[Federal Register: July 22, 1997 (Volume 62, Number 140)]
[Page 39213-39214]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[[Page 39213]]



New York Cotton Exchange Petition for Exemption From the Dual
Trading Prohibition in Affected Contract Markets

AGENCY: Commodity Futures Trading Commission.

ACTION: Order.


SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
granting the petition of the New York Cotton Exchange (``NYCE'' or
``Exchange'') for exemption from the prohibition against dual trading
in its Cotton No. 2 futures contract.

DATES: This Order is to be effective July 16, 1997.

FOR FURTHER INFORMATION CONTACT: Duane C. Andresen, Special Counsel,
Division of Trading and Markets, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st St., NW., Washington, DC 20581;
telephone (202) 418-5490.

SUPPLEMENTARY INFORMATION: On September 28, 1995, the New York Cotton
Exchange (``NYCE'' or ``Exchange'') submitted a Petition for Exemption
from the Dual Trading Prohibition for its Cotton No. 2 futures
contract. Subsequently, the Exchange submitted a corrected petition and
an update on November 21, 1995, and March 14, 1997, respectively. Upon
consideration of these petitions and other matters of record, including
staff review of Exchange audit trail test results to Commission-
specified tests, compliance with the order ticket customer
identification requirement of Commission Regulation 1.35, dual trading
surveillance data required under the Commission's August 12, 1996 Audit
Trail Report, and disciplinary and investigatory actions undertaken by
the Exchange during the period of September 1995 through January 1997,
the Commission hereby finds that NYCE meets the standards for granting
a dual trading exemption contained in Section 4j(a) of the Commodity
Exchange Act (``Act'') as interpreted in Commission Regulation

    \1\ The record consists of the NYCE's petition and amendment
thereto and supporting documents, the Commission's January 1997
audit trail test, dual trading surveillance, customer identification
information, and documents submitted by the Exchange as part of a
rule enforcement review of the Exchange initiated by the Commission
in February 1997.

    Subject to NYCE's continuing ability to demonstrate that it meets
applicable requirements, the Commission specifically finds that NYCE
maintains a trade monitoring system which is capable of detecting and
deterring, and is used on a regular basis to detect and to deter, all
types of violations attributable to dual trading and, to the full
extent feasible, other violations involving the making of trades and
execution of customer orders, as required by Section 5a(b) and
Commission Regulation 155.5. The Commission further finds that NYCE's
trade monitoring system includes audit trail and recordkeeping systems
that satisfy the Act and regulations.<SUP>2</SUP>

    \2\ Sections 4j(a)(3) and 5a(b) of the Commodity Exchange Act
and Commission Regulations 1.35 and 155.5, 17 CFR Sec. 1.35, 155.5.
Section 4j(a)(3) requires the Commission to exempt a contract market
from the prohibition against dual trading, either unconditionally or
on stated conditions, upon finding that the trade monitoring system
in place at the contract market satisfies the requirements of
Section 5a(b), governing audit trails and trade monitoring systems,
with regard to violations attributable to dual trading at such
contract market. Commission Regulation 155.5 requires a contract
market to demonstrate that its trade monitoring system is capable of
and is used to detect and to deter dual trading abuses and to
demonstrate that it meets each element required of the components of
such a system.

    With respect to each required component of the trade monitoring
system, the Commission finds as follows:
    (a) Physical Observation of Trading Areas--NYCE's trade monitoring
system satisfies the requirements of Section 5a(b)(1)(A) in that NYCE
maintains and executes an adequate program for physical observation of
Exchange trading areas and integrates the information obtained from
such observation into its compliance programs. The Exchange physically
observes trading areas by conducting daily floor surveillance during
the open, close, and at random times during each trading day. NYCE also
performs floor surveillance when warranted by special market
conditions, such as exceptional volatility or contract expirations. The
Exchange uses information obtained from such surveillance in evaluating
audit trail data and otherwise in executing its compliance programs.
    (b) Audit Trail System--The Exchange's trade monitoring system
satisfies the audit trail standards of Section 5a(b)(1) in that it is
capable of capturing essential data on the terms, participants, and
sequence of transactions. The system obtains relevant data on unmatched
trades and outtrades as required by Section 5a(b)(1) of the Act. The
Commission further finds that NYCE accurately and promptly records the
essential data on terms, participants, times (in increments of no more
than one minute in length), and sequence through a means that is
unalterable, continual, independent, reliable, and precise, as required
by Section 5a(b)(3) of the Act. Consistent with the guidelines to
Regulation 155.5, the Commission finds that NYCE also demonstrated the
use of trade timing data in its surveillance systems for dual trading-
related and other abuses.

One-Minute Execution Time Accuracy and Sequencing

    NYCE's manual trade timing system captures a one-minute time for
both the buy and sell sides of every trade and sequences all customer
and proprietary trades. In an audit trail test conducted by Commission
staff in January 1997, the accuracy and sequencing rates of NYCE's
trade times exceeded 90 percent. Separately, the Exchange provided the
Commission with four months of data from the period of November 1996 to
February 1997 demonstrating that more than 90 percent of trade times in
the cotton futures contract were consistent with time and sales data
during this time period.

Unalterable, Continual, Independent, Reliable, and Precise Times

    The Commission finds that trade records generated by NYCE,
including order tickets and trading cards, are recorded in nonerasable
ink and that alterations are completely recorded. Trading card
collections occur within 15 minutes after each half-hour time bracket,
and members must submit trade data for clearing within one hour after
each one-half hour trading period. Trade data, therefore, are provided
periodically to the Exchange, which is continual.
    Trade times are independently obtained through a reliable means, to
the extent practicable, since individual times separately submitted for
each side of a trade can be compared to each other, to underlying trade
data, and to time and sales. NYCE's trade timing system also produces
precise sequencing.

Broker Receipt Time

    The Commission finds that it is not practicable at this time for
NYCE to record the time that each order is received by a floor broker
for execution at NYCE.
    (c) Recordkeeping System--NYCE satisfies the requirements of
Section 5a(b)(1)(B) by maintaining an adequate recordkeeping system
that is able to capture essential data on the terms, participants, and
sequence of transactions. The Exchange uses such information and
information on violations of such requirements on a

[[Page 39214]]

consistent basis to bring appropriate disciplinary actions.
    NYCE conducts either annual or quarterly trading card and order
ticket reviews for a representative sample of customer orders and uses
information from these reviews to generate investigations. Commission
staff review of a sample of order ticket account identifiers
demonstrated 97 percent compliance with the requirement that the
account identifier relate back to the ultimate customer account.
    (d) Surveillance Systems and Disciplinary Actions--As required by
Section 5a(b)(1) (C), (D) and (F), NYCE uses information generated by
its trade monitoring and audit trail systems on a consistent basis to
bring appropriate disciplinary action for violations relating to the
making of trades and execution of customer orders. In addition, NYCE
assesses meaningful penalties against violators and refers appropriate
cases to the Commission.
    On a daily basis, NYCE reviews trade registers and computerized
surveillance reports to detect dual trading-related and other trading
abuses. All relevant trade data are included in these reviews. The
Exchange reviews its trade register daily and surveillance exception
reports at least three times a week. The exception reports are designed
to identify such suspicious trading activity as trading ahead, trading
against, preferential trading (withholding or disclosing orders),
accommodation trading, prearranged trading, improper cross trading, and
misallocating orders.\3\

    \3\ On a recent date, for example, NYCE's trading ahead review,
which isolates brokers receiving better prices than customers fairly
contemporaneously, identified one percent of trades in all futures
and futures option contracts for further review.

    From September 1995 through January 1997, the Exchange initiated 89
investigations into all types of possible abuses. Based on examination
of its computerized surveillance reports, NYCE initiated 48 dual
trading-related investigations during that period, two of which
resulted in referral to the Business Conduct Committee. In 1996, NYCE
assessed $31,000 in fines, suspended a member for 14 days, issued three
cease and desist orders, and agreed to a voluntary transfer of
membership in three dual trading-related cases involving three members.
    (e) Commitment of Resources--The Commission finds that NYCE meets
the requirements of Section 5a(b)(1)(E) by committing sufficient
resources for its trade monitoring system, including automating
elements of such trade surveillance system, to be effective in
detecting and deterring violations and by maintaining an adequate staff
to investigate and to prosecute disciplinary actions. For fiscal year
1996, NYCE expended $1,039,729 in salaries for self-regulatory
personnel and reported its total self-regulatory costs to be
$2,712,516. NYCE reported volume for this period as 6,228,285
    Accordingly, on this date, the Commission Hereby Grants NYCE's
Petition for Exemption from the dual trading prohibition for trading in
its Cotton No. 2 futures contracts.
    For this exemption to remain in effect, NYCE must demonstrate on a
continuing basis that it meets the relevant statutory and regulatory
requirements. The Commission will monitor continued compliance through
its rule enforcement review program and based on any other information
it may obtain about NYCE's program. Although the Commission has found
that NYCE meets the standards of independence and continual provision
of data to the extent practicable and has found that it is not
practicable at this time to capture a broker receipt time, the
Commission reserves the ability to reconsider what is practicable as
technology for order routing and trade reporting becomes more widely
    The provisions of this Order shall be effective on the date on
which it is issued and shall remain in effect unless and until it is
revoked in accordance with Section 8e(b)(3)(B) of the Commodity
Exchange Act, 7 U.S.C. Sec. 12e(b)(3)(B). If other NYCE contracts
become affected contracts after the date of this Order, the Commission
may expand this Order in response to an updated petition that includes
those contracts.
    It is so Ordered.

    Dated: July 16, 1997.
Jean A. Webb,
Secretary to the Commission.
[FR Doc. 97-19177 Filed 7-21-97; 8:45 am]

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