The Year in Review
In FY 1997, the Commission implemented new "fast-track" procedures for processing certain contract designation applications and exchange rule changes. These procedures significantly streamlined the review process for most new exchange contracts and many exchange rules, permitting approval within ten days for many types of contracts and 45 days for certain other contracts.
Prior to the adoption of fast-track procedures, the Commission had already reduced its average contract approval time to about 90 days. Since adoption of these procedures, 15 new contract designations have been filed with the Commission, seven of which were eligible for fast track treatment. The Commission approved all eligible contracts within the fast track period. Even contracts not subject to the fast track procedures -- such as stock index futures contracts, which must be submitted to the SEC for comment -- have been approved in record time. For example, during FY 1997, the Commission approved the CME's E-Mini S&P 500 contract and the CBOT's Dow Jones Industrial Average contract within days of receiving the statutorily required SEC comment letters.
The Commission's streamlining efforts have brought significant benefits to futures commission merchants (FCMs), commodity trading advisors (CTAs) and their customers. For example, in June 1997, the Commission approved an interpretation permitting streamlined procedures for allocation of customer orders which are bunched for execution by CTAs. The Commission provided relief to FCMs with respect to the capital treatment of short option positions to permit more FCMs to carry such positions for customers and to facilitate efficient use of capital without creating undue financial risk.
The Commission also streamlined many of its reporting and disclosure requirements. The agency amended its reporting requirements to permit filing by large traders of CFTC Form 40, Statement of Reporting Trader, only when requested by the Commission rather than annually. In an important development for CFTC registrants who are also SEC registrants, the Commission adopted rule amendments to harmonize certain financial reporting requirements with the requirements of the Securities and Exchange Commission. The Commission also approved in principle two-part risk disclosure documents for commodity pool offerings, which potentially would highlight the core information required to be provided to customers.
In early September 1997, the Commission proposed amendments to its rules governing the risk disclosure obligations of FCMs and introducing brokers (IBs). If adopted, the proposed rule amendments should speed the account opening process for financially sophisticated customers identified in the rule. The proposed rule would provide the flexibility to FCMs and IBs to design their own disclosure of risk by eliminating certain mandatory risk disclosure information and procedures. This proposal responds directly to industry calls to permit different regulatory treatment of sophisticated customers where appropriate.
The Commission has adopted a number of initiatives designed to take advantage of the increased efficiencies and reduced costs made possible through the use of electronic media. In June 1997, the Commission paved the way for FCMs to use electronic media in communicating with their customers. The Commission's Advisory permits FCMs to deliver confirmations and account statements solely by electronic media to customers who consent to electronic transmission in lieu of receiving paper documents. Also in June, the Commission authorized CTAs and commodity pool operators (CPOs) to provide risk disclosure documents to their customers via electronic media. The Commission's interpretation enables CPOs and CTAs to provide customers with a risk disclosure summary and a hyperlink connection to the entire risk disclosure document.
The Commission also adopted measures to permit the electronic filing of documents with the Commission. In April, 1997, the Commission adopted a rule allowing CTAs and CPOs to file their required disclosure documents with the Commission electronically. The Commission has also undertaken a program to permit FCMs to file required financial reports with the Commission electronically. These electronic media initiatives should increase the timeliness of information flow, reduce the administrative costs of commodity professionals and allow all members of the industry and their customers to reap the benefits of technological advances.
Delegations to the National Futures Association
The National Futures Association (NFA) is a self-regulatory organization of commodity professionals designated by the Commission under the Commodity Exchange Act to perform certain regulatory functions. During the past year, the Commission delegated additional authority to NFA in several areas including: registration decisions relating to floor brokers and floor traders with disciplinary histories; ethics training of commodity professionals; and various registration and processing functions relating to non-U.S. firms. The Commission is continuing to evaluate other functions that could be delegated to NFA, including the review of disclosure documents required to be filed by CPOs and CTAs.
During FY 1997, the Commission focused enforcement efforts on matters involving allegations of fraud in a variety of contexts. For example, the Division of Enforcement pursued cases against unregistered persons or entities which should have been registered and which have violated the anti-fraud provisions of the Commodity Exchange Act. The Division filed cases alleging fraud in the offer and sale of various off-exchange instruments, including hedge-to-arrive grain contracts, precious metals contracts, and foreign currency contracts marketed to the general public. The Division also pursued cases against firms and individuals using fraudulent advertising and solicitations.
In FY 1997, the Commission filed three separate administrative complaints alleging violations of various provisions of the Commodity Exchange Act and Commission regulations in connection with certain hedge-to-arrive contracts involving grain elevators. The investigation preceding the filing was prompted by the Commission's heightened surveillance of grain markets during volatile market conditions in 1995 and 1996. In In re Grain Land Cooperative, the complaint alleges that Grain Land, a grain elevator, offered and sold hedge-to-arrive contracts that constitute illegal, off-exchange futures contracts in violation of the CEA. In In re Roger Wright, et al., the complaint charges Wright with acting as an unregistered commodity trading advisor and with fraud in connection with his marketing and promotion of, and his entry into, illegal, off-exchange futures and option contracts. The complaint also charges A.G. Edwards and one of its employees with aiding and abetting Wright's unregistered activities and trading without proper authorization. Buckeye Countrymark, a cooperative grain elevator, is charged with entering into illegal, off-exchange futures and option contracts. In In re Southern Thumb Co-op, Inc., the complaint alleges that Southern Thumb, a cooperative grain elevator, violated the CEA by selling illegal, off-exchange agricultural options and engaging in fraud in connection with its marketing of the illegal instruments. The Division of Enforcement continues to investigate other individuals and entities in connection with hedge-to-arrive contracts.
During FY 1997, the Commission allocated additional resources to revise and streamline the administrative opinions process, with a view to reducing the backlog of pending cases. As a result, substantial progress was made in completing over 30 cases, many of which were complex enforcement appeals.
In FY 1997, the Commission reviewed and approved 51 applications for new futures and option contracts. Several of these approved contracts represent innovative approaches designed to meet specialized hedging needs. For example, the Commission approved contracts based on inflation-indexed debt instruments issued by the U.S. Treasury. These include the Chicago Board of Trade (CBOT) inflation-indexed Treasury bond, long-term Treasury note, and medium-term Treasury note futures and option contracts. These contracts, the first for inflation-indexed debt securities, were specifically designed to deal with the unique hedging needs of institutions exposed to risk arising from holding the inflation-indexed instruments recently issued by the U.S. Treasury.
Another example of innovation in the markets is the Chicago Board of Trade-London International Financial Futures and Options Exchange (CBOT-LIFFE) link. The link is the first international linkage which permits contracts of a U.S. exchange to be traded on the floor of a foreign exchange and contracts of a foreign exchange to be traded on the floor of a U.S. exchange. Commission staff worked with CBOT and LIFFE to develop rules and procedures addressing unique aspects of the linkage relating to handling customer funds, disclosure, order placement and acceptance, and surveillance.
International Regulatory Cooperation
The CFTC, along with British and Japanese authorities, co-sponsored an international regulators conference on physical delivery markets in London in November 1996. The 17 countries participating issued a Communiqué agreeing on certain basic principles of regulation. The participants also agreed on a year-long work program directed toward the development of international ''best practices'' standards in contract design, market surveillance, and information sharing to be released at a meeting in October 1997 in Tokyo. International ''best practices'' standards would establish world-wide regulatory benchmarks which can help each domestic regulator to assess how its standards and practices compare and consider possible regulatory improvements.
Establishment of Office of International Affairs
In late July 1997, the Commission created, within the Office of the Chairperson, an Office of International Affairs to enable the Commission to continue its leading role in international regulatory initiatives and to keep abreast of global changes. Over the past several years, there has been enormous growth in the international marketplace. New exchanges have been established around the world, trading volume has soared, new regulatory bodies have been created, and the need for cooperation and understanding among international regulators and exchanges has become paramount. The Office of International Affairs will enhance the Commission's ability to meet the challenges posed by globalization of financial markets in three important ways: (1) to respond quickly to market crises that have global systemic implications; (2) to remain an effective supervisor in a global marketplace where no one regulator has all the information or resources to regulate its markets or its firms; and (3) to eliminate unnecessary impediments to global business while preserving core protections for markets and customers. The Office of International Affairs will play a key role in an evolving process toward harmonization of regulations which ensure market innovation and access, while maintaining needed customer and market protections.
Agricultural Trade Options
Agricultural options - both on- and off-exchange - were traded in the United States at least from the time of the Civil War until the 1930s. However, concerns about fraudulent sales practices, failure to perform over-the-counter obligations, and the use of exchange-traded options to manipulate the prices of agricultural commodities prompted numerous industry and government efforts to limit or eliminate trading in agricultural options. In 1936, Congress banned all sales of options on certain agricultural commodities listed in the CEA. In 1982, Congress lifted the 1936 statutory ban, allowing the Commission to permit options on certain agricultural commodities listed in the Act. The Commission permitted exchange trading in these agricultural options in 1984. However, the regulatory ban on off-exchange agricultural options remains.
In May 1997, the Commission's Division of Economic Analysis issued a White Paper on this issue. The paper analyzed: (1) the current regulatory environment; (2) recent developments in agriculture that have expanded the need for risk-shifting strategies; (3) the benefits and risks of agricultural trade options; and (4) possible ways to strike a balance between the benefits and the risks. The staff analysis identified, for the consideration of the Commission, risks and benefits of lifting the ban. The analysis suggested that the Commission consider lifting the ban subject to appropriate regulatory conditions. Three categories of conditions include: (1) restrictions on eligibility of the parties; (2) restrictions on the instruments and their use; and, (3) regulations governing the marketing of the instruments.
The Commission sought public comments on the issue through a Federal Register notice and by holding field meetings in Bloomington, Illinois and Memphis, Tennessee. After careful analysis of all public comments, the Commission will consider whether, and under what conditions, to propose lifting the ban on agricultural trade options.
Delivery Specifications for Chicago Board of Trade Futures Contracts
In December 1996, the Commission voted unanimously to notify the Chicago Board of Trade (CBOT) under section 5a(a)(10) of the Commodity Exchange Act (Act) that the delivery terms of the CBOT corn and soybean futures contracts no longer accomplish the statutory objectives of ''permit[ting] the delivery of any commodity . . . at such point or points and at such quality and locational price differentials as will tend to prevent or diminish price manipulation, market congestion, or the abnormal movement of such commodity in interstate commerce.'' During 1995, the delivery capacity in Chicago under the CBOT contracts was reduced by about 58% as three of the six warehouses at that location ceased normal operations. In late 1996, a fourth warehouse announced intentions to cease operation. However, in October 1996, following almost one year of study, the CBOT membership rejected proposals to expand the delivery capacity of these contracts.
The Commission's notification gave the CBOT until March 4, 1997, to submit proposed amendments to its corn and soybean contracts to achieve the statutory objectives. Following this notification, the CBOT formed a special task force to formulate contract changes. On April 15, 1997, the CBOT approved proposed contract changes. Many objections to the revisions were raised in almost 700 public comment letters. In response to these comments and the CBT's request to present its arguments directly to the Commission, a public meeting on this topic was held on June 12, 1997. The Commission issued a proposed order changing and supplementing the CBOT proposal as required by the Act on September 15, 1997, and scheduled a public hearing for the CBOT to be held on October 15, 1997.
Also in December 1996, the Commission issued a request to the CBOT to undertake a study of the delivery specifications of its wheat futures contract and to submit its findings to the Commission. The CBOT responded by providing a report stating that the CBOT would refrain from acting on recommendations, including one to make certain changes to the delivery terms of the wheat contract, that had been made by a special task force that had been appointed by the Board of Directors in response to the Commission's request. Instead, the CBOT stated that it would conduct market research to determine whether a broader review of its wheat contract, not limited to delivery terms, should be undertaken.
In light of the CBOT's failure to reach a decision regarding the delivery specifications of its wheat futures contract, on July 8, 1997, the Commission published for public comment a list of specific issues related to the CBOT's wheat contract. The Commission believes that seeking public comment on these issues, including potential changes to the CBOT's wheat contract delivery specifications, will facilitate the Commission's consideration of these issues. The comment period ended August 22, 1997.
Audit Trail and Dual Trading
Accurate audit trails have been an aim of the Commission since its inception. In the past year, the Commission reviewed compliance with statutory and regulatory requirements regarding audit trails and dual trading in order to assure that trade monitoring systems are in place which, to the extent practicable, enable effective detection, deterrence, and prosecution of trading abuses, as required.
In order to review audit trail compliance, the Commission conducted tests of the Commodity Exchange Division of the New York Mercantile Exchange (COMEX) and the New York Cotton Exchange (NYCE). The reviews evaluated trade timing accuracy, trade sequencing, and conformity with the Commission requirement that customer account identifications be recorded on order tickets and required the review of approximately 3,000 trading records.
To address dual trading, the Commission provided five exchanges (the Chicago Mercantile Exchange(CME), CBOT, NYCE, COMEX, and the Coffee, Sugar and Cocoa Exchange (CSC)) with an opportunity to update pending dual trading exemption petitions prior to the Commission's issuance of dispositions of those petitions. The Commission issued unconditional dual trading exemptions to three exchanges (COMEX, CSC, and NYCE) that demonstrated that they could effectively carry out their trade practice compliance responsibilities. As of the end of FY 1997, the Commission staff was preparing recommendations on the disposition of the dual trading exemption petitions of CME and CBOT. In that regard, the Commission reviewed all aspects of their trade monitoring systems in order to determine whether they were in compliance with the relevant statutory and regulatory standards.
The Commission has taken several steps designed to make information and assistance more available to the general public. In addition to its Internet monitoring and surveillance program, commenced in FY 1996, the Commission has used its home page on the World Wide Web as a means of providing the public with brief summaries of the types of abuses commonly investigated and prosecuted by the CFTC. The Commission's website also provides descriptions of recently filed cases and encourages the public to report suspected abuses by providing an electronic questionnaire that can be filled out by visitors to the website. Individuals who want to find out whether a particular individual or firm is the subject of a pending enforcement action or has been found liable for violating federal commodities laws in an administrative or a civil action previously brought by the Commission can find the CFTC's Proceedings Bulletin on the home page. The Bulletin is published annually and updated every three months.
Individuals and firms that want information concerning sanctions imposed and registration suspensions can now obtain that information immediately through the Commission website. Both the Reparations and Enforcement Sanctions in Effect Lists are now available on the Internet as is the entire Reparations Complaint package. The package provides information pertaining to the reparations program and how to file a complaint with the Commission.
Automation of Administrative Functions
During FY 1997, the Office of Proceedings implemented a new case tracking system. The new system tracks the progress of each case from receipt through disposition in the Office of Proceedings, appeal to the Commission and appeal to Federal court. This system not only assists case management within the agency, but allows the Office of Proceedings to provide better information on the status of cases in response to public inquiries.
The Commission is making extensive use of automation to streamline financial and fiscal processing. For example, the upgrades to the financial management system improved functionality in the areas of budget execution, expired funds, standard general ledger, and electronic commerce. In addition, the Commission installed a new automated system, Travel Manager Plus. With this system, the processes of generating travel advances, authorizations and vouchers, and maintaining the electronic and paper records were decentralized to the Commission's support staff. The Office of Financial Management uses these electronic records to keep pace with the growing workload without an increase in staff.
The process for receiving financial and accounting data on the Commission's payroll administration was upgraded from a magnetic tape process to an electronic transmission. This change resulted in more efficient and timely updates of the financial management system and in the elimination of the cost of overnight mail delivery.
The Commission has used automation to streamline Library operations and procedures and to make information accessible in modes that possess greater functionality than traditional hard copy. For example, the agency is contracting for a full-text document delivery system, which will provide full-text copies of articles required by Commission staff from any of millions of journal issues.