Sactlon SaO) (D) of th* Act within tan yaars of
filing a ragistration application, as wall as parson*
convicted o£ Sactlon Sa(2)(D) typa f«Ionl«s Mora than tan
yaars pracading tha tiling ot an ^^licatlon.
HFA favors a**ndlng Sactlon ea(3)(D} to includa not
only situations whara a parson has actually baan convlctad
of a falony, but also thosa instancas whara a parson plaads
guilty to such offansa, avan though not roraally convictad.
In August 19BB, MPA adoptad tha policy of initiating a
dlsgual ideation action undar tha "othar good causa" provi-
sion of Section 8a(3)(K) against parsons who plaadad guilty
to a felony, although adjudication was withheld. HFA
Instituted this policy Baecausa it detemined that a person
who pleaded guilty to a felony Bay be unfit to ba reg-
istered, regardlasB of trtiathar or not ha was fonully
convicted. HFA was concerned that such person's treatnent
under the Act not be contingent upon the vagaries of par-
ticular atatas* laws.
The proposed aaandaant to Section 8a(3)(D) will codify
NFA's practice of Initiating diwiualification proceadlngs
against parsons who have pleaded guilty to a falony offense
even though they have not been foraally convicted. HFA
expects that the proposed amendment will have tha affect of
promoting uniformity of treatment among slailarly situated
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NFA also BUpportB tha Committae'e proposal to aliinlnBte
the t«n-year limit on falony convictions othor than tha typ*
specifiad in Section 8a(2) of tha Act. Currently, in
appropriata casas, NPA initiates actions against parsons who
h«v« baan convicted of falonlas othar than tha type speci-
fied in Section ea(2) mora than tan years ago, under the
"other good causa" provision of Section 8a(3) (M) of the Act.
HFA agrees with the Cammittee that a person's felony convic-
tion, ragardlesB of Its age, bears directly on a person's
fitness for registration and therefore favors eliminating
the ten-year limit contained in Section 8a(3)(D).
HFA recognizes that the presunptlon of unfitness
arising fro* such a conviction or guilty plea may well be
less than that arising from a mora recant conviction.
Moreover, it nay very well be that a person with an older
felony conviction or guilty plea «ay be able to present more
substantial rehabilitation evidence than someone who had
pleaded guilty or had been convicted of a felony >ore
recently. However, it Is HFA's view that these factors
relate to the issue of what weight should be accorded such
conviction or guilty plea, not irtiether such conviction or
guilty plea constitutes a disqualification in the first
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aaetlon B»(3WB1 of th« Act
Saction Bb(3) (B) of th* Act disqualifies troa registra-
tion persons who have been convicted of certain serious
■Isdenaanor convictions within the past ten years. HFA
supports the CoBBittea's pro|^sal to asend Section 8a(3)(B)
by elieinating the tan-yaar tiee liait and by including
instances whara a parson pleads guilty to a aisdeaeanor
oCfanse, although not foraally convicted. These proposed
aaandaents parallel thosa suggested under Section 8a(3)(D)
of the Act.
The proposed changes to Section 8a(3) (E) would sarv* to
codify NFA'b practice oC initiating cases under Section
ea(3)(N) of the Act, against persons who, although not
formally convicted, pleaded guilty to serious misdeBsanors
and against persons whose serious eladameanors are over ten
years old. nfA expected that the proposed amendMsnts will
promote uniformity of treatment among similarly situated
persons .
NFA also supports the proposed enendnents to Section
Ba(3)(E) which add to the list of serious aisdeMeanora those
Involving deception of customers, moral turpitude and
conduct inconsistent with just and equitable principles of
trade. HFA also favors supplementing the list of statutes
currently enumerated In Section 8a<3) (E) to Include those
involving conspiracy, tax evasion end tax fraud. HFA agrees
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that adding these klnda of aarlous alBd«K«anors to Section
8a (3) will significantly atrengthen tha raach of that
provision.
sj.ctiBiL.8,a.ULCg) Sit. m«,. Act
Section Ba(3)(a) of ths Act dlsqualiCies from ragistra-
tion a parson who willfully nakas any materially false or
nisleading statement or who willfully omits to state any
material fact in such person's application, in any report
reguired to be filed with the Commission, or in any proceed-
ing before the Comnission. In view of the fact that HFA
also conducts registration disqualification proceedings, HFA
agrees that it is appropriate for the Comaittee to adopt
amendments to Section 8a(3} (G) of the Act which will encom-
pass willful omissions or materially- false or misleading
statements made by a person In the course of a disgualiflca-
tion proceeding conducted by HFA. NFA also supports the
proposed amendment that makes it clear that omissions and
false and misleading statements contained in updates to a
person's registration application will constitute a dis-
qualification from registration.
Section ea(31 fHl of the Act
Section 8a(3)(H) of the Act disqualifies from registra-
tion persons who have pleaded nolo contendere to criminal
charges of felonious conduct, or who have been convicted in
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a stata court or in a foraign court of conduct which would
constitute a talony undar federal law i£ th« pff*n*a has
baan conaittad undar fadaral jurisdiction. HFA supports tha
proposed aaendasnt to Section 8a(3}(H) which would broaden
this provision to ancoapass convictions in Dnitad States
■llitary courts of ottensas regarded as felonies under
federal law.
It has baan HFA's experience that United States aili-
tary courts. Ilka certain state and foreign courts, do not
always explicitly distinguish between felony and ■isdameanor
offenses. Thus, it seees appropriate to include a reference
to such courts in Section 8a(3) (H) of the Act.
In the past, NPA has initiated under the "other good
cause" provision of Section 8a(3)(H) of the Act, an action
against a person who was convicted in a United States
Military court of an offense which would ba considered a
felony under federal law. The proposed aaendnent would
codify MPA's practice in this regard.
Section Ba(3KJ) of the Act;
Section 8a(3)(J) of the Act currently disqualifies froai
registration persons who are subject to an outstanding order
denying, suspending, or expelling such parson froa Banber~
ship in a contract sarket, a registered futures association,
orany other self -regulatory organization ("SBO"), or
barring or suspending such person front being associated with
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any uember or membars of cuch contract varket, registered
futures association or SRO.
HFA favors amending Section Ba(3) (J) of the Act to
includ« as disqualifications frou registration denials,
bars, suspensions and expulsions from foreign regulatory
organisations which the Commission has recognized as having
a comparable regulatory program to that of the Commission's.
The proposed amendment will prevent persons who have been
severely sanctioned by foreign regulatory bodies from
obtaining registration under the Act.
Section 9a[Jl(K) ,of,.tafl_ftct
Section 8a(3)(R) Of the Act disqualifies from registra-
tion persons who have been found by any court of competent
jurisdiction or by ariy federal or state agency or other
governmental body, or by agreement of settlement to which
any federal or state agency is a party to have violated any
statute, rule, regulation or order thereunder which involves
a serious offense such as embezzlement, theft, extortion,
fraud and the like. NFA supports amending Section 8a(3) (K)
of the Act to Include other serious offenses such as decep-
tion of custOMers and conduct inconsistent with just and
equitable principles of trade. NFA agrees with the Commit-
tee that the proposed amendment will serve to tighten the
requirements contained in Section ea(3) (K) .
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I have just oiM final point ragarding r*glatratlon . If
Congraas dacidas to raquira tha raglatration oC floor tradara, I
can aaaura you that HFA would ba capable of aaau>inq that pro-
caaalng function If raquastad to do so.
IV. TEtaifcBKBTIHG FRAUD
No job Is aora iaportant to HFA than tha pravantion of
d«c«ptlv« sal«B practicas by HFA Mambars, and that is praciaaly
whsrs wa hava focusad our rulaaaklng and rula anforcaaant
afforts. Tha antira futuras industry can ba justly proud that
its salas praetica ragulations ara aacond to nons in thalr
coBprahenaivensBB and affectiveness.
To bagin with, thara's tha CFTC ragulations ragardinq
risk disclosures for both futuras and options. Tha Cuturaa risk
disclosura statamant in CFTC Ragulatlon 1.55 dascribas tha risks
of futuras trading in a one-page stataaant written in plain
language that would scare the spots off a leopard. The options
risk disclosure is equally effective and thorough. HFA's "Know
Vour CustoDer" rule takes those risk disclosures one step further
by requiring that certain custoaars have to be warned that
futures trading is juat too risky for thea and that they do not
belong in these markets. On top of all of that, HFA Conplianca
Rules not only bar blgh-pressure sales practices — they actually
raquire that any standardized telephone solicitation which even
nantions the possibility of profit nust be accospanied by an
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equally prominent statement of the risk of loss. Considering all
of these rules, together with all of the other anti-fraud pro-
visions of the Commodity Exchange Act, CFTC regulations, exchange
rules and NFA rules, I am not aware of any industry selling any
proiSuot anywhere that has a more pervasive network of customer
protection regulations.
Furthermore, those regulations are being aggressively
enforced. Comparing NPA's first three years to the last three
years, sales practice complaints increased from 12 to 66, expul-
sions from 12 to 39 and fines fron just over $100,000 to over
31,000,000. All of this is in addition to the numerous sig-
nificant sales practice cases which the Commission has brought.
Notwithstanding all of the rules that already exist and
the effective enforcement cf those rules, NFA feels that if even
one customer is the victim of a deceptive or high-pressure sales
pitch from an NFA Member, that is one victim too many, and we
would welcome any legislation which would help combat that tiny
percentage of our membership which engages in this type of
conduct. Unfortunately, we have serious rasarvations whether the
proposed legislation would have that effect.
Ho rule devised by «an can prevent someone fron com-
mitting fraud if that's what they are intent upon doing. The
proposed rule is no different. It can ba broken just ss the
existing rules can be, and I doubt that detecting violations of
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such a rul* would be any aasiar than th« nilas that ara currantly
Nhile the proposad rule Bay not aCCact that Cringa
•laaant of our buslnssa which usas dacaptlva aalaa practicaa, it
could well be unduly burdansoBa to the overwhelming aajority of
our Maabara who are honeat, legiti«ata businasBBan. IdentlCylng
juat which "first-tiaa" custoaars ware solicited by phone could
pose substantial prablana in the real world. In addition, there
■ay be sophisticated, institutional custoaers whoae trading aay
not be exclusively hedga trades for whoa this "protection" would
b« both unnacessary and potentially harmful.
If there was « way to narrow the focus of this concept
to pinpoint the relative handful of unscrupulous firas in the
industry, NFA could support the proposal. In its present fora,
however, we have reservations as to trtiether its doubtful benefits
outweigh Its substantial burdens.
V. PUBLIC REPRESEWTATIOH QN THE BOARD
With respect to public representation on our Board of
Directors, NFA has always recognized the Invaluable perspective
which public representatives bring to the regulatory issues HFA
deals with. Prom our vary inception, our Articles of Incorpora-
tion have always provided for public representatives on our
Board. Three of the 42 persons on our Board are elected as
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public represantativas. Their varl«d backgrounds bring a wealth
of industry, legislative and academic perspectives to our Board.
But those public representatives are not the only
outside voices on NFA's Board of Directors, Covmercial firms and
connarcial banking Institution* are not ragulatad by HFA and yet
we hav« always r«coqniz«d that these Important users of the
futures sarkets could bring valuable insights to our Board.
Therefore, from our very Inception, our Articlss of Incorporation
have provided five additional seats on our Board for those two
categories, with two seats allotted to commercial banks and three
seats provided for commarcial firms, in all, eight of the 42
seats on our Board, or roughly 19t, are set aside for persons who
are not registered in any capacity under the Act and who are not
regulated by HFA.
Th« languaga of the proposed amendment to Section 17(b)
of the Act would require that at least 20t of our Board consist
of "outside members." I assuns that the Conmittas's intent is
that the phrasa "outside members" would include both public
representatives and commercial bank and comnarclal firm repre-
sentatives since they are all "outside" H?A's regulatory juris-
diction. If my assumption is correct, MPA is already in substan-
tial conplianca with the proposal.
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VI.
Tba iaau* of qualification atandards to s«rv* on HFA'a
Board of Dlractor* and disciplinary coMiittaaa ia on* vhich our
Exacutlv* Coiaitta* la currently conaldarlng. Wa hava hiatar-
ically b«an blaasad at NFA with a Board of Olractors and dia-
ciplinary connittaas which hav* baan drawn froa avonq tha «aat
raapactad laadars in tha industry- Ha cartalnly support any
proposal which will ansur* that that tradition contlnuas.
It May well ba appropriata to dlaqualify froa Board or
canmitt** nambarshlp parsons who hava B>««n found to hav* coa-
mlttod "a major rula violation." Ha would caution the Covusittea,
howaver, that in d*t*rwining what constitutss a "aajor rul*
violation," tha focus Must b* not on tha rul* but on th* viola-
tion. All HFA conpliance rules ara deaignad in otia way or
another to protect the public. A violation of any of those rules
could so undernine one's confidenc* in a person's judgnant that
h* should b* disquallfi*d from Board membership. At the saue
time, a violation of any of those rules may be technical in
nature. The best way to deteralne a "Major rule violation" Is to
focus not on the rule that was violated but on the sanction that
was iMposed. If that reflects the Committee's intent, we cer-
tainly support the proposed amendment.
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VII. ETpiCS TRATHIHfi
NFA also agrae* with tha ConnittM on the importance of
ensuring that registranta receive adequate training concerning
their ethical responsibilities to their custoaers. To that end,
NPA has already oade significant changes to the content and
format of the National Commoditiaa Futures Examination. With
very limited axcaptions, NFA require* all applicants for AP
registration to take and pass this proficiency examination. The
content of the axam has been changed over tha laat few years to
put greater emphasia on testing the applicant's Icnowledge of
regulatory requiraments as wall as market knowledge. The gues-
tions on regulatory requirements center on those rules concerning
fair dealings with customers.
HPA's Board took this process one step further in 1987
when it approved a fundamental change In the way that the exam is
graded. For grading purposes, the exam is divided into two parts
— market knowledge and knowledge of regulatory requirements.
Tha two sections are graded separately and an applicant must pass
both sections of the exam in order to become registered.
The changea outlined above have already improved the
Industry's attention to ethics training, but we fully support any
proposed amendments which will focus even greater attention on
this critical area. However, given the current focus of the
proficiency exam on ethical issues, we question the efficiency of
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r«quiriiK[ newly rttgist«r*d KPm to tak« an ctlilcs r*fr««h«r cours*
within six Bonths of passing th« cxaa and bccoBlng rcgistarad.
VIII. BMDTHOBIZATIOH PCTIOD
NFA alao strongly supports tha proposal to aaka tha
CFTC a parsanant a^ancy. Tbla proposal would ansura continuing
congrassional ovarslght of tha CFTC but would allalnata currant
uncartaintlas about tha agancy's axlstanc* and could sarva to
Incraaaa Ui« CoMilsslon's rasourcas to affactlvaly ragulata tha
tuturas Barkats. In our vlaw, such a proposal Is both walcoaa
and long ovardua.
DJS:ca(MISC)
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APPEHDIX TO
TESTIMONY OF ROBERT K. HILMOUTH
PRESIDENT
NATIONAL FUTURES ASSOCIATION
BEFORE THE HOUSE AGRICULTURE SUBCOHHITTEE
H CONSERVATION, CREDIT, AND RURAL DEVELOPMENT
RE: H.R. 2869
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NATMMUL nmHm ASSOCUTKM
A coNranima commitmdit to excillehce:
A MPOIIT AS or KCIMBni U, IMS
DUCVnVE SUMMARY
I. INTROOUCnON
The veiy concept of Mir-regulatlon Is now under a cloiK) of suspicion. Recent preu raportf
concerning Investlgstlons of an unspecined number of floor brokers and floor traders have
caused some to questton whelt>et salf-rafulaUon can be trusted, even with dingant
oversight by the Commodity RAures Trading Commission. The ultimate question ts
whether Indus^ professionals have demonstrated the ability end the wllllngnaaa to
protect the public by policing themselves. To answer this question, Congress needs not
speculation or rumor but cold, hard facts. This report prwldes those tacts arKl presents
overwhelming evidence that se/^egulation is tough regulation.
The list of responsibilities which Congress laid out fOr NFA was both clear and ambitious.
NFA was never intended to duplicate the elTorU Of either the Commission or the
exchanges, and It has not done so. NFA's regulatory efforts have focused iwt on trading
floor activity but on all other aspects of Its Members' dealings with the public. NFA's
primary responsibilities Include:
■ conducting investigations and audits to delect violations of those rules:
■ taking disciplinary action to punish and deter such violations;
■ preventing unethical flmis ftom entering or remaining In the irxJustiy by per-
forming the registration furvnion on behalf of the Commission;
■ prever)tirv fraud by educating the public concerning the rislts and opportuni-
ties in the futures maritets so that customers can make fully infomied invest-
ment decisions; arxl
■ providing customers with an arbitratkm fbruin which olTefs a fair, prompt and
inexpensive means of resolving futures-related disputes.
Those are the jobs which Congress and the Industry have assigned to NFA. In each of these
areas and the others discussed In this report. NFA's performance shows thet at NFA self-
regulation rtot only works but excels.
II. COMPUANCE RELATED MATTERS
The fonnuia for effective 5elf'regulatk>n at NFA is no real mystery. It irT/ok«s three basic
components — strong mies, thorough investigations and tough enforcement actkms. m
the past three years, NFA's continuing commitment to excelleiKe has been evident In all
ttvee of these critical areas.
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subjects ranglngfrom telemafkettngfraud and deceptive advertising to foreign futures and
options:
■ Complksr>ce Rule 2-29 bars the use of high-pressure sales practtoes and sets
stria content requirements for ell telephone solicitations and advertising
materials used by NFA Members;
■ Compliance Rule 2-30 sets an Industrywide Kr>ow Your Customer standard and
provides that certain customers must be told that ftjtures trading Is simply too
risky for them In light of their overall financial conditkin;
■ NFA 's Guideline for the Disclosure by FCMs and IBs of Costs Associated with
Futures Transactions ensures that customers of NFA Members are provided
with sufTiclent information about the costs of futures trading to make an
informed decision artd to compare the fees charged by different firms:
■ NFA Compllartce Rules and Bylaws were amended to exterHJ NFA's customer
protection rules to the activities of NFA Members regarding foreign futures and
option transactions: and
■ NFA's pronciency testing program was Improved with Increased emphasis on
the industry's ethical and regulatory requirements.
The toughest njles In the world, however, will not help protect custorr)ers If violations can
routinely go undetected. NFA has added to its standard auditir^ and investigative
procedures a new program using covert Investigative techniques to learn firsthand what
NFA Membersare telling prospective customers over the telephone. Using phone numbers
with out^of-state area codes and coiresponding mailing addresses, NFA staff members
have posed as prospective customers to receive telephone 50lk:ltatlons directly from
Members. This highly successful program has been expanded by enlisting the assistance
of state securities regulators from around the country and has produced a number of
successful disclpllrtary actions.
The adoption of these new njles and Investigative programs has led to dramatic Increases
In all aspects of NFA's enforcement program. The overall number of disciplinary proceed-
ings Initiated t^ NFA's Regional Business Conduct Committees ballooned fiam 51 in
NFA's first three years to 119 In the last three years. Moreover, the lion's share of that
Increase comes from cases Involving telemarketing fraud or other forms of deception of
customers.
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M
31
30
!.
■1
20
1
1
10
0-
k«Bll
1
1983 1984 1985 1986 1987 1988
The bottom line, of course, is not how many Complaints were Issued but what types of
sanctkins were Imposed. Once again. tt>e numbers tell the story. The most severe
sanction which NFA can Impose Is expulsion from membership slr^ce that effectively baa
the f\nr\ or individual from the Industry. In Its first three years. NFA expelled 12 Members
through disclplinaiy proceedings compared with 15 expulsions In 1987 elone and 31 more
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1983 1984 1985 1986 1987
Business Conduct Comminees can also Impose fines end have done so In record num-
bers over the last three years. In NFA's first three years combtned. Business Conduct
Committees Imposed s total of SiOS.OOO In fines, a figure which was surpassed In each
of the last three years. Fines In 1986 totalled $157,000, almost doubled In 1987 to Over
S2d3,lX>0 and more than doubled In 1988 to over S719.000.
23-500 0-90-15
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RNES LEVIED BY BCCS
1, 1983 through Decembw 31, 1988
800000
>71fi.475
600000'
1
^H
400000-
^m1
I
200000
sM\
H;
$24,000
t3S.0O
/
3 «46,000 ^^II^^B
1
0-
I^^SkIH
1983 1984 1985 1986 1987 1988
III. REOISTRATION AND MEMBERSHIP
One of the best ways to protect the public from unscrupulous firms and Individuals Is to
keep those people out of the Industry in the Tirst place. That Is the Job that NFA has been
handling since October l, 1985, when It assumed responsibility for registration denial aixl
revocation proceedings for all categories of registrants except floor brokers, leverage
transaction merchants and their associated persons. Just as with enforcement matters^
effectively screening out unethical individuals arvl firms In the registration process
requires three basic components: specific legal criteria to detemilne registration fitness,
a reliable screening process to identic the applicants who do not meet those criteria arMl
effective proceedings to bar those persons from the Industry.
The legal criteria used by NFA are those supplied biy Congress. In 1982, Congress
amended the Aa tc establish a two-tier system of dlsqualiftcations from registration. The
more egregious disquallTicatlons, such as prior revocations and certain ^pes of feiony
convictions, are set forth In Se^nion 8a(r) of the Act while Section 8a(3} sets forth less
serious disqualificattons. such as certain misdemeanor and felony convictions and
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actions by selT-regulatory bodies. Most of these statutory disqualifications provide very
specFfic guidance. The needed fiexIbilRy comes from Seclkm Ba(3)(M) of the Act which
provides that registration ma/ be denied or revoked for 'ether good cause.' Over the last
three yesrs, NFA's Membership Committee has appiied the 'other good cause' standard
and the other statutory disqualifications on a case^-case basis and has developed a
botly of case law which has tightened and Improved the registration screening function.
Though the legal criteria set forth In the Act set parameters forjudging registration fitness,
it is NFA's application review process which applies those criteria to the real wond. All
registration applications processed by NFA are subject to close scrutiny to determine
whether the standards set by Congress have been met. Each application contains a series
of questions which have been specincaiiy designed to track the statutory disquaiiHcstions
set out in the Act. Any 'yes' answer to tr>ose questions will automatically bar the applicant
from receiving a teniporary license and will trigger an intensive review and possible denial
proceedingbyNFA. Of course, with regard to critical Information such as en applk:ant's
disciplinary history, NFA does not rely solely on the appikiant's answers. NFA seeks
independent corroboration of the disciplinary history information on each application by
conducting an FBI fingerprint check and a review of CFTC and SEC disciplinary records, in
addition, any material derogatory infonnation. received through NFA audits or investiga-
tions, from discharge notk:es from past employers or from any other source will be
reviewed and, if appropriate, a denial proceeding will be initiated. Less critical information,
such as employment and educational history data, must be verified by the applicant's
sponsor. The sponsor must, at the risk of its own registration, sign a sworn statement that
It has done so. NFA has recently taken steps to further supplement the sponsor's
veriTication with its own spot-check of educational and employment inforrttation on
randomly selected applications.
The ultimate proof of the thoroughness of the screening process is the number of denial
or revocation proceedings whfch have been Initiated, in the last three years, NFA has taken
action in almost 200 cases to deny or revoke registrations. Furthennore, the 84 cases
brou^ in 198S represent a 50% increase over the previous year's total.
Not surprisingly, a disproportionate share of these cases Involve a relative handful of
sponsoring firms, in fact, just six sponsoring firms, .017% of NFA's membership, have
been involved in 23% of the registration actions NFA has initiated. Frve of those sixfinns
have already been the subject of NFA disciplinary actions, three are now out of business
and barred from the industry and two have been subject to substantial fines.
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TOTAL NUMBER OF FITNESS ACTIONS INITIATED BY NFA
From Jwniary 1. 1986 through DMwnbw 31, 1988
100/"
In processing the thousands of applications wftk^ come In each year. It Is Just as Important
to process promptly the 99% of the applicants who are qualified as It Is to screen out the
1% wtio are not. NFA has scored well on both counts. The processing time required to pant
temporary licenses has steadily been reduced from an average of 8.7 days in 1986 to an
average of 4.4 days In 1988. Furthermore, this 50% reduction In processing time was
achieved at the same time that there was a 25% reduction In the Registration Depart-
ment's staff, largely as the result of refinements that have been made to NFA's computer
programs and capablllbes.
IV. ARBITRATION
Congress has always recognized the value of arbitration as a means of resoMng customer
disputes in the futures Industry. In feet, in 1974, when Congress first passed the enabling
legislation which led to the creation of NFA, it specifically required any registered futures
association to provide an arbitration program or an equivalent program as a condition of
its registration.
In Its first three years, NFA built from scratch an arbitration prc^am which provides
custcmers In the futures lr>dustry with precisely what Congress intended — an expeditious
forum forthe fair resolution of disputes. Rules were developed, procedures Implemented
and a nationwide pool or volunteer arbitrators was assembled.
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In the last three years, NFA has built on that foundation to continue to provide e high quality
and inexpensive alternative to litigation. The dramatic growth of NFA's arbitration program
Is the clearest sign of its qualRy and Its acceptance by the Investing public it is designed
to serve. In Its first three years, the program received approximately 300 Demands for
arbitration from customers. In the last three years, that number more than tripled with
almost 1.000 Demands being filed, in fact, 1988 alone saw a 30% Increase In filings over
the previous year with almost 400 Demands filed. With the Increase 01 cases filed there
has been a corresponding increase In cases which have been concluded.
DEMANDS AND COMPLETED CASES
By Operating Year
□ Cases closed tnrou(n Setllement
■ Oamanos
1987 1988
PerXx) 4/1/83 — S/30/83
With such exponential growth, of course, comes a great challenge — the challenge to
maintain all of the advantages arbitration is Intended to provide. NFA has met that
challenge. In its last three years, the arbitration program at NFA has continued:
■ to provide an inexpensive altematlve to litigation. Despite the growth of the
program, customer filing costs have remained modest.
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■ to provide a eonvwiltnt forum for customars. UFA hat mstntslnad a pool of
vDkirftaar arbKrstors In 48 states and contlrKWS to routkwly pravUe customars
with hearings m locations corrMnlant to the customers.
■ to provkte an informal program. NFA's mtes and procedtres are designed to
ba simple enough that any customer can easily represent himsatf If he chooses
to without becoming lost In a maze of tegellstlc maneuvering.
Most Important of all, NFA has continued to provide a fair forum for the resolution of
disputes. The statistics on recovery of fiirtds by customers through NFA's arbitration
program emphatically ret>ut any contention that customers do not get e fair and impartial
hearing.
NFA has also resportdeO to the challenge of graoitn by refining Its niias, slmplHying Its
procedures, expending Its Jurisdiction end computerizing Its dociteting system.
V. CONSUIMER EDUCATION AND ASSISTANCE
NFA recognizes that the best protection against investment freud Is a welt Informed
consumer and has, Oterefore, eiways made consumer education one of Its most Impor-
tent priorities. Tlvoughout the last three years. NFA has continued to spreed Its message
of consumer awareness through every available medium — by radio, television, fllm,
seminars, printed materials and direct contact with members of the public.
That direct contact with the public occurs hundreds of times each week with the use of
NFA's toll^ea number. The highly trained staff in NFA's Information Center handled over
125,000 calls In 1988 alone, many from customers with questions about individuals or
flmis with whom they were considering doing business or with requests for NFA
educatkirMl brochures. But the telephone Is not the only way NFA reaches out and touches
the public. NFA has continued to publish and distribute e wide variety of brochures
concerning the futures Irtdustiy and the steps which customers cen take to ertsure that
their Invesment decisions are based on full and accurate mfbrmatlon. NFA representa-
tives have also continued to appear frequemiy on various radio and televisksn programs
focusing on custonwr protection and the futures Industry. In 1989, NFA took this practice
one step further and produced its owni4'minute film entitled FOrthelm&stor'sPmtactlon.
The film provides basic Informatkx) on how the ftrtures Industry functions end describes
the services which NFA offers to the public. In all of mese educational activities, NFA works
closely with other groups end agencies such as the American Council on Consumer
Interests, the National Association of Consumer Agency Administrators, the American As-
sociatk)n of Retired Persons and the U.S. OfRce of Consumer Affairs.
VI, OTHER CUSTOMER PROTECTION SERVICES
Though the customer services and programs discussed above are NFA's prlmaiy raspon-
sibiilties, they are certainly not Its only ones. Repeatedly over the past three years, NFA
has been called upon to take on additional responsibilities, and each time NFA has
answered the can. These additional responsibilities end projects are detailed In this report
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and include the following activities:
■ NFA has saved customers who were InvoKied in a class action suit against a
rirm whicn had previously been expelled from NFA tens of thousands of dollars
by serving as a court-appointed administrator of a $5.3 million settlement
fund. NFA was requested to administer the fund by the court and by the parties
end agreed to do so since by recovering only Its out-of-pocket expenses NFA
could preserve more of the settlement furtd for the customers Involved:
■ At the Commission's request. NFA performed a comprehensive study of the
Issue of FCM insolvencies, the protective measures already in place to guard
against them and the feasibll% of various additional protective end responsive
mechanisnw:
■ NFA has continuously worked closely with federal and state law enforcement
and regulatory ofTicisls to assist In any way possible with any futures-related
Investigations. For example, NFA meets on a quarterly basis with representa-
tives of the FBI and the Postal inspector's Office to review NFA disciplinary
actions Involving potential criminal violations. NFA's cooperation has resulted
In a number of successful Investigations arKl prosecutions:
■ NFA has been an active participant in the Justice Department's Securities and
Commodities Fraud working Group. This group consists of federal and state
prosecutors and regulators along with self-regulators from the securities and
futures industries. The group meets quarterly to discuss issues invoMng
techniques arxj regulatory coordination; and
■ At the request of Congress, NFA assisted the Commission In conducting a
survey regarding the leverage Industry and the possible consequences of
lifting the cun'ent ntoratoria on firms entering that business.
NFA performed each of these tasks without In any way diminishing its other ongoing
customs protection programs. Furthermore, while Increasing the scope and effectiveness
of its regulatory activities over the last three years, NFA has acbjally reduced the cost paid
for NFA services by the trading pubtk: which it serves. The NFA assessment fees for CxXh
futures and options trades have steadily decreased from 33t for futures and 20t for
options when NFA began operations to a projected level of 20t for futures artd 124 for
options effective July 1. 1989.
VII. CONCLUSION
A periodic review by Congress of the effectiveness of the concept of setf-regulaiion in the
futures Industry is both necessary and welcome. Ultimately, such a review con only berwftt
the industry, its regulators and, most importantly, the publk: we are all trying to serve. To
be effective, that inquiry must focus on documented facts. NFA strongly believes that the
documented facts concerning Its record of accomplishment throughout Its history have
vindicated the confidence that Congress, the Commission and the industry have placed
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Supplemental Submission
Before the Conservation, Credit and
Rural Development Subcommittee of the
^ House Agriculture Committee
1
I ! 1
ilR
* 1 Ip
1 II
t II
1 II
V "
^^^S==r-iJ
Irt
m ■■ ■
# ChicagoBoanJanhKle
July 20, 1989
„Coogle
Exacutlva
TMU OF eOMTEHTS
Foraign Co^^tition
Ovsralght and Enfarcaaant
TO* Padacal Invaatlgation
I^provad Narlcat Enhancaaanta
R.R. 2B69
Conclusion
J^pondix 1; Foraign Coapati-tlon Tablaa
J^pwidix 3i Brokar Trading (CFTC Subaiaaiona)
J^tpandix 3: 1987 and 19S8 Dlaclplinary Action Svuoaary
i^tpandix 4: H.R. 2S<9
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Tha Board of Trada of tha City of Chicago is tha world's
oldaat and largast futuraa axchanga, not only because OBOT sarli
ara tha Boat liquid cost-eff Iciant aarkaci in tha vorld, but also
bacauaa of tha Exchanga's comiiitt>ant to tha highest degra* of
aarkat intaqrity. Professional aarkat iiaer confldenc* In both the
intagrity and afficiancy at CBOT >arkata ia bast daaonstratad by
tha racord voluaa which tha Sxchanga hac axparlancad aaeh ysai Cor
tha laat dacada.
Tha Exchange doaa not nov condona, and navar ha> condoned,
trading abuaaa of any kind. Poundad on tlia concept oC seLf-
ragulation, the Exchange has conaistantly policed and disciplined
its ovn ■embers. Ifhen floor trading abusaa are detected and
proven, t:hi> Exoh.inqe has always sanctioned violators
appropr i.i'i^ly including rrie Imposition of suspensions finaa and
•xpulaione. Tha Exchanga's commicnent to preaarvlng the utvoat
a«r)cet integrity ia undlainiahad today.
Tha cornatatona of aarkat Integrity ia aaabarshlp integrity.
The Board of Trade haa always maintained the highest standards Of
aamber qualification. Aa United states Attorney Anton Valukus
recently aeaartad, "tha best experts in the world concerning
trading practicae are tha aambara of tha Board of Trade."
Additionally, tha Departsent of Investigations ( Audit's
("OIA") use of the Computerized Trade Reconstruction system
("Cnt") is a vital aaana of detecting rule violations thereby
Insuring market integrity CTTR is universally acknowledged to ba
tha bast audit trail in any of tha world's financial
■arkatplacas . slailarly, CTR-FLUS, the Exchange's surveillance
ayatem, is an unaurpaased system foi the detection of potential
■arkat abuaaa. Indeed, the CTR-FLUS system highlighted as a
potential abuse the trading activity of an apparent P&I agent
trading as a member at tha exchange, presumably pursuant to a
federal investigation. As U.S. Attorney Valukus has acknowledged,
tha Board of Trade haa ■■ . . . tha raaourcas to identify trading
practices in which fraud has occurred."
Regardless of this unparalleled record of success, tha
Exchange has consistently recognised that the process of iaproving
its aarkats and surveillance systems la ore of constant
evolution, an an ongoing basis, the Exchange exaainea ita aarkat
■achanisms and surveillance techniques to insure that it remains
the world leader in this regard. This self examination process
has intensified recently in tha wake of tha sensationalized pvasa
reports of P6I and United States Attorney investigations into
alleged trading floor abuses at tha Chicago Harcantlla Exchange
and tha Board of Trade.
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IQiil* no conf iroation of any trading abuses has yet been
oftarad, no indictoenCS isauad, and no convictions obtained, tiM
Ckchanqa has navertheless racognlxed that continUBd public
confidence in the narlcetplace roqulraa an intensive review of
market nechanisma as well as the •urvaillanca and disciplinary
proceasea. For the paat several aonths, special exchange
coamltteea have engaged in detailed reviaws and exasinations of
the Exchange's market structure and enforcement mechonisna. Those
deliberations have resulted in reports to the Board of Directors.
The Board, in turn, has approved (not merely proposed) numerous
revisions in our sarket aaclianisms and enforcement procedures.
Thosa Borket enhancements «re summariEad below.
On July 12, 1989, Representatives English, Coleman and Penny
introduced H.R. 2869, Che Commodity Futures Improvements Act of
1989. The proposed legislation would make sweeping changes to
several vital provisions of the Commodity Exchange Act ("CEA") ■
The Exchange supports the stated purposes of the bill to restrict
potential abusive practices and reinforce devslopnent of exchange
audit trails. However, we are greatly concerned that in critical
areas of the bill the precise methodology proposed to achieve
those common objectives may, at a minimum, render our domestic
futures industry uncompetitive with ever increasing foreign
markets and potentially destroy market liquidity. The proposals
regarding dual trading by floor brokers and the requisite audit
trail requirements are particularly crucial and require a modified
approach.
Broker Trading fPual Tradinal
Permitting floor brokara In tha futures industry to trade for
their own account vhlle also eitecuting customer orders recently
has come into question. Despite the fact that there have baen no
indications that any federal investigation is concerned with any
aspect of broker trading, and despite tha fact that the CTR-PLUS
system is specifically programmed to detect (inlet alifl) any
broker trading ahead of a customer's order, a few have questioned
trtiattwr this practice is In tha bast interast of the marketplace.
First, broker trading is not uniqu* to futures aarkats.
Trading for one's own account while handling custoMar orders is a
common practice in all financial ■arkata; spacialista and
securities firms universally trad* for their own account while
executing customer orders.
Second, Congress, the CFTC and the futures industry have
studied broker trading aany timas in the past decades. In each
instance, the results overwhelmingly indicate that the ability of
floor brokers to provide additional liquidity to the aarkat by
trading for their personal accounts Is a valuable and necessary
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tl)« >artc«tplaca. pnllvlnary Bitchutg* data IndlcatM that broker
trading providas froN 35-10% of futuraa aarkat liquidity ac tba
ceOT. Tha Exchange atrongly ballavea that any potantial abuaas of
dual trading can ba and ara datactad by currant survalllanca
ayataBB Therafora, tha Bxchanga faala that tha «lialnatlan of
brokar trading vould aarloualy lapalr urlMt llqaldity vhlla
aarving no nsafnl aarkat pUtftiaa
Howavar, the Bxcbang* racognltaa that concama axlat. Ihna,
tba Board haa retained the services of Dr Sanford J Groasnian,
tba John L. Weinberg Professor of Econonlca at Princeton
Dnivaralty, to aaXe a conprehenslve ooplrlcat study of brokar
trading in today'a futuras nartcets. Thia study, along with tboaa
conduetad in tha paat, aa well aa studies conducted by tha
Exchange staff and now balng conducted by the Coaaodlty Futuraa
Trading Commission ("CFTC" or the "CoBBlaslon") will foni th«
baaia of further evaluation of tba value of broker trading to the
nation's futurea Markata.
ma Board of Trade atrongly urgaa thia Coaalttea to evaluate
thaaa studlas in thalr entirety, ae well as additional studies
which Bay ba subaitted to the CoBvittae, bafora aaklng any final
dacialon an this vital isaua. The liquidity of the world's nost
efficient futures markets is at stake. 'Hie continued preeninence
Of United States futures aarkets deserves careful, conaldared
study before any final racoaaendatlons tor action.
Tha specific provlaioiw of R.R. 2tt9 regarding dual trading
ara draconian and potentially devastating. Banning dual trading
in contracts trading aore than seven thousand (7 000} contracts
pmr day is arbitrary and without any sound economic basis Had
such a prohibition been in effect from 19a4-19BS the nation'!!
grain markets would have suffered even noro severely than thay
did; 'had floor brokers not been able to aupplement their incomes
during that depressed period by alao trading Cor their own
account, there would have been all too few, if any, experienced,
capable brokers to execute the flood of ordara which cave to tba
■arketa in the suaaer of 19SS.
Hie audit trail exaaption to the ban contained In propoaed
Section 4j(l)(D) requirae perfection whidi la huaanly impoaslbla
to achieve. Detecting "... anx and all Inatancea of trading
violations ... attributable to dual trading ..." and being "...
fully verifiable' are abeolute atandarda unattainable in the real
Tha proposals sa^ to ignore the tact that tha united States
futurea aarketa present ly have the beat audit trail and coaputer
■urveillance systaas in any Barketplace, foreign or doaeatic. To
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placa thasa luiattalnabl* standards upon an alraady axcallant
aystea ia laudable In Intant but quaatlonable in reality. This la
especially true given that the Chicago Board of Trade and the
■Chicago Mercantile Exchange have agreed to combine their axlatlng
computerized audit trail and survalllanca syatems into A single
system capable of being used by the entire industry. Since both
systems presently capture lOOt of all trades and audit 100% at all
trades for market surveillanoa purposes, the CMbinad aysteiu will
achieva a level of review unmatched anyvhara.
The Board of Trade is also investigating further
technological means to improve the accuracy of the existing audit
trail. However our research indicates that despite such aCforts,
there ate limltatlonB to the adaptability at current technology to
our markets without risking destruction of market liquidity In
this regard, the propcsal of Section 4g( 2} (B) (il) (b) to state
verifiable execution times within thirty (30) seconds, and to
accouplish this vlthin three (3) years, appears totally
unrealistic and unobtainable. Moreover, this unrealistic,
unobtainable standard appears unnecessary, particularly In view of
the nature and extent of recent audit trail enhancements approved
by our Board at Directors.
The Exchange urges this Committee to consider Modifying the
provisions of the bill as follows (1) ban dual trading in those
contract market option months where the exchange's audit trail and
■urveillanca systeuB ate insufficient to detect potential abuses
that asy "be associated with dual trading; (2) provide certain
exemptions frcm the prohibition (such as to those brokers who are
predominantly spread brokers); (3) codify the existing «xchanqe
prohibition of trading ahead of (or "f rontrunning') a customer s
order; and 4 require that each exchange's audit trail be
verifiable to the nearest minute Adapting these aodif ications
achieves the Committee S objective of insuring tb* highest dagrea
of HarlCBt integrity without sacrificing tha market liquidity
naaded to coapeta in today's world sarkats.
Exchange Surveillance systems Market Enhancements (ftudit TraJlal
As a result of the recent extenaive ravlawa by select
Committees, the Exchange has inatltuted nuverous enhancements to
tha CTR and ctr-fLus systens. Tha following anhanceaanta and
improvements have baan approvad:
1} The CTR-PLU5 survalllanc* program has been expanded to
analyse ovary trada aada on the Exchange, rather than
statistically selected saaiples.
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4) Haw Civ* (5) ■Inut* tUw brack«t« bav* b*an approvad for
Um opaning and eloalng parloda ot trada whaa trading
ganarally !■ tMavl»at.
5) Th* Exchanga h«a anbancad trading card raeordation
raqulrasanta to now raquir* that all trada carda auat torn
accounCad Coi; all trading carda auat torn eollactad and
tiM-ata^Md hourly; and all tradaa auat ba autalttad to
tha Claarinq Hauaa within ana hour ot collactian.
6) CTR-PLD8 has b*an L^rovad furthar by providing axpandad
■urvalllanca tasts an axpanded relational data BMaa,
and lncr«aa«d atoraga capacity.
7} Tba bccbanga baa raquired that all trading- floor- tl»a
ataap clocka ba aynchronlzed and accurat* to within tan
sacond intarvala.
a) Additionally, tlv« naw co^iutar prograanara bava baan
hlrad to support an axtanalva aanbar/ataff raviaw and
raviaion prac«aa of all aurvalltanea ayataaa.
Offlea of Invaatl,gatlpn and Audita Enhancamanta
m* Offlea of Invaatigatlons and Audita "OU"), tba aacond
largaat dapartaant at tha Exchange haa alwaya «alntalnad tba
blgbaat laval of profaaaionaliBa and axcellence The high dagraa
of profess ionaliaa aifhibited by OIA has prom.ptad O S Attomay
Valukua to raaark "I hava a graat d«al ot confidence In tha staff
or tha Board ot Trada." To further atrengthen OIA, the r ■"
haa racoMBandad furthar anhancaaents. Thaaa Includa:
9)
Spaelal training prograns in invaatigativa tacbnlquas
conducted by professional consultant* hava baan approvad
and Instituted tor OZA staff.
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Board of Directora Pollclaa
Tb« Exch^nga bas raaxaninod tti« pow*ra, authorities and
afcructura of ita Board «f Oiractors. The Exchange Board is
currttntly a diversifiad body consisting of raprascntatives froB
all -aspacta of tha industry as well a« public directora. The
Rulaa of tha Exchanga and ttim div«ra« atructura at tha membership
Inaura that aucti broad represent at ion will continue t-o exist. To
enhance tha function of the Directora, ttia Board baa approvad the
tollovlng Naasuras;
13) Tha Board has approvad and aubaittad for aaabarahip
approval a rule anendoenC increasing tha fining
authority of the Board of Directora by Bora than thraa
hundred i^rcant (300%) from seventy-fiva thousand
dollars ($75,000) par violation to two hundred fifty
thouaand dollars ($2SO,000) par violation
1*) The Board of Directors haa tomally reaffirmed ita
long-atsndlng policy of excluding oembara with a history
of significant trade practice sanctions from being on
tha Board cf Diraetora and Ba]ar exchange diaciplinary
ecjBBlttaas .
Flcx>r Practicaa
The Exchange haa ravlawad intenalvaly axiating policies,
rules, regulations and practices governing floor trading. Tha
Exchange believes that Its rules and policies are highly reflnad
to preaetve both the utsoat integrity and market efficiency.
Mavarthaleaa, tha following enhancements have been made:
15) Broker associations ganarally do not exist at tha Board
of Trade. Nevertheless, to prevent abusive associations
from evolving, the Exchange has adopted a rule requiring
that any association of floor brolters oust register with
the Exchange in order to enhance the Exchange's
surveillance of their trading actlvitias-
16) Tha Exchanga has approvad and aubaittad to the CFTC for
ita approval a rule establishing a modified closing call
period at the conclusion of trading to better facilitata
orderly execution of closing orders and increase the
efficiency of price discovery during closing marlcet
periods This rule includes separate identification of
this modified closing call period for CTR-PLUS
surveillance purposes.
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Tlw Unhang* also has dona axtaiwlva work In tue etbar ar«aa
which vlll anhanc* tha Bxchanga'a aitdlc trail Mad. tharafora, ita
«urvalllanca capability, ror aany *ontha, tha Kxcbanga haa baan
davalopinq an «laccronie ordar-antry ayataa ("EOS') vliich will
apaad public ordara diractly to tha pit via coaputarliad antry
tha raaultlng ordar racord will ba accurata to tha aacond and will
graatly anhanca aurvalllanca aa wall aa battar aarva pntalla
Additionally, tha Bxchanga baa widar raviaw tba dawalopaant
of a hand-hald trada antry davlca tor usa by saibara on tha floor
to racord alactTonlcally all thalr tradas and Inatantly transmit
tha tradaa Cor claacinq Although tha tachnoloqy (or auch a
davlca ia not praaantly avallabla, tha Zxchanqa haa coaalttod
alqnificant raaourcas to tba davalopawnt of A hand-hald trada
taralnal which will accurataly rocord trada axacwtion to tha
nm Board of Trada ballavos thasa iaprovaaianta and othara
atlll undar atudy will inaure that ita aarkata rauln tha world'a
>oat aff iciart, liquid and aconoaical whila slaultainaoualy
praaarving tha hlgbaat dagxoa of intagrity and proCaaaional
participation. Thla ia a goal which wa balieva that all of ua —
tuturaa axchangaa tha CFTC Conqreaa and aarkat parCicipanta —
■hara aqualXy Othar exchangea (which havs diffarant aarkata,
trada other producta hava aaparata aanbarahlps and In many
eaaaa, diffarant aarkat uaaira) Say hava diatlnct naada with
raapact to anhancaaanta of thalr oxlatlng ayataaa Ha atrongly
urga thla Subcoaaittaa to conaldar thaaa diffarancaa In Its
conaldaratlon of any laglalatlon.
Wa ballava that if tha Suhco^lttaa doaa aa, it will CMncluda
that any ragulatlon of tha aarkatplace la b«st aecoapliahad In a
"aanagaaant by objactiva* fashion. For axanpla, whan Congraa* and
tha CFTC nandatad iaprovenenta to the audit trail in isas, that
nandate provided that each exchange ahould Beat a coanon goal by
vhataver aeana is best suited to its aarketa. Thua, the Board of
Trada and Chicago Mercantile Exchange responded by developing
CTR. So too, in any new requireaents for narket anhancenents and
iaprovaaents. Congress and the CFTC should aiailarty eatabliah
broad objectivaa which tha aalr regulatory organiiatlons ara
obligated to aaat, hut in tba aannar which thay cfaooaa to beat
aarva their particular varketplaca.
nia and raault of such a ■anageaant-by-abjectiva approach
vlll undoubtedly ba the further inprovanent of our existing
efficient, liquid and honaat futuras narkets. Tha danger of
falling to achieve this goal is that our current markets could
eaaily be exported to foreign nations who ara eagerly establishing
naW iuturaa markets hoping to capture what la now • unlqualy
Anarlean industry.
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Exchange currently ia designated by the Coaowdity Futuree Trading
Coamlaalon (■CFTC") an a contract narliet for fifty eight (91}
futuraa and futurea optiona producta twenty aix (26) of which are
actively trading; thaae Include qcaina financial futuraa and
pracioua netala Four of the vorld't top ten contracta (by 1988
volume are traded at the Board of Trada: United Statea Treasury
Bond Futures; Options On U.S. Treasury Bond Futures; Soybean
Futures; and Com Futuraa. Zn 19IS, the Exchange traded 143
million contracts nearly tvica that of the next largaat dosastic
future* exchange and ■or* than tba naxt four da*aatie exchangaa
coBbinad.
The Exchange strongly believes that the prevention of
potential market abuaes begins with the integrity of tha
meabcrship Itself. Innumerable member, staff and outsid*
profesaional investigation hours are expended 6'n each application
to insure that the utmost member integrity is attained In isas,
eight hundred twenty (820) applications for membership were
processed by the Exchange. Heobers must trade (l.-i. contract
with] other membera in the trading pits; the members tharafor*
demand that admission to aembership be a determination of
individual integrity which ensures fair, honest and eguitabl*
dealing among B*ab«ra.
The Exchange membership consists of 1403 Full Mambars and an
approximately equal number of Associate membership and maBbarahip
interest holders. The mesbecship Is a dlvttras nix at individual
(■local"} tradara, brokers, and masbar firms Including futures
commission merchants {TCHs") , commercial firms, Invastmsnt banks
and other processional market participants.
determined in the first instance by the Hemb«r3hip Committea and
approved by the Board of Directors. Those wishing to ba licensed
floor brokers handling customer orders must also nndargo
additional investigation through the National Futures Association
which Includes an FBI fingerprint check.
Applicants are required to submit axtenalve background
Information which is subject to independent, professional
verification. Applicants nust also obtain the sponsorship of two
existing meoibers; on soma occasions, sponsorship aay entail «
financial guarantee. The admission process includes at least one
personal interview before the Membership Committee. Applicants
are than recomniended to the Board of Directors for approval or
disapproval Those applicants recomaended for disapproval are
given the opportunity Cor a hearing. Disapproved applicants may
appeal that action to the CFTC.
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Thla rlgorouB Baabarshlp ■K>caval process balps kssur* tiM
tair daallng aaong BaBbars which fonw ttia comarston* of
■alf-ragulatlon. Aa coaaonly rscognizad ■alf-ragulat.ion doaa
Lncluda tha ability to prosulgata and anforca ona a own rulaa and
ragulatlons. Indaad, In 19B8, the Exchange aada saven hundred
tifty-niiM (759] rule and regulation ravlsions. Additionally, In
t9Sa cases, the Exchange issued charges tor trade rule violations
In sixty-nine (69) instances resulting In « total at seventeen
(17) years of suspensions and $1,475,000 in fines.
But self -regulation Bsana aore than rule proMilgaticn and
enforeesent. It also seans that nesbers are not going to tolerate
being treated unfairly or dishonestly by Chair fallow seabsrs.
Most trading floor abuses involve a trading opportunity wittaheld
froH tha entira trading arena. Fellow ueuber- traders are not
going to condone a lost trading opportunity Indeed, the
■ajorlty of Exchange disciplinary actions resulting in significant
sanctions began with a coeplaint troa a asKber regarding another
■wber's conduct.
Ibis is the essence of a* If -regulation: seabership integrity
upon adsission coupled with the vested' Interest to preserve that
Integrity on the trading floor It is by strict adherence to
ttaess princlpala that tha potential for trading abuses is
■iniaiiad even prior to survaillanca detection, enforcement and
sanction. This Is a principal reason markvt users hava such
oonfidenca in Board of Trade marJcets. indeed, In I9aa public
sarket users node only thirty f iva (35) complaints to the Exchange
reqarding potential trade practice abuses. Considering tbe one
hundred forty three slllion (143,000,000) contracts traded, this
is s reoarkably ^ull percentage of cosplalnts.
Nor is confidence in the Integrity of Board of Trade aarkets,
oversight and enforcement llaited to professional aarltet users.
It is also shared by top law enforceaent afflclals vho have
experienced through representation of clients at CBOT disolpllnary
bsarlngs the tborcugbness and efficiency of Exchange rule
enforcement.
One of the things ve do keep track of is wbat'a
taking place at the Board of Trade. He are interested
in the proceedings at the Board of Trade, We're
interested because, in ay estimation tjasgd on my own
ajtpertise in the area, the best experts in the norld
concerning trading practices are the members of the
Board of Trade. I have a great deal of confidence in
the staff of the Board of Trade. Thay are able to aak
the difficult questions; they have the resources to
J,deptlty trading practices in which fraud has occurred.
And frequently, in my experience, when they are holding
their hearing, they are able to get to the tough
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quastlons quickly. And alnc* th* Indlvlduala that ar*
subjact to tbaaa procaadinga ara subjact to axaBiitation,
ttiay aak thoaa quaatiana, gat raaponaaa and thoaa
raaponaaa ara an tha racord.
Ha oftan In thaaa caaaa call upon ttM Board to MOka
an avaluatlon of Kaabara from tha Board, Indlvlduala
froa tb« Board, in halping ua to find trtistbar or not
thara ia a fraud involved That ia to aay that «■ raly
on their ^^pertise. [Eophaais added.) Raaarka ot Anton
B. Valukaa, United States Attorney for tha Horttiam
Dlatrict of Illinois, Kent Comnodltlas Law Instituta,
Horkahop on Enforcenent/Crininal Mattora, Octobar 31,
1988.
It la thia combination of innovatlva, attlclant, liquid
Barkets and a raputation among profeaaional market users for
unaurpaaaad InCsgrlty vhich ia largely responsible for the Board
of Trade's preeminent poaltion in the vorld'a futures markets.
Howaver, that preeminence is fragile. Compatitlon for new markets
asong domestic exchanges, always fierce, has intensified. But
more critically, the challenge of foreign coapetltion for
doninance in futures trading is increasing dally.
FOREIGH COMPETITIOH
The afficlenoy and liquidity of United Stataa futures markata
ar* the envy of the entire world. Virtually every major nation on
earth - Japan, Great Britain, France, Swltierland, Australia and
even China - has established futures markets in the image of
Chicago's futures markets. These (ornign futures markets in many
instances are directly subsidized by the national govamaent and
are strongly supported by national mandate. There is no secret to
futures contract specifications; they can be imitated by photocopy
In ninutes. It ia the experience, expertiae and integrity of the
floor trading population which establishes Oilcaga's futures
markets as the uorld leader. But, that market edge la fragile and
could be easily upset or destroyed.
The foreign challanga to tha n.s. futures Industry has
incraased markedly in recent ya&rs. Although activity at U.S.
futures exchanges has continued to grow activity at foreign
axchangas has grown much faster The market share of O.S.
axchang«3 has declined because futures exchanges have proliferated
ovaraeaa; products offered by foreign exchanges have becoma more
divara* as the benefits of futures narkata become better
understood. Porslgn exchanges nov coapata directly with Axsrlean
axchangas; there ara now several contracts traded on foreign
axchangas which are identical to contracts traded dowaatleally.
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Th* Btatiatlc* ar* *obaring. It not ErlgtatMiing.
In tb* p«at four y««rs, tti* Board of Trad* has liicr»aa«d Ita
total voluB* of contracts tradad by 91%. BoiMvar, during that
aan* parlod tha Exchanqa ■ narkat ahara of trarld-wida futuraa
VOlima dacraaaed by 3 6 parcent tram 37. 6t of tha world Barkat ta
34t) . Tha rasBon tha Exchanga lost vorld Markat abar* was that
forelqn axchanga volUB* graw Ufii. IBmm Appandlx 1, Tabla 1 and
Figura i.)
In I9a5, tba tan Boat actlvaly tradad Cuturaa oontracts In
tha world vara aU Unitad Stataa producta. By 19«6, tJia fifth
Boat activaly tradad contract vaa Japanaaa, a poaltion vhich it
continuas to hold today By XiiT, tha savsnth aost activaly
traded contract waa rranch; today, tha French Bond Puturaa
contract has gToWi^ to occupy ttia nUMbar aix position on tha list.
(Stt Appendix 1 Tabla 3.] In 1995, no foreign futurea contracts
wara aaong the twenty-tlva Bost activaly tradad. Today, aix of
tba top twanty-five ara foralgn contracts. (Saa A^iandiK 1,
Table 4.)
ProB 1914 to 19Sa, tha nuBbar of doBastlc futuas contracts
trading grew 351. But the number of foreign futures contracts
trading grew by 84% in that aaiM period. (Sfig Appendix 1, Tabla
2.) Tha London International Financial Futures Exchanga ("LIFTK')
tradaa a U.S. Treasury Bond ruturea contract identical to tba
Board of Trada'a nost act lv*ay- tradad contract. Voluaa in tba
LIPFK U.S. T-bond contract baa triplad ainc* t9S5 to ovar two
Billion contracts par yaar.
statistics prove that aarkat usars ara willing and abla to
-quickly shift their aarket activity overseas, tor axaapla, U 8.
Treasury Bond futures trading was brisk following the October 19,
1997 stock market break On Tuesday, October SO, prices of the
Board of Trade a Bond futurea contract Increased up to the Upper
llBit alloved for a single day; aa required by Exchange rules,
trading in T-hond futures was effectively stopped. As a result,
leaa than 3S,U0O T-bond contracts were traded during daytiBe
trading at the CBOT on October id compared to the daily average
volune of 386, MS during October, IWt. Instead, aarkat usars
shifted their activity overseas to the LIFFB whan their needs
could not be net in the tJ 3 volume in tha LIPPB T-bond contract
exploded to ovar 47,000 contracts traded on October 30 nearly
eight tines its svarage daily voluva of 6,200 for the first tan
■onttaa of 1987 (Sfifi Appendix 1, Tabla 6.) Tha increase in
volume at tha LIFFE might have baan avan greater had narket usara
iMen mora familiar with that exchange and had thay not had auA a
strong preference for the CBOT margin and clearing systaM.
Despite the well-known integrity and liquidity of tha CBOT
T-bond contract, participants in tha T-bond market sought risk
Banagaaant services elsewhere once trading in the CBOT market
stopped. This event deaonstrates tha aaaa of shifting futures
Bsrkat activity abroad if necessary. Thus, even the world s Boat
active futures contract is vulnerable to foreign coapetition.
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It is clBar that thera ar« now nuK«rouB rlak aanagMMnt
vabiclea available to thoa* wito neea to tiedge against price risk
and to speculators who if* willing to accept that risk. Anarioan
futures markets compete net only with foreign futures exchanges
but also with altemaCiVA risk aanagemenC vehicles sucb aa forward
contracts, swaps caps, collars and other financial producta.
These various tlsk nanageaent products are available at the touch
of a telephone button; global narkats are all easily ■ccesaad and
or* becoming mare faailiar to market users.
The availability of so many other Methods and locations to
conduct risk managenont means that any increase in the costs of
using one of these vahiclea can result in a huge disadvantage
rslstive to the competition. This high degree of competition
■•ens that market iis«rd l»naflt as each provider must kaep its
costs low and tha quality of customer service must ba maintained
in order to keep customers, dn tha other hand, any regulations
that increase the cost of using futures markets or reduce the
quality of customer service being provided will put the U.S.
futures industry at a competitive disadvantage. To choose but on*
instance, restrictions on broker trading would reduce the
efficiency of U.S. futures markets and would lower the quality of
service provided to users of these markets. {It should be noted
that broker trading commonly is permitted in foreign markets.)
In tha face of such intense, dedicat__ _.
competition tor what were only a few years ago, uniquely American
markets Congress must carefully consider its actions to avoid any
action which could cripple domestic futures markets Bvan foreign
journalists whose home markets stand to benefit from any hasty
U.S. legislative reaction have axpressly cautionad us not to enact
ill-considered legislation.
America's politicians would therefor* ba well
advised to temper their natural desire to "do eomtthlng*
and refrain from hasty ill-considered regulation of
Chicago. That "casino", as it is described by its
opponents, 1* in fact one of America's most successful
industries.... Toyko and London, not to mention other
financial centres, would clearly love to get a blggar
slice and vill seize any opportunity to do so. It was.
it needs to be remembered, ill-considered American
legislation In tha ISfiO's that allowed London to becoae
the centre of the international debt markets, usually
known as the Euromarkets. Future Permanent, ni*
Economist, June 11, 1988.
Today, we have the best futures market* in the world, reputed
for both their cost efficiency and market Integrity. He nist
carefully preserve that delicate balance in the face of our less
regulated foreign compatition as w* consider any proposals for
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ragulktory cbanga. Ha auat not dacaiva ouraalva* iKto thlnKlng
that our foraign ooapatitora will not oraata a quality product at
tba lowaat pric* posalbla. Th* proot la aalf-avldast; tlwy hava
dona ao in eountlaa* othar Industrlaa wbara tba Dnltad St«t«s was
only racMitly tba world laadar.
QVEMIGHT * EHFOHCEWEirr
Co^atitlon tor sarkat «har« la not dapandant aolaly on
Borkat liquidity and atfLciancy. Market uaara valua tha intagrity
of tlia trading procaaa vary highly, tihila strict M«b«r adaiaalon
•tandarda and vastad Balf-lnCaraBt tora tba foundation of narkat
intagrity, vigorous ovaraight, atu^alllanca and •nforcaaent aca
also of paramount laportanca. Aa a asBberahip salf-ragulatory
organisation, tba Board of Trada insurss compllanc* wltti fair and
•gultabia trsdo practices principally through tha Floor Governors .
CoBalttaa, tba Bualnaaa Conduct CoBBiCtee, and tha Board of
Diractora.
Tba dutias and powara of tha Floor Govamora CaHU.ttaa ara
ganarally defined by cboT Kula 5«3.oa which provides that tha
Coialttaa shall assutrA that tba practices and conduct of n«mb«rs
of tha Aaaociation, aember firaa and other peiaohs with trading
privilag«a on tha Exchange Floor ara in conpliance witb tha KHlaa
and Ragulations of tha Aaaoclation. Tha COHilttaa la authorizad
to take action against parsona and flraa including: 1 disklssal
of chargaa and cloalng tba aattar; (2) issuance of ■ warning
lattar; or (3) issuance of prallalnary Oiarges and scheduling of ■
haarlng on tba aarits. If prallalnary charges are issued, tha
Coaaittaa will afford tha raspondant (a] an opportunity for a
foraal, evidentiary hearing of record with right to counsel. If,
aftar bearing, the Coanittee detarBlnes rule violations hava
occurred, tba Comalttea may fine or auapand the respondent or «ay
charge tha respondent and refer tba aattar to tha Board for tba
iapoBltlen of aanctions.
Additionally Regulation 540.09 provides respondaata with tbe
opportunity and daans to settle praliiilnary charges. SettleMsnts
■ay be accepted on auch taraa and conditions as tbe Ooaalttas uy
deea appropriate -
The duties and powara of tha Business conduct Coanlttae ara
generally -defined in CBOT Rule 543.00 which provides that the
Cavittaa is responsible for preventing price oanlpulation and the
cornering of any comodlty on the Exchange and for supervising the
business conduct of all Bembers mesber firms and other persona
with trading privileges In regard to tha latter responsibility,
two of the duties of the CsBnlttea are (1) to enforce the alninun
capital rules of the Exchange, as approved by tha CFTC and <2} to
enforce Exchange Rules and Regulations pertaining to tbe handling
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of cuBtomar orders, custooer accounts and Hargtnfl. Other dutiaa
Inciuda raviawing raquasts Cram flraa to pra-pay subordinated
loans, supervision of tlras that ara regular for delivery on Board
of Trade agricultural contracts, and all ganaral nattars of aeBbar
solvency.
The CoBBlttaa 1« authorized to impose spacltlc disciplinary
sanctions; to recommend that the Chainsan inpos« restrictions on
the operations of a member, member firm or othar ^tdon with
trading privileges; and to impose rsEtrictlons Ort sember FCHs that
fail to meet the capital raquirenents of the Encbange. The
Committee also is authorized to order any member to cease and
d«*i*t from past or proposed -conduct that It finds, after notice
and an opportunity for hearing, to be unfair unjust or in
violation of CBOT Sules and Regulations. The comiittee may impose
a fin* of up to twenty five thousand dollars ($25,000) for aacb
violation. Caasa and Desist orders are final and not appealable.
As an alternative to issuing a Cease and Desist order and/or a
tin* in disciplinary matters, the Committee may file charges
against a «*mb«r, member firm or other person with trading
privileges vith the Board of Directors.
Decisions of both the Floor Governors Committee and Business
Conduct Committee generally are appealable to tha Board of
Directors The Committees nay also refer charges to tha Board for
Its disposition where the Committee feels its sanctioning
authority is too limited for the severity of the violations
found Thus the Board functions in ttie one instance ii h pure
"appellate" body and in the other purely as a sentencing forum.
In either Instance, a general right of appeal from a Board
decision to the CFTC Is provided by Part Eight of CFTC
Regulations.
Hember disciplinary comnlttees are uniquely qualified to
enforce Exchange rules- The knowledge of trade practices ana
experience with the business of futures trading possessed by these
ssmbers cannot be duplicated outside the Exchange. Kesbers of the
Floor Governors Comaittee and Business Conduct Committee typically
have ten to twenty years experience in futures trading, most of it
at the Exchange. This member expertise is an invaluable and
Irreplaceable asset In the oversight and enforcement of Exchange
Equally valuable as aeBber expertise is the professional
staff support the Committees receive. The Board of Trad*
continually monitors member and member firm compliance with its
rules and regulations, as well as those of the industry, through
kt» Office of Investigations and Audits. As part of its
surveillance efforts the OIA is constantly in contact with other
Exchanges the National Futures Association and the CFTC to
exchange relevant information.
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OIA is coapria*d of Clva lnt«rr«lat*d i
InvaattgatioriB Oapartaant la raaponaibl* for Invaat lasting
inquiriaa froM cuatoaars and rae*rrala trom aaabara, BaabaE tlrm»
and tiim CFTC concamlng any sarkat activity or trada practlcaa
which Involva potantlal violations of Board of Trada mlaa and
raqulatlon*. Thaaa invaatlgationa Involva a coaprahanaiva procasa
of obtalfiinq atatananta froa witnaaaas and partia* involved,
conducting trada raconatructlon ravlawa and analy«lnq trading
docuBenta. Tha dapartaetit say cloaa caaaa adninlatratlvaly whan
tbarq la InauEflciant avidanca of rula vtolatiana. All -casaa
involving potantial rule violationa ar* aubalttad to -tha
■ppropriata Exchdnga disciplinary coaalttaaa. nM depart— nt is
rasponaibla for tha praparatlon and proaacution of eaaaa involving
it* invaatigation*.
Staff of tlta Invastigationa Oapartaant ia alao raaponslble
for initiating and conducting Trada Practiea Invaatlgationa
tPis"! on « continuoua baal*. TPIa Involva raviaving daily
axception reports of tha Exehanga'a trading actlvitias of aaobers
and nanbar flrss to datact patterns of conduct vhlch say indicate
rula violations TPIa are conducted utilising the coaputerlted
Trada Reconstruction Systan.
The Inveatigations Dapartaant alao aalntaina a floor
surveillance progran that involvas diractly obaarving floor
trading activity on a dally basis.
Tha Raporting and Kaaearch bapartaent is roaponaibl* lor
auditing tha Board of Trade a CTR systen. It also conducts
aurprlss on-sits reviews of all audit trail data suhKlttad by
■anbars and Benber firms Ttie department la alao rsaponaibla toe
■aintalning OXA's other various computer systems and coordinsting
tha departaant's Interaction with tha CFTC.
nia Narkat Surveillance Department ensures tha ordarLy
axpiratlon of all Board of Trade contracts and monitors trading
activity in order to detect attempts at price manipulation,
aquesaas of a commodity or corners In a market. To acconpliah
these tasks. Market Surveillanca complies and reviews Information
relating to volume, open Interest, currant cash commodity prices,
availabla stocks, deliverable supply, and positions hald by
clsarlng member firms and large traders. Market Surveillance 'a
analysis of ttaia information identifies Cutureaycash price
relationshlpa which may potentially ba disruptlv* to tha
■arketplBca . Statistical reports including historical >srk«t data
are also compiled weekly.
During a nontb in which a futures contract is eligible tor
delivery or expires. Market Surveillance say be in frequent
contact with aajor participants. Kith respsct to stock indsx
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iturcs contracts, MarlMt Survcillancs conmunicatas witb ■■■bar*
Alt intamarket surveillanca qroup that Includes staff froa th«
>v York Stock Exchanga, tha Aaorican Stock Yxchtntqn, the Cbie*g«
trcantil* Bxchanga, tha Chicago Board Options Bxchanga, tb«
liladalphia Stock Exchanga and tha Kansas City Board oC Trad*.
nt* OIA's financial Survalllance Departsent ansuras that all
>ard of Trada aanbar flraa conply with tha Exchanga's capital
lias and capital guidallnes. Tha Pinanclsl Surveillanca
ipartnent routinely analyzes the financial health of ■ambar tixmm
.th the Simulated Analysis and Financial Exposure ("BATE")
'Stan, tha nost sophisticated computerized financial survaillanc*
-ogras in the futures or securities industries. Tha SAFE systa*
■aluatas the risk of veiibar fims at current market lavals and at
variety of coobinations of different market and volaClHty
ivels. Tha SAFE system generates approximately one hundred
.ffarant reports, including but not limited to pay/collact
iforaationi/, margin data, and large trader reports. Tha OIA
tares use of tha SAFfi system with the Board of Trade Clearing
>rparation, which daveioped the system
Any actual or potential problama discovarad during tbe
lalyats results in an immedlats phcne call to tha firm or an
i-aita financial review Nombor firms are also required by the
lard of Trade regulations to notify the Financial Survaillanoe
ipart—nt at changes in key financial data.
The OIA Audits Department conducts biennial reviews of tha
lolcs and records of each Board of Trade member firs that is
iglstered aa a Futures Commission Merchant ("FCHs") to detemin*
«pl'l*'K* vith Exchange rules and regulations. Audits focus on
le tiraa' financial and compliance procedures. During a
.nancial audit, a firm's financial condition is analysed, along
.til the composition of balance sheets and capital cosputatlona to
irity that the firm has appropriate procedures to ensure the
intinuous subnission of accurate financial information to the
»bange. Also customer balances are reviewed and the proper
igregation of custoaer funds is verified.
nie compliance portion of the audit e^tSMines ■ saBber tira's
-ocedures for customer order preparation and processing margins,
lening an account, account documentation and discretionary
«ounts. Cash transactions are reviewed to establish that the
rm is properly accounting for customer transactions The Audita
apartment also makes surprise sales practice reviews of aamber
«s' branch oCficaa and guaranteed introducing brokers. These
^views cover the solicitation of custcver accounts and customer
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OiM Of th« principal toola usad by OIA to conduct Its B»rk«t
■urvaillanc* wm) invamtiqaClon raaponatbUiciaa La th*
COBput*rii«d Trad* Kaconatructlon Syataa and ica darivativ*
■yataa CTR-Plua. CTD ia Uia world'a aoat aopriiatlcatad sarkat
audic trail CTR docuaanta vho tradad uhat quantity at uhich
contracts at wbat prlc« and tha datarBlnad Cina of axacuclon ia
■tatad to tba naarast aacond for a11 10<» of tha contracta
tradad on tha Exchan^a. Critically, CTR data is availabla vithin
tvanty-four houra <:raat«d by tha Exchanq* in 1986 in conjunction
with tba Chicago Karcantila Exchdnga CTR alao ellainstes tha
paaalbility of ItMlivldual hu>an nanipulstlon of tlaas, without
iapalriT\g aarkat liquidity as vould occUC by ragulring tradara to
aark axacutlon ti>as cTft ia tha aoftvara aarriaga of Wo
indapandent coaputariied trade racords, Che elaarlng trad*
«attl«ment record and tha price reporting tiaa and salaa journal.
By altalnatlng rallanca upon tiuaan recording at tl»aa, CTR
anhancaa reliability ot tba audit trail data.
CTR-Plua ia coaprisod ot tha coaputarizad prograns deaignad
by OIA atafC, nembar committees and outelda professicnal
eonaultants to aonitor trade activity via computer. Although it
previously relied upon atatiBtically valid trade aaaples, CTR-Plua
now reviews loot oC the Exchange a trading activity vith a variety
ot sophiatlcated survailiance prograaa. These prograaa aonitor
tor potential abuses such aa trading ahead of custoaer orders
(■broker trontrunning') , croseing orders, talcing the oppoaiVe aide
of a customer order, prearranged trading, ring trading, inah aalas
and other aiailar potential violations ot Exchange and CFTC trade
regulations.
Si^ly atatad, CTR ia tha world'a boat audit trail and
CTR-Plua tba world'* nost sophisticBtad trade surveillance
prograa. Nevertheless, the Board ot Trade recognizes that succcaa
la a journey not a destination. laprovenents are always
peaalhle. Therafor*. an Gxchanga select oversight conalttee baa
baan intensively reviewing CTS and CTR-Plus to improve theic
Accuracy and effectiveness. Those enhancenenta adopted to data
ara spaclfiad haraattar.
Additionally, tha Board ot Trade and tba Chicago Karcantll*
Exchange have agreed to coablna tbair raapectlva systems and
expertise to craata ona, unified audit trail and ^urveillanca
system which can be uaad industry-wide Tha resulting
enhancements and Improvenients to the audit trail and related
analytical systems, already the world s best, will serve as a
model to other markets and a foraldable daterent to any potantial
trade practice abusers.
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THE fepfiRAL rHVESTIflATIOH
This Coiaitt** Is well 4wata that certain mmmbmrm of tlM
Chicaqo Hercatitlla Bxchanga and the Board at Trads have been the
subject of widespread nedla speculation regarding a United Statss
Attorney/ Federal Bureau of Investigaticn ("FBI") inveatlgatlon on
the trading floor of both exchanges. Recent praaa reports also
indicate that a CFTC (and possibly a federal grand Jury)
investigation is being conducted regarding trading activities at
several New York futures exchanges. Unsubstantiated press rumors
of alleged fraud at the exchangee have led adiAA to raise concerns
regarding the Integrity of the Exchange's marksts.
Initially, the Board of Trade does not condone — and never
has condoned --- fraud or any other trade practice abuse The
Exchange has consistently charged and sanctioned rule violators
vlth penalties ranging from fines to suspensions and expulsions.
He have developed CTt) and CTR-FLUS as part of our comnitnent to
the goal of ensuring fair and honest markets Oh uhich the public
and members alike can r-ely Should any federal investigation
result in proven cases of fraud, ve endorse and support the
elimination of dishonest traders from the markets But, at this
preliminary stage, we must remember several critical facta.
First, there have been no Indictments, merely subpoenas. A
subpoena does not establish guilt or even a presumption of a
problem, especially broad 'record-retention' subpoenas of the kind
Issued in this investigation.
Similarly, without indictments, thsrs obviously has bssn no
trial, plea or conviction upon which to assess the nature and
savsrlty of rule violations, if any. Discussions of any specific
rule violation, especially unsubstantiated alleged abuses of
broker trading, ar* purely speculative at this point At this
point, reports of any abuses reside solely In self-serving,
sensationalist press articles.
Thus, we cannot lose sight of what Is known. Hhat is known
Is that the United States Attorney has assured the Board of Trade
that the Exchange Itself is not the target of any investigation.
Hhat is also of record is the thoroughness and stringency of
Exchange member admission policies and practices. Hhat la
established is the excellence of the Board of Trads A CTR-Plus
system, a system which identified prior to subpoenas being Issued
the suspicious trading practices of an FBI "mole" trading aS a
member. Most importantly, what is evidenced by the market
enhancements detailed below is the uncompromising dedication of
the Board of Trade to improving its already excellent oversight
and enforcement programs.
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APPROVEP mUKET ENHAM CEMENTS
Ttwr* can b« no doubt that tha history of tba Board o£ Trad*
to this day !■ a uniqu* and anvlabla story oC succeu. Froa
pionaarlng fair, ll^ld, afficient agricultural futursa in tha
praviouB cantury to tha introduction of financial futuraa, tha
ccaatton of trading options on aquity sacuritiaa and tha growth of
tha world's largest futuras contracts, tha Board of Trada has an
unsurpassad racord of -achlavaaant
Navarthalass, tha Board of Trada racogniiaa that innovation
and iaprovaaant ara on-going, avolvlng afforta, not naraly an
axcuaa to point with prlda to past achiavasants. Tba txcbanga is
constantly axaainlng its narkat aachanisaw and survsillanca
tachnlquas to inaura tha continuad auccass and uaar conCidatwa in
our aarXats.
In racant aonths, tha spotlight cast by tba praas ravalatlona
of a grand jury Investigation intensified the Board of Trade's
axlstlng avolutionary devalopnent of market mechanisn refinenents
and surveillance systea improveaents . While self -regulation and
salf -Intersst alona would requira such exaBlnation, tha potential
for lost public confidence in tha integrity of these DarXets
daaandad a redoubled effort. Consequently, nimarous Exchange
coMBlttaas were delegated ttie task of a thorough review and
eKaalnatlon of numerous issues Including trade practices, trade
rules, CTR and CTR-Plua rafinaaants and aaBbership qualifications.
That ravia« pro^eas 'has culainatad in tMnty one (31) najor
raconmendations which have been approved by tha Soard of Diractora
tor ivpleBuntation. the txchan^e'a board of Directors and
-Beabarship believe thld program of enhancements to existing rulaa
and Bystems will oaks significant substantive Improveaents to tha
already efficient functioning of our markets as wall am halp to
assure that degree of public confidence necessary for tha narltata
to function affactivaly. X brief daacription of aaeh action
follows.
Brokar fPualt Trading
It is curious and disturbing that although thara has b«an no
hint of abuses by floor brokers who also trade Cor their own
account «v«n in the sensationalist prasa accounts of tha grand
Jury investigation, those who have long ni sunders tood tha rola and
value of broker trading Iiav« chosen to iise this as An
'opportunity" to resurrect thalr objections and sis conceptions.
Thus, it appears that Congress must ance again study and evaluata
tha function that brokar trading parfonu in tha *arkats.
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Tha practic* of broker trBding, or trading *■ ' principal and
as an agant, !■ wldeapread In tha TJnltad Ststss and abroad. For
•xaapla, brolcu: d«al«r» a* wall a* futuraa camniasion merchant*
('PCM'*") trade Cor the fir>'a proprlatary account and also handle
cuatoaar ordera. Securitlea apaelallata are not only peooittad,
but In ttfmt Instances obllgatad, to trade for their own account
irtiila ainultaneously executing customar orders Thua, any
axasination of floor broker trading In futures contracts also
•bould raquire reviav of the idantical phenoDena in the structure
of FOI'e, brokar daalara, securities specialiats and otltars.
Broker trading provldaa two principal benefits to tha futures
■arkats. First, because broker traders are permitted to trade for
Chair own accounts, they are able to engage in trading atrategies
. In the course of executing a customer order which result in a
batter price for tha customer than can be obtained by a broker who
does not personally trade. Tha Exchange's preliminary staff study
of broker trading (atCached hereto as Appendix 2) provides
datailed examples of these trading strategies, describes tha
specific advantages customers derive from broker trading and
presents letters from custoaars explaining why thay prefer to have
their orders executed by broker traders.
nils element of preference raises tha obvious but seldom
articulated fact that customers can choose to have their orders
executed only fay brokers who do not trade for tbair own account it
broXer trading Is an issue tor thea. Since moat futures Market
Tjsera are commarclala or large institutional investors their
ability to ao choose cannot be doubted, interestingly, as tha
letters incorporated herein at Appendix Z) demonstrate, nany such
usera atrongly py^feir broXera who trade for their account to
execute their orders.
nie second principal benefit of broker trading is that It
adds substantial liquidity to the market. For example, over a
three weak period in fourth quarter 1986 in the Exchange's
Treasury Bond futures contract, broker traders executed an avaraga
of almost 5fl 000 contracts per day for their own account. Tha
Exchange s updated analysisl/ (attached hereto as part of Appendix
3) ahowa that futures market liquidity provided by broker trading
nay amount to as much as 80. Ot on a dally basis across all
contracts analyzed and as much as S4.0I in the Exchange's aost
active contracts. Because broker traders are not solely
restrioted to trading for their customers, they can trade for
their own accounts in slower markets, during less active times of
the day in a given market, or in any situation where additional
market making
1/ The study notes the Exchange's objections to tha definitions
which the CFTC required the Exchanges to uaa for purposaa of
the data analyaia. Therefore, more analysis ia nacaaaary to
verify tha accuracy of the data aa requested by the CFTC.
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••rvioca ar* iM«dad. Thua, tlMr* ar* Bor* buy«rm and aallara in
cha sarkata and Bora capital; this parmlta ordara to b« axacutad
■ora aaally and at lowai coat. Th* study axplalna boe* fully tha
aachanlaaa by which thla liquidity la providad by brokac tradara
(for tba banaf it of xJ^ aatkat uaara) , praaanta furthar atatlstlca
daaorlblnq tha avtant of brokar trading activity, and axplalna why
cartaln othar posalbia aaana of providing aarkat liquidity ara not
•ubatltutea for brokar trading.
Brokar trading ia particularly valuabla to tba Beard of Trad*
bacauaa of tha natura of our aarkata SsttanalvB apraadlng
•etlvlty haa charactariiad tha contracts at tba Xxchanga Vhlth
togathar with brokar trading haa baan a kay part of thaaa
particular aarkata and haa halpad than bacoaa tha aoat afficlant
in tha world. Tha prica relatlonahlpa anong tha dalivary aontha
in tha grain contracta, for axanple, ara tha baala for hedging
long tarn atoraga coats, an application of apraadlng which is an
intagral part of tha D.S. agricultural Industry. Likevisa, tha
coat of carrying govarnnant aacurltlea can ba hadgad through
apraadlng in contracts such as Treasury Bond tuturas at tha
Bxchanga. Tha rola of brokar tradars is particularly critical in
facilitating Intar- and intra-aarkat spreading, thus distributing
liquidity serosa coaaoditlas and dalivary aonths and forcing
bid/ask spraada (cuatoaar casta] as low as posaibla.
In addrasaing concerns that potantlal trading abuses say bs
aaaoclatad with broker trading wa auat carefully differentiate
batwaan tha valuable practice of broker trading and the potential
trading abuses which may use that practice as a vehicle. By
analogy, tha practice of check writing Is oceaaionally abused by
aoaa who draft fraudulent checks. Restricting or prohibiting
cback writing would not address the abuses, but it would destroy ■
valuabla, lagitiDaCa acononlc activity. Ensuring that a sound
■aans of detecting abuses Is in pL&ca and that a stringent set of
sanctions has bean defined and is applied as appropriate is a mora
direct and logical approach to dealing with trading abuses than
the restrictions «r prohibitions of broker trading which bobb hava
proposed laportantly, this approach would not daaage narkat
parforsanca as a broker trading curb vould.
It Is critical to keep in aind that the Exehanga'a CTBr-Plna
aystea enables OIA to easily pinpoint any Instances of abuse.
Mditlonally, enhanceaenta which have been na-de recently and whidl
ara planned in this systea will furthar insure even greater
deterrence of potential abuses, aapacially given tha severe
penalties which are applied if auch trading atauaaa ara datactad.
This self -regulatory ayaten lAich conbinas ease of datactlon vitb
strict penalties provides an affactiva datarrant of potantlal
abuses which may be associated with brokar trading at tha
exehangaa.
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The exparlanca of the doBeetic grain Harkcts (principally
corn, vheat, BoybeanB and oats) from 1983 to dat* is a vivid
illustration of one aspect of broker trading's value. Beginning
in 1984, these aarkets experienced a "depresBion* characterized by
abundant donestic supply and stable prices. For the futures
■arkets, this situation meant vastly decreased need to hedge rialc
since cash market price risk wa* reduced) and, consequently,
decreased futures market volu>a. For four years, floor brokers
and independent traders experienced a "drought* of business and
concomitant: decreased opportunity to eatn a living. Many were
forced to leave the pit; some wsrA forced to a«ll their
memberships. Then, suddenly In 1988 the draught markat greatly
Increased price uncertainty thus the need to hedge price risk
exploded virtually overnight. Mltb that need came increased
futures orders and volune.
Critically, had brokers not Iseen able to trade for their own
accounts during the 1984, 1989, 1986 and 19B7 markets, many more
would have been forced to leave the pit and seek their living
elsewhere Had that happened, the 1988 market users would have
found few Lf any, experienced brokers to execute their orders and
vastly reduced market liguldity.
Futures markets are not Indestructable; they are highly
fragile. Banning broker trading could well sat America up to lose
Its ability to price its own caBOMditias; the experience of
19S4-19BS markets vividly shows how that could occur.
However confident the Board of Trade is regarding the value
of broker trading and the ability Co detect and punish potential
abuses, ws recognize that the public debate generated concerning
the subject requires careful, professional analysis For that
reason, the Exchange has retained Dr. Sanford Grossman the John
1, Weinberg Professor of Economics at Princeton University, to
complete a detailed, empirical study of broker trading Dr.
SroKsman is a world -renowned market expert who anong other recent
duties, vas a primary contributor to the report of former U S.
Attorney General Nicholas de B. Katzenbach to the ttew York £tock
Exchange following the October 1987 stock market crash Dr.
Grossman's preliminary findings are expected soon; detailed
empirical analysis and a final report are currently scheduled to
be completed within sin months thereafter.
Hith expert analysis such as that provided by Dr. Grossman,
congress will be able to m*sa better the true value of broker
trading to our vibrant but fragile futures aerkets. Anaed with
such background, ve should all be in a position to dstemlne what
Modification, if any, is necessary. In so doing, we must also
carefully evaluate the differences in different markets.
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I to Mcchang* and avMi vlthin dlf
. I. Th«r«far*, only through ■BansgcBant by obl*ctlva" - th*
■•ttlng of ultlBat« goAl-a to ba acliieved by a variety of B«ana -
can ragulatlon in this critical araa Cunction wiChout risking
Irravaralbla dasags to Uia aarkata Sine* wa all abara tba ommbb
objactlva of honasi: liquid, officiant tuturaa sailMta, tha
Kxchango ia confidant Uiat a ■anagaaant-by-objactlTa ragulatotY
approach for hroXar trading will work aa wwll as tliia appraadt
workad in 19l« whan tha CPTC adoptad It for tha audit trail
Exchanaa Survalllanca Enhancaaanta
Tba Board of Trade s markat aurvaillanc* cyataM, CTIt-PLOa, la
built upon tba world s finest audit trail, CTtt. Ragardlass of
thalr axcallanca, CTS and CTR-PLUS are new systeae, fully
operational only since .July 1987. Therefore, independent of
recent events, the Exchange haa been evaluating inprovaaanta and
anhancenents to the ayatea These recant intensified conlttaa
reviews have already resulted in Board approval of the folliwing
significant anhancenents to tha ayataaa;
(1) cnt-HiUI Bov rarlawa ararr trade tzaBaaata4 as tba'
Originally, , CTR-PLOfl waa craatad (aa ara all standard audit
systems) to ravisw a salactad, atatlstically valid aaaple of data
rather than tha antira data base. Recant technical sdvancea and
OUT long-standing coHaltaent to iaprovenent have now resultad ill
tha expansion of CTR-PLUS review to every trade transacted in tba
Exchange's narkets. This Uauld ba equivalent to the Internal
Sevenue Service auditing every taxpayer's ratum rather than tba
statistically valid sanple which it does Tba result should b«
not only greater effectiveness of trade practice surveillanca, bat
alae greater deterrence to any potential abusars.
I ■llIloB dollars for cn rai
Sophisticated, affective survaillanca systeos require tba
investnent of both expertise and capital. The developnent of CTB
and CTV-FLUS was never hindered by budget restrictions.
NevertheleBs to further enhance the systems will require
additional funds. The Billion dollar fund approved by the B6ard
evidences the Exchange's coaaltaant to continued systas
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Tb* •ffaet:lv«naB* of CTR-PLDS is In part dapandant upon th«
tiaa-brackat parioda usad by floor tradara to tiaa trades.
Currantly, thirty (30) minute bracket parloda ara required. Tbm
Board baa approvad reducing those periods to fictaan (IS) ■inuCaa,
a aigniflcant Inproveaant. As a result, tha alraady bigh accuracy
rat« of cnt ti>as should iaprova even furthar.
2iTa
A aubstantial portion of tha volu«a in any markat occur*
during the opening and closing periods To further iaprova tha
audit trail and surveillance of thea* critical periods, tha Board
haa approved separate five (S) ainut* brackets for these critical
periods of trading.
The CTR and CTR-PLDS systeas rely in part upon tha accuracy
of trade data reflected on a floor trader'* individual trading
cards The accuracy of those systems will be further enhanced by
Board approval of new requirements: (1) all trading card records
must ba accountod for; (2) all trading cards must be collected by
clearing firas on an hourly basis and time -stamped; and (i) all
trades must ba subalttad to tha Clearing House within one hour of
collactlon. These steps will not only enhance tha audit trail and
surveillanc* systavs, but the clearing process as wall.
(•} CTS-PLm has baaa teohuo logically anbanead.
Being a cooputerized systav, cnt-PLUS is abla to ba laprovad
by technological Innovations and enhancements. Tha Board has
approved several such enhancements to CTR-PLUS including: (1) an
expanded relational -data base to permit more rapid investigations
of trading activities extending back In time (I.e. expanding from
a "snapshot" of trading activity to permit an investigator to
scroll over an extended period of trading activity); (2) expansion
of the number and nature of surveillance tests conducted on a
routine basis; (3) use of expert systems technology which will
permit Investigators to quickly design prograna to specific needs;
and (4) expanded storage capacity which will perait rapid access
to one year's data. These technological enhancements should spead
Investigations and Increase the efficiency of professional
investigator resources.
23-500 0-90-16
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A critical alaawit ot CTR and CTR-PLU8 in accurata timmm.
Currantly, thara is no raquirsaant that tha hundrada of Bxcbanga
trading floor clocka which ara u»ad t-o tlsa ataap cuatoaar ordara
ba aynchronliad to within tan-a*cond inCarvala acroaa tha floor;
tbarafora, ainor dlscrapanclea in tlnaa can occur whicb nay affect
cm logic. Tha Board haa approvad synchroniEing, at conaldarabla
coat, all trading floor cloclca to ona aaatar clock to inaura
unifora, accurmt* ti>a infarmatlon baing input into Cnt.
I bav* b*«a addad t« anhaaea
Aa BOtad pcavlously. the Exchange regarda the self -regulatory
:aaa to ba «volutionary, not static. OIA currently soploya a
wida ir«riety of axcellant conputer programoars to assist their
surveillance and investigative efforts. However, those efforts
can ba enhanced by the addition of new staff dedicated solely to
Improving existing programs and writing naw onaa The Board *
approval of five (5) additional prograaaars will graatly anhanca
OIA' a aetortB.
offica rnvaatloatlona and Audit Enhancaaanta
OZA's staff bas always nalntainad tha highest dagrea at
professional isn and efficiency. Because training for OIA staff
poaitiona aftactively occurs only at tbe Exchange, hiring
qualified personnel and training then expeditiously is a constant
challenge. Tha Board has recognized that additional professional
parsoTuial to support OIA's afforta will enhance all of DIA'a
aCforta. Tharafora, tha Board haa approved a thirty percent (30%)
incraaaa of OIA profaaaional ataff ovar 19B8 budgetary levels.
Tha Lagal Dapartaant of tha Exchanga providaa lagal counaal
to OIA aa It doaa all Exchange departments. Nhila all attomaya
are involved in tha self -regulatory process, previously only ona
attorney was saaignad to exclusive OIA liaison and support
duties In consldaration of the inportance of Exchange
disciplinary actions, tha Board has approved trlplltig dIA ■ lagal
support to encompass three attorneys whose afforta ara devoted
entirely to supporting OIA. This increased aupport will incraaaa
the efficient use of OIA staff efforta.
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Survaillanc* and •nCorcsnant techniques tor futur«i wukatB
ar« »ac* an areano -art than a precise science Tbm b*at training
for n«w OIA staff is by existing OIA staff and Exchanga Aenbers.
Hsvartheless, soae Invastigativ* tachniques are coamon to nany
■arkata. Tharafora, tha Board has approved institution of special
training program* in invoatlgation techniqusa for OIX ataff to be
conductad by non-Exchange professional consultants The
additional training should enhancs OIA's existing axcallant
invaatigation efforts.
CU) OU floor •urveillaBoa tiB« has Man laoxaaaad.
Given tba conjecture that Che grand jury Investigation la
concerned with potential floor trading abuses, some question has
been raised reg-arding whether an increased presence of OIA
investigative personnel on the Exchange trading floor would
enhance detection of trading abuses and provide an incraasad
datarancB to potential abusers. It has been the Exchange's
experience that floor trading abuses are rare at tha Board of
Trade and that uhen they do occur, tbay ara sophisticated and
subtle enough to be detected best by fallow traders and/or
sophisticated computer Burvelllance such as CTR-PLUS.
Havertheiesa, the Board has authorized additional dedication of
OIA investigators to trading floor presence and observation.
Although the returns on such an Investaent of valuable resources
>ay be small, public confidanc* in floor trading intagrlty aakas
such aCCorts worthwhile.
Board of Directors Composition
The Exchange's Board is currently a diversified, expert body
consisting of twenty-four (24) representatives (roa all aspects of
tha nembership, industry and general public. The Rules of the
Exchange require and foster that diversity. For example. Rule
102.00 requires that the committee which nominates Director
candidates ■... give special consideration to the desirability of
having all Interests of the Association represented on the
Board." Moreover, the Nominating committee itself is elected from
the diverse Exchange membership which includes Individual traders,
FCHs broXer-dealers, banks, comaarcial firms, institutional
Invastors and others.
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(1> tbr** (3) noii-a«Bb«rm txam thB 7anar*l public svctor
(which bav* includad • forMr Dnitad Stat«s Attomay Cmmt*!,
a IlaB»«l Prii* vlnning •conovlBti, th* chairman of a national
agricultural association and otbar alailar nationally
raapactad public f Iffuraa) ;
(3) thras (3) non-realdant aaabcra vbo, balng raquirad to
bava thair principal placa a£ biuinaa* Bora than fifty (SO)
■ilaa froB Chicago, aCfactivaly ar« quaal-public Diractorai
(3) sicht (8) Haabar Director! who arm currantly prlnclpala
or offlcara of aambar firxs and thiu rapraaant tba
fCH/bcokar-daalar connunity;
(4) alx (6) oiractors whosa principal occupation ia aa
brokars axacuting cuatoaar ordara on tha floor of tba
Bxchanga;
(9) thraa (3) individual *aMbara whoaa principal occupation
is as activa tradars on tha floor of tha CKchanga for thair
parsonal accounts (i.a. ■ "local" tradar) ; and
Any critlclsB of tha Exchanga'a Board as baing biasad toward
aombers or one aspact of tha ■aabarahlp is sisply contrary to tba
facts Furthermore, prasant Rulas and policlas will insur*
continued diversity of raprasantation; no naw rulas or lagislatlon
are raquirad.
As described previously, the Board of Dlractora sits aa tha
ultlxata disciplinary body of the Exchange, either in an appellate
capacity or by referral fron a coaslttee. Historically, the Board
has always found Its authority to suspend, expel and otherwise
sanction to be nor* than adequate. However, with tha growth of
institutionaLlied trading and the consolidation ot «e»ber rima,
tba Board concluded that its current fining authority lS75,0OO par
violation] nay not be sufficient in all instances to adequately
sanction abuses especially where larger capitalized respondents
ara Involved. Therefore the Board has approved for a ■aabarship
ballot vote increasing Its fining authority sore than tbraa
hundred percent (300%) to 5390,000 par violation.
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(14) *k« Board ha* x—ttixm»a tbrangh farmal Mselutloa ita
leng-asiBtlBQ pollay «e •selvdiB? ■•■bMCa «ltb hlataciaa of
•IgnifleaBt trad* pcaetiea abosas txom partlelpatioa an tha Board
and aajor Biehaaga dlaeipllaarr ooMBittoos.
Ttia Board has long had a policy barring scabars with a
history of algnlflcsnt trade practioa aanctiona froa participation
on tha Board Itaalf or on althar of the Exchange's major
diaclplinary cooalttaas the floor Governors and the Buslneaa
Conduct coBwittaea The Exchange is committed to maintaining tba
atBoat intagricy of tha salC-regulatory disciplinary process and
thoaa who administer it. To insure that there is no doubt
concaming this continuing comaltmant, the Board has approved a
tonal resolution approved by tha Exchange's Rules Committee
reaffirming and formalizing this lang-exlsting policy.
Floor Practice Enhancements
Tha Board of Trade has hiatorically adopted all ita Rulaa,
especially trade practice rules, to meat tha highaat atandarda of
both Integrity and Darkat efficiency. Existing rules proscribe
unjust and inegultabls trada practicas, forbid trading ahead of
customer orders, insure that any profit resulting from the
arroneoua execution of o custonor order goes to the customer,
prohibit pre-arranged and acconnodation trades, as well as
prohibit all other forma of trada abuse. The Exchange believes
that these axistinq Rulaa are aora than sufficient to deal with
all potential trade practice abuses Nevertheless as part of Che
on-going review of all Exchange operations, the Board haa approved
several enhancements to floor piactica regulation.
(!■> kll broker aasoeiation* wamt ba cagiatarad with tha
Associatians of floor brokers sharing profits, expanses and
loaaaa — particularly with the inclusion of local tradara — do
not exiat at tha Board of Trade to the best of the Bxcbange's
knowledge. Such associations do exist at other Exchanges and
present those Exchanges with unique self -regulatory challenges to
insure market integrity. The potential for abuse of cuatoaer
ordars and market efficiency due to broker groups is, therefore,
not present at tha Board of Trada-'
However, some independent brokara at tha Exchange do share
order decks to facilitate customer order execution especially in
options contracts where liquidity in deep out-of-the-money options
ia thin Others share the expense of common clerks. To insure
that these arrangements do not evolve into potentially abusive
ones, the Board baa approved that all associations of brokers
which share income must register with the Exchange providing
certain information to enhance surveillance of their activitlaa.
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TIM Board ia co^lttad to pravcnting any potwitial abua* of
custoasr ordttra which would raault froa th« ocbarwla* lAgltiaat*
busliMKa ralatlmtahipa of BMibar floor brolc*r*>
Markat-on-eloa* ordars If antarad lata, can craat* problaa*
in Bchlaving sn atflcianC, Aarrow and accurata cloalnq ran^a.
Etflciant cloalng ran^aa ara aaaanttal Co tba coasarclal uaac;* Of
futuraa contracts, aapecially aa a pricing aachaniaa for oaah
Mrkat tranaactiona. Tha addition of tha aodiflad cloalng call
provtdaa At\ opportunity tor auch lata antarad ordara to ba
coaplatad and ior individual floor tradar* to 'evan-up* attar
providing liquidity tor doaing ordera Alsoi a aora atficLant
doainq ranga facilitatas • aor* accurata sattlaaant prica which
fraquantly ia tha baais Cor caah varkat pricing.
Haw Regulation 1007.02 would aatabliah an additional
two-ainuta trading parlod for all contracta at tha concluaion Of
trading aaaalona. During thia parlod, tranaactiona could t9km
placa only at pricaa within tha pravioualy aatabLlahad closing
ranga Ito naw ordara could antar tha pit but cancallationa would
ba paraittad Stop ordara and liait ordara alactad by tha elo«iag
rah^a could ba fillad during thia pariod
Tba Bxdtanga baliavaa that tha aatabllahnant of a ■odifiad
eloalng call will banafit public custoners tor a nunbar ot
raaaona. Firat, aora etticiant cloaing rangaa banafit caab Barkat
pricing. Additionally, bacaus* tha naw procadura will anabla
individual floor tradcra aora raadily to adjuat their poaitiona
(to "avan-up") thay wiU. ba Doro willing to provide liquidity to
the cloaing public ordara at tha aoat coopatitiva pricaa.
Finally, no trada nade during tha noditiad cloaing call would ba
advantaged ovar thoaa made pravioualy in tha aarkat due to tha
raatrlctlon of pricaa to thoae aatablishad previously by the
Cloaing range.
Tha Ixebanga alao notaa that tha audit trail for ttia moAUlmi
cloaing call will ba pracisa bacaus* tha closing call pariod Kill
rscaiv* a saparat* CTR dasignation, thereby enhancing tha
I'B Burvaillanea capabilitiss tex thia pariod.
Floor clarka ara raaponaibla for tha clerical handling of
eustoaar ordara and other trade docu>anta. Nhila having no
trading prlvilagas, clarka ara naverthalaaa intisataly invalvad in
tha trading procaaa. Bacauaa of that involvaaant, darks ara
often ta^tad to trad* for their own account. Mhila su^ trading
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has historically ■•rvad as a valuable »«an* of apprantlcsshlp
training to bsc^M a asabsr, tha Board has dstaralnwd that tba
rights of ■•■bsrship trading' aust b* rastrtctsd to thos* who pass
Um Intanslvs HaBbsrshlp admission proosss. niarafor*, th« Board
has approved prohibiting floor elarks froa salntalning trading
Additional Technoloatcal Enhai
Ttia Board of Trads tiaa not Ilnited tachnologlcal Innovation
to the craatlon of CTR and CTR-Plua Tha Board of trad* is on* of
Um most technologically advanced narketplaces in tha world. Two
aspects of that technological supraaacy ar« worth noting in the
prasant contaict.
(lf> Tka BxobOBga's alaotxeala oxdax-antry sr'taa (-tOB-i
will not OBlT inaraaa* tha aff iolaaor of austoaar ordar axaoutlan -
sad olaariag, bvt also tha aeeuraof at cm.
For aany aonths, long bstor* tha current news of a grand jury
inveatigatlcin, tha Board of Trade hai bean developing an advanced,
electronic order-entry systea ("EOS' . Electronic order-entry
vill speed coasunication of custoner orders to the trading floor,
expedite conlirmation of execution back to the customer, and
Bubnit trades for clearing directly. These enhanced efficiencies
■will not only sirvo custonera better and reduce fCM enpensea, they
will also provide a coaputerited record of custoDsr orders vith
tlB*s accurate to the second. This enhanced tinlng will Inprove
the accuracy of the CTR audit trail and, therefore, tile efficiency
of the CTR-Plua surveillance systea.
Approved by the Exchange membership or
is now on a prototype basis. As use of the
of CTR data will be enhanced even further.
Juat as EOS will enhance custoaer order tiae data, a
hand-held computer teminal to replace trading cards would not
only provide on-line clearing of trades but also unimpeachable
trade execution timing to tha nearest second However n-O current
technology exists to create such A device for use in the auction
varket. For this reason, the Board has approved significant
expenditures of Exchange staff and aember committee tine to work
with outside profasaionals in developing such a teralnal to aaat
the needs of our markets. Preliminary work has already begun.
Hopefully, these efforts will lead to tha developaent of suitable
technology within a fav ahort years.
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On July 13, 19S9, ChalrBan BrKilish and R*pr*a«ntativaB
COlaowfi and Penny introducad th* 'Coaaodity ruturaa Inprava&entB
Act of t9«»," B.K. ia«9 (attachad harato at Appandix 4). Tha bill
propoaaa to (uiand ttia CoBBodtty Bxchang* Act ( Intar siia) to
idprov* tba ragulation of futuraa and option* trading, raatrlct
potential cuatoaar abusaa, ralnCorca davalopmant of axcbanga audit
trails and astabllah Itighar atandard* for ■•rvlca on govamlng
board* and diaclpllnary comMittaaa of aalf Tsqulatory
orqanisstlona.
Durinq * Juna 39, 1989 praa* eonfaranoa praoadlng tba
introduction of th« bill, Chairaan English noted that this
Subcomalttee's inquiry 'found that the systea aa a whole ia aound"
and that "the real 90BI ia to produce strong Incantivat to tha
industry so that wa can protect against these kind of vton^a."
Rapraaantatlva Colaaan statad that tba focua of thia pr^ioaad bill
ia tha "raatoratlon of intagrity which baa baan qiMstionad by tha
■adia and cuatoaers."
Tha Chicago Board of Trade conoura wholeheartedly tn the
objactlvas of the bill and the approach of providing incentives to
the industry to protect against potential market obuaas. Howsver,
several provisions of the bill present seriously -daaaging
approaches to achieving our conmon objectives. If enacted these
proposals could prevent U.S futures aarkets froa aarving their
public interests and seeting successfully the challenge of foreign
conpetition. Therefore we urge tha Subcoaalttee to re-axaaine
and revise several proposals, especially those relating to dual
trading and audit traila.
R.R. 3889 proposas (in pertinent part) amending Section 4j(l)
of the CEA (7 D.S.C. <j) to prohibit dual trading by a floor
broker In any contcact market trading in excess of 7,000 contracta
per day baaad On a six month aoving average. Tha CPTC aay
Incraaae or decrease that threshold level based upon a
deteraination that the prohibition upon dual trading craataa
undesirable price volatility, unacceptable widening of bld-aak
spreada or otherwise threatens the public Interest.
under Section (D), tba bill proposes to permit the Coamlaeion
to axaopt a board of trade from tha dual trading prohibition if
the exchange can denonstrata to tha Comalssion that tha Bxobanga'a
audit trail can detect "any and all instances of trading
violations which the comDiseion determines to be attributable to
dual trading and la ttf^lY verifiable." (^phaaia added.)
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section (C) at tha bill raquir** tti* Comlaslen to
paricKlieally detamlna whathar dual trading should b« p«raitt«d
and, 1( so, undar what taraa -and condition*. Cor thoa« contract
narkata trading balow the 7,000 contract per day level. Section
(BJ oC the bill seta forth tha detsminatlons tha Caeaiaalon Miet
malca in thoae contract markata where dual trading is prohibited.
subsection (vil) providea a floor broker nay dual trade if a
custoner designates an individual floor broker by naa* in writing
on at least an annual basis.
Initially, any proposal to ban dual trading aboold be studied
carefully subject to extensive expert input. Ae diaeussed
previously, dual trading providea a valuable narket function which
should not be BUBnarlly abrogated without eirtenelva input and
evaluation. At a eininuB, thia Subcommittee should review,
consider and have hsarlnga regarding the CoDmiseion's study of
dual trading as wsll as those of other experts in tha field.
Assueing the subconnlttea deena It necessary to proceed
without the benefit of such background, any restriction of dual
trading should be predicated principally upon tha ability of the
Exchange to detect potential abuses. The audit trail exemption
contemplated by subsection (D) of H-R. 2869 provides the framework
for such an approach. However, the specific provisions contained
In the bill provide an unrealistic and unworkable standard for
conditioning dual trading.
By requiring the audit trail to detect "any and all"
potential dual trading abuses and be "fully" verifiable, the bill
eatabllBhes a standard of perfection unobtainable in the real
world. Instead tha bill should be modified to reflect the
objective of excellence shared as a goal by Congress, the
Commission and the entire industry. The current industry audit
trail is the best in the world. The Subcoiiuilttse should not lose
sight of the system's existing excellence by insisting on
unattainable perfection.
Improvements and enhancements are possible. Included herein
is a detailed description of an exteneive prograa of such audit
trail enhancements already implemented by the Bxcbange. These
enhancements will achieve the bill's objective of Improved audit
trails (an objective shared by the Board of Trade) without
presenting the potential for the destruction of contzact earkat
liquidity.
The bill's audit trail exeeption should be revised to be more
realistic without sacrificing the coneon objective of aaxinuB
detection of potential trade abuses. Such revisions should
Include the following:
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(I) prohibit dual trading unl«*s an axchaima.can davonatrat*
that its audit trail la variriabl* to tha naaraat ainuta to at
laaat tlM 901 laval aa datanlnad during tha CFTC'e parlodlc rula
anforcasant raviaws;
(3) thoa* brokara whoaa cuatoaara hava axpraaaly raquirad In
writing that thair brokar* ehall not dual trada will ba prohlbltad
froB dual trading; and
(3) ahould an axchanga Cail to achiava tha audit trail
partoraanca standard dual trading will ba prohlbltad in thoaa
contract aonths which do not attain tha standard until covpllanca
can ba deaonstratad unless tha contract Month dlaplaya low
liquidity. Tha prohibition will not apply to those brokar* who
ara predoninantly spraad brokars. For purposaa of thia
prohibition, a Bavbar la claaaltiad aa a brokar or a tradar on a
dally basis and, Intra-day ia not classifiad a brokar until ha
aakaa his first cuatooer trada of the day This prciiibitlon
applias by separate contract ncnth, tor futuras and options
contracts separately. Henbsrs handling custoaar ordars
functioning in a clerical capacity shall ba daaaad to ba brokara
for purposas of this rula.
If thasa ravlsiona ara adoptad, tha coMMon objactiv* of audit
trail anhancaaant and datactlon of potantial dual trading abusas
can and will ba aat. Crltfcally, this comon objactivs will ba
■at without risking tha daatruction of aarkat liquidity and Uw
loss of JMarican lurlcata to toraign coapatitors.
Audit Trails
Section aoi of tha bill proposas (in partinant part) to a>«nd
Sactlon 4g{l) of tha CEA <7 U S c Eg) by raqulring that tha trad*
tiaa axacution raquired by the section ba varifiabla and statad
within a ona ninuta increment within one yaar of anactaant and a
thirty (30) aacond increnent within three (3] yaara of anactaant.
Paragraph (b] of tha bill amends Section 5 o{ CE&
(7 U.S.C. 7) to condition contract aarkat atatua upon this
raquiraaant.
As statad aarllar, tha Board of Trada sharaa tha
Subcommittee's desire to hava tha best audit trail obtainabla
which does not nagativaly Impact the functioning of the marXat.
Bequiring standards unobtainabla by present technology only sats
up tha aarkec place for failure, to the detriment of all
involved. Defarring tha requirement provides nO solution baoauaa
there Is no assurance that technology will davalop auffioiantly in
tha interim to maat tha standard.
Tha Subcommittaa'a objactlvas would ba batter aarvad by
siaply raqulring that tha audit trail ba sufficient to proparly
wonitor tha market and datact potantial trading abumas. Tha salf-
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rttgulatory axchangaa and th* CaMBlaslon mxm in th* b««t position
to datarain* tti« particular ap*elflcatlona of that raquirwMnt.
X* Chairaan English has atatad, V^ciaa audit trails and
raaponalva tina raoonstructlon Cor trading ara abseluta
nacaaaitiaa •■•■' Praolsion and rasponsivansss, than, sbould ba
tha standard, not an unobtalnabla fixad raquirasant.
SRO DtatjlpllnarY Comaittaas
Th« bill proposaa in saction 309 to ajaand Saction 8c of tha
CUi <7 D.S.C. 13c} Co requira that axchanqa disciplinary
coBBittaaa ba coapriaed so that for any glvan haarlng, a aajorlty
of tha haarinq fianal ahall ba of ■ dltCarant trading atatus than
tha raspondant Trading status is dlvidad betwaan floor brokar or
floor tradar, non-tloor memberB and staff (if any].
praBlse of Brit Ish-Anar lean jurlsprudenca is the requirement of
trial by one'a peers. Tha conmittae's proposal laqislates
precisely the opposite: trial by those guarantaad to ba unfaalliar
and IneKparlenced with the standards applicable to the
respondent's conduct and the conditions under which the
respondent ■ actions were taken. For example, if the respondent
i« a broker in the cOrri futures pit, he will be judged by a panel
whoa* majority is not now (and lllcely never has been] engaged In
floor trading of Com futures, far less brokering in that
contract Hot only is floor trading Itself (and brokering in
particular] a unique and complex activity, customs and practices
■ay wall vary avan akong diCEareot contracts.
Surely tha bast judges of ona's conduct are ona'a paara.
Given that, it is contrary to reason and tha bast interests of tha
■arkatplace to require a disciplinary panel to ba co^risad of a
majority of non-peers.
Prasmably thasa provialons of tha bill ara almad at rasoving
the perception of soma unarticulated bias In tha current structure
of exchange disciplinary panels. The Board of Trade is unaware of
any problaa of this nature, whether real or perceived. However
It the Subconmlttae is convinced (for reaaona not evident} that
cttangas must be made to tha structure of «xchange disciplinary
panels, the provisions tor Board of Trade arbitration panels
provida a better model than that proposed in tha bill. fSee a^O^.,
Board of Trade Regulation 610 Ol . Thosa rules provide that Civ*
members of the committee be chosen for each exchange arbitration
panel froa four major categories (1] floor traders 3} floor
brokers; (3} brokerage firms and (4) commercial firms Such a
model presents significant problems in the disciplinary context
which are not applicable to the arbitration process.
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N«VM:tlMl«a«, it Is ■ b«tt«r aaana of iiwurlng tha iMa*«»ary
amqrmm of relevant indiwtxY •xpartiea an a disciplinary pansl tbsn
tha provision of tha bill.
tha aactlon alao providas that bchangaa dany asabarsbip on
tha Board of Slractors or any disciplinary coaaitcaa to thos*
guilty of a "sajor vtolaCion of any rula' viutln a p«rio4 of tias
to b* dacaralnad by tha CoBaiaslon and raqulras tha class iflcatlon
of Exchanga rulaa aa -malor- or "minor" for this purpos*.
laa no objaction to this provision; as s«t forth
[ Trad* alraady has tonwlizad ita long-atsndlng
policy prohibiting aambars with significant blstorlas of trado
practlca abuaaa troa Bsmbarahip on tha Board or on Exehangs
disciplinary connlttaas. Sowavsr, tha Exctianga notas that tha
arbitrary clasalf tcation of rula violations aa ">ajar' and "minor"
nay distort tha gravity of any glvan oCfanse without dua
. consldsratlon to tha facta of sach individual caaa.
Brofcar Aasoeiatioiia
Sactlon 102 of tha bill proposss to amand Saetlon 4j of tha
CKk (7 D.S.C. 6j) to rastrict trading among brolcsr asaoclatlons as
that tarm may ba dafinad by Coaviasion ragulstion.
As datailad abova, brokar associations as thay axiat at othac
axchanqaa are not coanon at tha Board of Trada and prasant no
prasant trada practioa protalaaa. Tha Sxchanga, howaver does
share the SubcoBoittea's concern that asaoclatlons of brokers that
are established for laglti>Bta bualness purpoaas not ba paraittad
to evolve into abusive antltlas. Tbarafora, tha Bxcbanga aakas no
content on thia proviaion of tha bill at this tima.
Publtff Bepraaent^tion on Governing Boarda
The bill propoaaa to aaand Saction 5a of tha CSK (7 O.a.C.
7a] to require that -outside aasbars" aa dafinad by tha CMadsaioa
conprlaa at least twenty [Mrcant (20%) of tha govarning board Of
each contract aarkat.
Sivan tha divars* raprasantatlon of th* UtAsnga'a Board of
Diractor's as datailad above and the rules, regulations and
policias insuring that diversity, the Ixcbange Bakes no OMOwnt at
this time on this proviaion of the bill.
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Baalatratlon of floor 1Tad*pa
Section 305 of tba bill propoaas to twand Saction 3{a)(l] (A)
of tha CEk (7 O.S.C. 3) ••■antlally to axtand tha raqulraaants at
floor brokar ragl*tration to all floor tradars.
In via* of tha txchanqa'a rigoroua ■
as daacribad abova, tha Exchonqa aaXas ne
this proviaion of tha bill.
<?th«r Provlalona of H.R. 2969
CONCLUSION
Tha combination of sophisticated conputerized surveillanc*
systems and the vastad sell-intereat of the Exchange's rigorously
screened membership In ttie preservation of narlcet Integrity
combine to create an extremely effective mechanism for Cha
detection of potential exchange trading floor abuses Tha Board
of Trade has never condoned and does not condone today — any
trade practice abuse Proven offenders have always baan
appropriately sanctionad (including Cinas, suapansions and
axpulalons) .
Navarthalass, tha Board of Trada racognlias that auccasa is
an avolutionary procaaa, not a static ona. Thus, despite craating
CTR and CTR-?LU3 — tha world • finest «udit trail and
surveillance ayataaa — tha Exchange has considered all «a«na to
preserve and improve market integrity. The result of the most
recent, intensive internal study ia th* twenty one (21) point
program of enhancements detailed herein. These improvements (and
others still under conaideration) will insure that the Board of
Trade a markets remain the world's most efficient liquid and
aconoaical with tha hlghaat degree of Integrity and profaaalonal
participation.
In considering these Issues, we urge this Subcomnittae to
remain mindful of the potential (indeed, likely) consequences of
precipitous, hastily oanaiderad action- Hhile currently the world
leader in futures markats, the O.S. could easily lose this unique
and valuable in'dustry to eager foreign competitors, if
ill'considered regulation is mandated. Therefore, critically
valuable trade practices such as broker trading must be carefully
evaluated, especially where their value is indisputably docusentad
and no evidence exists regarding any abuses.
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In faablonlng uiy Iwgislation, this CoiHitt** sheold also
look with prld* to tho procodont sot In l»ts rogardlng tbo awllt
trail looiM. nion, tho CFTC foal of oiw-alnnto tlao
Idontl float ion waa loft to oach aaparata oitehango, vlth Its
dlfforlng »aaborshlp and aarkats, to boat dotoraliM hew to Bsot
that qoal. nta rosult oC thla Banagaaant-by-objoetlva approach
was tho craatlen of cnt, tho world's flnost audit trail. It
Congross acts slsllarly now aftar earsful study, tho rooult sbonld
bo tho oontlnuod iaprovoaont of what ara alroady tho world's Boot
honost, liquid and ottlciont futuroa oarkots. Thla is tho 900I wo
ftavaral of tho provisions of H.R. 2»tt, oopoclally thooo
rolatlng to dual trading and audit tralla, apMsr ill eenooivod to
OOhlovo tha atatod ob]activas of tha bill, ebjoctlvos aborod by
tha Board of Trada. Inataad of tha prohibition of dual trading in
our *OBt inportant aarkata, tha SubconUittao should eoadltion dual
trading upon tha ability of tba contract oarkot to oaintaln a
praciso, axcallant audit trail, not an unobtalnablo and
nonoxiatant parfoct aystoa. If such an approach Is adoptod,
ovoryona'a coooon objoctivo of aarkat intagrlty and liquidity oan
and will ba aehiavad.
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Kvnmi* Dally Volu>a.
CBOT
298,147
S<>3,144
oth«r U.S. Futuc«
„,,.„
Poraign Futucn Exctuutgss
.,!....
.«,,.,
□.3. KarkaC Shar*
.....
,1.7,
Foreign Market 5hac«
U.4.
J..J1
„Coogle
«d Fulura* OpOoM VoMim; 1 N4 w. IflM
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ContractB Tradlii9 •
tha Horld'B Futucas Enchangaa
g.a. Futuraa BitchMa«»
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ll il
i\ n i\
il il !
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u A h H fi H
i II H n il II !j
I
Ullli
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II
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ill I
II ll il It
' ^1 ]i H 1^ il Jl I t: H H
i\ i\ }] II II ll y ll If li
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il
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„Coogle
[ Foreign Futuram and OpCtor
Tradad in eh* Top js by vcilii>a in tha World; 1984-19S9*
iaa« 1995 1986 1331 ma. 1331'
•JanuarY-Harch, 1989
„Coogle
496
Annuil QroMtti RMn; 19BS-198>**
U A FuluraB Muaky vs. Principal F
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VolUH Srcwth of Financial Puturaa and Options
Contract! Trading on Forsign Futuras Exchangaa
19BS - 1989*
Ikvaraga Daily Voluaa 13,686 77,980 171,733 189, 7S1 318,038
Qrowth Bat* (*] — 4«9.S 120. Z 10.5 14.9
Avaraga Dally Volma 1,590 S.SSS 59,914 47,438 75,3
Orowth Rata (<) — 318. « SOD. 3 -20. 3 58
■January-March , 1989
„Coogle
roiUGM COHKTITIOi
Tr«aiurr Bond Futuri
and London Iat«rn«e
Oecobar t ,
IS VoluB*: cniCMO Board at Trad*
lonal Financial Futuraa Exebani*
t9ST to Octobar 30, 1987
urn
1O/0t/87
10/02/87
23.«66
9,0*7
ii;::;i
i?;:;ji
5,970
999
1O/05/8T
10/06/87
10/07/8T
10/08/87
10/09/87
10,96J
T,6i3
10,S2Z
10,626
i?,36J
267,009
2««,2!9
362,278
«2.l89
308, 7«2
372.800
192.815
32«,105
7,779
l0/lj/e7»
10/13/87
10/14/B7
10/15/87
10/16/8T
10,370
i»;s8T
12,100
19,270
21,967
ai,S96
278,279
511,021
6«0,!17
36S.S32
91.996 .
293,181
lii:iS)
387,199
iii.«82
28,892
•83,949
S<.WT
13,903
IT. 0881
10/21/87
10/22/87
10/23/87
11,552
'A:lli
311,180
366:911
323,253
359,732
380,811
351,519
19,959
12.165
16,079
tO/26/97
10/27/87
10/28/87
10/29/87
10/30/87
19,203
20,937
15,270
15,5«2
17,100
272,109
280,699
337,029
221,911
220,010
291,612
301,992
352,299
210,193
237,110
10.900
iTaraga Dailr
(laar-To-Oata)
12,385
286,909
297,121
6.186
„Coogle
lillllC!l|IOli!i
Kraiii ExcIkiiiiic
iraa contracts and option
testiflad befora tnls connlttes in connection with this yaar
reauthorization. 1 will limit my remarks to isauas of najor coi
the Hinneapolia Grain Exchanga.
First, a ganaral connent. I an the newconec in represen
exchange in a setting such as this but I am familiar with busii
government. Tha futures industry today — ulth all its sija, i
and variety — owes much of its growth anil credibility to the ai
an exclusive, independent regulator to regulate the nation's
markets. The child oC that legislation, the Conmodity Futures
Conmiaslon, has done a good job undar difficult circumatancas. I
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va ara conoamad that parts ot this bill sarva to r«vi«a tlia 1974 aandata
and put alcro-BanagaBant of Boaa aspacta ot tba Induatry In tha Congrass
and out of tha handa of tha aypart ragulator. This appaars to na to ba
bad bualnaaa and bad QovarnBant.
Spacltlcally, dual trading ia assMitial to praaarving liquidity In our
futuras contract*. Dual tradara ara tnvolvad In avary aapact of tuturaa
trading at tha lltnnaapolia Grain Exchanga. Tbay cannot ba aaparatad fro>
trading In tha currant option, or apraadlng againat dafarrad optiona, and
parait ratantlon of any aaablanco of liquidity. It dlahonaaty spring*
tta* dual trading, va aust ineraaaa our vlgllanca to pravant it (avan
though thara la no avidenca of diahonast dual trading at tha Hinnaapolla
Grain Bxchanga. ) if diahonaat dual trading aprings froa highly liquid,
•ctlva tuturaa aarkata, lat us idantlty and punish tha dlshonaat tradars,
but lat us not. In tha procass, daatroy tha futuras aarkata. niasa
BBTkats hava provldad tha baat, and oCtan tha only, sourc* ot pricing
Information and Bargin protaction dating back alBoat to tha Civil War.
Tachnology Is raachlng tha point that vary accurata, tiaaly audit
information is avallabla to halp Idantlfy thosa tradara oho Blfplt try,
unfairly, to do battar than thalr trading aklll alona might patmlt. At
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th« Hliuisapolia Craln Kxdianga, wa ballav* that our audit prograa
providaa a aatl a factory aaana by irtilch to varify tha tialng data
au^ittad to tha Claarlitghouaa and to datact Inaccurata or alaalng trada
data on aourca docuaanta.
In ttala ragard, tba Comlaalon, during Ita 1988 Rula Bnforcaaant
Ravlaw of tha Kiimaapolia Grain Kxchanga, found that tha Bxchanga'a ona
ainuta tlning ayataa waa axtra»aly accurat*. Th* CFTC atatad, "... tha
BKchanga'a ovarall avaraga accuracy rata waa 96. a parcant." Ha ballava
that an accuracy rata of 901 or graatar ia a propar targat, and vill, of
couraa, contlnua to atrlva to aaintaln a high laval of parforaanca In
thla araa.
Lat mm taka a alnuta to congratulata xr. diarry and hla atatt on thair
profaaaionallaa. Ha vara vlaitad at tha Mlnnaapolla Grain Bxobanga by
Mr. McDonald who waa coapatant and thorough. It ia our viaw that tha
frulta of thia long, datailad invaatlgation ahould ba fully uaad by tha
Comittaa aa part of ita raaponalbllitiaa to ovarsaa tha CTTC. In tha
naln, tba CFTC baa aora than anough atatutory authority In tha araaa of
ao oallad "dual trading", audit trail and oo^maltion of boarda at
axchangaa. I think it ia antlraly an>roprlata for thla COB«lttaa to
ravlaw tha raeord of tha CFTC on thaaa laauaa) it would ba vary riaky to
incorporata your concarn in atatutory aandataa.
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Dual trading i« said to occur whan an antlty BOHatljMa
tradaa «a a broker for cuatoaara, and at ottiar tlaae tradaa for
ita own account. Dual trading la qulta parvaeiva tbroughoat tb*
Unitad Stataa aaeurltlaa and futuraa aarkata aa wall as In
financial and coaaodlty aarkata throughout tha world. Tha
parvaalvanasB of dual trading la dua to tha fact that aany of tha
■killa and facllltiaa raqulrad to ba a good brokar ara alao
nacaaaary to ba a good tradar. Dual trading Incraaaaa tha aupply
of both brokara and floor tradara bacauaa a dual tradar can aam
Incoaa from two actlvltlaa to covar tha coata of training, an
Exchanga aaat, and tiaa apant on tha floor. Ha haa laaa Idla
tlaa and taeilitlaB whan ha can switch froa tha activity In low
daaand to tha activity In hl^ daaand.
Dual trading haa botb a diract and an Indiract atCact on tha
quality of cuatoaar aarvlcaa. Tha diract affact la an ineraaaa
In tha quality and quantity of brokara. Tha fact that dual
trading Incraaaaa tha aupply of brokara >aana tha cuatoaar has
mora brokara to chooaa troa and at a lowar prica. Forthanaora,
ualng a brokar who la a good tradar Baana highar quality
axacutiona for cuetoaara.
Tha indiract affact darivae froa tha ineraaaa in tha
liquidity of tha aarkat cauaad by tha ineraaaa in tha nuabar of
aarkat aakars. Partlaa who trada for thair own account by buying
at a low prlca and aalllng at a high prica aarva a aarkat aaklng
function. Thua tha ability for an antlty to uaa Ita tacilltlaa
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for proprietary trading rcaultm in an incraaaed preaanca of
market Makara on the floor at tiaes when their servicea are most
needad. Mora tradara standing ready to trade make for a more
liquid aarket with snoothar price changaa.
In order to aid in a comparative analyaia of dual trading I
distinguish two typaa of dual trading. The first type, called
slmultanaoua dual trading occur a when a firm trades as a
principal for its own account, and an agent for its customer in
the aasa transaction. This type of dual trading is prsvalent in
securities markets, currency and interest rate swap aarkets, and
tb« fixed income market. Sieultaneous dual trading does not take
place in futures varkets. The second type of dual trading called
conaecutlve dual trading occurs when a fin trades for custoasrs
as an agent and at other times trades for Its own account as a
principal, but the firm does not do both in tha same transaction.
Consecutive dual trading occurs in futures markets, as wall as In
all of the earksts in which there is simultaneous dual trading-
Dual trading plays a particularly laportant role In futures
narkets as contrasted with securities Barkata. Tha feet that all
trading in futures takea place on the exchange floor and that
spread trading is an important part of hedging strategies make
the skills of a trader more necessary for a good futures broker.
The iemediacy regutrad by the futures market Mkes liquidity aora
important, and thsrefore eakea a larger supply of Market wUcera
Mors critical.
There are three types of brokerage services the customsr
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n**d«. Th« first ■«rvlc« ("■•■rch") lnvolv*a ■•arching for tb*
parti** who ar« inc«r«at*d in balng on th* othar aid* of th«
trada (i.e. , tha contra-party) . nia aacond aarvica ('tiaing')
involvaa obtaining and procaaaing infar>ation to dataralna how
long to wait for tha arrival of tha Hoat advantagaoua contra-
party whila balng aicpoaad to tha riak of an advaraa price aova.
Tba third aarvica ("bargaining") involvaa acttvaly bargaining
aaong available contra-partiaa to obtain the baat prica.
A aacuritiea broker can uae bla akllla and aalaa tore* to
prearrange tradea 'upataira". Upataira aearoh la oftan^ an
effactiva aubatltuta for tha downataira working of an order lAara
■timing" and "bargaining" akllla are needed. A futures broker
cannot prearrange tradaa upataira. The brokerage fir* cannot
aubatitute "aearch" akllla for trading akllla. flia order auat ba
worked on the Bxchenge floor. nia floor broker auat hava tha
ability to trade in auch a way on the floor of the Ixchange that
he brings the other aide of the trade to tha floor at a good
price for hla custoMar. niarafora floor trading akllla are
relatively more iiq^rtant in the futuraa aerket than in the
aecuritiea aarkat.
Further, auch tuturea trading involvaa "apraada" where a
cuatoaar wants to buy and sell two (or aora) contracts
siaultaneously for a guarantaad net price. The oustoaer's broker
can execute the spread by trading with a "local" on the floor, or
tha broker can execute the individual "laga" of tha apraad
consacutivaly. The latter will ba in tha beat interest of hla
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if the brokar i« a skillad tradar, slnc«, by trading
each leg himaelf, th« broker avoids paying tha local a praniun
Cor the risk in trading th« spread. Such spread trading is
inherently risky to a broker, sine* attar he executes one leg of
the spread his customer can hold him to a price for the other leg
of the spread, which the broker may find Impossible to achieve it
the price moves attar he does the first leg. This aspect of
futures trades as wall as the relatively higher underlying price
volatility in aany futures contracts increase the trading skills
burden on a futures floor broker relative to that of a securities
floor broker.
Futures trading custo*ars often have a high desand for
Immediacy because they are tradir^g to hedge an underlying spot
narket position. The tact that immediacy of trade execution is
extremely important to futures customers Impliss that they will
have a greater deaand tor »rket makers than will be the case In
markets where the cost of delayed execution is eaaller. A
commodity hadger bears great risk if he does not do his futures
trade iMmediately. nils risk nay force hia to trade using a
"aarkat" order, for example to sell iBsadlBtely to the highest
bidder currently available. It there are tew aarkat makara then
he will receive a relatively low price, i.e., his trade will have
a high market intact cost. Thus futures urkets have a great
demand tor traders who in effect serve a market uking function.
The institution ot dual trading pemits this deaand to be aet at
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Dual trading lner«««*B th» supply of ttw typ*a of ciutoaar
Mrvlc«B which «t« r«lativ«ly bobc d»>«ndad by futuxa* custoaars.
Du«l trading la pr«val«nt in tha aacurltlas »arkat, both on tha
floor and off tha trading floor, inatitutional aacuritiaa tradaa
ara of tan praarrangad off of tha floor, and thla laaaana tha
burdan of aacurltiaa floor brokara. It would ba quita paculiar
to alialnata dual trading tor futuraa and aalntain It for
aaourltiaa whare tha dual trading by floor brokara la laaa
liq^rtant. Tha alivlnatlon of dual trading frea futuraa Barkata
will ban cuatoaare by raduclng tha quality of brokara irtio do
custowor bualnaaa. Tha baat tradara will trada for thalr own
account, laaving cuatowara with brokara who ara loas aklllad
tradara. 8y pravanting tradara froa acting aa brokara, tha
aliaination of dual trading will raduca tha nuabar of floor
tradara, and thua raduca aarkat liquidity. Foralqn aarkata will
gain an advantaga ovar DS aarkata cauaing larga euatoMara to
laava ua aarkata which will loaa liquidity. Ibarafora aaall
cuatoaara, unabla to trada ovarsaaa, will ba aoat advarsaly
affactad by tha loaa of liquidity In D8 aarkata. Spot aarkata,
auch aa qralna and tha OS traaaury bond aarkat will ba advaraaly
affactad by tha loaa of liquidity in futuraa aarkata, and apet
pricaa will baco^a aora volatlla. Finally, cuatoaara will loaa
tba fraadoa of cbolca thay now hava to pick aitbar a brokar who
alao tradaa for hia own account, or a brolcar who tradaa
axcluaivaly for cuatoaara.
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AN ECONOMIC ANALYSIS OF DUAL TRADING
Sanford J. Grattnun
TruBtaa Prof assoc eC Pliunea
Onivaraity at MniwylvMiln
Jttly IS, !»••
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Tahla at eonfnf
1. EMCUttM <i.~-..^
3. IntrodueCian
1. Cuato—r OrdT Flow and Wrfct Struetura .
DiacuBBlon of Tabla 1
Tabla 1
Dlsciuslon of Tabla a
Tabl* 1
4. Tha Datair»lMHta at —rltat r,tqiitiittY ^vfl prnha^fBt ayvt™^ -
4A. ■rakaraja garvlcaa
Brokarag* Sarvicaa For ItiBCltutional Saouritlaa
CU*to>ar*
Brokaraga Sarvloaa for ruturas cuatoaar*
«•• ^h- naf>-tn.nCa af Ifai^t Ltaniiiltv
Final Cuatraara
Markata aa Inforaatlan convayora ■
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Dual TrMlina. Warlcaf. T.tgutdttv. and th» OuaHty of Brolcyo. .
Tha ImporCanca of Dual Tradinq In FuCuraa Harkata • • •
Ttia Exchanga Floor la a Poeal Point tn ruturaa Karkats
Futuras Cuatoaara Saquira Brokara Hha ara Tradara . . .
Dual Trading and Liquidity on Futuraa Karkata
. Praliainary Evaluation of Propoaala to Raatriet Dual Tradlnq .
A. Conaaquaneaa of EHmtnattng nual Tradlmp
Tha HuBbar of Market Kakaca and of Brokara Will
Markat Liquidity Hill Ba RsducMl
Spot Karkats Will Ba Advaraaly Affactad
Foraign Markata Will Raplaca OB Markata
Cuatoaara Mill Loaa Thair Praadoa Of Cholca . . .
B. Bavtaw at Pronoaala to Partially tllainata Dual
1. Mflnata n»-1 TraJtim tti t-itnitd Contraeta . .
2. gHainata Oaat Trading at tha Onan and tha
eloaa of Trading
]. tAmif ft>. %X" "t Cua*— "• f^"m gMmtabIa by
4. TilBit mMl T^dtnT to <•!« Ilaefc Mnntha
laaurina tha —naflta »f Ouat Tra^laa
nia Dataralnants of Dual Trading
Iba Banaflta of Dual Trading
23-500 0-90-17
D,gnz.dbvC00gle
Dual Trading In Foraign MmrkaCa .
AuatralU
Balgiua .
Braill
Hong Kanq
InAU . .
Italy . .
Kavleo ....
Katharlanda . .
Slngapora . . .
South Africa .
Spain
swittarland . .
Unltad UngdOM
unltad Stataa .
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1. BxBCUtlv a
Dual trading 1b a* id to occur vh*n an entity i
trad*a a> a brokar tor cuatoaara, and at othar tluas tradaa for
ita own account. Dual trading la quit* parvaalva throughout tha
Unltad Stataa aacutitlca and futuraa aarkata «b vail aa In
financial and connodlty RMrkata throughout tha world. Tha
parvaaivanaaa of dual trading la dua to tha fact that aany of tha
akilla and facllltlaa 'raqulrad to ba a good brokar ara alao
nacaaaary to ba a good tradar. Dual trading Incraaaaa tha aupply
of both brokara and floor tradaca bacauaa a dual tradar can aam
incona fron two actlvltlaa to covar tha coata of training, an
Exchanga aaat, and tlaa spant on tha floor. Ha baa laaa Idla
tlma and facllltlaa whan ha can awltch froa tha activity In low
damand to Cha activity in high daaand.
Dual trading has both a dlracc and an Indiract affact on tha
quality ot cuatoJaar aacvlcas. Tb« dlract affact la an incraaaa
in tha quality and quantity of brokara. Tha faot that dual
trading incraaaaa tha aupply of brokara aaana tha euatoaar haa
■ora brokara to cbooaa (roB and at a lotiar prlca. Purtharaora,
ualng a brokar who ia a good tradar aaana highar quality
axacutiona tor cuatOBara.
Tha Indiract affact darivaa froa tba Incraaaa in tha
liquidity of tha aarkat causad by tha incraaaa In tha nuabor of
aarkat nakara. Partiaa who trada Cor thair own account by buying
at a low prlca and aalllng at a high prlca aarva a aarkat asking
function. Thua tha ability for an antlty to uaa ita (acllitiai
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for proprietary trading raiulti in an lncr«as«d prtmmtto* ct
■arkat kakars on tha floor at tisa* whan thatr •arvleas ar« Boat
n«ad«d. Nora tradara standing raady to trada maka for • »er*
liquid aarkat with ••oothar prlca changaa.
In ordar to aid in a coaparat^va analyaia of dual trading I
diatingutah two typaa of dual trading. Tha tirat typa, callad
■{■ultmn»nu« dual trading oceura whan a flea tradaa aa a
principal tor its own account, and an agant (or Its custoaar In
tha asMa transaction. This typa of dual trading is pr«¥al«nt In
sacurltias sarkata, currancy and intarast rata swap Msrlwts.-.-and
tha tlKod Incoaa aarkat. Slmiltanaoua dual trading doaa not taks
placa in tuturss aarkats. Tha sacond typa of dual trading eallsd
eonaacutlv dual trading oceura whan a fira tradss for euatoaars
as an agant and at otltar tlaas tradas (or tta own account aa a
principal, but tba fir* doas net do both in tba aaas transaction.
Cenaactttiva dual trading oceura in futuraa aarkata, as wall as in
•11 of tha aarkata in which thara is siaultanaous dual trading.
Dual trading plays a particalarly iapertant rola in futuraa
■arkats as eentrasted with aecarlttaa aarkata. Tha fsot that all
trading la totura* takes place en tba aachange floor and that
sprsad trading is an iiportant part of hedging atrategies aaka
the skills et a trader aore necassary for a good futures broker.
The iaaedtaey required by tha futures Mrket aakea liquidity aore
laportant, and therefore Bakas a larger supply of aarket aakera
Bors critical.
Thara are three types of brokerage aarvless the enstcaMt
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needs. Tha flrat ■•rvlcs ("■•arch*] involvas acarchlng foe cha
partiaa «bo ara intaraatad In balng on tha othar alda of tha
trade (i.e., tha contra -pa rty } . Tha aacond aarvlca ("tlaing")
Involvea obtaining and procaaalng information to dataraina how
long to vait for tha arrival of tha noat advantagaous contra-
party while being expoaed to tha riak of an advaraa price nova.
The third aervlce ("bargaining") Involvea actively bargaining
auong available contra -part lea to obtain the best prlca.
k securltiea broker can use hi a akills and aalaa force to
prearrange trade* "upetalra" . upataira aaarch ia often' an
affective substitute for tha downstaira working of an order where
"tlMlng" and "bargaining" skills ara naadad. A futures broker
cannot prearrange trade* upetair*. The brokerage tira cannot
substitute "search" akilla for trading akllla. Tha order mat be
worked on the Exchange floor. The floor broker mat have the
ability to trade in such a way on the floor of the Exchange that
ha brings the other aids of the trade to the floor at ■ good
price for hie cuatoaer. Therefore floor trading skllla are
relatively aore Important in the futures aarket than in tha
aecurltlea aarket.
Further , auch futures trading involvea "spread*" whers a
cu*to>*r want* to boy and sell two <
aiaultaneously for a guaranteed net prioa.
can execute the apraad by trading with a "local" on the floor, or
the broker can execute the individual "legs" of the apread
consecutively. The latter will be In the best J
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custeaMt 1( ch« bromr Is ■ aklllad trader, ainc*., by trading
•ach lag hlaaalf, tha brokar avolda paying ttaa local a praalua
Cor tha rlak in trading tha apraad. sucb apcaad trading la
Inhacantly claky to ■ brokar, alnca aCtar h« axaeutaa ona lag at
tha apcaad hi* cuatoaar can hold hlB to a prlca tct tha othar lag
of tha apraad, whlcb tba brokar aay find iapoaaibia to aehlava If
tha prica Bovaa attar ha doaa tha (irat lag. Tbia aapact of
tuturaa tradaa aa wall bb tha ralatlvaly highar undarlylng prlca
volatility in aany futuraa eontraeta Incraaaa tha trading akllla
burdan on ■ futuraa floor brokar ralativa to that of a aaouritlaa
floor brokar.
Futuraa trading cuatonara oftan hava a blgh daaand tor
1— aJlacy baeauaa thay ara trading to hadja an undarlylng spot
•arkat position. Tha faet that i*aodlaey of trado axaeutlon la
axtraaaly lapertant Ce futuraa ouatoaaca lapllaa that thay vtll
hava a graatar daaand for »arkat aaliai ■ than will ba tha oaaa In
markata whara tha coat of dalayad ameutioa la aullar. X
po— edity hadgar baara qraat riak It ba daaa not do hia futuraa
trada inadlataly. Thla riak nay foroa hia to trada uaing a
•■■BrkBt" ordar, for asanpla to aoll 1— idlataly to tha highaat
biddar oacrantly avallabla. If thara ara faw Markat aakara than
ba will raealva a ralatlvaly low prlca, l.a. , bl> trada will hava
a hl^ aarkat ii^aet coat. Thua futuraa aarkata bava a graat
daaand for tradara who in aCtaot aarva a aarkat aaking function.
Tba Inatitutlon of dual trading pacaita thla daaand to ba aat at
low coat.
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Dual trading Incraaaaa tha aupply of tha typaa tof cuatcaar
aarvleaB which ara ralativaly Boat dasandad by futuraa cuatosara.
Dual trading la pravalant In tha aacuritlaa Markat, both on tha
floor and off tha trading floor. Inatltutional aacuritlaa tradaa
ara otton praarrangad off of tha floor, and tbia laaaana tha
burdon of aacuritlaa floor brokara. It would ba qulta paculiar
to allBinata dual trading for futuraa and wilntaln It for
aacuritlaa whara tha dual trading by floor brokara la laaa
laportanC. Tha allainatlon of dual trading Iro> futuraa aarkata
will harm cuatoaara by raducing tha quality of brokara whd do
cuatonar bualnaaa. Tba boat tradara will trada for tbalr own
leaving cuatoaara with brokara irtio ara lasa aklllod
By pravanting tradara (roa acting aa brokara, tha
ali>lnation of dual trading will raduca tha nuabar ol floor
tradara, and thua raduca aarkat liquidity. Poraign aarkata will
gain an advantaga ovar OS aarkata cauaing larga cuatoaara to
laava US aarkata which will loaa liquidity. Tharatora aaall
cuatoaara, unobla to trada ovarooaa, will ba aoat advaraaly
' afCactad by tha loas of liquidity in US aarkata. Spot aarkata,
Bucb aa graina and tha US traaaury bond aarkat will ba advaraaly
affactad by tha loaa of liquidity In tuturaa aarkata, and apot
pricaa will bacoaa aora volatlla. finally, cuatoaara will loaa
tha froodoa of cholca thay now bava to pick althar a brekor who
alBo tradaa for hla own account, or a brokar who tradaa
axelualvaly for cuatoaara.
„Coogle
10
I. tntrnduetlM.
Dual trading !• said to oceur wbrn an antlty aoaatlMB
ccadas aa a br«)Mr tor cuatMMCS, and ac othar tlaaa tradaa for
its own account. m* papar axploras tha •oonoaio function of
dual trading, and propo*** — thoda Cor ealeulatlng Ita lapaot on
■arkat liquidity and tb* quality at ouateaar brokaraqa ••rvlcaa.
A latar papar will lvl«>«i>t tboaa aatboda «n actual trading
data.
lb* atnietura of this ptpvc la am Collowat
Saetlen J provlda* •«■• g«naral baefeground en gtba
organiiatien eC aarlMts and trading. It will ba umma that dual
trading la parvaalv* la tha Onitvd ItatM wewltlaa and fntuTM
markata, though fntuvaa ■arkats eaa bm diatinquiahad fra«
aacurltlaa Mrlwta by tha fact that dual trading ia pazMlttad ofC
tha trading Hear la aecoritiea whila It ia prohibited for
tuturaa. Iba tppandJjt pi'u»idaa a aamary of tha extent te wblA
dual trading exlata en narkete tbranghoat tha world.
saeclon 4 prwrldaa an aoenoHle analynia el thn datarmlnanta
et the etCaetiveneea et narfeeta. it arantnaa the daaand lor, and
tba eivply ot varlena brekeraga aarvlaaa. Zt alee axplalne tha
detemiaaate ef eajcfeat Uqnidity.
•aaelOB 9 abOM how dual tradlaq liveota on the abUity of
brokara to deliver the abeve aarvioan, and bew Awl tradlag
Inpacte on aerkat liquidity.
section •.appliaa tha above aaalyeia to detemlna tha likely
cenaoquancae at alininating dual trading In futnraa narkete.
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Spaeial attantlon la glv«n to avaluating proposals to.aalactlvaly
•llslnat* dual trading In particular cosBOdltla* or contract
saetion 7 discuaas various Battaods trttlch can ba usad to
coaputa tha sonatary banaflts to custoBara froa tba aklatanea of
dual trading.
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1]
]. CuatQ—r QrdT now «nd Wrmc struetura .
Dual cradlnq can b«at ba undaratood by tracing tha Bannar in
which ■ cuatoBar ordar la axacutad. It la convanlanC to baqin
with a cuatoBar who wanta to buy an ■Itaa". Thia Itaa alght ba a
tucucaa contract, • llatad aacurlty, a govamaant bond, ate.
Dlaeuaaion at Tabl* 1
Tabla 1 praaanta tha tirat part oC tba path which tha ordar
can travaraa. Part A »t tha Tabla analycaa tba ordar tloit It tha
cuatoaar glvaa hia ordar to a daalar, whlla Part B conaldarartha
caaa whara tha ordac foaa to a brokar. In Part A, tha oustoaar
daaia with a pcinclpal, whlla In Part S, tha br«iMr acta mm tha
Part Al la tha ataplaat caaa, whara tha cuatoaar tradaa
dlraetly with tha daalar. Thia typa at trad* la charaetariatie
of tha tlicad IncoMM Bartat, for axaapla US traaaury bonda,
■unicipal bonda, cetperata bonda, ate. It ia alao tha aathod by
which tha apot and terward Markat in toraign axchanga, and
intaraat rata aw^a oparata. In auch aarlcata, tba euateaar
tradaa dlrvetly wltk a daalar. Aa will tm alaberatad in tba naitt
•action, tha cuatawir nut angaga in aetlva aaardi to find tha
daalar wtw ta offariag hl> tha baat prica. H* la not aaploylng
an agant to do tba work for hia.
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with Whoa Doai th« Cuatomr Initlaf Hla Tradg
X. cuaConT n»M a DaalT.
Al. Tba cuato>*r can trad* diractly vtth a daalar who aalla
to hia CroB tha daalar'a Invantory.
A2. Tha cuatoaar can trada diractly vith a daalar who
obtaina tha itaa alaawhara.
A2a. Tha daalar could obtain tha itan trom anothar
daalar who baa It In ita invantory.
A3b. Tha daalar could obtain tha itaa ttom anothar
A2c. Ttim daalar could obtain tha Itaa indlractly fro>
anothar cuatoaar by obtaining it froa a daalar who obtaina it
fron anothar cuatoaar.
B. Tha cuatoaar can uaa a brolcar to find a buvar.
Bl. Tha brokac can find a aallar on an Bitctaanga.
B2. Tha brokar can find a sallar froa ita own cuatoaara.
c. Tha cuatoMi- uaaa Brekar/D—lT 3«vlc«a.
Tha Brokar/Daalar axacutaa It* cuatoaar'a ordar by aalllng
froa Ita own account and by finding cuatoaara who want t« aall.
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pare U eoMiOar* tha «••• Hhara ttM cuacoMr, dasiraa an
itaB which tha daalar daaa net hava In bis Imrantory. in aueb a
caaa tha daalar will aec«Mpt to obtain tha itaa froai anatbar
daalar, or troa anothar cuatoMr. That la, tha daalar la acting
Ilka a bcokar by angafinq In aftorta to obtain tba Itaa for bia
cuatoaar. Tharatora avan in pura daalar Barkata, brokaraga
aarvlcaa ara provldad. Hora iaportantly. It ia l^oaalbla to
dlatinguiah tradaa aada on bahalf of a euaCoMar troK tradaa aada
tradaa aliMd at him c^mtammrm In a pura daa^ay Mrhat- .Tha
brokar/daalar auat da a« in ordar to obtain tba itaa tor hla
Part B of Tabl* 1 canaidara tba caaa vhara tha cuatMMr uaaa
a brekar to obtain tba Ita* for hla. na daaraat axaapla of
thla aituatien oceura vith ragard to futuraa eentracta. A
cuatoaar daairing to trada a futuraa contract, ia prohibltad by
crrc ragulationa froa trading dizootly with a daalar oft af tha
floor of an Kx^ianga. Tha cnatoaar auat angaga tha aarvlcaa of a
brokar to aat aa hla agant. mia la labollod Bl on Tabla 1.
A Bora oo^^ax aitnation ia au^Hritad by B2, whara tha
brokar ean find a aollar froa aaong ita Mm cnataaara. An
liportant aUMpla of thla ptiannaannn oceura in tha Inatltutlonal
trading af i i^iiii atock. A ouateaar who daalraa to purcbaaa a
larga block of eoaaon atock aay aak an Itysi aaabar tlra to
attaapt to find aallara. Tha aaabar fin will utllita varleua
Inforaation aouroaa to locata axlating holdars of tha atock who
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atght ba sallats. Tha manbar Cira will than bring both tha buy
and sail ocdara of Ita cuatonara to tha HYSB Cloor uhara tha
ordara will ba croasad.
Part C of TBbla 1 conaidara tha caaa whara tha euatoaar usaa
tha flra to ba alnultanaoualy a brokar and a daalar. This waa
alraady iKpllcit In tha "pura" daalar ralatlonahlp daacrlbad In
Part A3, but it can ba vary axpltctt In tha casa of aacurltlaa.
Consldar tha axaapla aantionad abova whara tha SISZ >aiibar lira
la putting togathar tha purcbaaa of a larga block ol atock tor a
euatoaar. If tha brokar/daalac cannot find anougb cuatoaara ' wbo
want to aall. it night aall out of Ita ovn invontory, and thua
takaa part of tha othar aida of Ita own cuatoaar'a trada. It
would than bring tha whola trada to tha NYSE floor tor opan
Tha abova raaarks indlcata that aacuritlaa ara tradad by
tlma that angaga in a typa of dual trading idiich X will rafar to
aa almiltanaoua dual trading. That la, tha flraa ara baing both
brokara and daalara at tha aaaa tlaa for tha aaaa cuatoar. It
may ba uaaful to contrast thla vith what I will call conaaeufclva
dual Cra^^J.^>fl in trtiich tha fir> aoaatlBas tradaa aa principal and
B^Mtiaas tradaa aa agant, but doas not do both In a alngla
tranaactlon. Siaultanaoua dual trading occurs In tha sacurltlas
narkats [Including options) but doaa not occur in tha futuras
A cuatonar in tha sacurltlas or futuraa industry will usa a
flra which doaa ona or tha othar of tha abova typas of dual
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IS
trading. Tha •conoalca of why this i> th* ems* will b* uialyaaA
in tha n«xt two Sactlons. Har* it auttlcaB to neca that juat
about avary fin which accapta cuatoaar orda» alao tradaa for
Ita own account: thara ara vary taw tirsa that trada only for
thair «wn account, or that trad* only for euateaara. Xhi» la
litarally tru^ In tha daalar markata Ilka tha flvad incowa
■arkata and tha ov*r tha eountar atock aarkat (wtiara tha
dtatlnction batwaan principal and agant tradaa doaa not axLt) ,
but it la alao trua for coaaon atock and futuraa eontraets.
Diaeuaaian of Tabla a
Tabl* 3 traoaa tha naxt atap followad by tha coatoaar'a
ordar undar tha aaawiptlan that It la not axacutad dlr«etly by
tha brokar/daalac accaptlng tha ordar. In particular, tha ordar
la traead through Ita axocutlon on an Exchanga. It la ooovaniant
to ratar to tha brokar who flrat racalvaa tha euatoaar ordar aa
tha "upataira brokar". It la cencaptnally uaaful (and nanally
daacrlptlvaly aeeurat*} to visuallta tha upstairs brokar
tranaaltting tha ordar "downatalrs" to tha trading near of an
or tranaalttlng It t«
both euatoaar buslnaaa and alao tradaa for hla own ■
principal (eatagory B on Tabla i).
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Traelny th« C^imtoaar'a ordar On An 1
itoiwr'a ordT handlad bv an ACgMT on tiim Zxchamw floor.
A.l Employ** of Cha Exchanga amcutaa th* cuatOBar'a ordar.
A. 2 Floor brokar who spaclallz** In trading for custoMar*
•xacutaa tha cuatosar'a ordar.
B. Cuato— r'a ordar h»ndl«l bv a PRIWCIPAL/XCEIIT on tJia gitchaiw
floor.
Bl. A brokar/daalar bandlaa tha ordac.
Bla. Tha broKar/daalar handlaa It a* an agant.
Bib. Tha brokar/daalar handla* it as an agant and
principal .
B2. A brokar/tradar bandlaa tha erdar aa an agant.
B3. A brokar/aarkat >ak*r handlaa tha ordar.
B3^. sa handlaa it aa an agant.
B3b. Ha handlaa it as a principal.
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Tha puraat fan at an ■agent" wha axacutaa tha custoaar'a
ordar on tha Exehang* doer la an a«ployaa at tha Exchanqa uho
axacutaa cuatasar ocdera (category Al In Table 1). Ttila occurs
on aany (oralgn Ixchangaa (such aa tha Tokya Stock Exchange), a*
wall aa an tha Oilcego •oartt Optlotia Dtehanga (CBOE) when an
Exeheng* eapleyee ■aintaina a ll>lt ordar book tor cuatoaar
ordera, and handlaa tha axecutltm ol thaae ordera whan the aarket
price reaches the level at which the cuatoaer Indicated that ha
ia Intareatad in trading. Hat* that by ■executing the euatoaar
order", I do not aaan that he taJua the other side of tha trade.
Rather, tha agent folloHS the prescribed rules ot tha Exchange in
an attaapt to gat tha beat prlee Cor the eustaaar. This *ay
involve announcing to the trading crowd that he haa an order to
till, and then trading with tha Baaber sf the trading crowd who
oftera tha bast price. Tha BeBbar ot the trading erowd with whoa
the agent tradaa say hiaealt be rapraaanting euataaara aa an
•gant or ha could ba trading tor hlaaelt aa • prineipal.
Part U of Table 1 indlcataa a leaa extraaa sltnatlen where
B aeaber of the Exchange daeldea to specialiie in trading tor
custCMara ea the floor, and aaaentially deea no trading aa a
principal fer its own account. Alaoat all exchanges have
IndlvidDBl eaabera who have built ■ reputation as good brokara
trading tor custoaars, but Mio do little or no trading on their
In contrast to tha above situatlona i4iera tha cuatMMr order
Is handled by ■agents', an anorsous aaount at floor brokerage is
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•ffectea by firss that ar* broker/daalara, brokar itradara, or
bEolcer/narkat aakars. Tbase caCagoriaa appaar in Sactlon B of
Tabla 2 . An axaapla of eatagory Bl Is a brokar/daalar auch aa
Harrill Lynch vfho handlaa a cuatonar'a atock trada on tha NYSE
Exchanga floor. Tha Karrill brokar can act aa a pura agant
(catagory Bla on Tabl* 3] vho buya tha atock on tha Bxcbanga froa
another brokar In an opan outcry auction. In a mora coaplax
eaas, Karrill >ay ba both a principal and an aganti aalling to
tha cuatoaar partially traa ita own account and partially tor
othar Marrill cuatoaars. For larga Institutional tradaa. 'tha
Marrill floor brokar Bay ba rapraaanting Karrill Lynch, and both
buying and sailing cuatOPMra on tha NYSE floor at tha saaa tiaa
In tha Sana trada. Harrill nagotiatas tha trada sacratly
upataira, and axpoaaa tha ordara "downataira" on tha trading
floor by of faring out ona sida of tha trad* to whosavar ia
prasant at tha spsciallat post.
Catagorlas Bla, and Bib Indicata that tha brokar d«alar aay
handia tha ordar aa an agant (not talcing a part of tha trada on
Ita ovn account) , or in contrast as in tha abova axaapla, tha
fira Bay ba acting aimiltanaously as a principal and an agant in
axacutlng tha custOBar's ordar. In tha situation whara tha
brokar/daalar acta as both a principal and an agant, it la
angaglng In uhat I call alBultanaous dual trading. In tha casa
whara It axacutas this custMar'a ordar aa an agant, it Bay ba
engaging in consacutiva dual trading, ainca at seaa othar tlBa it
nay ba trading in tha atock as a principal.
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In ordMT to turtliar •uphkalt* th« distinction batvMn Uim*
typ«s ot dual trading, Tabla 2 contain* tha additional eatagory,
B3 of * broker/ tradar' . A brokor/tradar 1* a Cloor tradar vhe
aoaatl>a* tradaa en hla own account aa principal, and at ottiar
tl>os tradoa aa a brokar for euatoaara. Ra la not a "daalar" In
that ba dooa not tak* tbo othar aid* at custoaar tradaa. Ra la a
cenaacutlva dual tradar but net a almltanaeua dual trader. As
noted aerller, conaacutlva doal trading la paraitted on futuraa
■arketa, but slaultanaous doal trading la not peialttad. in
contraat, botb typaa of dual trading ooenr en tha door: of
aaeurltloa Bachangaa.
Tha final category of Table t, lebelled 13, conceme tha
situation where a dealgnatad Barket Baker handlea the cuatcaar
order. For exaapla, en tha nsi, the ivatalra broker nay give
the "epeclallet" (who 1* a brokar'a broker, and a markat aakar on
tha nSE door) a oustoaar order, the epeeUllst asy handle this
order aa an agent and find the other aide of tha trade aaong
ether floor brekara (oategeiy >3a In Tabla 3). On tha othar
hand, the apaciallat aey act aa a prlnolpal, and take tha other
side of tha trade en Ita own Boooant. Thus the ^eelallat can
engage in aiBMltaweeua dual trading.
A cuatoaer'e order for eacurltlea or futuree viil uaually be
handled by flras engaged In dual trading. This Is the eana at
the "ivetalra- level where the cuataaer order arrlvae et a
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aacurltiaa brokar/daalar
•ach of wh™ trad*!
However, V
trading CI
■psciatisC, brokar/
It abould
Cacllitiaa (or trad;
provlda high qualll
■laalon Marohant (FCK),
■ wall aa
'downatalra' laval on tlia
OEdar i> handlad by a
daalar, ar brokar/tradar, vach af whoB angagaa
ba aurprlBing that Ciraa irtilcb davalop
ig on thalr own account will alao ba abla to
/ axacutlona Cor ciistoaara. In tha naxt
axplain wby It Is tha c«aa that good axacutlon* oC
cuatoaar ordara oftan Involva aubatantial trading akilla.
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4. Th« P*t»r»l ■■..^y. of tttrkat Llnuidltv and BrolfrMM Sarvieaa
4A. BroltT»g« STvicaa
Conaldar a euatoaar who da*lr*B to trad«. Ha nay daalr*
"daalar" and/oc "brokaraqa" sarvlcaa. Ma will aaa balow that it
can BOBatimaa ba ditClcult to dlatingulah daalar from brokaraqa
aarvlcaa. Thara aca thraa typaa at ■braKacaga' aarvlcaa ttia
ctiBteaar naads. Tha first sarvlca ('aaarch') invalvaa aaarchinq
Cor tha partlaa who ara Intaraatad In bainq on tha othar aida at
cha trada (l.a. , th* contra-party) . Tha aacend aarvica
("tialng") Invoivaa obtaining and procaaaing intorBBtlon. to
dataiBlna bow long to uale tor tha arrival of tba Boat
advantaqaoua contra-party whlla balng axpoaad to tha riak ot an
advsraa prica Bova. na third aarviea ('bargaining*} Involvaa
actlvaly bargaining aaong availabla eontra-partlaa to obtain tha
baat prlca.
Tha abova thraa actlvitiaa (or aarvlcaa) aira parfonad In
obvious ways in aoBa aaxkata, but In a aubtla Bannar In othar
■arkata. For axa^la, tha Bala of a heuaa oftan raqulraa Cha uaa
et a brokar who advartiaaa tha houaa and aaarchaa for buyara.
Tha ownar of tha houaa «uat daclda whathar to accapt tha tint
ottar ha raeaivaa or dalay cha aala until othar potantlal buyara
(hopatuXIy villtng to pay Bora than tha currant buyar) ara found.
Finally, tha aallar aust bargain 'a>ong tha buyara to try to
obtain tha highaat prica.
Brokaraoa a.prtc.a Tof Inatitutional aacurltlaa Cuatotra
Tha inatitutional aacuritiaa Barkat provldaa ■
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of brokaraga aarvlcaa. a portfolio Bonagar nay daatira to hadga
hla portfolio of atocka buy purchaalng put optlona. Ha alght
want 10,000 SPX Indait options. Thaaa optlona trad* on tha CBOB,
and tha typical trading voluaa In tba particular option of
intaraat Bight ba 1,000 optlona par day, and tha quotation on tha
option say ahov 100 optlona offarad at 93.00 par option. Tba
portfolio aanagar will call tha indax products dapartaant of a
brokar/daalar. Tha brokar will call Ita tradar on tha Exchanga
floor to ascartain at what pxica 10,000 option* can ba purcbaaad
on tha floor. Typically, tha pcica will ba hlghar than tba Si.OO
•hown on tha quotation acraan at irtilch only 100 optlona wara
offarad for aala. At thia point, tha brokar will uaa Ita
knowlodga of Ita othar custoaara' trading daalraa to aaareh for a
battar prlca than la balng offarad on tha floor. It may find
cuatoaars willing to aall 9,000 optlona at S3. 00. It »ay than
"accoaaodata" tha cuatoaar by sailing 900 optlona froa ita oun
account. Tha brokar will than bring tha ordar down to tha floor
of tha CBOE and bid tor 10,000 optlona for a prlca of S3. 00.
Aaaualng that tha crowd on tha trading floor la atill only .
otfaring 100 optlona, tha brokar will aall 900 froa Ita own
account, and 9,000 froa ita othar cuatoaara, affactlvaly eroaaing
tba ordar on tha Exchanga floor. Hot* that tha brokar angagod in
a daalar function in ordar to battar provida brokaraga aarvicaa
to ita oustoaar.
It ahould ba aaphaalaad that tha "saarcb" function 1*
Intlaataly ralatad to tha "tlalng" function. Tha cuatoaar la
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•ubl«et to th« rick that th« urlMt will mov agmln^ hla wblla
h« trlaa to gat a battar pric* than la cucrantly gffarad an tha
BKChanf* tor tha lacga nuabor of optlona which ha is attoaptlnq
CO buy. Ka alaa baar* thifc riak. If ha and tha brokar angaqa in
bargaining to attaapt to gat a higbar prico. It la crucial that
bis brokar hava ■ ■taal" tor tba potantlal prlca aavaaanta, and
alae knewladga about tha prieaa at which hia own euatoaars ara
willing to aall. It tba brokar acta aa a daalar by aalling bom
optioiia fro* hia own aeeount to aeee^ndata tha ouatoaar, than bo
■uat alao ba«« tha aaaa kinda ot biowlodga and ability. ; To
BU^Mrisa, tha inatitutional brokaraga funotion will ba partoiaad
■eat attactivaly by a fira with tba akilla and knowiadgo et a
tradar. For tradaa wkid cannot aiaply ba aant to tba Cxcbanga
ter iaaadlata amcutloa <t.a., ■■ a "karkat" ordar), tha brokar
ia not aaraly a olark. Ka auat angaga In all ot tba aetivitiaa,
and bava all «t tba akilla at a tradar.
Tba aaarch tvnotion ia «van aoro inportant for tbo narkat in
individnal Lo—an ataek. A boyar of a larga block et coaaen
atoek Buat oftan find aallara off of tha txehango floor. Bara
again tba infenatien larokara hava about aallara will bo crucial.
rtrat, tba brokan ean raviaw public docnsanta wbieh provida tho
naaaa of larga Inatitutional holdara of tho ateck. Tha brokar
can than aolielt Mlliag intaraat frea thoa. Sacond, tha
brokaraga fira ean call upon tba knowladg* of ita aalaa tore*
which ataya in day-to-day contact with invaatera, and thua eoaaa
to know aoMthing about who ia willing to aall and at what priea.
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In th« B*eurlti«* narlcat a brokar can dlrac^ly contact
potantial trading partnara who are not ptaaant on tha Exchange
floor and ha ia tharaby abla to gain tnfomation for his cuatoner
about tha coats and benafita of da lay. Tha fact that it la
poaalbla and nacaaaary to gain off-floor inforaatlon
diatlnguiahaa tha actlvltlaa and nacaaaary akilla of aacurltlaa
brolcera, froa futurea brokara. Though any floor brokar can
coBBunlcBta with hia upataira offica, futurea aarkata ara
diatlnguiahad froB aacurltlaa sarkata by tha fact that prica
dlacovary occur* axcluaivaly on tha trading floor tor futuraa,
whlla prica dlacovary occur a upataira aa wall as downstalt* in
tha aacurltlaa aarkat. Dnlika aacurltlaa brokara, futuraa
brokers cannot aacratly praarrang* tradaa upataira, and thua tha
futuraa floor broker auat trade In auch a way aa to bring tha
Dthar aide down to tha trading floor, aa ia analyzed below.
Brokaraoa sarvjeaa for Futuraa cuatoiaara.
consider a grain atorage tltm which deairaa to hadga Its
poaition. Tha brolcar who raceivea this order will tranaalt it to
tha futures Buchange. He Is prohibited by ragulationa fron
working the order "upstairs". The broker who executes the trade
on the trading floor mat carry the full burden of "search",
"tleing", end "bargaining". For cuaBpla, if the order ia to sell
3 ■illion buahels at a tisa whan only 100,000 bushels era being
bid tor $3.00, then the floor broker euat trade in auch a way
that ha Inducaa buyera who eay be "upstairs" to send orders to
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th« floor. This iB >n iBpllclt fona of ■■■■rch". Tha brokar
could Blaply announca chat ha haa ] allllon to lall, and hop*
that^ tha othar floor broKara will call potantial cuateaars
'upatalra' Co Induca buylnq. Howavar, unllica sacuritia*.
coBBOdlCy futuras brokara aay hava !«•• Intoraation about ttaalr
custoaar* undarlylng Intaraat In particular poaltiona. Thla
lntor«atlon la oCtan proprietary and atroitgly ralatad to tha
undarlylnq bualnaaa oparation of tha coaaodltlaa cuatoaar. nnw,
tha only aftact of announcing chat ha haa ] ■llllon bnahala to
•all will ba to cBuaa a larga tall In prlea which will gtwa...tha
cuatoBar a poor (it any) aiiacutlon.
Tha situation Is furthar coapllcatad by tha fact that tha
cuatosar aay ba baaring axtraaa rlak whlla tha brokar dalaya tha
axacutlon of tha trada in an attaapt to gat a battar prlea. Tha
fact that futuraa cuatosars ara oCtan hadging undarlylng
coBBodlcy or aacurltiaa posltlona aaans that thay can faea
graatar rlak troa dalayad axaeatlens than a saourltias eastoasr.
In tha abova axaapla, tha grain atoraga flra's overall
profitability will autfar graatly If grain pricaa fall bafora It
can hadga Ita Inrantory.
ma floor brokar can aall bom futnraa, parhapa dstvlng fu
prtca down a littla. Tha fall in prioa cMMinieatas -through
pricaa' that tha aarkat naads buyara. Tha pricaa at wbtdl tradaa
occur on tha Exchanga ara cosaunlcatad to tha world. A wiatfar
(oft of tha Citcbanga floor] who waa not intaraatad in baying at
tha pravlouB prlca Bay bacoM intaraatad in buying attar aaaing
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Cradas at lowar prlcaa. Tha floor brokar 1* thutf uaing bla
trading to Indirectly coBBUnlcata with potantial cuatonara who
ara off of tha trading floor. Thia ia an altarnative aachanian
to that which occura in tha trading of aBcuritiea whara Buch
eoBjiimication occura upataira on tha talaphona batwaan broKara
and thair cuatoaara.
Tha Cuturaa brokar attanptinq to aall 3 nilllon buahala will
aonatinas find it nacaaaary to diaguiaa tha trua intantion and
•ira of hia ordar. Ho buyar wanta to buy froB tha brokac ]uat
batora tha brokar aalla 2 nilllon buahala. A brokac tAto kaapa
selling in an attenpt to ganarat* buying Intaraat can actually
cauaa buying Intaraat to diaappaar. For thia caaaon a brokar aay
tind it advantageous to occaaional intaraperaa hi* cuatonar aall
ordar* with buy ocdara (or hia personal account. This helps
diaguiaa hi* Intantlona. Tha aftactiva axacutlon of tha cuatoaar
ordar involvaa a aubtla interplay between coa>unicating a daalra
to sell in an atteapt to attract buyers, while dlsguiaing tba
Cull size of the order.
The floor broker on tha Cutucaa aarket can only bargain with
thoae preaant on tha floor. At each atage of the execution of
hi* cuatoaar'B order he can accept the blda currently being aada,
or ha can aaka a countar-ofCar. He bargains through open outcry
with tha trading crowd on the Exchange floor. This is in
contrast with the seourltlaa Market, where a floor broker can
seek batter bids 'upstair*".
The above rensrka indlcata that tha floor brokar on the
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futnr** Baxkat sust h«va all of skills ot ■ good trader in ordar
to 9iva hit cuatnar a high quality axacutlon. A paraon who
tradaa for hi* own account on th« Exchanqa door aakaa aonay by
b«ln9 abla to judqa whara tha sarkat la going to aova In tha
short run. A floor brokar'a graataat taar la that tha aarkat
will Bova away troB hi« (tor axaapla, that tha axlatlng blda will
dtsappsar and ba raplaead by lowar bida) wblla ha da lays
axaeutlon of hla cuatoaar'a ordar In an attaapfc to gat hia a
battar prica. Tha ability to ]udga abort run aarkat aovawanta !■
thua at tha aaaanca of baing a good flotw brokar and balng a good
Am dlatinct charaetarlatica of a futures karkat laply that
a futuraa brokar auat babava Ilka, and bava all tba akllla of a
tradar. Thia la aueh aora Uia eaaa than In aacurltiaa aarkata
wbara a brokar can atfaet a good oxacutlon tor hla cuatoaar by
tho uaa of a Its upotatra aalaa (ere* which bring* both aidaa of
th* trada togathor. Tba koy akill* If tha floor trador ara
■tlaing" and 'bargaining' - tbao* ara uaad in plaea of upatalra
■■aarcb' to obtain • contra party for hia custonar at th* baat
Tha quality at brekaraga aarvieoa ia only on* of tha
dataralnanta of tha quality of ordar axacutlon. k ouatonar can
hav* an axcallant brokar, but it tha aarkct in which th* brokar
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s tha trad« Im illiquid, than it will b* veiy d:tfflcult to
qat a good axacutlon. Tharafora an undarstanding of tha quality
of customer ordar axacutlon raquiraa an undarstanding of tha
datarainanta of narKat liquidity.
Claarly, sarkat* aarva tha function of anabllng partiaa to
angaq* in trada. Houavar ttiia ia not tha only function of
markata. Marhata aarva a prlca dlacovacy function: providing and
agqragatlng Intornation accoaa both activa and Inactiva aarkat
participants.
Thaaa points can ba clarifiad by tauporarily Baking tha
folloulng artificial distinctions. Dlvlda ttia potantial Barkat
participants into thraa groupst brokars, aarkat aakars and final
custonars. Pura bcokar* ara agants, who by datlnition. navar
taka a position in tha instcmwnt balng tradad, and I hav«
dlscuBsad tha> axtansivaly in tha pravious saction. Karkst
■aKsra, by dafinitlon, taka a position only for short tarm
trading profits, 1.*., tha avaraga ratum frOB a position hald
for tha long run will not raward thas tor tha risk of capital
cosalttad ovar tha long run ralativa to othar usas thay havs for
thalr capital. Final custoaars, by daflnltion, ara willing to
accapt tha avaraga ratums for tha risk of thalr positions ovar
tha long run, and ara trad inn parhapa with grsat currant
iBBSdiacy to achiava that oca it ion. This division ot actors la
obviously artificial, but It will halp to axplaln b<
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Tha final cuacoaar could ba a bond daalar who attlla bond
Cuturaa to hadga • percfollo of benda in itm Invantory. Tha
cuat«*ar taeaa tha rlak that bond prioaa will fall batora ba la
•bl« to Mil tha bonda In hla Invantory- Ha iiwuraa Agalnat thia
risk by aalling bond futuraa. Ha baara tha rlak of a prtea fall
whila bia brokar attanpta to till hia ordar on tha Ixcttang*
floor. ntia custoBar say ba willing to accapt no caturKi on
»vr«^ froH baing abort tha bond tutura. Ha ta willing to taka
a laro or avan nagativa aapactad ratum poaition bag Hi— of tba
Inauranc* providad by tba poaition. In particular. If bond
prioaa riaa, than hia loaaoa en tha bond futuraa ara offaat by
gaina on tba bond invantory.
in tha aaouritiaa narkat, tha final cnatoaar night ba a
nonay nanagar who wanta to add a partlenlar Induatry gr«9 to it*
portfolio of flBMiaw atoek. Ibis typa of i
i^Mdlaey of ordar axaeution than doaa tba I
ia trodtng to hadpa a poolfclen. nw nonay nanagar doaa not bold
a lar9a greyp of aanata that aro naaaaaarily polnp to anjoy a
prica nova in tha TP"'** *'■•■«*'«■ tren tha prion nova in tha
atoek* that ara balng purebaaad. Ilioagh thara nay ba aoaa
divaraifioatlen aftoet loading to a risk roduotlon frea a
' Saa Sanf ard Croaanan and Martei
Markat Structura," Th« Jnnm»i ** Hm
Bo. 3, P.SX7-37.
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■•curitias trad*, it tands to ba Buoh nullar than i
raduetion aftactad by a coBBOdity futuraa badqa.
Tba narkat aakar could ba a daalac buying at a prlc* fron
which It Bxpacta hlqb abnoraal ratuma. Tha >arkat aakar buy*
tha inatnuoant in altuationa Hhan tha prlca la ta>porarily lew,
whlla tha final cuatoaar buya tba inatruBant bacauaa (a] tba lang
run avaraqa ratum la high ralatlva to ita riak, or (b) tba
raduetion in rlak of hla ovarall portfolio co^anaataa for Cha
lav axpactad ratum of buying tha InatrwMnt. Mora pcaciaaly,
tha aarkat aakar takaa poaltiona bacauaa of tha yf ^'^'t^-^-^T !■>
tha airoactad ratum C buying idian axpactad ratuma ara high and
aalllng «h*n axpactad catuma ara low), vhlla tha final cuatoaar
takaa poaltiona baaad upon tha long run avaraqa axpactad ratum.
Many trading inatitutiona wbo ara uaually final cuatoaara in tha
abova dafinltlon, will function aa aarkat aakara whan thara ara
claar varlationa In axpactad ratuma. For axaapla an SCP 500
Indax Fund aay aubatituta futuraa tor atock whan futuraa ara
trading at a dlaoount ralativa to atock. Tba fund ia taking a
poaltion in tha apraad bacauaa tha apraad baa a taaporarily high
(rlak adjuatad) axpactad ratum.
TO battar undaratand tha rol* of aarkat aakara, conaldar tha
following axaMpla. For raaaona uncalatad to infonutlon about
tutura payoff a, a group of aqnlty holdara daalcaa to aall a
Bubatantlal block of aqulty. Aasma that a nagliglbla prlca fall
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would ba rsqulrAd to induc« tha rast of th« aconoBy to Incraaaa
Ita aqulty holding by tha aaount that 1* to ba lold. That la, It
final buyara could bo aatchad with final sallars, than thara
would ba no prlca l«p«cc of th« trada. Howavar, tha potantlal
final buyara ara dlaparaad throughout tb« acenoay (If not ch«
world) , and ara not In constant eoBBunleatlen with tha aarkat. A
aarkat aakar will buy tha offarad atock into bia invantory to
bridqa th« tlaa intarval batwaan th* arrival ot tha aallara and
buyara. Ka baara rlak whila tha atock ia In hla invantorVi and
hane* suat, on avaraga an]oy a raward.
A Mrkat Mkar (or final cuatoaar, bahavlng lika a aarkat
■akar) buy* whan axpcetad ratuma ara high (ralativa to tha
nerBal riak adjuatad ratum tor tha aaaat) , and aalla whan
axpactad ratuma ara low. A larga unanticlpatad flow of sail
ordara which eceun in tha abaanea ot InforBation about tutur*
payofta, will lowar priea and ralaa axp*ctad ratuma (in tha
abaanca ot aarkat aakar Intarvantien) . It la tb* fall in prlca,
in tha abaanca ot nawa, which aignala to tha *arkat aakara (and
avantually tha final buyara) that thair intarvantlon la
nacasMEy. Tha prle* aewa ia a crucial aignal (or allocating
rasonroaa. Tha buying activity of Mrlwt nakara trying t« taka
advantags of tha high axpactad ratuma will dialniah tha aita ot
tba prlca fall, and thua atabiliia tha aarkat.
Karkat aakara angaga in axactly tha aaaa activitiaa in tha
futuraa aarkat. Tha only laportant diatinction for our purpoaaa
la that tha activity only occura on tha EKChanga trading floor in
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th« ea«a of futuraa, whlla it can alao occur otf of t9ia Bxchaitga
floor In th« caaa of aacuritiaa. Tharafora tha Barlcat nakara on
the floor of a (ueuraa Exchang* ara tha only aourca of liquidity
tor a futuraa custonar, whlla thar* ara alao off-floor aourcaa of
liquidity for aacucltiaa euatoBara.
Marlcata a» Inforaation Convavora
Tha idaal aarkat would ba ona In which avaryona In tha
aeonoiiy could coatlaaaly, af fortlaaaly, and contlnuoualy
partlclpata. In auch an idaal aarkat thara would ba no brolnra
(and thay auraly would dlaagraa with thla daCinltlon of idaal) ,
bacauaa chara would ba no aaarch for contra-partiaa. Thara would
alao ba no aarkat aakara, ainca no ona ia naadad to bridga tha
gap in tiaa baewaan cha arrival of buyara and aallara at tha
narkatt all potential buyara and aallara ara alwaya coatlaaaly
and sffortlaaaly preaant. Dnfartunataly, dlacuaaiona of Idaal
narkata can ba atarlla, aa I faal ara dlacuaaiona about Ideal
worlda without vara, aarthquakaa, bad wa«thar, oc govamaent
ragulatora .
A aajor factor which oauaaa aarketa to deviate troa the
ideal ia the fact that continuoua participation and infonutlen
ratrlaval and evaluation la neither affortleaa nor coetleaa. If
ona party vanta to aell, tbia inforaation ie not coatlaaaly
dieaaainatad to, and proceaaed by all potential buyara. Noea
Inportantly no a ingle peraen ia being aade aware of tha
collective deaand and aupply achedulea of the reat of the aarket.
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TIM fact that w* an not all part of this fantaatlcj talapathic
natwork eraataa tha naad for Inlonatlmi t« b* pnvidad by
■arttata and broXar/daalara, aa wall aa tha naad tor aarkat
Harkat aakan taka a pealtion In tha instniMnt, and bridga
tha gap in tiaa batvaan tha arrival of tha final aallara and
buyara. In tha abaanea of a larva aupply of aarkat aakara, a
cuatoaar ecdar will hava a larga "aarkat i^»act" coat of
axactttlen. Thia coat la tha fall in prlca eauaad by a aallara
da«and for inadiata ordar axacntien, and tha rlaa In priea
oauaad by a bwyara dwand far tmadiata ordar axaeutten.
Iba aarkat ti^aet of a trada claarly dapanda on how tha
trada ia avaoutad. ntara ara two raaaona for thia. rirat, ordara
wbtoh dwand iaaadiata axaeution eonray inforaation to othar
partleipanta. Ibrkat participanta know that ana raaaon that a
tradar daaanda iMMdtata axaeution 1* that ha haa inforaation,
thay thna affar to trada at advaraa pricaa with tha tradar wtto
daaanda liMadiaoy. of couraa, laaadiaey aay ba ■*—-—*-■■ for
othar raaaona, aoA aa a liquidity or hadging naad. Tha waight
put on tba iBferaatloa aotlvatlon for tha trada will datamina
tha alia af tba aazkat i^aot of tba trada. Iba aarkat iapaet of
a trada lirinlT on tha aathad by wtaieh it ia axaeutad for a
aacend raaaon, na»aly if a final anato*ar ia not praaant to taka
tb« othar aida of tha trada, than aaaaona mat aam a ratum trea
taking tha otbar aida of tha ordar Into hla invantory. Thia
ratnm ia to eovar tha riaka and othar eoata of aaintainlng an
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invantory, and tha Mirkat nakar aams thia ratum by. taking tha
othar alda of tha trada at an advaraa prica to tha ciutoaar.
Thla advaraa prlea movb la tha Barkat lapact of tha trada.
Tha graatar ara tha nunbar of narkat nalcara, tha anallar
vill b« tha aarkat lapaet of a glvan custoaar ordar. Th* ispact
ia aaallar not only baeauaa of tha incraaaad coapatition, but
alao bacauaa aach aarkat aekar can taka a aaallar traction of tha
euatoaar'a ordar Into hi« Invantory whan thar* ara aora aarhat
■akara. Tha aaallar la tha poaition that a aarkat aakar la aakad
to tak*. tha Bora willing ha la to trada at a prlea which doaa
not diaadvantaga tha cuatoaar (for axaapla., > aarkat aakar will
ba willing to buy at a hlghar prlea, th* l«aa h* la aakad to buy,
alnca ha haa a aaallar Invantory and thus laaa riak) .
Tha nuabar of aarkat aakara avallabla to taka tha othar alda
of a cuatoaara trada will ba dataralnad by tha coata and banafita
of aarkat aakar activitiaa. Tha caata of aarkat asking Involva
<a) tha coat of capital to carry (or aargin) poaitlonat
(b) tha coata of training;
(c) tha coat of tha tlaa apant on tha trading floor.
Anything which radueaa tha coat of aarkat asking will ralaa
aarkat liquidity, and lowar tha aarkat iapact coat to cuatoaara
of aftactlng thair tradaa.
Tha quality of axacutlon availabla to a cuatoaar will dapand
I tha quality of tha brokaraga aarvicaa provldad to hia aa wall
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aa tha undarlylnq liquidity of tha a«r>tat In which ,h« tradaa.
Tha floor brokaraqa aarvicaa naadad by a Cuturaa cusCoaar Involva
tria brokar In tha uaa of trading cachnlqua* which only a akillad
tradar will hava aaatarad. Tha (1) inability to praarranqa
tradaa 'upatalra' for futuraa cuatoBara and (3) tha qraafe dawind
for laaadlacy Inharant in a hadqa tranaactlon, laply that floor
tradinq •kllla ara ralatlvaly aora laportant to tha typical
futuraa euatoaar than to tha typical aacucitlaa cuatoaar.
rurthar, tha abova two charactariatlca of futuraa trading alao
iaply that tha liquidity of tha Buchanga floor will ba ralativaly
■era Inportant for future* than tor sacuritiaa cuatoaar*.
Anything which can raduc* tha coat of aarkat aaklng will thua
tand to b« ralatlvaly vary iiportant for achieving quality
futuraa trada axaeutioiw tor cuatoaara.
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5. Pual Tradtim. Wrt.t Uouldltv. »Hd th« Quality of pirolMraT«
Tha aconoalca of brokang* sarvicAB and Barkat liquidity
outllnad In Section 4 provid* tha baaia for undaratandlng ttia
parvasivaiMsa of dual trading dlacuaaad In sactlon 3.
Tha praviouB diaeuaalon abowad that tha akllla of tlalng and
bar9alning ara iaportant both (or tha brokar In gattlng tha baat
anacution tor hia cuatoaar and for a aarkat aakar trading for hia
own account. It ahould ba addad that a brokar nho tradaa tor
cuatoaara baara riak. Thla rlak occura bacauaa ha agraaa to
axacuta liait ordara, apraad ordara, and atop loaa ordara tar
cuatoaara. It ha falla to axacuta thaaa ordara aa agraad than ha
will hava to aaka up tha loaaaa to hia cuatoaar.' tha
inatltution of dual trading paralta an individual t^ uaa hia
tlma, akllla and riak baarlng capacity for two activitlaa, naMly
■arkat aaklng and cuatoaar brokaraga. In ordar to angaga in
trading, a paraon auat baar tha coata of training, an Exchanga
••at, and tha tiaa apant on tba trading floor. A ayataa In Hbicb
tha tradar can aam a ratum froa thaaa coata by apraadinq hia
talant and anarglaa ovar two actlvitiaa will olaarly ancourava
aora paopla to ba angagad in tha actlvitiaa. Tbua tha
inatltution ot dual trading Incraaaaa both tha aupply of aarkat
nakara and of brokaca.
Tbarafora dual trading haa both a dlract and an indlract
< For axaapla, If tha brokar accaptad a liait ordar to buy
at a prica of $3 or balow, and a trada occura at $3.90
aftarwarda, and than all tradaa occur at pricaa abova S3. DO, than
tba brokar will ba bald accountabla by hia ouatoaar for a prioa
batwaan S3. 90 and S3. 00.
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•<f*ot on th* quality of euacoaar aarvieaa. Am dlracc atfact la
that it ineraaaaa tha pool of brekara availabla to cuateaara uho
ara aklllad at providing tha aacvleaa ol aaarch, tlalnq, and
barqainlnq. Tha indtraet attact la that It Incraasaa tha aupply
of markat makara, ao tbat avan if tha euateaar'a ordar la not
axaeutod by a dual tradar, bia bcokar will ba abla to provida th*
abova aarvlcaa at lettar coat bacauaa ot tha incraaaad liquidity
providad by tha Ineraaaad nuabar of aarkat sakara.
''''** T^y^if-if— -r mm Jj-^lwuf In FMtMT»« Itorfcf
Onal trading haa a particularly important function in
futuraa Harkata in tha Dnitad Stataa for thraa raaaona. firat,
varieua ragulatlona aaka tha Bachanga floor of tha futuraa aarkat
tha only focal point ot trada. lacond, tha natura of aany typaa
of futuraa tradaa would aaka it vary difficult to aaarch for
centra-part iaa ■^pataira", avan If audi activltiaa vara
panittad. Finally, tha high dcqraa of i—adiacy daaandad by
«any futuraa cuatoaara both tncraaaaa tha advantagaa of using a
akillad floor tradar aa a brokar, and alao tha advantagaa of
having a liquid ■arfeat on tha bcbanga floor. Thasa polnta ar*
alaboratad npen balow,
Tfta Iftfptifnoa Floor 1^ a Focal Point In Futuraa Warkata
It ia a violation of CFTC ragulatlona for tradaa to ba
arrangad off of tha trading floor. Ranca tha only aourca of
liquidity to cuatoaars la tha liquidity provldad on tha BKchang*
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floor. nils should ba distingul*had from tha sttuqtlon vhlch
ptavallB In sacuritlas aarlcata. a aacurltlaa ciutoaar who, for
aiuBpla, wants to aall a larga block of stock can usa tha
aarvlca* of "upstaira" brokara to saareh (or buyara oft o( tha
Exchanga floor. Evantuslly, tha brokar will find buyara and
poBslbly comlt It* ciun capital aa a buyar, and bring tha trada
down to tha floor ot tha stock Bxchanga to ba crosssd. Tha
"upatairs" saeurltla* brokat is abl* to sasrch for buyars without
ravasling to tha world how Buch its cuatoar la Intaraatad in
sailing. Furthar, ha can provlda inforaation to his custobar
rsgarding trhat prlca can ba obtainad tor tha block. In a futuras
Barkat this typa of Infenutlon csn only ba obtainad by carafnl
trading. Thar* is a graatar burdan nut on futuras floor brokars
than la nut cm aaeurltiaa floor brokara. Mrfonlng th« taaks of
tialng and bargaining ara mora difficult on futuras Bsrkata than
on sacuritlaa narkats bacauss tha absanca of upstair a saareh
placsa all tha buzdan on floor brokar a. In particular, tha
futuras brokar Bust aictcact InfocBation through hla trading that
would hava baan . axtractad by tb* aaeurltiaa brokar through
talaphons calla.
Anothar Iwortant eonsaquanc* of tba fact that tha fukuraa
pit ia tba focal point ot trad* is that potantial buyaca
aallara do not hava to aaarch aseng upataica brokars for tb* baat
prlca; thay nasd only look to tba trading floor. Though
futuraa floor brokar BUSt wocH bard to co^nuiieata his clian
nead to tha world through trading, thla has tha atCact
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•nhanclnq Ch« valu* to tiM world of tbo obaorvod prlq«« at which
tradas occur on Uia futuraa floor, l.o., prlc* dlscovary takaa
placa on tha trading floor. Tbla la in eontraat to tha
■acurltlaa aarkat wharo Mieh InatltutlMial prloa diacovary takaa
placa in aacrat upstairs. if a trsda la nagotlatad upstairs,
than thla la dono in aacrot, and tba roat of tba world is not
InCoraad until tha trads ia brooght down to tha Ixcbangs floor to
Tha fact thst futurss sarfeats put a hsawy buvdsn on floor
brokora Msans that tbsra la a graator nssd tor sklllsd fl»or
trsdara In auch Bsrluta. Tbs skills itaadad by a floor hrokoe ara
vary aisllar to tha akllls naadaJ by soaiBwa trading for hia own
account. Tba ability to loaattaaa work as a beokar and otbar
tiaaa work as a trsdsr laeraasss tba rswsrds that a aklllad
tradar can aarn, and hanca Ineraassa ths mnbar of »vcb tradars
praaant on tha Kxdianga fltmr.
It Bhould bo ■^iliaalml thst tha CFTC ragnlationa
prohibiting "upatalrs" trading ars not ths only rsasmi that a
futuraa txchanga tands to ba sora of a foeal point of trada than
ia tha esas for a atoek Ixohangs. Tbs fact that a focarss
custoasr's hsilaing tit-'- ara Intlaatsly rslatad to aacrot aspscta
of its businsss will Hks it rslstivsly Mrs ditflealt for
brokora to know wtasrs to find contn-psTtlss to a futurss trado,
than it is to find contra-pattisa to a aaewltiaa trada. A qraln
aKportar who haa juat signsd an agvaMsnt to dollvsr wbaat to a
foralgn country, and aay thus hava a grsat daaira to hava a long
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Cuturas poaitlon, will not tand to publiolia tbia tact. This is
in contrast to a Bonay Banagar who dasiras to add an industry
group to its portfolio ovar tha naxt faw waaks. Tha lattar la
likaly to b« cavaalad to aacuritias brokars. Thus It Is Bora
likaly that aaouritisa brokars know whara to look for tha "buy'
slda of tha trad* In tha abova sscuritlas axan^la, than that thay
could discovar that tha grain axportar is a potantlal buyer in
tha co»odlty axaapla. Tha contrast Is avan aora axtra>a wban a
brokar naads to find ths ssll sida. In tha caaa of coaaon stock,
tha brokar can find all larqa institutional holdars ot tha stock
(froB fora 13F filling aada with tha SBC) and solicit a aala froa
thaa. Ho corrasponding holdara of short coaaodity positions naad
an 1st. Tha vary tact that thara ara "aharas outstanding' of
aquitias is In contrast to Cuturas whara "short' and "long'
positions Bust ba craatad by custoaar*. Tha sxistsnos of ths
sharas outstanding craatss sharaholdsra (i-a., potential sallara)
who can ba diractly contaotad by brokars, in oontraat to futuraa
whara all potantlal oroators of "short" positions would hava to
ba contBctad In an attaapt to tlad a sallar.
Many futuraa ordara ara for 'spraad' tradaa. A spraad trada
involvaa sailing ons contract and buying anothar contract. For
axaapla a cuatoaar currantly holding a short Traaauty bond
contract for Juna auplration aay want to buy ths Juna contract
and aimultanaously aall tha Saptaabar contract, i.s. , hs wants to
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buy tiM Juna/iapr ibar aprcad. Thla typa of trada la nry i \\m\ ii
bacaua* , ucil ttm eoaaon atack, f utur*a contracta a^lra . A
cuatosar who vanta to aaincaln hla tiadgad poaltton suae "roll"
hla poaltion Into tho naxt contract Bonttt (by trading out of hla
peaitlon In tha contract wbtch ia about to axplra, and
•laultanaoualy trading Into tho ■>■• poaltion In a contract with
a latar a>plratlan} . Hoto tbat tha cuatoaac will glva tha ordar
to tho brokar aa a alngla spraad trad*, rathar than aa two
aaparat* tradas bacaoaa tho euatoaar doaa not want to boar tha
rlak of a prlco aeva whlla only ooa "log* of tbo trada la b^lng
tbo cuatoaar'a brokar baa two ebelcoa In oxocutlng a aproad
trod*. Ro can trado with a aai^cot aakor who aolla kla tba aproad
at a apoeltlad prloa, or ho eon "log- tlw trado blaaolf by, tor
oxaaplo, soiling tbo Saptaabor contract first, and than waiting
for a propitious tl«s to boy tbo Juno contract. For oaa^lo,
aupposo tba eusteaar govs hla tbo ordar to buy tho aproad fox
3/» wbieb aoans to pay 3/13 aera for tbo Juno contract than ho
racolvao froa oolllng tho Soptoabor ceatroct. Aoro aay bo a
■arkot oakor en tbo floor who lo willing to Mil tbo sproad tor
3/3). Howowsr, tbo eaatoaor's brokor aoos that tbo Juno contract
la bolng effforod at ••-07, and tbo •aptaabor eontraet Is bid tor
91-04 and offorod at •••«•.* So ho doeldos to boy tho Juno for
91-07 Inodiatoly, and otfor tbo •optoabor at 9«-«9, with tho
hopo of BBvlng hla cnatoaar 1/13. If ho la rl^t In his Judgnont
* Hot* that 9«-0« aaana 96 and fi/32.
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Of tha sarkBt Chan ha will ba abla to sail tha saptapbar at se-
es, but it ha la wrong than ha Bay hav* to sail at 96-04 or
balow. II tha aarkat Bciva* againat hla batora ha can a«ll tha
saptambar at 94-04, than ha will hava to pay hla cuatoaar for tha
dlffaranca batwaan 96-04 and tha prlca ha axacutaa tha trada.
spraad trading la inharantly rl*)[y.* A good brokar i* a
tradar aklllad at taking tha typaa of rlak daacrlbad abova. Thla
vary apaclallEBd trading aklll la uaad by a dual tradar to trada
for hla own account with tha brokara for othar custoBara who do
not want tha riaka, or to trada for hi* own euatoaara. : A
particular apraad tradar Bay go throu^i parioda whara ha haa no
custoBar buainaaa, but la abla to aupport hlaaalf by trading for
hla own account. Hhan hia cuatomars naad him h* ia abla to atop
trading for hia own account and provida tha> with apraad
brokaraga aarvioaa. Tha inatltution of dual trading thua put*
Dora apraad tradara on tha Bxchanga floor than would otharwiaa ba
praaant bacauaa it givaa aach tradar >ora buainaaa In which ha
can aam a ratum froa hla akllla, for tha tlaa ha apanda on tha
floor, and tor tha coat of hia Buehanga aaabarahlp. It alao
panlta tha brakar to uaa hla riak baarlng capacity to both covar
tha rlak of trading on hla own account aa a aarkat MUcar, and
alao tha riak af balng unabla to fill ouatoaar Halt and atop-
loBB ordara.
* k brokar can avoid thia riak by trading tha apraad
diraetly with a local, howavar than tha cuatoaar la indiractly
paying aoaaona aloa to boar tha riak, and In affBCt uaing two
paople to axacuta tha trada rsthar than ona paraon.
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Dual Tfdtna .iwl i.tquiili^Y pn FuturM ttorlft«.
Tha abova raaarka Indlcata that custoaaca will racalv* »ota
sHlllad brokaeaga bacauaa oC dual trading. Howavar, thara la an
indiract banatic to euacoMara ttom dual trading vhich thay
racaiva avan 1( thay uaa a brokar who navar dual tradaa. Thia
banaflt la tha tact that dual trading will Incraaaa tha nuabar of
■arkat aakara and aapaclally apraad aarkat aakara. Tha nuabar of
■arkat aakara la Ineraaaad Croa dual trading tor axactly tha aaaa
raaaon that it loerMaaa tha nuabar at akillad brokara. Tha
ability to angaga in euatoaar brokara^a anhancaa tha valua of an
txchanga aaabarahip to a wkrkat aakar. nia narkat aakar knowa
that attar to baa og^ittad aa auoh ot hla am capital ttot ha
can to trading on hla am account, than thara la atill anothar
way to aacn incoaa trca hla praaane* on tha trading floor, naaaly
cuatoaar brokacag*. Thla "aaoond Inceaa* can ba • aubatantlal
inducaaant to ba a aarkat aakar, which aignltlcantly lowara tha
•ttaotlva coat.
Tto taot that l^Mdlaey of trada axacution ia axtraaaly
la^artant to tttfeaxaa euataaara lapllaa that thay will havo a
graatar daaand Car aarkat aakara than will bo tha oaaa In aarkats
wbara tto OOM of dalayad axaeutloa la aaallar. A cu^jllty
hadgar baara gzaat riak it to doaa not do hia tuturaa trada
iaaadlataly. Thia riak aay toroa hla to trada ualng a ■aarkat'
etdar, tor axaapla to aall iaaadlataly to tto highaat biddar
currontly avallabla. It thara aro faw aarkat aakara than to will
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rsosiva ■ ralaClvaly low price, l.a., his tcnda will b«va a hifh
■arkat inpact cost. Thua tutviraa Barkata hava a graat daaand for
■arkat aakara who accoBBodaCa iiMdlacy of ordar enamtion. Tha
InatituCion of dual trading panita this da»and to ba net at low
Tbara is also graat variability in tha cuatoaar danand for
both brokaraga and Barkat Baking aarvicaa. Tha variability in
price volatility which is cobboh in futures Barkets crsatas both
a great need for raaarva brokerage capacity (as seen, for
exaapla. In tha suBBer of 19BB where grain price volatility and
trading voluBe rose after sobs slow years) and produces lulls
during which it. is hard for non-dual trading brolcsre to survive.
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6. Pr«ll«ln«rv Kv.l.i.ttBn of Prowntl. to Iftriet Pu.l Tradlmi
A. Canmmaumnemt of glialn.tlno Du.l Tr.dlna
Tha t«et chat a brokac tradaa far hla own account and also
tradaa for cuatosara la a potantlal aourca of a conflict of
intaraat. On* major conflict of Intaraat la that tha brokac may
"front run" hla euatoaar ordar by trading on hla ovn account
bafora axacutlng tha cuatovar'a ordar. For aKaapla, • br^Mr
holding a larga aall ordar for a cuatoaar aigbt aoll out of hla
own account flrat and tharaby banaflt troa tba prlca fall nana art
by tha axacutlon of tha cuateaar ordar. Tbla potaotlal afefw*
•Klata In both tha aacurltlaa sarkata and tuturas ■arkots. It ia
a violation of HYtl rulaa for a a—bar to trada ahaad af tta
cuatoMor, and It la alao a violation of cnc ragalatlona for a
futuraa broker to trada ahoad of Ita cuat^Mr.
Though tho ollainatlon of dual trading aay raduco tha abev«
conflict of Intaroat, It will actually incraaao aimtbor typa of
conflict of intaraat. Front running ia not tha only aourca of
conflict at Intaraat batwaan a brokar and a cnatoaar. Tha bnricar
gat* paid tor gatting tho trada axocutad. Tbo cuatoaar wanta an
axocutlon at a good prlco. Tha taator tha brokar ean gat tba
ordar axootttod, tba aoonar ha can bagin axacuting tha aaxt
cuatonar'a ordar and aam anothar coBBiaalon. Tha fact that •
cuatonar wanta tha brokar to axpand both ti>a and affert to do
tha trada confllcta with tha fact that tha brokor gota a
eoaaiaaion on a particular trada Indapsndwitly of how hard ha
worka tha ordar. (Of couraa, tha cuatMNr will not glva rapMt
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buainsss to a brokac who ha knows provide* hlo , vitb poor
•xccutlona.) Thia conflict of intaraat ia altlgatad for a
■killad broker/ tradar bacausa it ia aaaiar for hla to glv« hi*
cuBtonar a good axacution. It la alao >lel(latad whan thara ara
uany brokera (each, not ovarbutdanad with ordan to ba axacutad) ,
and whan a larga supply of aarkat ukara ara avallabla qlvlng
good bids for larga alza ordara.
Thus, tha firat consaquanc* of aliainating dual trading vill
ba to axacarbata tha conflict of intaraat batwaan a brokar and
his custonar. Wa will show balow that tha allalnatlon of dual
trading vill dacraasa tha nuabar of brokara, dacraasa tha niabar
of narkat makara, and dacraasa aarkat liquidity. In tinaa of
haavy daaand by custoBsrs for broker sarvlcas, thara will
tharafora ba fawar brokars to handla tha custoaar ordars, and
aach ordar will ba nora difficult to axacuta bacauaa of tha
dacraasa in >arkat liquidity. Sinca haavy damand by cuatoaara
tor brokars ottan occurs at tha saaa tlaa that aarkat volatility
rises, tha allalnatlon of dual trading will causa thara to ba;
(a) fewer brokers to satisfy tha inoraased daaand for brokara,
and (b) fawar locals trading as aarkat aakars to oountaract tha
incraasad volatility. Brokar/tradara who ara vary skilled at
trading will trade for their own account, while brokar/tradara
who ara soaewhat laas akllled will trade only for cu^toaers. In
periods of heavy custoaar trading, theee las* ekilled brokers
will naceaearily ba under great pressure, to quickly trada each
ordar eo that they can aove on to tha next ordar, thus aaxiatiing
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tlMlr total coMiaalon.
Tha analyaia praaantad In tection « ahovad that thara ara
tour »«ln banaflta aaaoclatad with dual tradlngi
(1) Cuatoaata eacalvo brokaraga aarvicaa troa aklllad tradaca.
(1) Tha nuBlME of brokara la Ineraaaad.
(3} Tha nuabaE oC aarkat aakara la Inoraaaad.
(4) Tha liquidity of tha aarkac la Incraaaod.
In addition to axaoarbatlng tha conflict of Intaeaat batwaan
brekara and cuatoaara, tha allalnatlon oC dual trading will
claacly lowar all of tha abov* banatlta.
Thl nWT Trailara mil "ot tn, niltt— r TTlrtl
Tha baat tradara ara thoaa Indi vidua la who bava
ooaparatlva advantaqa at Jud^lnq abort run aarkat aovaa.
tbo«« Indlvlduala auat diooaa batwaan aitaeutln^ auatoaar tradaa
or thalr own tradaa axelualvaly, than tbay will cbooaa to trada
Cor tbaaaalvaa. "Otm aoat that a brefear can aaka troa a cuatoi
trada la tha coaalaalen. It ba la a «oad tradar tor cuatoaai
than ba will qat aora eo^laalon bualnaaa, but ha cannot ahara
tha profit troa Individual tradaa. Tha aoat aklllad tradara wl
net 9iva up tha unlialtad profit troa buying lew and aalllnq hl«b
lAleh tbay obtain froa thalr own trading,
eaaaiaalena froa euatoaara. Ttwaa trading protlta ara ottan high
on tha aaaa daya whan thara la high prlea volatility and tbua
high daaand by cuatoaara for aklllad brakars.
wa notad In sactlon S that tha facta that futuraa trading is
foeuaad on tha Exchanga floor and that tuturaa i
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doslra Bpraad fcradas >nd Cradas chnractarltad by graft naad for
imnadiacy all ecmbina to aalca ■ futuras cuatomar naad ralatlvaly
■ore akillad floor brokaraga aarvLcaa than a sacurlttaa cuatonar.
Tha ellninatlon of dual trading froB futuraa narkata, whlla tha
maintananca of dual trading on aacurltlaa >arkata vould ba
alialnatlng the akillad floor brokers froa tha cuatomars who hava
ralatlvaly tha graataat naad Cor thalr aarvlcas.
Tha Himhar of Warkat Makara and of Brokara Mill Daeraaa*
Tha fact that an Individual can angaga In two aetlvltias to
earn a return tor tha cost of an exchange seat, th* axpansasi of
training, and the tlaa apant on tha Exehang* floor vill
inevitably increaae the aupply of individuals vbo are
broker/traders. eii>inatlng dual trading will lowar ths valu* of
being on tha floor for both actlvltlaa. This is because an
Individual who now concent rataa on being a broker can trade on
hla own account when hia own brokerage buaineaa is light, and an
individual who special lies in trading on his own account can
switch to cuatraer bualnaas lAen cuatoaera damand heavy brokerage
earvices or whan ha has coaaittad all of his capital to trading
on hia own account.
Dual trading creates a raaarva group of potential brokers
who cen fraaly awitch to customer businaaa whan tha voluBa of
cuatonar orders rises. It alao creates a rasarve group of aarkat
makers who can add liquidity vt
have a large narket lapact.
Market Licnilditv Will Be Seduced
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Th« «liatiMtion at diul trading will r*duea tha i^ak capital
nada avallabla by floor traders who act aa aarkat >akara. This
will Incraaaa bid aak apraada. It will daeraaaa tlM liquidity
providad In tha pacloda iiiMn it ia naadad Boat, n«>aly whan thara
la an unanticlpatad inflow of euatoaar ordara. Tha Inability of
brakara to owitch froa euatoaar boalnaaa to trading for tbolr own
account will pravant thaa froa taking tlia otbar aida of tha larga
Inflow of ordora. Thoratoro prlca aovaaants will ba aaacarlMtad.
Narkat pricaa will ataow graatar volatility.
««« wrfc»f mil — Mwraalv AMaetad
Tha dacraaaad liquidity and incraaaad volatility of taturaa
pricaa will advaraaly affaot tha undar lying apot aaticaits.
Puturaa aarkata aarva a bodging and prioa dlaoovary function
lAidi will ba l^airod by tha altaiMtioa of dual trading, thla
will aaka holding tha spot oo^wdlty or financial InatEtaant aor*
risky. This will iivaet on a who la ranga of undarlylng
actlvitlas froa grain storaga to tba financing of tha m traasury
dabt.
Ons axa^la of UM typo of iapaot ean bs soon In tha grain
aarkat. Sraln slavstors buy grain and ator* It. Ibay bsar tha
risk that tha pries will tall bstwaan tha ttaa thay buy tha grain
and tha tlna tbsy sail tha grain, lbs alsvator ownar oan hsdgs
this risk by sailing ths grain forward on ths fotnrso aarkBt. Hs
tharaby shifts tba risk to tha rsst of tbs world, rathar than
baaring it all by hlMOlC. Tba fact that tha grain alavator doss
not hava to baar ths risk of prioa tloetuatians ■asns that it la
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■blB CO pay laracra mar* for ttia grain. It tha alatrator ownar
had to baar tha clak of prlea fluctuation, than ha would pay the
fanMF laas, so aa to covac tha risk ha baara in storing tha
grain. If tha liquidity of future* narkata falls, or if
transactions costs rlsa, than tha attaetiva cost of obtaining
Inauranca froa futuras aarkata will riaa. Thla Incraasad cost
will be passed along to faraera In tha fora of a lower price they
racalv* for their grain. Final usare of grain will not receive a
lower price, but eay even have to pay a higher price, since the
grain elevator'* effective oost of storing the grain has risen
due to the Increase in Its cost of obtaining insurance In the
futures BBrket.
Another exaaple of the deleter lous effects of reducing
futures Market liquidity cen be seen in the US treasury security
market. Bond dealers who put in bids et US treasury auctions can
hedge tha inventory of bonds they acquire fay uaing the US
treasury bond futuraa sarket. The ability to hedge their
inventory Increaeas the aaount that they are able to buy at
auctions, and the price that they are willing to pay. If tha
coet of trading on the futuras earKat rises, than thle will
Increase the cost to the US treesury of lasuing treasury
securities.
The enomous i^ortenca of futures markets in our economy
means that even small increases In tha coet of using tb* market*
or the liquidity provided by the markete can have very large
Impacta on tha aconony. If farmers receive $.05 lesa per buahel.
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or It consu>»rB auac pay (.OS bot* par buahal, ox, it tha us
traaaury racaivaa 1/11 laaa par Sloo o( bond* tt iaauaa, than tha
eonaaquanca* par 100 ■llllon buahala and par t crllllon dollari
of dabt ara anorsoua.
Faralan Wrkata Will Bapl«« us Wrfcata
TIta tact Chat dual trading la paralttad in Bany toralgn
•ackata will giva thoaa BBTkata an advantaga ovar th* 08 aarkata.
Tha praaainanca of many US Cuturaa aarkata ariaaa fra> tha graat
liquidity addad by "loeala*, who ara tradara riaking thalr own
capital ta add liquidity to aarkat*. Ttwaa locala will loaf- an
iaportant aourca ttt Chair potanCial incoaa 1( thay ara axeludad
froB cu*ca*ar brokaraga, and hanca ba dlacauragad troB antarlng
tha trading bualnaaa.
Tba BovaBanC of brokaraga bualnaaa ovaraaaa will turthar
dacraaao tba liquidity ot HI aarkata bacauaa Char* will ba fawar
euateaara for a givan cuateaar on Ch* US aarkaC to trada with.
cuatoaars torcad to trada in tha US will tharaCora ba trading In
laaa liquid aarkaCa, aftar Bobila cuatoaarB taka thair bnsinaaa
alaawhara .
euatowa mil I^i— Thair Fraadoa of tatojea
currsntly, with dual trading paraittad, a cuBtoaar cencamad
about contllcta ot intaraat can chocaa to lua a floor brokar who
doaa not angaga In dual trading. On tha otbar hand, a cuatoaar
who is not concamad about tha conflict of Intaraat and wanta an
activa akillad tradar oan ohooa* a floor brokar who doaa angaga
In dual trading. Tbia fraadm of cboica will ba loat to
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cuatoaars if dual trading ia bannad.
B. Raviaw of Proncaaala to Partially Ellalnaf Bum Trading
1. Ellainata Dual Trading in Llautd Contraet»
Thara ara two problaaa with thla propoaal . rirat, ttw
contracta Bay ba liquid exactly bacauaa of the ability of
brokar/tradars to ivitch to Markat BBkinq activitiaa whan thara
ia s larga cuatosar ordar t4iioh would otharwiaa hava a larga
advaree price lapaot. It 1* vary difficult to aaintaln a liquid
futuraa Hsckot. Hoat contracta which hava baan Introduced '. by
Exchangaa fall to baeoaa liquid and diaappaar. Ho cuatosar will
Initiate a poaitlon when he (aara that the Market will not ba
liquid whan ha wanta to take off the poaitlon. If cuatoaara loaa
confidanca in the liquidity of a aarkat, than that Barkat will
fall. A dalioata balance ia required for a aerkat to aurviva,
and anything which raducea the liquidity by aven a aaall a>ount
can initiate a vlcloua circle whereby cuatokar confidanca ia
loat, voluaa fall*, ao confidanca furtbar faila, and liquidity
totally diaappaars.
A second problaa with eliainatlng dual trading only froa
liquid contracta ia the prevalence of apcead trading between
illiquid and liquid contracta. A typical apraad trad* will
involve, for exaap^*' buying the near liquid expiration Bonth,
and Belling a later leas llqnld aonth. It sight even involve ,
Balling a laea liquid cowBOdlty and buying a ■or* liquid
cosBodlty. For exasple, a bond hedger say want to aell federal
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tundc tuturaa (• !■•• liquid contract), and buy tr«a*ury bond
tuturas <• sera liquid contract) , to tiadga aqalnat a chanq* In
tha taea atractur* oC intarast rac*s.
In ordac for tha apraad wirkat to b« liquid a tradar auat ba
•bla to do both cuatoaar and principal bualnaaa In both tha
liquid and illiquid contraeta.
A tbled pr^la« with •liainating dual trading in th* liquid
contracta la that tho volua* and liquidity ot « particular
contract can ba qait* varlabla. Durlnq partods oC umwual
w^atbor, a grain futuraa contract that baa had vary llttlo vaXuaa
can ahow a huga Ineraaa* in voluae. If dual trading la bannad
eras tha contract wtian its voluna of trad* riaaa, than whan thara
ia a auddan riaa In volma, tbara will ba a ahortaga ot brokara
and tradara to >«rv« euatoaar naada.
3. KllBlMti Dial TridtiiB It titM-BBMi ind-JJa CIoml of . Tgiflino
Thaaa ara porloda of tba day with hlgbaat voluna of trada.
It la vary mamf for ordar inbalancas (for axaapla, a
prapondaranca of euataaar aalla ovar buya) to appaar within a taw
aaconda In thla parlad aa brokara attaapt to aaacuta "narkat on
op«n' or "aarkat oo eloaa" ordara. Sia aarkat naklng capital ot
• brokar/tmdar can taaMt cnelal to ■alntalning prloa atablllty
in tha spaea of a taw aaconda. Tb* banaflta trtm •witching fro«
brekara^a to principal trading can thua appear within a faw
aaconda. Thla craatoa banaflta troa dual trading «v«n at tb*
opan and th* eloa* ot trado.
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3. Llalt th« aitm at CuatMT Ordra Rifeutuhla by a Pti.l Trader
This would lowar th« quality of brokaraga aarvicB* to large
cultonara who oftan naad it tha Boat. It would ineraaaa price
volatility, aa lar^a ordara hava highar aarkat iapacta dua to
axacutlon by laaa akillad tradara. Tha larga tradara ara tha
■oat Bobila, and will thua mova thair ordara to foraiqn Darkata
if thay can ba axacutad >ora affactlvaly thara. Ttiia will lowar
tha liquidity availabla to tha cuacoaara who raaaln. Tha
cuatoaara who raaain ara likaly to ba a>all cuatoaara. Kanca
thla llaltatlon on dual trading will hana atull cuatosara noca
than It haraa larga e
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4. Li»tt eiu.1 Ifrtlng to th« Hefc Manehm
I hav* alraady notad ttia problasa with allalnatlng dual
trading fro* liquid contracta. Ellnlnatlnq dual trading froa tha
front Bontha will aak* apraad tradlnq vary difficult, for raaaona
notad abova. Hawav«r It will also hava anothar aubtl*, but
dalatarioua atfact. It will aaka it lapoaalbla for tradcn in
tha back aonth to hadga thalr risk In tha back «enth contraeta by
taking an offaattlng pealcion In tha front aontha. For axaapla,
a brokar/tradar who buya a back aonth contract lika tha Pagaabar
IMO bond futura (tharaby providing liquidity t« a cuatewar Mha
wantB to Ball it) would normally aall tha front Bontb ta hadga
hla poaltlen. Kowavae, It ha loaaaa tha ability to txada tba
front aonth, than Ha will caaaa to tcada tha back aonth bacauaa
of tha rlak invelvad. Tharoforo allalnatinq dual trading froa
tha front aontha will alao cauaa dual trading to dlaappaar Croa
tha back aontha.
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7. Heaaurinq tha Banefita of Dual Trading
The prsvlous ssctlona provida a thaor«tlcal ovarviaw of the
economic rola of dual trading and tha natura of ch* bene fit a
cuBtODcrs derive troM dual trading. Much of the dlacusaion in
the previoua sections can be quantified. in particular, it is
possibla to neaaur* the contribution Bade in varloua future*
narkets by dual tradera. It should be noted that the neaaurenent
of the benefits is quits a conplex process, and to the beat of ny
knowledge no atudy exlata which haa Beasurad the potential loaaaa
to the econoay of eliainating dual trading.
Kn enpirical analyala of dual trading oust begin with an
analysis of the extant to vhlch dual trading exists In particular
narlcata, particular contracts, and particular periods. Ho
coaprehenslve analyala axlata of th* extant to which an
individual nexber tradea for his own account and also trades for
custoaara. The trading records of individual aeabers exist and
can be used to raconatruct a record of overall dual trading.
Thla data can be analysed froa two pointa of view. The first
view ia "positive". I.e., an attsapt to deteraine what underlying
factors have lad to the observed historical pattern* of dual
trading. It would then be deteralned whether the obaervad
patterns are consistent with the theory of dual trading outlined
in the pravloua Seetiona. The second view is "norHatlvs" . Thla
approach will coapuCa the extent to vhlch dual traders have
directly and Indirectly banatlted custoaers, and the extent to
which thesa bans fits would disappear if dual trading is
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prohlbUad. ^
Th« D«C«»lMnt. at au»l Tr»dln«f
ma Chaoratlcal traaavork davalopad in thia raport tapllaa
that tha tolloHlnq tactors will cauaa dual trading to ba
laportant.
1. Tha axtant to vhleh euatoaaca daalra l^Mdlacy of
WMCutlon. It tDara ar« larqa euateaae ordara wtalch mat ba
"werkad" [in tha aanaa that trading it liaadiataly "at aarkaf
will qiva tha cuatoaar a poor prlca) , but for which tha euatosar
baara graat riak whlla tha ovdar ia untillad. than thara wilt ba
a graat daaand for brokara who ara akillad tradara.
3. tbm axtant to which cuatoaara daair* eo^lax apraad
tradaa. mi* ia anothar axaapla whara tha cuatoaar daaanda
brokara with atreng tlalng and bargaining akilla.
)■ Tha axtant to which thara ia inaulfictant cuatoaar
bualnaaa or inautficiant principal trading buainaaa (oc an
individual to aacn a living fro* angaging In only ona eC thaaa
aetlvltiaa.
4. Tba axtant to uhlcA tbara ar* larga awinga in tha daaand
for altbar brekaraga or principal tradaa. Dual trading will ba
Important whan thara ara aurpriaa ineraaaaa or dacraaaaa in
cnatoaar buainaaa which laad to wlda and unpradictabla varlatlena
in tha appropriata usa of a brokar/ tradara tlaa and affort.
ma abova factora can ba quantitlad and uaad in a tlaa aarlaa and
crosa aactlonal analyaia of dual trading, to saa if thay indaad
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•xplaln th* daqraa to vtaich dual trading occura ,
futuraa contracts In varioua parioda.
Tha Banaflta of Dual Trading
Tha factara ■ophaaliad In tha pravloua Sactlor
that dual trading haa a diract aftaet on cuatonara via providing
battar floor brokcraga aarvlcaa, and an Indlract a f tact of
Incraaalng >arlcat liquidity.
Maasuring tha diract banaflta of dual trading Involvaa tha
following analyaia.
1. CoMputlng tha aictant to which diract brokaraga coata ar«
raducad, for a glvan laval of brokar quality, bacauaa a dual
tradar haa nultipla usaa of hia tiaa, akilla and Bxchanga aaaC,
and thuB can oCfar to trada at a lowar coat.*
2. Kaaauring tha axtant Go which euatoaara raeaiva battar
axacutlona on eo^lax apraada, and larga ordara through tha uaa
of dual tradara.
Maaauring tha indlract banaflta of dual trading on sarkat
liquidity involvaa tha following analyaia.
1. Coaputing tha axtant to which tha effactiva bid aak apraad la
raducad dua to tha axiatanca of dual trading.
3. Conputing tha axtant to which tha affactiva bid ask apraad ia
raducad tor apraad tradaa.
laauring tha Oparatlonal Coat of Dual Tradlngt An
~ ~ iwork", Kannath L. Stanlay, Tha Journal of ruturaa
, Ko. 3, 339-336, 19B1.
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<M
). CoBputlng tb* axtant to which tha aartut can ataerb larqa
ordan to bgy, or larqa ordara to aall with a aaall »ar1ut li^act
(i.a., aarkat dapcb) .
Tha Maaaurcaant of attactlva bid aak qtcaada, wtd tlM
Maauraaant ot aarkat dapth will ba aacoapliahad by varloua
■athoda. All aathoda will raly upon tha idaa that ti^adaa wbich
hava • larq* aarkat l^act and/or ara asaentad againat wlda bid
aak apraada will causa prlea and aMpaetad ratnms t» aova in
oppoalta dlractlona. Racall that. Car axa^la, a aall«r will
hava a larga aarkat iapact it tha priea ean ba aiyatad ta ^aa
frOB tha prlca at which hia trada ia axacutad. Varleua aatboda
will b« u*ad to ce^^ta tha axtant to whldt prica and — tiit-ttit
ratuma ar« nagativaly corralatad, inclodinv toll's aaaaura
darivad (roa tha autocovarianc* of period by parlod ratuma) ,
and tha Oroasaan-Hillar autocorralation aaaaura, aa wall aa
xalaan tlltseing approachaa.*
It ia iaportant to control for othar affoota wkicA aay
lapact on actual aarkat liquidity, thaaa atfaota incloda
variation acroas contracta in voliaa tradad, avaraga trada staa,
apot prica volatility, tiaa to a>piration, tba iapertanea eC
* Tbaaa approachaa ara iiimii IiiI in i ■KcotMBle ceata and
BacMClts «C tba Proposad OnaHUimta Tlaa ■raoketing togolatloas,-
Sanford J. Sroaaaan and Narton Miliar, gaooMl Bt tBtaiSM
Markata ■ vol. t, no. 1, 19M, 141-l«a. "Liquidity and Narkat
Struetura," Sanford J. Groaaaan and Msrton Millar, *"" -t«h.mi nr
Financa ■ July 19M, Vol. 41, Ho. 3, m-t37. "Datarainanta of
Liquidity Coata in Coaaodlty ruturaa Narkats," gfwl— of rWilfT"
jiarlcatH ■ Spring lais. ■Infarrlng tha coai^nantB of tha Sld-Aak
Spreadi Thaory and eaplrleal Taata," Hana atoll, laOBMl—at
Financa. vol. 44, no. 1, March 1919.
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ntra-aarkat and Intac-Barkat apraad trading. Furthar, it is
iportant to dlatlnguiah cauaa tram attact. In particular, tha
laqnltuda of tha abova factoca aay ba althar a raapanaa to tha
aaa in liquidity cauaad by tha ammly of dual tradara or
.nataad ba tactora Nhieb contcibutad to tha i<»»»i>rt for dual
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Dual Trading In Fnralan Wrlff
In looking aC financial aarkac* throughout tha world, ona
finds that dual trading is very pravalant. This la not
aurprlsing, glvan tha laportant banatlts Chat dual trading
provldaa both to brokar* and to clianta. Ny prallainary raviav
of world aarkata Indieat* that 19 out of 19 countrlM paiait mtmm
tors of dual trading. Dual trading can taka th* torB^.- of
t radar/ brokara on tha Bxchanga floor aa in DS futuraa Barkwt*, or
tha form of banka which act aa both principals and agwtta for
custoaara, or tha form of daalgnatad ap*ciallata, or tha tora of
brokar/daalara who can trad* on or oft tha Ischanga floor with
Tha (ollowlng dascrlbaa tha stnictura of financial axchangaa
throughout tha world, with ragard to brokarag* sarvicaa and dual
trading.' Unlasa spaclfically notad, tha Exchangsa daacribad ara
Btock axchangaa.
corporation, Park Ridga. Haw Jarsay. —ior fltoek Markata of
Europa. Paul stonhaa, IMS. St. Martin's Praaa, Kaw York. Xbi
Prinetoal Stock Enehaiwaa of tha World. David E. SPray, 1»64,
Intarnational Econoaic Publishara, Inc., Washington, O.C..
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Australia
On tha Sydnay tuturaa Exctiang* a local can Crada tor tiia own
account aa wall aa tor other Baobara of tha Bxchanga. Ha la not
paniittad to trada ahaad of hia cuatonar.
on tha Auatrallan atock axchang*, atockbrokara aay trada on thalr
ovn account, aa vail aa acting for cllanta. A brohar daalar auat
dlacloaa than ha ia acting aa auch. An odd lot apaclallat ia a
nanbar brokar who axerclaaa a francbiaa to handla all odd lota.
Ha la abla to buy odd lota at a aat rata of dlacount and aall' at
a sat rata of praalua, In ordar to ba raooapanaad for hla
Optlona ara tradad on tha Australian option* Mickat in nueh tha
aa>a nannar ■• ordinary aacorltlaa. A Il*giat«r*d Trader la
raqulrad by th« axchang* to provlda a contlnuoua and orderly
narkat by vaklng a varkat In at laast on* contract trttan oallad
upon to do ao. Ha alao Baintaina an agnPi^oprlata price
relationship aMong tha options aerlea in each atock he deala
with. A floor trader la a rapreaentative of a Mavbar flea and
axecutaa client orders on behalf of hi* firm.
Austria
Thoao holding stock exchange card* include banka and other credit
inatltutiona, who >ay deal directly with eaob other in purchasing
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or aalllng aacuritlcB. OCtlci*! broker* say not MigBqa In uiy
•Cock axchanga dMllnga on tbalr awn bahalf. tha ••eurlcios
qaot*d on ttM oltlelal Hat ar* dlvidad up ae tbat aach official
brokar handlaa only cartain aaeuritlaa. Brokara «ay alao trad*
ott tha axehanga. Praa brokara, who ara not otticlaliy appeintad
by tha axehanga, aoc aa intaraadlarias batwaan cradlt
inaticntiona, or batwaan eliants and cradit Inatitutiona. may
•ay alao trada on tliair own bahalf. rx*a brokara alao daal in
aaouritlaa wbicb aay ba tcadad on tha axehanga floor but whiA
ara net officially quotad. ui aaciwitiaa My ba tradad off ..tha
Trading la dona axoloalTaly by I
Thaaa brokara ara toxbiddan to acit aa a principal. Tha brokara
can raoaiTO ordara dixaetly troa ellanta or Indlractly froa
corraapeadlag brokara or baaka. Corraapowding brokara racaiva
erdara froa ollaata aUdi tbay wmt bring te tha brokara tor
aaacntion. Baaha anat alao go throogh ttia brokara to gat tradaa
axacntad, aaeapt far ordara of avar Mr. la aiUlea.
y act aa both agant or
■ thalr own aeeannt i
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By contraat, Invaataant banka and <IiBtrlbution
Bay trad* for thair own account.
N*Mb«r flra brokara trada for fchalr cuatomara and rata in a
cOBBlaaion au pay>ant. Sacuritlaa Clna who wlah to trada Hated
■acurttlaa without formally Joining tha axchanga My do ao as an
Buthoriiad non->aabar. A Ragiatarad Tradar acta aa a daalar in
apacific atocha aaaignad to hin by tha axchanga. His function ia
to act a> a Mrkat nakar in thoaa atocka - to contribute to
■arkat liquidity and anhanca prica continuity. The Regiatarad
Tradar can execute tradea aa an agent for a aeabar fim and nay
aiao trada hia own account, within liaitationa.
Finland
Moat aaBbara are banka. MaBbara aay trada tor thair own
aa well aa for clianta. Banka ara aajor invaatora aa
Clianta mat place tbair order a through e bank which ia
rapcasantad on tha atock aKchange. Banka My trade aacuritiaa
for thair own account, take tha other aide of a cuatoner
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poaltlon, or arrange for anoehar bank to Caka tha othar aida.
Thay Bay alao placa tradaa through a brokac. Official brokara
ara aaalgnad cartaln aacurltlaa by tha axchanga. Thalr funetian
la to arranga tranaactlona and aat official quotatlona. Qm
official brokar aata a alngla prica for aach aacurlty which
paralta hla to axaeuta tha largaat nuabar of ordara racalvad far
ttiat aacurlty. If additional ordara ara naadad to balanca
axlatlng ordara, ha calla tha quotatlona to racalva thai. Ra may
than antar into tha trading hlaaalt oo far aa It la naeaaaary to
till oKlatlnq ordara. Otharwlaa, otflolal brokara ara .not
anppoaad to daal In thalr aaalgnad aacurltlaa for tbalr own
account. *Fraa brokara* axaeuta tranaactlona 1
May alao trada foe Chair own account.
Maabar tlrM of MkTIP, tha Prancb financial futuraa BxAaaga, ara
•bla to axaeuta both proprlatary and cuatoaar ordara.
Sacuritlaa eltants say placa ordara through a bank or a raadalar,
an 1 nraat— wt aOvlaor. Tbm banka and roalalara la turn tranaait
tha ordara to a brakar who axocutaa Umb on tha floor ar off ttaa
axchanga. A brokar nay not trada for hla own account or aovlra
any Intaraat In or any aanagoMnt rawonalblllty tor any
eo^rclal or Induatrlal antarpriaa othar than hla brokaraga
tirm. Banka aay alao daal dlractly, off tha axchanga, Inolndlng
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trading on thatr own account and taking tha <
custonar ordar.
All ordara >uat ba axacutad by stock axebanga brokara or thalr
aaployaaa. Brokara nay alao trad« on thalr ovn aceounta, aa long
aa thaaa tranaactlona ara aagragatad tro> Choaa for thalr
clianta. Brokara say aaploy authoriiad clarks or Mlaa
rapraaantatlvaa to axacuta ordora on tha floor. Thaaa aBployaaa
Bay not trada for thalr ovn ■
I Hong Kong Futuraa Exchanga pantlta diMl trading-
Any nanbar can act aa both a principal or an agant, aa long ai
providas notification that ha la trading for hia own aoeount.
Italy
Banka aay racalva eliant ordara and Batch tlMB, but all tradaa
•xacuCad on tha axohanga mat ba dona by brokara. Tha brokara
may not trada on thalr own account nor own any intaraat or accapt
any managarlal raaponalblllty In any coaaarclal or induatrial
fira othar than thalc own brokaraga tirm.
23-500 0 - 90 -
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Regular a*nl>«ra of ttia sKChang* ara caapanlaa who both racaiva
ordara (roa clianta and trada on thalr own account. Moat raqular
aaabara alao underwrlta aacurltiaa. Spacial aanbara parfora tha
(unction of connacttng sarkata by handling ordaca at tha Tokyo or
Oaaka axchanqaa which could not ba f Iliad on tha ragional
•KChangaa. Excapt In aituatlona of unuaually high volusa, atock
•xchanga Barbara Hiut awtd ordara to tha aaltorla for aKacutlon.
Thaaa ara coapanias who ara raaponalbl* for Matching ordara .and
fixing tha prlca foe thoaa atecka aaalgnad to thai by tha
Ixchanga. Saitorla cannot trada for thalr n
atooka to whloh thay «e« aaaignad.
Stock axehanga Maabara ara baaka or atockbrokaraga firaa.
Stockbrekaraga tlraa aay axacuta tradaa on tbalr own Account aa
wall aa tor clianta. tanka and brokara aay trad* dlractly
batwaan tbaaaalvaa, without intaraadiarlaa. Bank* aay taka tha
otbar alda of a eusta«ar trada.
Maabara ara aithar individual brokara er aaihai
Individual brokara aay trada for thair own account
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■■ab«r fim. Brokaraga tiiaa say axacuta ordars fortolianta or
trada tor thair
HaCliarlanda
Banka and brokara racalva ordara tra> elianta. All ordara ara
tranaaittad to a hoakaan, or apacialiat. Tba ^vciallata axacuta
Cradaa in a particular aat of aacurltiaa. Thay racaiva ■
comiaalon fora tha banka and brokara for parforaing thla
llMy »ay alae trada for tbalr own a
TlM Buropaan Option* Bscbanga ia an aaaoclation nat up imdar
Dutch law. Haabara tncluda banka, brokara, and prlvata teadara
froa Horth Aaarica, Canada, Waatam Buropa and tha Far Eaat.
Public crdar aaabara raoaiva otdara froa th« poblio and pa*a tb«a
to a- floor brokar tor axaewtlon. Xarkat aakara ara tradara who
ar* raaponalbla for aaking a saxlMt in thoaa optlona aaalgnad to
thaa. Thay act axolualvaly for th«lr own aooeunt.
Singapora
Thara ara thraa kinda of atock axdiang* daalar. A atockbrokar ia
a aharaholdar in a aaabar (ira. Ba aay act both for ollanta and
for hia own account. A daalar ia an aaployaa of a aaabar fira.
A raaiaiar ia a coaaiaaionad agant of a MMbax f Ira. H* aay otay
tranaact bualnaaa on bahalf of tha fira ha ia axployad by.
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TO
Tradas can alao ba carrlad «ut att tha floor and .entalda of
Tha Stngapora tntamational Konatary Cxchanga la a fucuraa Mrkat
which paraita dual trading by floor brokar/tradara.
South Ktrlea
Stockbrokara primarily trada for ellanta, taut aay alao trada on
thalr own account. A "daalar In atocKa and abaraa" prlaarlly
tradaa tor bla own •coeont, bat aay alao held biaaalf out to^Uia
public. Trading alao takaa placa off tho axcfaangoi typically
dlraetly botwoan laatltutlonal Invoatera, ancii aa banka or
Insuranea eo^anlaa.
inka or diroetly with a
atoekbrokar. U.1 otdaz* aust ba avaentad by a atockbrokar.
Stockbrokara aay not trada tor tholr own aeoount.
Swltiarlaiid
Banka ara tha only Miabira of tha stoek axciianga. MMbar banks
■ay trada althar on or ott tha floor. Oft tbo floor trading
paraita bank* to aatoh cuatoaar ordara against oaA otbar. Banka
■ay trada tor ellanta and alao trad* dlraetly wltk aadi otbar aa
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principals. Panully, Boat orders ara axacutad by. tha banka
acting aa prlnclpala.
Dnitad Klngdoa
Tha London Intamatlonal Financial. Puturaa Exchanga panalta dual
trading. In particular. Public Ordar Haabara ar« paralttad to
trada for thalr own account*, aa wall a* tor cuatoaara.
Tba naw aacurltlaa "aarkat" ia baaad on a ayataa of broKar-
daalara functioning in a dual capacity, trading ■■ aganta for
cllanta aa wall aa prlnclpala on tbalr own account. Brokar-
daalara say alao taka tha othar aid* of a euatoaac ordar.
Cartaln brokar-daalara act aa Markat Bakar* in apaciflc
aacurltlaa. Thay >ay daal dlcactly with invaatlng cllanta.
Intar-daalar brokara provida a aacbanlaa tbrough which aarkat
■akara can trada anonyaoualy with aaeh othar. Intar-daalar
brokara ara not allowed to taka pcaltiona in atooka. Soaa aarkat
aakara ara located off tba floor In tbalr own trading rooaa and
1 by talaphona.
Unltml Stataa
Tha Haw Vork Stock Exchanqa [NYSK) paralta tba daaignatad
apeciallat to trada aa a broker 'a broker and alao to trade for
Ita own account. NYSE broker/daalara can trada for thalr own
account on tha NYSB floor aa wall aa for tbalr cuatoaara, but
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tlMy eaimoC trad* •bMKI o( thmlt cuatoaars. Othar Stock
Exchanqaa hiva alaiiar rulaa.
Tha Chicago Board Options Exehanqa raqulraa floor tradara to
ehooaa whathar on ■ qlvan day thay will axacuca cuatotMr bualna**
axelualvaly or trada (or thalr own account axeliulvaiy.
Brokar/daalara Mho ar* awtara bava aHpioyaaa an tha tloor who
■ay trada for thalr tlra'a aeeount or tor cuatoaara.
Ul aajor futuraa Bxchangaa paralt dual trading.
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Statement of
Warren Lebeck
Representing the
National Grain Trade Council
Mi. Chaunun ind Menben of the Subeomniitne:
My name u WaiKii Lebeck and I q^Ku before you tod^ KpRMMing Ote Nitumal Gnin
Tnik CoundL 1 am the immediate pan '■>"'nnftn of dw Coimdl and Kive on the
organization's Executive ConunitKe. On behalf of the 63 nKmbet orguiizationi and
companiet of the QnincQ, 1 with to thank you foi die oppominity to (bare om views wilh
you on H.EL 2869. Ihe "Commodity Futuies bnprovementi Act of 19B9.'
2. To advocate and defend, coniiitent with pubHc ioterett, the princqdes
and toeiitl of open and competitive markets for tbe discributioD of agiicultuiil
conunoditiei.
Council memben cover the full ipectram of die agiibuiineu infiaitiunuie. Our memben
include fiimi who handle buJk giaim, tranq>ott«tion Snni, conqwnie* that proceu agricuhuial
products into coisumer-ready itemi we purchase oo the groeeiy thelf. rwh tiuiAels where
grain it bought and told, and futures maikets where die price risks associated widi
merchandiling grain are hedged.
Futures mariwtt and the gnin trade grew up side-by-side in die United StaKt eeonoo^. Since
the middle of the last century, the gtain uidustiy has relied on futures markets to hedge
market risks; and funirei nu^ieti have fulfilled duu puipose in an ^en and >ffWiTit manner.
American coiuumen are dius deep into their second century of eiOoying the wide-ianging
beneRts of prke efficiency created by dus economic relalionsli^
It is economical^ true that mariuts work best when two conditiont are met: (I) die widen
possible number of bids and offers are available in aiiy given mariiet, and (2) Aat same
maricet it free from artificial restraints and influences that affect price discovery.
Maximum liquidity means free and open access to the market by die widest possible spectrum
of buyers and sellers who have individual independent opinions about the price of a given
commodity. Tlie more bids and offers in a market, the better wiH be the price discovered in
it; and the more bids and offen in a market, die more reliable getting in and out of it
becomes for those who need to use iL
As in any endeavor where people are invohfcd. unfortunately there are always those who are
lenqjled to finds ways to gain an unfoir advantage. Consequently, futures maritets must
constant^ remain vigilant in their surveillance and market protection efforts.
„Coogle
Hie Nabcmil Grain Trade Coimcil, thcrefoK. lupporo podtive Improvwueiin to ptevum and
detect ■buiei. We mon^ luppoit most elemenn of K.R. 2869 ind wc ttmisiy endone the
Intent o( the kjliliiiiiii
: nauthorizition of the Commodity Funina Tradinf riOmniininn fOTQ-
afoiAe CFTC To the extent my
■U uncotiiiur aboui the pemuneace of
V of US. fuiurei nudwU. It would abo eate the
id tesulatory letouicet which aie now divcited evoy three
finfezprint end bacbfroimd checks, and e good Mt ctf ttatutofy fitnftt qualificaliooi*
FiThifl minillH We nton^ nqipoit the piopoted ethia training tequirenenti fat
those regiitered under die Commodity Exchange AcL As mi->iiinii>j| enlier, cxie of the
CoundTi ofajeoivei is to promote better undemanding of grain maifceting by the
public Futuies madMs aie a voy complex and often misundoilood pan <^ grain
muketing. For this reason, we believe it is inqxutanl fbi the putdic to peTccive thai
subject to such mining
; For nmilai teason*. we strong n^poit the
— T****** HJL 2869 wtnild place on having public diiecton on exchange governing
boanb. We would note the major giain exchanges abeadjr have significanc public
repiexntatioii OD dieii govemuig boardi. The Council Ukewue qiplmd* die provision
«4iieh would prohibit exchange meiaben found guilty of rule violations considered
'roajot' by an exchange from serving on such boards or exchange committees.
The National Grain Tnde Council bdiev«« the two most critical element* of die biU. howevier,
are die audit mil and dual trading provisiani. The Council beUemi these two areas ecnam
die bur* beM and worn featnte*.
The beat feature of K.R. 2869 is iB enqihasis on inqinmng exchange audit IraiU. The ben
way to curtail potential trading abuses is to have audit tiaib flut will efleetively catch rule
breakers. The test is not «4iethcT the systems meet some atbitraty time or odier standard.
Hie test is whether the systems work. Will they catch violators with such predictability that
diey have a.deienent effect as well?
Hie members of the Caundl recognize diere is no such thing as a 100 perceivt accuraK and
verifiable audit trail We are heartened for at least two reasons that H.H. 2869 would not try
to establish such a standard. First, it is deariy a complex issue. Thus we believe tegulamry
spedlics should be established by the Agency subject to Congressional oversi^L We bdleve
„Coogle
NGTC S
July 20, 1969
Page3
The National Giain Tiade CouncQ endona all practical tlforu to reach tbat goal We urge
the Congreu to eierdie iti ovmight role vigonnuly to eniure the C7TC will puih faaid
toward diat end: audit tiaili that icare ofi would-be rule violators without hanniiig the
DMitot and eiMomen and tndett they are detigned to protect
The rule violation wue biingt me to the Cmindrs final comment on K.R. 2869 - dual
trading. The biD propoiet to limit dual tiading to iddien the possibilit)' of abuie by biokcra
trading ahead of tfaeii cullonien. Iliii practice, however, can be best prevented thiou^ a
lough audit trail
Applying ■iq' ban to die more activety traded contracts would most lignificantfy threaten the
liquidity in defened months of those contracts. Dual trading contributes imponantly as an
a4JU0ft source of market liquidity in those back months, allowing commercial users to hedge
future sales. Commercial usen ue still feeling the impact of reduced liquidity in deferred
months which occurred following Qmgressional action in the early 1980*$ to require that all
funnel positions be marked-to-moriiet for tax purposes at the end of each year. A move that
would limit dual trading would futthet damage the already ftmgQe liquidi^ io those deferred
months.
In addition to harming toaAet liquidity, a ban on dual trading could cause the more successful
broker/traden to choose not to handle customer accounts. As a practical matter, diis could
leave public cultomer orders in the hands of less efSdent brokers, which would result in
worse, not better, fills for diese orders.
Mr. Ouumuui, the Council feels so strong^ about this issue because as commerdal users of
futlues markets, our members do not have the hutury of being able to stay out of the futures
maritets. We must be and we are buyers and sellers of futures contracts during every minute
the futures markets are open. The economic beneRl of additjorul liquidity is difficult to
measure, but ir is teal and cannot be refuted. Section 101 would force the unknown cost of
doing without it onto die commercial users of the markets. This would raise costs ruit on^
for market useis, but for all dial produce, use, or consume grain, irt short - all of us. It
seems dear to us diat the cost of this supposed remedy gready exceeds any perceived benefits.
The efficiency of our futures markets must be preserved and enhanced, Mr. Chairman. As I
have said, the National Grain Trade Council believes H.R. 2869, with one exception, would do
just thaL The answer to eradicating possible trade practice abuses is dirough detection and
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'Xlie CotmcQ uiga you to keep ui eye imnrd what freatet coniiibutiDnt Anerican futum
mariua can provide our country. Thii very Gunmiitee cooiinuet to gnpple wilh die ittnrt
price liiki in die production of U.S. commodiliei. As production dediioiu continue to move
toward maiket-drivcn from government-driven, the daiiic risk-lhifting functiani at futunt
Aemrdingly, Mr. Chairman, I wiih to ckne by conylimrntinf apin die tmphim HJL 2U9
would place on audit tiail enhaneaneiit. The Ntdonil Gtun T^ade Council tatm^ vtfu die
Subcomininec to giw die CFTC and die exchangei all potAle n^peft to itiu cod.
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JOHN L. FREDRICKSON
KEHTLAHD ELEVATOR & SUPPLY, INC.
KENTLAND, INDIANA
Chairman English and NEMBEfis of the Committee:
Ny name is John L. Fredrickson. 1 am a partner in Kentland
Elevator S Supply, Inc., a country elevator located in Northwest
Indiana. I have been involved in the management of grain
elevators for over twenty years. I ALSO own and operate a small
FARM, SERVE AS AN OFFICER OF OUR STATE GRAIN AND FEED ASSOCIATION,
AND SERVE AS DIRECTOR OF AN INSURANCE COMPANY.
The firm I represent is an independently owned country grain
ELEVATOR WITH THREE LOCATIONS. THE PRIMARY BUSINESS OF OUR
COUNTRY ELEVATOR IS PURCHASING GRAIN FROM AREA FARMERS AND
RESELLING IT TO GRAIN PROCESSORS, GRAIN EXPORTERS AND LIVESTOCK
AND POULTRY FEEDERS.
When WE PURCHASE GRAIN FROM A FARMER, WE ARE AT RISK IN THE
MARKET UNTIL WE HAVE SOLD THE GRAIN. WE HAY CHOOSE TO SELL THE
grain to a user for immediate delivery. or we may choose to keep
the grain in one of our storage facilities to sell at a later
time. if we choose to store the grain, we must transfer the
market risk to someone else immediately. this is accomplished by
hedging the grain in the futures market at the chicago board of
Trade. We place an order to sell futures contracts for the amount
of grain we have purchased. when we decide it is no longer
economically feasible to hold the GRAIN. THE FUTURES PORTION OF
THIS TRANSACTION IS OFFSET BY BUYING FUTURES CONTRACTS AT THE SAME
TIME THE CASH GRAIN IS SOLD. OUR ELEVATOR'S MARGIN IS THE SELLING
BASIS, LESS THE BUYING BASIS,
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The execution of the futuoes orders is a critical component
OF THE transaction. AND MUST BE CONPLETED AT THE BEST POSSIBLE
PRICE AND EXECUTED PROMPTLY. ThE LIQUIDITY AND FLEXIBILITY
PROVIDED BY DUAL TRADERS MHO CAN TRADE FOR THEIR OWN ACCOUNT AS
WELL AS EXECUTE CUSTONEft ORDERS. IS A CONTRIBUTING FACTOR FOR OUR
COUNTRY ELEVATOR TO OBTAIN THE BEST PRICE AT THE LOWEST COST.
SOMETIMES WE NAY DETERMINE THAT IT IS NOT ECONOMIC TO SELL
THE CASH GRAIN A$ THE FUTURES EXPIRATION APPROACHES AND DECIDE TO
'ROLL' THE HEDGE FORWARD TO A DEFERRED CONTRACT MONTH. THIS
TRANSACTION IS CALLED A SPREAD SINCE IT INVOLVES THE SIMULTANEOUS
PURCHASE AND SALE OF FUTURES CONTRACTS IN DIFFERENT MONTHS.
SUCCESSFUL EXECUTION OF A SPREAD TRADE IS OBTAINED BY UTILIZING AN
EXPERIENCED DUAL TRADER WHO CAN 'LEG' INTO THE POSITION BY
EXECUTING ONE SIDE OF THE TRADE WHEN PRICES FOR THAT CONTRACT ARE
HOST FAVORABLE. HE HAY NOT BE ABLE TO OBTAIN THE DESIRED PRICE
FOR THE OTHER LEG OF THE TRADE, BUT NAY PLACE IT IN HIS OWN
ACCOUNT AT A SLIGHT LOSS IN ORDER TO SATISFY THE CUSTOMER AND KEEP
HIS BUSINESS. The ability of the dual trader to obtain FAVORABLE
PRICES FOR SPREAD TRADES HELPS INCREASE THE LIQUIDITY IN
RELATIVELY LESS ACTIVE DEFERRED CONTRACTS. AND RESULTS IN MORE
ACCURATE INDICATIONS TO MARKET PARTICIPANTS OF THE COST OF
CARRYING COMMODITIES.
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The banning of dual trading could increase transaction costs
for our elevator by widening bios and offers due to less pit
PARTICIPATION. This increased cost KILL CAUSE EITHER A REDUCTION
in our return on investneht, or a reduction in prices paid to
farmers by our firm.
Dual trading increases the supply of both brokers and floor
traders because a dual trader can earn income from two sources to
cover the cost of training, an exchange seat and time spent on the
FLOOR. Dual trading encourages greater competition between
brokers, thus keeping commission charges down. if dual trading is
banned. the best brokers will trade for their own account,
decreasing the number of brokers available to execute orders for
our elevator. this will reduce the liquidity of the marketplace.
thus making it more difficult to have our orders executed promptly
at the market.
Dual trading is voluntary on the part of customers]
customers can now prohibit their brokers from dual trading if they
choose. additionally. u.s. futures exchanges are engaged in a
continuing process of improving their market surveillance
systems. if abuses can be curbed through adequate surveillance,
there is no reason to eliminate a practice like dual trading which
contributes to the liquidity for which american markets are known.
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SlHPLV STATED. THE IDEAL LEGISLATION WOULD PRESERVE DUAL TRADING
MHILE INSURING THE EXCHANGES BEAR THE RESPONSIBILITY FOR DCTECTltH
ITS POSSIBLE ABUSE.
I STRONGLY URGE CONGRESS TO EVALUATE THE PROS AND CONS OF
DUAL TftADINQ BEFORE MAKING A FINAL DECISION ON THIS VITAL ISSUE.
YOUR DECISION MILL EFFECT THE ENTIRE AGfflCULTURAL INDUSTRY. AS
WELL AS THE FUTURE OF OUR MARKETS.
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DAVE DANKER
BUCKHSIT ORKIN, INC.
PERRYVILLB, HO 63775
Chairman English and nteinb«rs of tb« Connittee, my name Is
Dav« Danker and I «dd the Vice President and General Manager of
Buchheit Grain, inc., located in Perryvllle, Missouri. Buchhelt
Grain is part of a small, family-owned feed, grain and general
merchandise business founded In 1934.
My purpose In coming here to speak to you today Is to attempt
to explain how we use the futures markets. In particular the
spread market, to affectively manage our business and how that
relates to one of the aubjects your Coomlttee is reviewing, i.e.,
dual trading. Me have approximately 1,250,000 bushels of apace In
two different locations. In order to survive aa a grain merchant,
we must fill all of our apace at harvest and hopefully handle
60-70% of that volume once again after harvest. In order to
manage this need in a business-like eanner, it is imperative that
wa pre-spread our space and the volume of grain that w« hope to
handle post-harvest. A brief example of pre-apreadlng would be
the simultaneous purchasing of 10,000 bushels of December Com
futures while selling 10,000 bushels of March Com futures. As
the corn is purchased from farmers during October, we simply sell
December Corn futures. This automatically spreads the purchase
out to the March futures position.
Pre-spreadlng is an inexact science, but as one gains
experience, it becomes easier to establish reasonable goals and
achieve then. We like to enter our spread orders prior to the
time the contract actually trades. Oftentimes this results In
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getting a good till that Bay iMwr b* avallabla at any othar tlaa
during tha asckatlng cycla. Quit* oftan, dua to poor liquidity in
thoaa dlatant contract aonths, our brokar has to 'tag* a apraad in
ordar to gat it flll*d. By lagging tha apraad, tha brokar tirat
takaa ona aida of tha apraad, than filla tha othar atda aa aoon aa
ha la abla.
During tha tiaa alapaad batwaan tha axacutlon of both laga of
tha apraad, tha brokar aaBuiMa tha rlak of not gattlng tha apraad
tillad at or abova ay ordar. If ha foila to aoooivllah that fill
and anda up trading tha apraad at a laaaar aaount, tha loaa la for
hia acXMSunt. A brokar'a ability to dual troda glvaa hla an
opportunity to offaat thaaa loaaaa by trading tor hia own account
throughout tha day. I faal that thla aakaa apraad brokara aora
Hilling to tska chancaa in ordar to gat thalr i iialiwai a tha baat
poaaibla fill, tharaby Maintaining thalr raputatlon and poaltlon
In tha Barkatplaca.
I had a peraonal aaperlanca with thia aituation laat wlntar
that I would Ilka to ahara with you. Laat January, I bagan
planning tor tha 19B9-90 aarkatlng yaar. I budgatad tha purchaaa
of 200,000 buahala of aoybaana at harvaat. I aatlaatad that wa
could buy at harwat, atora and latar raaall aoybaana If wa oould
gat our November /March spraada aat at 17 canta/buahal or battar.
I callad ay trading flra and antarad an ordar to apraad 200
Novaabar /March aoybaana at 17 canta or battar. A Caw daya aftar
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th« March '90 soybean contract cane on tha board, my spread got
filled at 19 c«nt a /bushel . Given what I know about epread
conditions at that tlMe, I have to assuae that the trade was
legged by the broker.
Now, I realise that not all trades will have such a happy
ending, but I believe that It illustrates ay point that If you
trade through a brokerege firm that does the Job In policing and
controlling the trading activities of the brokers that it uses,
you can get good honeat ftlla. It aeeaa to ne that If a customer
Is knowledgeable about the current condltlone of the Market,
offers spreads, options and futures transactions at a given level
or better, he will obtain the fill he wants.
Tha key to obtaining these fills la In prior evaluation of
the guallty of broker that you choose to deal with and In the
ealBtence of surveillance aystens that detect and deter abuse.
The ISBue is not whether the broker dual trades. The real issue
IB whether or not there are sdaquete monitoring systems In place
to detect cases where the practice of dual trading Is abused.
In Bumaary, I would like to stress that I feel tha current
system of allowing brokers to both fill orders and take risks for
their own account, provides e more liquid Market and, most
probably, a more aggressive trader. The system, as It exists, has
provided us with the structure to build a successful small
business. I would like to encourege you to provide a means for
protecting and improving the integrity of the current system of
dual trading rather than changing soaathlng that. In my opinion,
already works.
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Raaarka of Joavph J. Kui«, Floor Broker,
B«rora tbo Subooaaltto* on CanB«rv*tlOD, Cradlt M>d Rural
Dav*lo|MMnt of the Houaa Agrioultur* Coaaitto*
July 20, 1989
Chalrnan Ensllah and Heab«r3 or th« Coaaittfle:
Thank you Tar letting ne appear before you today. Hy naae la
Joseph J. Kane. I am a diember of the Chicago Board of Trade and
have been a floor broker since 1952. I have alao been a neaber of
nuoeroua other exchangea Including the Chicago Hercantlle Exchange
and the Hew Xork Coffee, Sugar & Cocoa Buchange. For seven yeara,
I Has a director of the Chicago Board of Trade and have served on
Bost of the Exchange's aajor conmlttees Including the Bualnesa
Conduct and Floor Governors CoDnltteea. In fact. In 1968, I was
chalraan of the Reorganization CoBDlttee that vas responsible for
Introducing public nenbers to our Board of Directors and for
creating the Floor Covernora Conalttee which has prloary
responsibility for policing the conduct of our Beiibers on the
Exchange floor. I was born, raised and educated In Chicago and am
the father of eight children. Many of ny children have worked In
one capacity or another in the futures business.
I have been at the Chicago Board of Trade long enough that I
can say I knew the grandfathers of two of our present meaberB of
the Board of Directors. I know the Board of Trade's rules,
cuatoma and practlcea. I have aeen thoae rulea, customs and
practices evolve. I have also seen the conpetltion for business
which exists on the floor and the solid ethical standards upheld
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by Doat DeniberB combine as a potent tarae for the protection of
Navarth«leaa, I know this SubcoDDlttee la concerned about the
practice of dual trading. I believe I an In a good poaition to
dlscuas this practice and the rules which govern this practice
because, throughout ay tblrty-seven years as a floor broker, I
have also routinely traded for my own account. Over the years, I
have given a lot of thought to the subject of dual trading. In
1975, I was co-author of a study on that topic whtoh foraed a part
of the Report of the Chalraan of the Advisory Connlttee on the
Regulation of Contract Markets and Self Regulatory Associations of
which I was a neDber which waa subnitted to the CFTC that year.
In that report, we cane to the conclusion that dual trading
waa a aajor Ingredient In the liquidity of our marketa and that
its elimination would impair that liquidity without conferring any
maaaurable benefits on the publio. We recoBBended that dual
trading be preaarved but that rules be adopted which elearljr
prohibit a broker buying or selling for his own account while
holding orders for others at the market or at the saae price. We
also racomaended that surveillance systems b« Improved so that the
exchanges In conjunction with the CPTC could ensure that abuses of
that and other practices were detected and punished.
I believe our reooBDendatlona were valid than and that the
last 14 years have vividly demonstrated their validity. In the
intervening yeara, our markets have enjoyed an unprecedented
growth In volume and liquidity, making them the envy of the
world. At {he same time, the Chicago Board of Trade and other
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exohangas adoptad atralBhtrc
trading, 1>«. • trading ahi
violation.
And, Host laportant i
particular, tha last Tlva ]
unlaaglnabla in 197S,
aurvelllanca ayateaa for del
trading ahaad . In partli
co-daalgnad bj the Chicago E
Harcantlla Bxchanga haa d«>c
oapabilltr offered b]r no
least that was the view «
Praaldential Task Paree ichl<
I don't pretend I
1 Bake the slauae of dual
- order, a trade practice
ar the last ten years and. In
a exchangea ha*a taken strldea,
create and lapleaent effective
iting all trading abuaea, including
the coMputerlied audit trail
i Board of Trade and the Chioago
»onstrated • deteotlon and deterranoe
' financial aarket in the world. It
:presaed by Nicholas Brady ae head of the
I studied the 1967 stock aarket craah.
t for the entire floor broker
oOBBuntty in ooalng here today. But I know if I conducted a
survey of the Many, aany reaponslble floor brokers with whoa I
work each day, they would want to stress for you the followiiig
points. First, they would tell you that you would tak* away a
■ajor aeans of servicing their custoaare if you take away dual
trading. Dual trading allows a floor broker to go after tha beat
rill for hla cuatoaer knowing the broker has the fleklblllty, if
neoeaaary, to trade out of resultant losing poaltiona through hla
personal account whenever the opportunity arlaea. Second, they
would tell you they aupport the adoption of the beat. Boat
coBprehenalve aurvelllance ayatea devisable as a aeana of
protecting theaaelvea as wall aa thair cuatoaera.
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The Dessage I would leave with you la sinple. He have the
beat, moat liquid narkets in the world. I an not an eoonomist,
but I believe a rational review oT the econonlc literature
available on the subject will lead to the conclusion that dual
trading haa contributed to the unrivaled suooess of our narketa.
In copying every aspect of our market formula in an effort to win
business from us, foreign marketa have also copied us in
perttittlng dual trading. But foreign markets do not have our
surveillance capability. They don't have the know-how and they
don't have the commitment to eliminate trading abuses and the
perception that such abuses exist. Let ua use our know-hou and
our comfflitment to keep U.S. marketa in their preeninent position.
Hith your help. Me can preserve our llquiditr, and all the factors
that contribute to it, including dual trading, while reinforcing
the integrity for which we lust equally be known.
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Fann Entgrprises, Inc.
DC tOStS
. Crtdit* 1 Run) DtitlopHnt
grktd I* th* put t
Sli>c.r«ly,
-TOUJITT FARM ENTERPRISE
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<ll^jjRwm^
Hiflh Street, H«cket1«to*n, New Jeney 07840rre(ephonH 201 - BM-IOOO
Congrssciun Glann Englliri
eeOb Rayburn Hdu» Offica Building
UHtiington, D.C. E0313'36D6
Dear CongrBmmiun English:
th<t Hould rastrict dual traOing ir certdir ruturas narkal^.
Our fir« uses suijar. futures s>ten*ively Co nedge its price ri«l-». It is iapor-
tint that the narkats f use for the purpose are sufficiently liquid to aseiira
ity Htll result in jncreaw costs of operations, Hhich xltl be passed on to
could hurt their liquidity. Ue, therefore, urge that no restrictions De adopted
J.i^Jt ffC£e^^
.,Q,oo<^z
■ *-
JLIU.JL'SUmu
Hon, Clam Ingltili. Chairman
Eloua* Agricultural Sufcco^tca* o
Conaarvattoa, Cradle and luial I
Rofl* 1301, LnigifOTth Houaa Offle* Bulldlnf
Waahlnston. B.C. 20S1S
■•: m 3lt« Tha CuMadlty futuna taprovaaaat Act of L9B9
I>aar Qwliaan tacllah:
Tha RaH York
Foundad In 1170, HTC^ la tha oldaat cs^ndlcy aschan(a In >a« Tark and takaa
graac prtda In lu 120 yaara of aarviea to tha cotton trada and to dia piAllc.
Hanca. wa ara particularly grataCul for jrour concam and Incaraat la t^
tntogrley and afttclancy of tha coawMUt; fucuraa Mtkata In cha Italtad
Ua baliava that dual trading abould contlnua to ba allomd with
approprlata aaphaali on accurata audit tralli and rlgoroua onforcoaaat o
axchanga rulaa.
Ha ara aattatiad that our praaant ara^as of capturing tha Blnuta-by-
alnuta asacution tlH la aftactlva. Ua ata coneomad that tha propoaad
■10 aacend rula' would raault In inctoaaad Inaccuraelaa.
Tha Exchanga «111 conttnua vtgotoua antorcaaant of Ita audit trail rulaa
and ia proparad to taka ptoapt action agalnat aif aaabar ahoaa
parfoiaanca lapalra tha affactlvanaaa of our audit trail.
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Tha CFTC la ts b« appluidad for noC ■andatlng ona iyilam tor all
axehangaa. Rachar. tha CFTC has follosad ■ parfocBanca atandard vhlch
alltnra aaeh axchanga to tiava Ita own Bachaniaa, Conaaquantl^, tha ihatad
goal ahould not ba Co saiulata on* audit trail lyataa, but rachac tha
foatatlng of aceuraca and affactiva audit tralla on aach of our aarkota.
(3) Thraa.Bav CoollM Off Parlod
■atlat .
flrokar Aaaop-lationa
aioeiatlon attanpta t
D diractly and that ■
ttia ciutooaT'a oaac mtaraata. that bcokar aaaoclation ahould ba
ptohlbitad froa doing lo. Ua do not balLava a atatic niiriHc <a,g. 2S(]
la tha appToprlata nay to daal vlth chla. Rathar, «a ballava chat audit
trail racorda and trada practica aurvaillanca progTama naad Co ba
•ufficlantly aophlatlcacad to laolata thoaa activltiai. Thacaaftar,
proapc and aftactiva dlaclplinary action ahould ba takan to root out auch
prohibltad actlvltiaa,
Paraananc Ba-autharit.tion
Wa agro* that tha CFTC ahould bacona a pamananc aganejr.
Dndareavar Survalllatica
Ua ballava that tha ovarc aurvaillanca that aliaady tskaa placa tn tha
aschanga coimunity la thorough and producClva. Ua do not ballava thara
la any laglalativa naad or purpoaa aarvad by alngling out ai^ Induatry,
nhathar it ba tha banking induatry. dafanaa eontractora, haalth eaca, oc
any othar Induatry. for fadaral undareovar oparatlona. Thoaa. «o
praauaa. taka plaea whan and aa cha appropriata Ian- anf otcananc agoneiaa
<7) Govamtni Hoarda
Aa an Exchango iihleh haa had public board Bambar rapraaantaclon for noto
than a daeada, tra aupport tha concapt of public sai^Tahlp but do not
aubacrlba to a rigoroua pareancaga (10%) auch aa chat found In tha
propoaad bill.
On cha lubjact of barring cartaln rula vlalatora from aarvlca on
governing boarda for a parlod of yaara. wa andoraa and foatar that
concapt. Houavar. axparianca ahowa that ona axchanga'i cata|orlzatlon o
a violation may ba dlffaranc froa anothar'a, avan though tbay uaa tha
taaa ot dlffaranc labala. Fcohlbltion froa govamlng boarda for a
threa-yaar period aa a penalty for a rula vlolacton ahould ba handlad on
a caia-by-case baala by aach exchange for aarloua violation*,
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Il.tr.-in. nf BttelpUniTT f^"— "^"T
Ua b*tt*w* dlaclpllnary coaBlctm ■hmild to axpart and raaeh fait and
proopt daelaloiw. Va baLlava tfesc ■ lysMa of catagotliBClon of
participant* on dliclpllnary paiula la valuabla eoly to tha aitant diat
It doaa not tntartar* with thoaa |oala.
Thla bcbans* Jolnad with other lav Tork aaehangaa In Inaugutatlng a
CBsporatlva athlca eoura*. Our Board appravad that concapt In Paea^ar
I ara plaaaad with tba na^r In iihlch It la totn(
opaaala ara propar and haa n
t hava aafcad dta Praatdapt of tha bchanga, Joaaph J. O'Valll, and our
Uaahlnston rapraaantatlT*. Uaa HcAdan, to ba avatlabla to tto SubeoMlttM an
Ita ataff with laapact to any ^uaatlsna that say atlaa aa Oa la|Ul«tloa
ptocaada. I, ot couraa, vlll to |lad to tolp in ttot aftort
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B.W. DYER & COMPANY
July 18, 1»B9
Th* BonocBbl* Glann Engllih, ChalrMln
Subconralttee on Conaecvatlon, Credit
and Rural Davelopnent
Rouse Conunlttee on Agiicultui«
1301 Longworth Home Office Bldg.
Maatilngton, DC 20515
Dear CongcesBnan Bngliahi
This letter explains wby we fuE&E dual trading on the CoffeCi
Sjgai i cocoa Exchange.
For peiBpective, the wcitec ha« been a Beiiiber of CSCE alnc*
1945. Thia makes »e the oldest active aeitfwc in aenioiity. I bav*
served on the Exchange Boatd and Many Exchange CoBniitt««i> although
I have never been a floor broker or floor trader.
In my Judgsent, no valid reason so far has been ahown why dual
trading should be prohibited on this Bxcbang*. On the contrary! w*
believe such a ban would importantly impAir liguidityl
Please do not throw out th* baby with th* bath water.
Since r*ly,
B. M. DVER t COHFMn
Dajiiel L. Dyer
Pattnar
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>fl
Arrierop
Th« Konorabl« Gl«nn English July 31, 19B9
Chalcman
Subccmnltta* on Conasrvation, Credit
and Rural Development
Houae Connlttee on Agriculture
1301 Lonqworth House Office Bldg.
Nashington, DC 20515
Dear He. Englli
Me ai
Reauthoilzatlor
As a large futures coimiisslon merchant company
which uses the Coffee, Sugar ( Cocoa Exchange every day, we
stEongly feel that the CFTC Reauthorization Bill will piove
haniful to the CSCE and the other comnodlty exchanges in the
□nited States If passed. The Bill would Induce a loss of
liquidity which Is an essential factor to the proper
functioning of any exchange. This, In turn, would dlainish
the volume reducing the Market's viability as a hedging tool.
Moreover, the Bill presents provisions that ace
redundant to the existing regulatory powers of the CFTC, and
asks for a reauthorization of appropriations every two years,
which Is too frequent to allow the CFTC to conduct its
regulatory mission effectively and impartially.
He hope you will agree with us that the CFTC
Reauthorization Bill will do more harm than good to the US
futures Industry. Meanwhile, we are available for any
questions you may have.
Sincerely yoursJi,
„Coogle
yS
Arr»<e£;oiO
The Honorable Glenn English July 31, 1989
Subcommittee on Conservation, Credit
and Rural Development
House Committee on Agriculture
1301 Longuorth House Office Bldg.
Washington, DC 20515
Dear Mr. English:
As a large sugar trading company which uses the
Coffee, Sugar i Cocoa Exchange every day, we strongly feel
than Che CFTC Reauthorization Bill will prove harmful to the
CSCE and Che other commodity exchanges in the United States
if passed. The Bill would induce a loss of liquidity which
is an essential factor to the proper functioning of any
exchange. This, in turn, would diminish the volume reducing
the Market's viability as a hedging tool.
Moreover, the Bill presents provisions that are
redundant to the existing regulatory powers of the CFTC, and
asks for a reauthorization of appropriations every two years,
uhich is Coo frequent Co allow the CFTC to conduct Its
■ regulatory mission effectively and impartially.
We hope you will agree with us that the CFTC
Reauthorization Bill will do more harm than good to the US
futures industry. Meanwhile, we are available for any
questions you may have.
„Coogle
CZNTilflDW Riluras kic
DD jDVtlfl^llMl fa
„Coogle
STATEMENT SUBMITTED BV
CONSERVATION, CREDIT AND
RURAL DEVELOPMENT
JULX 20, 1989
My name is Dan Huber. I am a Gcoup Vice President
with Cargill Incorporated, Minneapolis, Minnesota.
Cargill merchandises and processes agricultural and
other commodities. We make significant use of futures
markets for hedging purposes. I emphasize that the
views I express in this statement stem from Cargill 's
experience as a commercial hedger.
When we and other commercial interests use futures
markets to hedge some of our price risks, we require
that those markets provide two things: liquidity and
integrity.
We need markets with enough volume and open interest
so that we can enter them and exit from them without
creating undue volatility. We need markets with
sufficient volume throughout all the months traded eo
that we can move or spread those hedges from nearby
months to deferred positions.
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Comtrclal userSf as w*ll >■ the public, also need
to have absolute confidence in the integrity of the
■arketa. He want to know that our orders will be
honestly executed.
He conpliment the Chalrnan and nenbers of this
Bubconnnittee for focusing legislation reauthorizing the
CPTC on these twin goals. He support the general thrust
of your efforts and will focus our coaaents on the
balance that needs to be struck In pursuit of the twin
goals of integrity and liquidity.
DUAL TRADING
Dual trading -- the practice whereby a floor broker
nay trade for his own account or fill custoaer orders
during the same time period — is an inpoctant factor
that helps provide market volume and liquidity. The
proposed legislation clearly recognizes this. There Is
nothing inherently evil about dual trading.
In fact, at Cargill we prefer that the independent
floor brokers we use to execute our orders also trade
for their own account. He find that this experience
broadens their market view, gives then a better 'feel*
for the market and helps then develop execution
strategies for our orders that lead to better fills.
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606
Limiting or eliminating dual trading promises other
costs as well. Usually the best brokers are found in
the most active pits, trading the most active months.
Thus they are the ones who may be forced to choose
between handling customer business or trading for
themselves.
Unless a broker can be assured of handling large
customer accounts, his own best interest may well cause
him to trade for himself. This might not impact
Cargill. But it will certainly limit the access of
smaller commercial firms and the public to the most
accomplished brokers. It will impose costs on such
interests either in the form of poorer fills or higher
brokerage rates or both.
The most common justification for dual trading
concerns its effect on volume. There can be no doubt
that dual trading adds to volume and liquidity In
important ways. This legislation attempts to deal with
this by eliminating dual trading in already heavily
traded commodities options, but allowing it In lower
volume markets.
23-500 0-90-20
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606
Yet, we ceiMln concerned that this partial ban will
ham our ability to spread our hedges £ron nearby to
more deferred contract nonths, especially since we nay
not be able to use the same broker on both sides of the
spread. This is extremely in^ortant for any comnercial
hedger.
If the proposals before this subconnittee becone
law, we expect to give our independent (loot brokers the
necessary written exemption to allow them to dual
trade. We are reluctant to lose the direct advantage of
the better executions we experience from the dual
trader. He believe others feel — and would act —
likewise.
Still, thi 8 may not be adequate to ensure needed
liquidity in a contract. We would hope that the
legislative language would be modified to emphasize that
the primary objective is for exchanges to demonstrate to
CFTC that they can audit and manage the dual-trading
process. If a 7000-contract (or some higher number)
level Is retained in the bill, the legislative history
should Indicate that the CFTC should regard the contract
level merely as a guideline and that it should be
prepared to use discretion to permit dual trading where
added liquidity Is useful and where other adequate means
exist for preventing abuses.
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607
AUDIT TRAILS, SURVEILLANCE AND ENFORCEMENT
In creating the CfTC in 1974, Congress placed
primary responsibility foe regulation of the futures
markets in the hands of the exchanges and the industry,
subject to the agency's oversight. Cargill supported
this approach in 1974, and we continue to support it
today.
He applaud this subcommittee's attention to the need
to detect trading practices abuses, to enforcement of
the rules and to uniform disciplinary action against
those who break the rules. Cargill believes that the
reauthorization process can provide a constructive
opportunity to examine the performance of existing
regulations and the need for refinements to those
requirements.
One area of major attention has been the detection
of market abuses through audit trails. The exchanges
have made substantial progress in meeting audit trail
requirements that are already in place. These audit
trails are in the self interest of the exchanges, market
users and the public. The CFTC can play a constructive
role in assuring that these efforts to develop fully
verifiable audit trails continue to progress.
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«06
Exchanges and the CPTC also should contlnu* to
vigorously enforce existing rules. Poc example, the
only abuse that might stea fcon dual trading is 'front
running' ahead of custoner orders. But the practice is
proscribed by Broker Conduct rules 350.5 (A and B) at
the CBOT. Other exchanges have sinllar rules.
Hacket expertise of cptc surveillance personnel also
can be improved. We believe that an understanding of
the 'cash' or 'physicals' Market that underlies a
futures contract is essential for those who police
futures.
Exchanges also should be required to ensure that
their business conduct and investigative connittees have
expertise in the appropriate 'cash* markets that
underlie the futures contract.
CPTC also should require exchanges to set industry-
wide standards for levels of abuse, disciplinary actions
and punishment. This legislation provides useful
monentun in that regard.
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He believe that these suggestions, along with
ceirtain others contained in the bill, will do iniich to
ensure the market integrity that is the goal of all.
Improvement in the way that futures markets are managed
by the exchanges and the CFTC can be achieved, we
believe, without damage to that other goal of
liquidity. In fact, as public confidence in market
Integrity grows, liquidity also will grow. That is the
most effective way to achieve both goals.
Thank you.
- *« -
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JPMorgan
Hw Honordils Glvwi EhgliA
2206 Itaytaum House Office Building
Haddngtcn, DC 20515
Dear Representative fiiglldi:
It MOB a pleasun having the appactimity to aeat with you owr
brwOcfast sevezal uedos ago. He aFprwcintad your visit to J.P.
Hacqan, and the insic^its you etax«d with us.
Wb also ^preciatad your opemess to further iiput en tlia jtM^^pw
oovered Airiiq the breakfast. Since your visit, we have bad ttw
chanoe to reflect en scne of Uiese areas, nils letter will
ccnv;^ our thoucfits on dual trading, broadening tlis role of state
securities admlnistratoTB for ocmnodities enfarooBBnt, the CFTC'b
ptcposals regarding hybrid and rslatsd instzunents, and
formalizing the role of tiie HCxfcing Graif>.
1. Dual ^tadinq: Ne are pleased tiy the fT^™*^* Vu banrs
intzoduoed to deal with potential fzcnt-cunning and tlis
conflicts of interest iiterent in tbe fractice ctf dual
trading. Your tcujuuenJaticn to prctdbit dial trading in amy
contract itazicett that has a daily average voliae cX 7,000
contracts or incc« is a thoughtful ctnprcmise. It would
instantaneously eliminate this potential for frcnt running
and conflict of interest pni>lens in a^focKinately 90t of
futures trading volume. At ttie same time, it would leave Urn
dual trading practice in place in analler voliae contracts,
vdiidi arguably need the additional lic^iidity. bsed en 1988
statistics, we estlinate that ^prcDdinately 60 fUtuzes
contracts would not have been affected ky Om Aial trading
limitations, but those contracts rqireaent only eliaut 10% of
total futures voluoes.
Wb have given sane thoi^it to tiftiether the 7,000 per day
lijd.tatlcn Ediould be raised ac loweted. interestingly, wb
note that if the average daily trading linit was raised to
10,000 contracts, cnly tuo additional Dartets would gain Ami
trading rights — live hogs and ocfper [again based en 1968
statistics). U»ler this unre relaieed liaitation,
^i^aRadnately 89% of total futures trading vdltae wodld still
have been pntected fittm abuse under the Aial bading ban.
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JPMorgan
ReprBsentativ Glom Bigll^
July 14, 1989
Cn tbs other hand, there are nine contract mrkets vhldi
trade in Uw range of 5,000 to 7,000 per day. If tlie dual
trading ban ifi implied to ccntracts trading in eoaxsa of
5,000 per day, almcet 96% of all futures trading volume would
then be captured under the rule.
Ihe S,000 to 10,000 range seems to be the ri^it order of
magnitude. Within that range, the choice of a precise cutoff
linit becxines a natter of judgment. He might argue that the
limit first be tried at a 10,000 daily volume level so as to
test the iipact cn liquidity, assess tlie effectiveness of the
dual tradijig ban, provide maxinmn cfportunity for snialler
volune oontiacts to pin^ier, and oicourage the develcpnent
and growth of new contracts for glcbal carpetitiv^wss.
Adjustmait to the cutoff level could then be oade with better
Empirical evidence than we have today.
CFTC Requlaticn of Hybrid and Related InstrumaTts: J. P.
Hsrgan, individually and throi^ the Hew Yotic Clearing Kuse
Association (tr^oi) , has provided extensive canoentaiy to the
crrc cn its i^qposed regulations for hybrid and related
instruments. Ccpies of the sutinissicns of J. P. ttorgan and
the m<X to the CFTC are attadied to this letter fCs- your
review. Sane of the sali^it points fras that subnissicn are:
a. Hybrid instrum^its that axe Bocurities or are <g»a»H by
banks (and are therefore, in both cases, governed ty
other federal anc^'or state statutes and regulations
presiding fOr substantial investor pct^tection} are not
futures or opticns under the Connxlity Qcchange Act, and
the CFTC has no jurisdiction over these instruments.
b. In light of the substantial protecticn provided to
investors in h^iarid instruments which are securities or
bank products and the leick of ai^ identifiable prdslems
(such as fraud or sales practice abuses] resulting frcn
the sale and nariceting of these instruments, there is no
policy reason or regulatory justification for additional
regulation by the CFIC.
c. Ihe practical inpact of the proposed regulations will be
to plaoe U.S. financial instituticns at a ocnpetitive
disadvantage to their foreign counterparts lAo, for the
most part, are ncA restricted in offering to tlwir
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Ik(v«Mntativ» GUm bgllA
July 14, 1989
JPMorgan
amitaaorm prodoAs (in particular, ik(»Bit InBtnasnta)
lAich ai« indaMBd to neasurss of value oUisr Uian
traditicnal int«re«t rataa.
Ilia tftt^Kjaud ragulaticrs will alao hann Qie «f fact of
natrlAing pcodixA Itnwaticn in Uie U.S. and iniartlng
n» itoilit^ of U.S. financial instituticm to tailor nw
preAeta to aeat Qia '**■■*''''<■ of a repidly dianging
a. Hie cnc rtiould attoiiA to hazncnize tlie atatutocy and
zagulatocy eMclusicna and exaiptlcnB prcvidad ty tha
fonazd ccntxact aHClusioi, Ow ao-called lk«aaury
aaanlnciit and the traiSe cption esanffticn ao as to icovide
a aafa hartor fco- off^-eNchancfe, privataly nagotiated
ooaDsrcial transactlaia batwesn scfiiisticRted
institutiorB and nnteES of the financial ■ervioas
industry.
Bole of State Securities Mnlnigtratats in tt^adltlae
the need to aasure effective enforemnt of CDnedity
Bochange Act pmrisiona, especially as thiy serve to ptoteuL
email Indlvit^iO. participants in the naz^et. You noted the
difficulty of asBurijTg that agencies with limited raoouL'oaa
^ including the OTC as well as federal and stats
pFoeacutoaro — are able to pursue effectively all aerlous
■.■■■mijUng enfoToaiient ratters. You noted that mcxB ham
reoonnBnded a faroader role fCir the state securities
administratoTB in carrying cut provisions of the Cedaral
ocnraodities laws.
He diare the ocnomms you raised and believe it is Ixpcartant
that effective enfoEoaient be achieved if the credibiUty of
the ocnmodlties narfcats is to be pvesexved. He stxcngly urge
you, however, to find a naans toVaihanas enfiacGeaant
czQBbilities that does not ragoire an ajganded nfle far tlis
state securities administrators. He believe it would be a
serious mistake to follow the imdel of U.S. securities
regulation and establi^ tuo aepazate regulatory Btructuras,
one at tte Cedaral level and one at the state level. Ha are
infOmed fcy associates at J.P. Horgan Securities Inc. Uiat
tte dual structure of securitiea regulation fra^ioitly hawss
taneoessarily cuttersaDe and diftliative. It is erardaliy
difficult to ooazdinate the ti{)prcivala of dozens of states
«hen doing a large securities offering or qualifying a
brolsex^^lealer to do business naticnally. This dual strucbK*
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Rept«sentativ» Glcm BqliA
JUly 14, 1989
JPMorgan
also QUI ooatdlcate paxtic^paticn in intexnatlcnal offsarings
by U.S. brcter-dealers, placing U.S. fixns at a ooqpetitiv*
disadvantage.
Fbr these reasons, we believe it would be a sorious nistake
to expand the role of state securities adndnistrators under
the federal cannodities laws.
i House Working Groi^ on Financial Hazkets in late
1987. It made great sense to bring together senior officials
froB the Tt«asury DGpartinent, the CFIC, the SBC, and 'Qie
Federal Reserve. Mhile lUEnbers of the group were not alw^s
unanimous in their reccumEJidations, the general tone of the
gmp's i«miiiinndaticrs cocmod iqprcpriate and ccorrect to us.
But quite ^art frctn the siibetance of the grot^'s
reaannendaticns, ve strongly believe that the ocmnodities and
securities regulattu^ should have a regular, formalized forum
for ooordinating their regulabury efforts, ihe all-iipartant
issues of financial integrity, trading halts, proAxrt
listing, jurisdiction, etc. need to be reconciled amctig the
various cannodities and securities exchanges and, critically,
at the regulatory level. Cbvlously, we think that
formalizijEf the role of the Horking Groip is a good first
step to greater integration of securities and ocmnodities
regulation of financial narkets.
He hope these thouc^its are useful to you and we look forward to
getting together a^dn in Hai^iingtcn or New York. If you ca: your
staff would like to disaiss any of these ideas further, please
feel free to ocntact roe at your ccnvenienoe.
Sincerely,
Attachments
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PO Boi 9ar • El Rmw, ok 73036 •
Jun« 29, 19B9
Daoc Mr.. Engllshi
Through the loedla, I have read ceportB conalderlng tl
of dual trading in futures contracts on agricultural coanoditlss .
I have a concern that eliminating dual trading will take away certain
efflcivnciea in place in the market presently,
I strongly suggest that your House Subcommittee look at avenues of
detection and penalties for abuses of dual trading through the
exchanges and regulatory agencies rather than elininating the
process of dual trading in cDmmodity contracts.
The system has worked efficiently for nony, many years, and I hope
that we can keep a successful systoD intact and weed out the abuses
through detection on the exchange level.
Please give this consideration In your CoHalttea activities.
^At /.
^-ImJuj/ivImju
„Coogle
OP
SARAB VOGKL
AGRiaPLnntE COHHISSIOIIBK
HORTB DUOTA
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TBB H0U8B AGRICDLTURI COHKITTBB
[CDLTDRB SDBCONHITTBB OH C0MSB8VATI0M CRBE
AND RURAL DBVXLOPNSHT
Representative GLeoD Bngllsh, ChairBan
July 20, 1989
1 my objections to the manner In which
the Chicago Board of Trade ICBOTl exercised Its supervisory and
regulatory role In Issuance of an Baergency Order (the Order] on
July It, 1939 pertaining to the July soybean contract,
1).
or points In this testimony are as follows:
Ho contract narket should be allowed to iseae
emergency orders without releasing to the public,
as well as to the Comnodltiea Futures Trading
Commission (CPTC) the specific reasons why th«
action Is bslng taken. Congress and this sub-
cormittee should demand that the CFTC Imraedlately
release to the public the "detailed explanation" by
the CBOT of the reasons for Its July 11 emergency
order. This explanation should be available from
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th* CPTC because the law (Section 5a) requir** any
contract aqency who uaea the authority to Ibbu* an
«M«rq«ncy rule nuat give « dacatled •xplanatlon to
the CFTC upon exercise of that authority,
2. The cnc ahould have ch« aaana and th«
will to investigate and proaecute Inaider trading.
The CPTC shoald closely eNantne the CBOT's ua« of
'polling* Board nenbers for conflict prior to
Issuance of the Order.
1. Because the us* of th* eaergency order authority
bypaasaa nonaal CPTC oversight and advance public
notice, authority to use energency orders shoald be
predicated by a close •valuation of tha suitability
of the renedy. In the caae of the July II CBOT
Order, It appears that the CBOT's rcMedy did not
preserve fair and orderly trading, but rather
destroyed it.
4. nie CBOT board and connlttee nembers and eaployees
have an sxcasslvaly liberal leqal and nonetary
indemnification policy. It ahould be narrowed
so that self-indulgence does not raplaca
aelf-pol icing.
1 . DISGLOSDSB OP TBB SPICIPIC RBASOHS FOR TBS ORDBt,
/
As stated In the Order, the CBOT acted on the basis of an
'energency*. The Order, however, totally (ailed to describe the
•nergancy which allegedly threatened 'fair and orderly trading'.
It gave no facta and no reasons for Its conclusion that an
anergency existed. (See Attachment 1)
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In the days since the CBOT's action, runors have awlrled
around the country that the Order was Issued at the behest of
CBOT members who were In a short position on July soybean
contracts. The principal name mentioned In the press reports is
Carcfill (see, for example, the Hall Street Journal, July 13,
I9S9, p. C1 ) . These traders, of course, stood to gain If the
market collapsed — as It did. There la nothing to rebut these
rumors at this point.
Therefore, I recommend that the Committee mandate that the
CFTC require the CBOT, as well as other contact markets, to Issue
to the public a statement fully explaining the specific facts
surrounding and reasons for any emergency order. Ho
authorization to issue emergency Orders should be allowed without
requiring simultaneous public disclosure of the reasons for the
order. The facts and specific reasons I would like to see
included in a public explanation would be the names of the
companies and officials Involved, the specific conduct that was
the trigger of the or^er, the harmful consequences that would
ensue unless the order were issued and, finally, the manner in
which the remedy being applied will prevent those harmful
consequences and preserve confidence In the market.
Only this type of public disclosure would be sufficient to
dispel the perception, which now appears to be based on fact,
that the CBOT is a private club run In secrecy for the best
interests of Its powerful trader members.
„Coogle
Thia dlscloauce la not a radical step. Sactlon 9a of th*
CooNodity Futures Trading Act now raqiitroa any contract narkat to
provide the CFTC (but apparently not the public! with a
'coMplat* axplanatlon of the a««r9«ncy Involved.* (Attach««nt 2)
Moreover, at the hearing today, thta Copwlttee ahould deaand
tull.releaae of the Section 5« explanation that pr««u«ably naa
received by the CPTC on July 11, 1989 Baergancy Order. Thla
eKglanatlon ahould then be wldaly dlatrlbutad eo that the CBOT
action can be fully evaluated.
2. SBLF DBALmG/IMSIDBR TRADIHG
The CBOT enerqency order was alleged to have been leaked
before the clone of the trading day on July 11, 1989 — even though
the order was not released until after closing.
The following two paragraphs froai the July 17, 1989 Hall
Street Journal are very provacativei
'The board Is also fending off rumors that news of its
liquidation order might have leaked out before the Close of
trading Tuesday. Exchange offlclala have said that all th*
directors that voted on the action were polled to ensure
officials have said that all the
directors that voted on the action were palled to ensure
that none had a position In ttM July contract.
Burton Gutterman, Chief executive Officer of Index Futures
Group, Inc. and a CBOT director, said he was the only
director to excuse htnself from the decision.
The questions that Innedlately cone to nlnd are i
1) Bow long had the CBOT discussed this najor action
before they took the vote? According to the attached
chart, the narket fell precipitously from just before
July 7 to the present.
2) What action did the CBOT take to ensure that excluded
CBOT directors, such as Hr . Guttenaan, did not go to the
floor and act on the knowledge that an naergeacy order
decision was pending?
„Coogle
3) Who checked up on the vetsclty of the CBOT's
self-administered and self-imposed "poll" of self
4) Given the need for absolate secrecy, how much time did
the CBOT directors have to assimilate the facts of the
alleged squeeze before acting? Has that time adequate?
5) Which staff members or other persona made the
recommendations for the emergency order to the CBOT Board
and what control was there over those persona' self-interest
and potential for self-dealing?
In contrast, to the apparent preternatural awareness of
various traders involved with the CBOT, compare the shock to the
farmers who were also affected by the order. The July 17, 1989
Wall Street Journal stated:
'It's [the CBOT's] reputation Is reelcing among small
'It makes us look like crooks," said John J, Heber, a grain
commodity advisor in Redfleld, South Dakota. 'We'll lose
business over time.' The wild price fluctuations triggered
by the Board's action forced Hr. Beber to ask about SO
farmers for more money to back their positions. Many of
them had never used futures contracts before he opened shop
two years ago, and they are angry now that they tried It.*
It is crucial that this Committee ensure that the CPTC prevents
and punished "insider trading" and also prevents appearance of
potential for Insider trading. The CBOT's "poll" of its
directors reeks of insider trading potential.
3) Was the 'cure* worse than the disease?
The "squeeze" that the newspapers have described at the
basis of the CBOT's order. Involved around one percent of annual
U.S. production of soybeans (23 million bushels of a 2 billion
bushel crop. )
Bigh prices, from a farmer's perspective, are a positive,
not a negative. It appears that the CBOT does not show this
„Coogle
SoorMi Nail 8tr««t Journal (7-1I-B9)
The chart printed abov* ahowa a Juna through aarly July
qradual riae In prlcea. It appaara that the narket prior to tb*
CBOT action waa a auch nor* 'orderly* warttat than cha narlMt
after the CBOT order.
The reiaady choaen by tha CBOT «aa draatlc, abrupt aalaa of
all poaltlona in exceBa of I nlllion buahela, whether for hedging
or apeculative purposear In a very ahort tineframe, Thla
'renedy' haa had an unbelievably dlaruptive effect on the July
contract, other soybean contracta and the cash price of aoybeana
and other cropa, Corporationa and individuala and doaeatlc and
foreign buyers have been affected. The credibility of the CBOT
and other contract narketa haa also been hurtt In the aaae Manner
as an enbargo.
„Coogle
It is hard to imagine what greater chaas could have been
caused by the undescribed 'emergency' that the CBOT sought to
Congress should require that contract markets' authority to
use emergency orders under 17 CPR 1.41 If) should Involve only
measured remedies carefully tailored to the alleged harm and
should disallow remedies that cause greater harm to the public
than the harm sought to be prevented. The broad 'menu' of
remedies allowed by Section 5A of the Act and 17 CFR 1.41(3) (f>
should be preceeded by better defined guidelines and
restrictions. Also, fines to disgorge ill-gained profits by
specific firms should be explored in lieu of remedies that punish
the innocent as well.
4) Indemnification of CBOT directore, officers, eonunlttee
members and employees.
The honesty of a largely self-policing board such as the
CBOT rests, in part, on Individual members' evaluation of risk to
be incurred by an improper action versus a potential profit to be
CBOT Rule 182.00 provides free legal counsel and complete
indemnification for all directors, officers, committee members
and employees. Only where a court in a judgment or a majority of
the CBOT Board or a lawyer (if the majority of the CBOT Board is
disqualified) in a settlement finds that the director or other
person was derelict or guilty of gross negligence or willful
misconduct would that soon be excluded from ^is policy,
{Altachment 3)
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As thla Coaaitt** aay know, aoybean CaraarB ara
contaaplating laqal action baaad on injurlaa caau«d to tha« by
CBOT's ordar. It la obvloiia that even CBOT Bcabara who aay have
accad willfully or In a groaaly negllgant aannar will have
unliBlted free legal counael during the lawault. Moreover. If
CBOT »aabera ara found to be negligent but not groaaly na9ll9ent
they will be fully coapenaated by the CBOT.
Congreaa ahould narrow tha virtual invitation to abus* that
CBOT Rule 182 repteoenta. Mhlle board Benbera need protection
fro* frivoloua lawaulta, the public alao needa better protection
froa bad actors in contract aarkets.
Thank you for the opportunity to present theae views.
„Coogle
ATTACHMENT j
® Chicago BoardofTrade
EffACl
tlv«
t as o(
1989,
an/ p.r.or
conjQi
net:
ion with
a gte«i
purpo!
tti* July
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1 by it
BKERIENCV lEflOLOTIOH O? THE DOMO op DIAECfOM
or THi tnxKD or tbadi or the city or Ciricjtao
BEUtTIHd tU THB JULV 1(S> SOyBEAN rUTUSEI
CCJHTRACT; kOOPTED rURflUAMT TO XSaOCIkTIOll RULE
lao.Oa AXD REGULKIIOH laO.Cl, COKKODITV IXCKMiat
XCT SECTION 5>(1Z>> UtD CFTC REdUUTIOM l.<l|f|.
RMOLVED. that th* Baard o( Dlraiitors of tha Board of
Trad* of the city &f Chicago hireby dctaralntta chat an aaorgancy
■Klats uith raqarJ to tha July 19S9 aaybaan futur«a contract tradad
on tha Exchsngo that requires Imrediata action and threotans or My
thrAatan fair and orderly tradliig in, tha liquidation of, and
dallvery purtuAnt to, tha July isa^ acybc^n fututas contract, and
haraby adopt* tha follovlng itaasuraa to daal with thia aaargancy:
(1) Effactiva as o( tha oytninq of tha Bnrk«t on July 13,
- '- /, althat alona or In
r person or er.tity, who owns or
jross short posit.lon tor any
gss of thrae Billion bushals In
I contract tradad en tha
sdJJ position and aubsoiuant
t 20\ par trtidlng day lubjact to th»
fullnulng absoliita Units.
Ko pvrson or entity, aithar alonn or in conjLnctlon with
any othar parson or antlty, shall own or control a gross
long or gror.c short position for any purposa whatsoawae
In tho July 1989 soybaan futuvco contract tradad on tha
Inohanga in axcess of tnraa vllllon bushala as of tha
cloi# of trading on Tu*iday, July IB, 19S9.
Ho parson or antity. aithar alona or In conjunction with
any othar parson or antlty, shall own or control a qress
lonj or grosn short position for any purposa whatsoavar
In tha July 19<9 soybean futuras contract tradad on tha
Exchange In Excans of ona nllllon bushela as of tha
anpiratloii of trading on Thuradsy, July 10, J989.
) all positions, whathar
Falluru by any MBbur or vrnbar firm to eoicply with this
Ei.eru.ncy B«f)l..tlon, or failure to aaalst in coBpllaoc*
with this emergency resolution Including as dlractad by
tha Executlvo Conmlttea pursuant to paragraph {») balow,
shall bo daamad to ba an offanae agalnat tha AsaocUtlon
and an act datrUantsl to tha Intsrast and walfara of tho
ftssociatlon.
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Th« tKSeutlva CoNiltt*« la authttricad and aapewarad to
taha all atapa It daaaa nacaaaary In Ita aola dlactatien
t« aaaura conplianca with thla Snaraaney ■aaolutlon,
tncluilira buc not lt>It*d to tha ordartng ot tha
liquidation on tha txchanqa [by brokara aalactad by tha
£oMitttaa In ita dlac(ati«n| of tha July 19a> aoybaan
futuras poaltton ot any paraon or antlty not In
coapllanca with para9r»pti (1} abova, to tha antanC Of
igch noncowpllanca, Tha dlractlon of tha bacutiva
Coaalttaa ordering liquidation on tho txchanga ahall b«
daa«ad tor all purpoaaa, tncludlnq undar tha rulaa and
radulationa of th« kaaoclatlon. to b* tha act »f tha
far»»n mw >nt(Cr whsaa pkattten t> b>ii>v llt|uldatad.
Hethlnq In thla EBaT9c-n<:y ReaoluC on ahall ba daaMd In
any way to eracluda tha Aiaociai on troa Impoalna
■■iietluiiB un 4rt^ AtDDar or naabal^ Ilrp Cor any violation
of A>a(M:latlon ruli* at trequlatlona, or thla raaolutton.
In eonnaetlon with July if8» aoybaan (gturaa.
Thla Enarqancy Kacolutlon la axpraaaly adoptad purauant
to kaaoclation Pula no. 00 and Kaqulatlon 110. 01, faction
5(a}<l>} of tha Couodicy Exehanqa Act, and CPrC
■tabulation 1.41(f).
Nothing haraln ahall ba daanad to pracluda tha tuainaaa
Conduct COBBlttce or tha Board of Dlractora tron taking
auch furthav kct on, purauant to tha authorltlaa
rafaiancad r paragraph (9) abovo or othar«laa, as say b«
naeaaaaiy in the Coaalttca'a or th* »oard'a ludqaant to
(uithar pruvlda for orderly trading and liquidation ot
July 14>9 aoybaan CuCures and dalivory purauant tharato.
Data) July 11,
Karatan MahlMnn,
ChalrMn ot Xha ftoard,
loard of Trada of tha City
of Chicago
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avo^<m <> aicnM S'lltni tnrj ti )hiI onc-iniid «l V>t tull Bo*'d ia |^rt-»'i|r DiVMnt. niy
rtgu^tl'Dn or n«to>uIi«ii >»»" t« ea>l*d e'iKnptiv en <M IIMf a' int Eichang*.
W An «ir<«rgancr n>«u>ation md ft*iolutlon «h«>l«iplr< upO" iri*l>«cp*nlna afiny et Iht Iqi
Vl mt Bai'a i^tii riix toltd lo '(Kind IK* •mcgaKcir tt>g>ji(lisn m naulutigii in ihi
Irx (r-a-otncy Ragulalionor R*toiulian wilAin Ihiity OS) atyiatlar >taa(toe>!on to> a parred
f ma Bea'd (x tr>a Msmt>«'] of in* Ai»Kii'ion than nav* 'a'^ad lo adoet V-a amargancr f**B-
gi*h«n a>R((aivi<on In a:ford*nc* w>lh Ru:*t lO'SO or 13} 00 dvtrno Ihi Uma pki'iai
nnan the ■n>*'e*ncir la in allacl.
EIth(^;tc«nl'*cl>lKallft*auBJKllol^*«I•-el>»oft^•a**n1•'}arc)lpow«rlDy1^•Sol'a
wall at tfa aiarcitt Sy tha Ciaa^lng Houl* o( tM jowa't rMarvtdio It bf lit cKanar. by<i»*
I Trading Commii-
a>on incraundar.and *" eina' ci'iumalancM ^n •f^ien an •margtneir can t«>irfuiif M Sadarad Or
it) Eicact la sl-arwin ilatad in an •mtrjaneii a»flulal.on o( Waao'ulion kdoptad Nanuntfar. Ih«
0Ow«:i aiarcMd or tn* Board unda;iMa Rule inaT M inaOdil'onloang nof in daiofiilisn ol [r*
auinsi.-r gianird 9r l,na Ruiai and Argvialiont to i cofl>'n<1I*t or oriici' ol ln« Aiaoclat'On to
takt •el'On ai vOMII<M in*rt>n
ItO.Oi Pbraitai tm»is(r>«i*a-in tt>* i«*ni Kit pKralcai [yncliona ol iri Aaieclalvn i^t. oi a-*
trii«t1*n*d le M. aav*'*!]' ang ta(*ra«i|i intelad B> a phfaical »>r(rg«ne)r lucH (a But no) llmllM 10
■(• or oihar caauallr. boinn lli'uia, autiatanll*! inciantnt waattigr. powor falljrM. cocnmunicalioni
I* CiaeulM ComnlitM »r ■ncl^•r ott«*r ol IM tiicli»ng«. Ii auDwrltad 10 lakt
(^a1l oatm nocitwy Or apo^pnala 1o daal wiln awcn ■marganeir lnc)vdlr>fi bi
iDtnoing ana liilonng trading In nrnoi* »r in (wrt. oroildM thai no badlno avapo
■ " ■ arlW1altO.OO. I»«
^IW£t ^tmargano AcUsna Un4*( Rii)t IHM-Pu'wani ar
TKTQKIlia tOB'S iriir laki oi di-aci auEn aeliona *« n d**n>> r
'>> nacaaaary or aMrecriit* to m
(a) llniling Iradrng w HouMatlon only. In wnola or In ptA.
M limiting Uading lO UquidaMn only, aicapt nam i|i*» lor Mi'tary:
tc) tittnoing or ahentnlng Ida lima tor tha ajiplral^n ol fading,
(dl «l*no.ng in* Urn* lor d*i:>«ry.
Igl Ordaring tna rMuclkm o( poa:i'ona.
Oil orMfing in* iimtlai ol ooa1«na. and lA* monar. aacu.-HIaa and prneaity aocurlng audi
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(Hill 0) H^ul mlKond^et 0( grou ntgi^nei m il'.« ptrforTinc* a( duir on V* port ol tucti OrtcMr,
oKcH cerni4<M ii>*mB*r or •"perM ''i •><*■■ b* ontllM 'o ImMmnlteibun only i«on ■
Mrmiraton In goad ii^ih bj g rjjoinr ol t^• i>l>a'i Bo«'d ol DirMIO*! thot wch claim, tcUon. luit or
pracMd'e did no) I'^ii Br lOiion ol 1^• eviliclion. g-oii ntgl-e*nc* or oiKwi mltcontfiict ^ wcti
Ditcior, pit'c*'. cofnTiilM nfirtxi or ("pieiH in V14 partoin-inc* a( nu Outin » •uch; [d no
nrtciM wno >K*" ly nugni ni n it^ i pa^r is cii avcli ciiim teitfi, anil oi prouMina. or who tfioll
Mv« e> hi<* Md *nr imiAc (I inwtt) Mv(-M 10 tnt «■
■n Hcn Otlvm-nition. Ml it • caioMt* SI tM OiiMio'* si IM Aaaoc^av
ptiicipai*. I^■ OiraciB, oflc*-. ce>nniH-«« mamb*' « •ixotorM aaaiiing
UWd iM-tiB onir U0on M opMion ol MynM. aM ahall M a*;act*d By Bi« loM niM MMMr MMg>
nalae Br 1 cd wnoaa coargat toi *vch opinion ana M paid ki »• waociauon. mat aucn DmaMr.
«'l<*>. oomniinM maniM- v ameiOraa Kat noi fi**" da>*IM or guatr o< rs*a nagSovtc* gr uriKil
niacendacl In ina pofTonna^ t o< hit diiuaa. an« :•) wa ineamnmcaiion prooidad t«> 4n Diig lliitt iMM
flSt ti-ana to art KaMi't M a 0"aciar. oTMar, Mmmlrta maniMr Of gm^iOfM M Ota AaaocMMn. or
«»ar eorpcaUon m onvn ii^a Diteoaiien own* M-poraia tiack, lor cowitsi IM* <! »a aiaoriitow
anan nana Man •nlU>g to ^'"l*S eour.iai 01 ni m*i cAoica lo Mlantf awch DiracMf, afTtar, camMOaa
*an«Baf or ampiorta »nfl in in* I,*aarran( ol iha •01-e ol W'atioia of iha *aaotlatlori. *<-ol eawioalaa-
■acMd ti V* Bea'd o< Di'aclO't ai proxdad m <ltii>a tdl iBo<a. tht^ waa no (uallflealton far aucfi
^•cio>. oiriar, comMUaa mamOa' or anpioraa to angipa csunaai oHw *ian IM aninaal ohich »•
■oaM ol O'lCiori waa oiiiing ut lumiaA. Tna ngM ol indBmn:licatian aaraM proiiMd anal nol b«
aicloaiiaef oo-arrigntaM allien anriucnparaoa may baantiiiadaa a manafoiuw. M
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The Honorable Glenn English July 31, 19B9
Subcommittee on Conservation, Credit
and Rural Development
House Committee on Agriculture
1301 Longworth House Office Bldg.
Washington, DC 20515
Dear Mr. English:
Heauthoclj
As a large coffee and cocoa trading company which
uses the Coffee, Sugar i Cocoa Exchange every day, we
strongly feel that the CFTC Reauthorization Bill will prove
harmful to the CSCE and the other commodity exchanges In the
United States if passed. The Bill would induce a loss of
liquidity which is an essential factor to the proper
functioning of any exchange. This, In turn, would diminish
Che volume thus reducing the Market's viability as a hedging
Moreover, the Bill presents provisions that are
redundant to the existing regulatory powers of the CFTC, and
asks for a reauthorization of appropriations every two years,
which is tou fiequent to allow the Cftc to conduct Its
regulatory mission effectively and impartially.
We hope you will agree with ua that the CFTC
Reauthorization Bill will do more harm than good to the US
futures Industry. Meanwhile, we are available for any
questions you may have.
Sincerely your:
„Coogle
July 26, 1989
Chairaan
iral Developaenl
Since I did not receive sufficient notice to properlr pr*psre
testlBony for the CFTC reauthorltatlon hearingB, I
respectfully request that you Include the following in the
record relative to aald hearinga:
Ht . Chairaan and BeBbera of your coBBlCteei
More than 50 years ago Congreasional action provided
selling only on an "up-tick" of the Bsrket as a means of
deaoralizing crashes In the aarket due to nassive speculative
Proof that the "up-tick" rule ia alive and well was evident
m the May 26, 19S9 Wall St. Journal, which reported that
SaloBon Brothera, Inc.. was censured by the SEC Hay 25. 1989
after being accused of violating the "short sale" provisions
of federal securities law in its trading during Black Honda;,
Oct. 19, 1987.
WSJ further stated: "Federal securities lavs have long banned
short sales on a °doHntick', or a at a price below Che last
ealgned to keep traders
Ice of a falling
orney said the short aale rule has
. downward BanlpuXaclon of stock
icceleratlon of a decline in a
I cattle prices in early 1986 following
of the Dairy Termination Program In which cattia
es dropped the limit on 11 out of 20 trading
ler with the recent fiasco in soybean prices, are
lers that the time is way overdue for grain and
oducera to be provided with siBilar protection
inlimlted number of speculators who can, under
„Coogle
and which they sell at prices the actual owner never agreed
to take) A ridiculous situation, to put it mildly!
I believe Congress has the authority to place much-needed
Units on speculators in the comsodities markets since the
first paragraph of the Comaodity Exchange Act of 1936, Sec.
and remove obstructions and burdens upon interstate
commerce in grains and other commodities by regulating
transactions therein on commodity futures exchanges, to limit
or abolish short selling, to curb manipulation, and for other
purposes." (This law was sustained in legislative intent by
the Futures Trading Act of I97S)
the Congressional Record oi
a measure of control over those forms of speculative activity
I respectfully request that you and your Committee make a
diligent effort to provide grain and livestock producers with
the protection they need and deserve In the commodity pricing
system by recommending either strict limits or abolishment of
reauthorization of the CFTC (the CFTC should be replaced by
the SEC), or more accountable futures trading practices will
do nothing in terms of protecting grain and livestock
producers against grossly unfair speculative selling.
of an editorial from July 26, 1969 Farm
h providea some interesting and very
equest that you place that editorial In its entirety, along
'ith my testimony, in the record.
Talk publicatioi
ir.nl ^'-^"-'
P.S. If you have any hearings on futures again soon, I would
like very much to participate if given anple notice. I hope
they will be out here where other producers can participate.
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