UNITED STATES OF AMERICA
Before the
COMMODITY FUTURES TRADING COMMISSION

___________________________

In the Matter of :

Wayne I. Elliott

Francis Maritote, J. Brian Schaer, and : ������������ OPINION AND ORDER

Jonathan A. Sion,

Respondents.

___________________________:

The Division of Enforcement ("Division") appeals from an Administrative Law Judge's dismissal of a three-count complaint charging respondents with trade practice violations in connection with 32 trades involving March 1991 wheat futures on the Chicago Board of Trade ("CBOT"). The December 1994 complaint charged respondents with violating Section 4c(a)(A) of the Commodity Exchange Act ("CEA" or the "Act"), 7 U.S.C. � 6c(a)(A) (1994), by engaging in wash sales, violating Section 1.38(a) of the Commission's Regulations, 17 C.F.R. � 1.38(a) (1997), by executing noncompetitive trades, and violating Section 4c(a)(B) of the Act, 7 U.S.C. � 6c(a)(B) (1994), by causing non-bona fide prices to be reported. Following an evidentiary hearing, the ALJ found that the evidence adduced by the Division was insufficient to sustain those charges.

The Division challenges both the ALJ's factual findings and his legal analysis and contends that the ALJ committed reversible error by discounting the probative value of the Division's body of circumstantial evidence and instead crediting respondents' assertion that the trades were competitively executed. Based on our independent review of the record, we agree that deference to the ALJ's assessment of the record is inappropriate in this case. As explained more fully below, we reverse the initial decision, order each of the respondents to cease and desist from future violations of the Act and Commission regulations, impose six-month suspensions on each of the respondents, and assess civil monetary penalties in the amount of $50,000.

BACKGROUND

Wheat Trading and the Delivery Cycle

The transactions at issue are spread trades in the CBOT wheat futures contract.⁽¹⁾

Delivery months for the CBOT wheat futures contract are March, May, July, September and December. The futures delivery month that is closest to maturity is designated the "nearby month." The more distant futures delivery month is designated the "deferred month." Glossary at 13. Buying the nearby month and selling the deferred month is known as "buying the spread," while the reverse is called "selling the spread."

At the CBOT, long position holders are assigned delivery on a "first in-first out" basis. Thus, the buyer with the oldest open long contract receives the first delivery notice, and the buyer with the next oldest open contract receives the next delivery notice. CBOT Rule 1048.01.⁽²⁾ This sorting of all the long position holders results in a delivery line arranged in chronological order with the trader holding the oldest open long position located at the front of the line and the trader holding the most recently purchased long position at the back of the line.

The CBOT reports positions in the delivery line in the "Deliveries Last Trade Date Assigned" Report. Another CBOT report, the "Issue and Stop Listing," is published on a daily basis, beginning on the first notice day and ending on the last calendar day of the delivery month. For each clearing firm, the report tallies the total number of bushels contained in the delivery notices that the clearing firm issued on the previous day. It also provides the total number of bushels contained in the delivery notices that the clearing firm received, or "stopped," on the previous day. Tr. at 94, 179-80, 536-39, 549-52, 553-54, 558, 573, 622-24, 641-43, 776-77, 778.

The success of some trading strategies depends on the trader's ability to maintain a long position until late in the delivery month without taking delivery. Moving to the back of the delivery line permits a long trader to maintain his or her position by deferring delivery. To achieve the goal of moving to the back of the delivery line, the trader must liquidate his or her original long position and then establish a new long position. If the market moves significantly between the liquidation of the original long position and the opening of a new position, the trader may suffer a loss on his or her overall position. If the trader fails to move to the back of the delivery line, however, he or she may be forced to accept delivery.⁽³⁾

A trading strategy known as "freshening" is used by long position holders who want to maintain their positions until late in the delivery month. Because delivery is assigned to buyers on a first in, first out basis, a trader who wants to maintain long positions will act to move to the back of the delivery line. The trader liquidates his or her current position, offsetting it against his or her oldest position in the same contract and establishing an equivalent long position in the same contract. Because the new position has been established later in time, the trader defers the assignment of delivery.⁽⁴⁾

Many traders elect not to hold open positions in the delivery month or are prohibited by their clearing firms from trading during the delivery period because of credit requirements associated with carrying the cash commodity. Thus, the number of traders active in March 1991 wheat decreased as delivery approached. During the time period at issue, the number of participating traders ranged from 41 on February 26 to seven on March 13. Division Ex. 14; Resp. Ex. D.

The Challenged Trading

During the relevant time period, all four respondents were members of the CBOT and were registered with the Commission as floor brokers. Each of the respondents was an active trader in large volume spreads, and all held long positions in the March 1991 contract and short positions in the May and July 1991 contracts.

The challenged trades occurred between February 25 and March 13, 1991. All but one of the trades exceeded the Commission's large trader reporting level of 500,000 bushels, and each of the trades accounted for a significant percentage of the March 1991 volume on the dates in question. Rooney, Verified Statement at 54 ("Rooney"). The trading cards for each of the respondents for their wheat spreads during the February-March 1991 delivery period revealed 32 trades in which respondents, in various combinations, each bought and sold identical quantities of the same spread at identical differentials. In each trade, three of the four respondents were able to move to the back of the delivery line without suffering a loss. None of the respondents realized a profit or incurred a loss on these trades, and no traders other than respondents participated in the trades.

The Division's Evidence

The Division did not challenge the legitimacy of freshening as a trading objective, but asserted that respondents had used unlawful means--prearranged wash sales--to accomplish that trading objective. Hugh Rooney, a supervisory trading investigator for the Division, gave expert testimony at the hearing. In reaching his conclusion that respondents' trading was more likely noncompetitive than competitive, Rooney analyzed trading cards and daily trading statements for each of the respondents for each of the trading days at issue. He also made a comprehensive examination of the specific components of each of the challenged trades, including the date and time bracket of execution, quantity traded and differential price for each trade.⁽⁵⁾ Rooney observed that respondents were able to obtain significant liquidity during an illiquid period. He also found that, in each of the challenged transactions, the participating respondents were able to obtain a wash result.⁽⁶⁾

Rooney also found it significant that, although there was a large population of active wheat traders in the pit during part of the relevant period, no other traders participated in the challenged trades.⁽⁷⁾ Rooney at 56-58. In this regard, he testified that, while the trades probably were done audibly and visibly, the fact that no other trader "jumped in" suggested to him that the outcry was not genuine. Tr. at 197-200.

Rooney also described a number of audit trail irregularities and deficiencies relating to the trades. Although he conceded that occasional recordation mistakes occur during periods of price volatility, he testified that the specific irregularities suggested noncompetitive trading since no price fluctuation was involved. He testified that many of the trade initiations and offsets were recorded on consecutive lines or on the same trading card, from which he concluded that the trades were executed serially or simultaneously. Rooney at 18, 63-64. In his opinion, independent, competitive trades would have been executed at different times. Finally, Rooney gave his opinion that respondents shared a motive to avoid market risk in freshening their positions, which provided an incentive for these respondents to enter into an arrangement for noncompetitive trading. Tr. at 192-93.

At the hearing, the Division established that on at least one of the days at issue respondent Schaer engaged in freshening for which he was not charged with noncompetitive trading. The characteristics of that incident of freshening differed markedly from the characteristics of the challenged trading. On February 27, 1991, the first position day for the March 1991 wheat contract, Schaer's freshening of 1,010,000 bushels involved ten round-turn trades opposite ten other traders over several time brackets and at slightly different prices. Tr. at 54-58.

In a charged trade on the same date, respondent Elliott sold respondent Sion 2.5 million bushels of the March-May spread in a single trade. The Division established that Maritote needed less than 1.5 million bushels to get behind the delivery line, but nevertheless bought from Sion the 2.5 million bushels that Sion needed to get behind the delivery line. Maritote then sold Elliott 2.5 million bushels of the March-May spread in two transactions. Tr. at 509-510. All the transactions were executed over three trade brackets, at the same differential with no profit or loss for any of the respondents. Maritote stated that he was willing to take on this large position because he knew he could "lay it off" on Elliott, who was also bidding. Tr. at 514.

Respondents' Evidence

At the core of respondents' case is their contention that the challenged trades were entered into with a legitimate market purpose.⁽⁸⁾ Each testified that his trading was independent, open and competitive, and all respondents denied prearranging any of the challenged trades. They maintained that each of them was able to estimate the others' trading needs, either through publicly available delivery information or intelligent observation. Thomas Willis, a veteran CBOT trader who testified as an expert, reviewed the investigative statements of the four respondents as well as some of the trading cards for the challenged trades. Willis testified that he saw no evidence of noncompetitive trading. Tr. at 875.

Respondents also offered a series of character witnesses who attested to respondents' reputations for honesty and integrity. Stan Komparda remembered observing respondents trading to freshen their positions at the time relevant to the complaint. He testified that he remembered this trading because it was unusual that all four were trading the expiring option, and he specifically recalled that they were bidding and offering by open outcry. Tr. at 741-45. Like other exchange members who testified on behalf of respondents, Komparda saw nothing unusual about the configurations illustrated by Rooney's diagrammed trades. Both Komparda and another witness testified that they believed that they could have participated in these trades. Tr. at 745-47, 758.

The Initial Decision

The ALJ found that respondents had testified truthfully that all their trades were executed competitively by open outcry and that any trader present in the pit had an opportunity to participate in the challenged trades. Initial Decision at 5. He concluded that the pattern and configuration of the challenged trades reflected respondents' knowledge that a buy or sell order by one of them would likely be followed by a reverse transaction in order to get behind the delivery line, and he credited respondents' assertion that the trading information available to them enabled respondents to anticipate each other's trading needs.⁽⁹⁾

The ALJ criticized the Division's failure to present direct evidence of prearrangement and declined to infer prearrangement from the seven "significant characteristics" identified by Rooney:⁽¹⁰⁾

Taken as a whole, these characteristics do not prove that the challenged transactions were the result of an implied or express agreement to prearrange trades. The trade characteristics cited by the Division reflect a natural outcome of trades that can occur in a constricted market among perceptive and intelligent large volume traders who want to secure a later delivery date.

Initial Decision at 11.⁽¹¹⁾ He concluded that "traders who abide by the rules of the marketplace should not be punished for their perception and intelligence." Id. at 12, citing In re Angelo, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 24,943 at 37,436 (Initial Decision Oct. 19, 1990, summarily aff'd March 24, 1993). In this connection, the ALJ emphasized his obligation to "refrain from drawing lines that will have the effect of outlawing legitimate economic behavior." Id. at 8, citing In re Buckwalter, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 24,995 at 37,684 (CFTC Jan. 25, 1991).

The Parties' Arguments on Appeal

The Division urges on appeal that the ALJ's factual findings and legal analysis reflect clear error and are not entitled to deference. It cites two "central issues of fact" on which it contends that the ALJ erred. First, the Division contends that the record does not support the ALJ's finding that each respondent could rely on publicly available delivery information to estimate the other respondents' open positions and the volume the others would need to trade in order to move to the back of the delivery line. The Division emphasizes that the CBOT's Issue and Stop Listing was unavailable on at least some of the trading days at issue and on other relevant days contained only partial data. Similarly, the Division argues that the ALJ's finding of a constricted market is only partially supported by the record. The Division emphasizes that there were trading days early in the delivery cycle for March wheat on which both the number of traders and the volume of trades were substantial. DOE Br. at 29.

Turning to the ALJ's legal analysis, the Division asserts that he erred principally by: (1) failing to consider motive in determining whether respondents' knowingly participated in noncompetitive trading; (2) concluding that the fact of open outcry negates any inference that the challenged trades were executed noncompetitively; and (3) assuming that a liability finding in this case would act as a de facto ban on the practice of freshening.

Respondents counter that the ALJ committed no error warranting reversal. They maintain that the Division failed to prove prearrangement by the weight of the evidence and suggest that the "suspect circumstances" described by the Division do not support a finding of liability. Resp. Br. at 14-15, citing Buckwalter, � 24,995; In re Rosenberg, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 24,992 (CFTC Jan. 25, 1991); In re Gilchrist, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 24,993 (CFTC Jan. 25, 1991).

Respondents contend that the evidence shows, and the ALJ reasonably found, that respondents were large volume wheat traders, each of whom independently believed he could make money by holding a March-July bull spread or a long March position as close as possible to the expiration of the March contract and three of whom, by competitive trading, freshened their March long positions to avoid delivery. Doing so, respondents maintain, was a legitimate trading practice in the CBOT grain pits during every delivery cycle. In the absence of other interested market participants, respondents argue, they had no choice but to trade among themselves, and the characteristics shared by the challenged trades were the "inevitable consequence of legitimate market activity." Resp. Br. at 26.

In urging deference to the ALJ's decision, respondents emphasize Commission precedent holding that an ALJ's credibility determinations are entitled to deference. See In re Citadel Trading Co., [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 23,082 at 32,190 (CFTC May 12, 1986). Respondents emphasize that, when an ALJ expressly finds one witness more credible than another, the Commission traditionally has accorded that finding the "highest degree of deference." Buckwalter, � 24,995 at 37,682. Moreover, respondents contend that this deference should extend to the scope of inferences drawn from the record so long as there is sufficient analysis of the reliability of those inferences. Rosenberg, � 24,992 at 37,643. Respondents maintain that the Commission's recent decision to discontinue its practice of deferring to an ALJ's assessment of sanctions does not purport to change the degree of deference customarily accorded to an ALJ on other matters. In re Grossfeld, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) � 26,921 at 44,467 (CFTC Dec. 10, 1996).

DISCUSSION

Prearranged trading is a form of anticompetitive behavior that violates Commission Regulation 1.38, 17 C.F.R. � 1.38 (1997). In re Gimbel, [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 24,213 at 35,003 (CFTC Apr. 14, 1988). A prearranged transaction "negates both the risk and price competition incident to an open outcry market." Id.⁽¹²⁾ In the Division's view, the common characteristics of the 32 challenged trades (size, configuration, limited participation, and wash results), combined with evidence of common motivation and the presence of audit trail irregularities, form a body of circumstantial evidence that compels the conclusion that the trades were executed noncompetitively.

The ALJ criticized the Division's failure to present direct evidence that respondents prearranged trades in order to exclude other market participants. Initial Decision at 7. However, as the Commission has repeatedly found, direct evidence of noncompetitive trading is rarely available, and the circumstantial analysis of trading patterns is an appropriate starting point for proving noncompetitive trading. To prevail in a circumstantial case, the Division must show that respondents more likely than not knowingly participated in prearranged trades. Rosenberg, � 24,992 at 37,643. Once the Division has established a prima facie case, the analysis must focus on respondents' explanation of the challenged trades. In re Bear, Stearns & Co., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 24,994 at 37,663 (CFTC Jan. 25, 1991).

The ALJ correctly observed that illegal conduct cannot be inferred from the fact that respondents entered into the challenged trades for the purpose of moving to the back of the delivery line. Initial Decision at 7. The Commission previously has found "no principled incompatibility between the motive of trading to get behind the delivery line and an intent to make a bona fide market transaction." In re Collins, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 22,982 at 31,903 n. 25 (CFTC Apr. 4, 1986), rev'd on other grounds, Stoller v. CFTC, 834 F.2d 262 (2d Cir. 1987). However, prohibited trading techniques are not made lawful because they are done for a legitimate market purpose. Collins, � 22,982 at 31,900; cf. In re Murphy, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 22,798 (CFTC Sept. 25, 1985). The question before the Commission is whether the ALJ properly determined on the record that the Division's circumstantial evidence was insufficient to support a finding of noncompetitive trading by respondents.

The Common Characteristics of the Challenged Trades

On eight trading days between February 25 and March 13, 1991, three of the respondents were able to sell and repurchase large volume March-May or March-July wheat spreads in equal quantities at the same price differential without suffering a loss, making a profit, or changing their net position. The configurations of the charged trades reflect a precision and symmetry not generally found in competitively executed trades. As the Division's expert noted, ". . . since price should be the only reason to prefer one trader over another trader, competitive trading is usually dispersed among numerous traders and brokers." Rooney at 59. The characteristics of the charged trades are, moreover, markedly different from those of at least one respondent's freshening trades that did not involve the other respondents. See discussion supra, at p. 7.

In the charged trades, each participating respondent needed to sell the spread in order to repurchase it and move to the back of the delivery line for March wheat. Nevertheless, in each set of trades, at least one respondent entered the market buying the spread--sometimes in excess of what he needed to get behind the line--and increasing the size of his existing position.⁽¹³⁾ Because respondents were attempting to freshen their positions, the trading of such large positions--sometimes in excess of what was needed to get behind the delivery line--created an unusually large risk. Moreover, the initial trade in a move to freshen one's position is unalterable: once the trade is made, it cannot be undone. If a single respondent in the ring-like transaction failed to play his part, none of the respondents would succeed. In these circumstances, it is unlikely that a trader would repeatedly act against his own economic interest without advance knowledge that the other participating respondents would continue trading the spread, enabling him to offset his newly-acquired long position.

A pattern of interrelated trading characterized by uniform conduct of the participants is a critical element of noncompetitive trading. The Commission has found that a similar trading configuration was consistent with the inference that the trades were interrelated, prearranged and intended to result in a wash of the individual positions. Gimbel, � 24,213 at 35,004; see also Collins, � 22,982 at 31,900 n.16; Gilchrist, � 24,993 at 37,651. Respondents explain--and the ALJ agreed--that the size, configuration and limited participation common to the challenged trades are attributable to the fact that no other traders were interested in participating in the trades. In this regard, the ALJ found that the market was naturally constricted during the delivery period. He further found evidence that these trades were executed by open outcry and concluded that that evidence lent support to respondents' claim that other traders were not excluded.⁽¹⁴⁾

That the trades appear to have been made with the formality of open outcry in the pit does not compel the conclusion that the trades were competitive. The Commission previously has cautioned that, "because a wash trader is often in an excellent position to create a false appearance of bona fide trading, evidence consistent with the appearance of lawful market activity does not necessarily negate an otherwise valid inference that traders were knowing participants in wash sales." Bear Stearns, � 24,994 at 37,663. Thus, the existence of outcry in the pit is "only the beginning of a meaningful analysis of a transaction's validity under Commission Rule 1.38." Buckwalter, � 24,995 at 37,683. The essential characteristic of a wash sale is the intent not to make a genuine, bona fide transaction.

The Commission in Bear Stearns, � 24,994 at 37,663, observed that in a wash sale a trader gives the appearance of submitting trades to the open market.

His actual intention at the time he initiates the transaction, however, is to both buy and sell the contract at the same or a similar price--in other words, to create a financial and position nullity extraneous to the price discovery and risk-shifting functions of the futures markets. The intentional creation of such a nullity cannot be deemed a bona fide futures transaction, even where the trader's facially independent purchase and sale are executed by open and competitive outcry in the appropriate trading pit. Indeed, "[i]n order to obscure his unlawful purpose, a wash trader will seek to achieve his goal in a manner that preserves the appearance that the transaction was the result of lawful market activity." In re Citadel Trading Co., � 24,082 at 32,190.

Bear Stearns, � 24,994 at 37,663.

In Gilchrist, � 24,993 at 37,653, the Commission found an absence of intent to undertake a bona fide trading transaction where the transactions were "structured in a manner to negate price competition or market risk." While the transactions at issue here appear to have been "cried out," the absence of any profit or loss to any of the respondents in any of the 32 transactions supports a conclusion that the trades were not competitively executed.

Respondents' claim--credited by the ALJ-- that they were the "only game in town" during the delivery period is not supported by the record. Although the market became more constricted as the delivery period progressed, the number of traders buying and selling the March spread peaked on the first three days referenced in the complaint. On February 25 there were 32 traders trading the March spread, and on February 26 and 27 there were 41 traders participating.⁽¹⁵⁾ DOE Ex. 14 at 57. The ALJ's decision neither recognizes this distinction nor addresses how an open and competitive market could so precisely accommodate the financial and timing goals of four traders acting independently of each other. In re Buckwalter, � 24,995 at 37,684 (prearranged trading is "the best explanation for respondents' uncanny ability to anticipate (and benefit from) a level of liquidity that was not generally available to most traders in the [CBOT] wheat pit.").

The ALJ's analysis adopted respondents' explanation that the pattern of trading reflects the fact that they "knew that a buy or sell order by one of them would likely be followed by a reverse transaction in order to get behind the delivery line." Initial Decision at 11. However, as the Division observes, the fact that trader "A" sells a March-May spread to trader "B" would not inform trader "A" that trader "C" would be willing to sell the identical quantity of the same spread back to him. Div. Br. at 35. The ALJ further reasons that respondents could determine their position in the delivery line from the Deliveries Last Trade Date Assigned Reports. From that report, the Issue and Stop Listing and their own observation, the ALJ concluded that each respondent could estimate the open positions of the other respondents and anticipate the volume that the others would need to trade in order to freshen. "With these circumstances as a backdrop, it is not surprising that the [r]espondents bought from and sold to each other an equal quantity of the March spread without earning a profit or incurring a loss." Initial Decision at 11.

While the Issue and Stop Listing might have permitted respondents to estimate one another's positions, it would not have revealed the exact quantities involved. Moreover, the Issue and Stop Listing for the March 1991 wheat contract was not released until February 27 and thus was not available to respondents on the first two days charged in the complaint. Resp. Ex. F. In addition, the Issue and Stop Listings did not reflect any delivery notices for respondents' respective clearing members until March 1 for Maritote and March 4 for the other three respondents. Resp. Ex. F. Thus, respondents would have been unable to use this tool to estimate position totals on the first four trading days charged in the complaint.

We agree that there may be circumstances in which intelligent, experienced traders can, as a result of familiarity with the market and its participants, independently predict other traders' responses to the establishment of a certain position. However, the characteristics of the challenged trades required analysis by the ALJ as to whether respondents' parallel freshening of positions was the result of independent activity or was facilitated by an express or tacit agreement to achieve a noncompetitive result. That respondents were able to estimate one another's trading needs with exact precision strongly suggests that such results were not the result of independent activity. The Division has demonstrated that the delivery information on which respondents claim to have relied was not public on several of the charged trading days. In addition, respondents were able to trade large volumes--sometimes in excess of what they needed to get behind the delivery line. In each of the 32 charged sequences respondents "achiev[ed] uniformly matching results." Div. Br. at 30-33.

Common Motivation

Participation in trades that achieve closely matched and precisely timed results "takes on additional meaning . . . when the record establishes . . . a likely motivation for participants to arrange for the results reflected in the pattern. . . ." Buckwalter, � 24,995 at 37,684; see also Bear Stearns, � 24,994 at 37,663. In addition to the configuration of the trades, the Division offered an "obvious motive commonly understood by all of the traders involved." DOE Appeal Br. at 21. Three of the respondents stood to profit from the narrowing spread if they were able to freshen their existing long positions without incurring substantial losses. By selling and then repurchasing March-May or March-July spreads to and from each other and Maritote, they were able to move to the back of the delivery line for March wheat, avoiding delivery and increasing their potential profits as the spread narrowed.

Moreover, because there were relatively few traders in the pit near the end of the delivery cycle, respondents' trading was necessarily interdependent: the conduct of one trader certainly would affect the behavior of the others. Once a freshening trader offsets his old position, he must find a trader willing to enter into an opposite transaction at a price equal to the price of the trade just made. In an increasingly illiquid market, that trader's success depends on other traders' willingness to provide quick liquidity to the market. Given the large positions held by each of the participating respondents and the volatility of the March spread market, respondents' interdependence was clear. Early in the delivery cycle, when the contract was more liquid, respondents may have been less dependent on each other and may have had less motivation to prearrange trades. However, the more likely conclusion is that these traders were interdependent throughout the entire delivery period. The record indicates that there was an abundance of "off-grade wheat" in the market during the February-March 1991 delivery cycle, and thus respondents had an unusually compelling motivation to insure that they would be able to freshen and avoid delivery. Tr. at 626.

The circumstantial evidence surrounding these trades supports the conclusion that the challenged trades were prearranged. The series of steps taken by respondents to execute the challenged trades exhibited parallel and mutually beneficial courses of action. Respondents' motive was clear, and the opportunity was present. Based on the totality of the circumstantial evidence in the record, it is unlikely that respondents could have known one another's precise needs without some meeting of the minds or could have achieved, this kind of trading symmetry in a volatile market by competitive execution. In these circumstances, we find that the ALJ erred in discounting the probative value of the Division's body of circumstantial evidence and relying instead on respondents' assertion that the trades were competitively executed.

Absent clear error, the Commission generally defers to the ALJ on matters relating to the credibility of witnesses. Gimbel � 24,213 at 35,003; cf. Buckwalter, � 24,995 at 37,686. Where as here, the ALJ's credibility findings are strongly contradicted by other compelling evidence, and the issue to be decided involves derivative inferences rather than testimonial inferences, the Commission will review de novo the inferences to be drawn from the record. See N.L.R.B. v. Stor-Rite Metal Products, Inc., 856 F.2d 957, 964 (7th Cir. 1988); Kacem v. Castle Commodities Corp., [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) � 27,058 at 45,030 (CFTC May 20, 1997). Based on our independent assessment of this record, we find that deference to the ALJ's inferences would be misplaced and reverse the Initial Decision.

The Division has established that respondents failed to execute the 32 charged trades openly and competitively as required by Commission Regulation 1.38(a). The interrelationship of these trades, illustrated by precise and symmetrical configurations, the exclusivity of trading among the four respondents, and the absence of profit or loss incurred, compels the conclusion that the trades were prearranged by respondents. Respondents claimed that the configuration of these trades was the product of experience, insight, and publicly available trading data and, moreover, that they traded only among themselves as a matter of necessity. While experience and trade data might be useful in predicting the approximate size that another trader might intend to trade, these tools do not explain the accuracy with which respondents were able to buy and sell precisely offsetting quantities in all 32 of the charged trades. Respondents' contention that they were the "only game in town" is not borne out by the record. Although there were relatively few traders in the wheat pit on the last two of the charged trading days, respondents' noncompetitive trading commenced on February 25, when there were as many as 41 traders in the pit, and continued throughout the eight charged days.

Freshening, when accomplished through open and competitive trading, serves a legitimate market purpose. However, a lawful economic purpose does not legitimize prohibited trading techniques. Collins, � 22,982 at 31,900. A prearranged transaction that is accomplished in the pit is a fictitious sale within the meaning of Section 4c(a)(A) of the Act, and "when a prearranged transaction in the pit is structured to produce a wash result, it is both a fictitious sale and a wash sale under Section 4c(a)(A)." Gimbel, � 24,213 at 35,003. Because the trades were not executed openly and competitively, the prices reported from those trades were not bona fide. Accordingly, respondents are also liable for violations of Section 4c(a)(B). Gilchrist, � 24,993 at 37,653.

SANCTIONS

Sanctions in Commission enforcement proceedings are imposed to "further the Act's remedial policies and to deter others in the industry from committing similar violations." In re Volume Investors Corp., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 25,234 at 38,679 (CFTC Feb. 10, 1992). In determining the appropriate level of sanctions, the Commission focuses on the relative gravity of a respondent's misconduct in light of the following factors: (1) the relationship of the misconduct to the regulatory purposes of the Act; (2) the respondent's state of mind; (3) the consequences flowing from the violative conduct; and (4) the respondent's post-violation conduct. In addition, the Commission considers any mitigating or aggravating circumstances presented by the facts. Id. In connection with the imposition of civil monetary penalties, the Commission also has considered whether the misconduct was intentional or willful, the number and duration of the violations, and whether the respondent acted in concert with others. See A Study of CFTC and Futures Self-Regulatory Organization Penalties, 2 Comm. Fut. L. Rep. (CCH) � 26,264 at 42,219 (CFTC Nov. 1994); CFTC Policy Statement Relating to the Commission's Authority to Impose Civil Money Penalties and Futures Self-Regulatory Organizations' Authority to Impose Sanctions: Penalty Guidelines, 2 Comm. Fut. L. Rep. (CCH) � 26,265 at 42,247 (CFTC Nov. 1994). Based on our assessment of these factors, we impose the following sanctions.

1. Cease and Desist Order

A cease and desist order is particularly appropriate where, as here, there is a reasonable probability that a respondent will again engage in unlawful conduct. Respondents, when holding a large quantity of wheat for which they might have to take delivery, repeatedly engaged in noncompetitive trading to freshen their positions while limiting their risk. They have urged consistently that the trading characteristics identified by the Division are endemic to freshening and have suggested that the benefits of freshening to the marketplace as a whole somehow justify the noncompetitive execution. In these circumstances, it is reasonable to assume that respondents will continue to engage in unlawful prearranged trading in order to accomplish freshening. Accordingly, respondents are ordered to cease and desist from further violations of Commission Regulation 1.38(a) and Sections 4c(a)(A) and 4c(a)(B) of the Act.

2. Trading Prohibition

By definition, respondents' violations of Sections 4c(a)(A) and 4c(a)(B) impacted the integrity of the market by significantly inflating the volume in the wheat spread on the charged days. Although the trading did not involve customer accounts, a clear nexus to marketplace integrity has been established, and we impose on each respondent a six-month trading ban. See Citadel Trading, � 23,082 at 32,191; cf. In re Murphy, � 22,798 at 31,355.

3. Civil Monetary Penalties

Sanctions imposed in an enforcement proceeding should be commensurate with the gravity of the violation. In re Brody, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) � 23,081 at 32,181 (CFTC May 20, 1986). Violations such as these involve noncompetitive trading and harm to market integrity and thus implicate core provisions of the Act and Commission Regulations. They are not mitigated by the fact that the challenged trades caused no specific, quantifiable injury to particular customers or other traders. Buckwalter, � 24,995 at 37,688. In these circumstances, a civil monetary penalty of $50,000 for each respondent is commensurate with the gravity of their conduct and consistent with sanctions imposed in recent trade practice cases.

CONCLUSION

In light of the foregoing, the ALJ's Initial Decision is reversed, and respondents are hereby ordered to cease and desist from further violations of the Act and Commission Regulations. The trading prohibitions and civil penalties shall become effective 30 days from the date this order is served.⁽¹⁶⁾

IT IS SO ORDERED.

By the Commission (Chairperson BORN and Commissioners HOLUM and SPEARS).

Commissioner TULL, dissenting.

________________________________

Jean A. Webb

Secretary of the Commission

Commodity Futures Trading Commission

Dated: February 3, 1998

In the Matter of Wayne I. Elliott, et al. CFTC Docket No. 95-1

Commissioner John E. Tull, dissenting

This is a case based on circumstantial evidence. I recognize that in many of our trade practice cases, circumstantial evidence is the primary�sometimes even the only�basis for proving the alleged violations. In those instances, we must decide the case by drawing inferences from the evidence in the record. Such is true in this case. As we recently stated:

To succeed in a circumstantial approach, however, the Division [of

Enforcement] must do more than present suspicious circumstances suggesting the possibility of knowing wrongdoing. It must establish that "the existence of these factual elements is more probable than their nonexistence."

In the Matter Rousso, et al., [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) � 27,133 at 45,308 (CFTC Aug. 20, 1997) (citations omitted)

I am not persuaded by the Division's evidence that the alleged violations probably occurred in this instance. Therefore, I differ with my fellow Commissioners here on the interpretation of what inferences should be drawn from the circumstantial evidence presented by the Division of Enforcement. Accordingly, I would vote to affirm the ALJ's finding that no trading violations have been proven by the evidence in the record.

This agency has long acknowledged that "experienced professionals cognizant of the customs of the pit, the members of the Floor Governors Committee are in the best position to draw inferences from evidence presented to them." In the Matter of Malato, [1987-1990 Transfer Binder] Comm. Fut. L. Rep (CCH) � 24,084 at 34,708 (CFTC Dec. 22, 1987). As a former trader myself, I believe that I am uniquely qualified among my fellow Commissioners to interpret the implications and inferences of the trading activity that lie at the heart of this case.

There is no dispute that it is permissible to "freshen" a position, as the traders did here. The majority argues that these individuals merely used illegal methods to achieve the freshening. I do not believe the evidence supports their view. The traders gave direct testimony that they did not engage in improper methods to freshen their positions.

In layman's terms, the majority engages in "second guessing" the activities and intentions of the traders in this case. In so doing, they ignore the findings of the ALJ based on

his first-hand observation of the demeanor of the traders and other significant evidence supporting the credibility of the traders:

1) the ALJ found the four individuals charged to have "testified truthfully;" (In the

Matter of Wayne I. Elliott, et al., CFTC docket No.95-1, ALJ's Initial Decision,

September 11, 1996, � 28 at 5),

In the Matter of Wayne I. Elliott, Commissioner Tull, dissenting

(Continued)

2) their Pit Chairman testified that they are all honest traders; (Id. � 27 at 5 and Tr.

588-591), and

3) this agency's Enforcement Division even stipulated that the Respondents "have high integrity and honest reputations as traders. They do. No question." (Id. � 27 at 5 and Tr. 729-730).

Admittedly, it is also possible to freshen by noncompetitive trading. As an experienced former professional trader, I simply do not agree with the majority's conclusions in this case.

On the facts presented, the Division of Enforcement has failed to convince me that such unlawful trading has been proven in this case. I believe that this freshening occurred by lawful means.

Since I concur with the ALJ in finding that the Division of Enforcement failed to meet its burden, I must respectfully dissent from the majority's opinion in this case.

BY: ________________________________ , February 2, 1998

John E. Tull, Jr.

1.