Rule Enforcement Review
I. Introduction - Purpose and Scope
The Division of Trading and Markets ("Division") has completed a limited-scope rule enforcement review of the Minneapolis Grain Exchange ("MGE" or "Exchange"). The purpose of the review was to evaluate the Exchange's trade practice surveillance and disciplinary programs for compliance with Sections 5a(a)(8) and 5a(b)(1) of the Commodity Exchange Act ("Act") and Commission Regulation 1.51.1 The review covered the period of July 1, 1997 to June 30, 1998 ("target period").
The Division's prior rule enforcement review of the Exchange was dated September 30, 1996 ("1996 Review").2 The 1996 Review was a Follow-Up Rule Enforcement Review to a September 14, 1995 review ("1995 Review), which included several recommendations for improvement to the Exchange's trade practice surveillance program. In the 1996 Review, the Division found that the Exchange had implemented each of the Division's recommendations, including enhancing its written guidelines for the initiation of trade practice investigations. In addition, the Division found that the Exchange opened a larger number of investigations, eliminated a backlog of old investigations, improved the timeliness of investigations, and conducted investigations that were generally thorough and well documented.
The Division also found, however, that in implementing its trade practice guidelines, the Exchange adopted an investigatory approach that may have unintentionally prevented staff from identifying potential trading violations and limited the number of possible substantive violations warranting further review. As a result, the Division recommended in the 1996 Review that the Exchange modify its guidelines to allow its investigators more latitude to exercise independent judgment in the identification of potential trading abuses. The Division also recommended that the Exchange, to the extent practicable, review all transactions that are identified by its automated trade surveillance system as potential substantive trading violations. By letter dated October 9, 1996, the Exchange represented that these recommendations have been implemented.3
In conducting this review, Division staff interviewed Exchange senior staff and reviewed the following Exchange documents:
The Division provided the Exchange with the opportunity to review and comment on a draft of this report on March 3, 1999. On March 9, 1999, Division staff conducted an exit conference with MGE staff to discuss the report's findings and recommendations.
III. Current Findings And Recommendations
Trade Practice Surveillance Program
· Disciplinary Action Program
IV. Trade Practice Surveillance -- Section 5a(b)(1) and Commission Regulations 1.51(a)(2), (4),(5) and (6)
Section 5a(b)(1) of the Act states that "each contract market shall maintain and utilize a system to monitor trading to detect and deter violations of the contract market's rules and regulations committed in the making of trades and the execution of customer orders on the floor or subject to the rules of such contract market." The system must include the commitment of resources necessary for a trade monitoring system to be effective in detecting and deterring trade practice violations, including adequate staff to develop and prosecute disciplinary actions; trade practice surveillance systems capable of reviewing, and used to review, trade data to detect possible violations; and physical observation of trading areas. In addition, Commission Regulation 1.51 requires that each exchange use due diligence in maintaining a continuing affirmative program for the surveillance of trading practices and the investigation of alleged or apparent violations.
The Vice President, Market Regulation ("Vice President") joined the Exchange in 1987 and assumed his current position in June 1991.5 The Vice President heads the Compliance Division ("Compliance"), which is comprised of two departments: Audits and Investigations ("A&I") and Exchange Room.6 A&I staff are responsible for surveillance and investigative matters, and Exchange Room staff are primarily responsible for capturing and disseminating price information on the trading floor.
The Vice President reports to the Exchange President and is responsible for the oversight and management of the Exchange's market surveillance, audit trail, trade practice surveillance, financial surveillance and disciplinary programs. The Vice President, among other things, determines whether an investigation should be initiated when questionable trading activity may be detected and establishes the scope of such investigations. In addition, the Vice President is responsible for the prosecution of possible trading violations before the Exchange's disciplinary committees.
Five investigators report to the Vice President. Investigators are responsible for conducting daily market and floor surveillance, analyzing financial statements, investigating possible rule violations that may arise from daily reviews or other sources, and preparing investigation reports. During the target period, the Exchange experienced a high turnover rate with respect to its Compliance investigators. Over the 12-month period, four investigators left the Exchange, including one that was hired during the target period, and two others were hired, leaving five investigators reporting to the Vice President at the close of the target period.7 Of the five, two are experienced investigators. One, the Compliance Supervisor, is an attorney and accountant. He was hired in February 1991 and is responsible for the training of staff investigators, providing guidance on surveillance matters and investigations, reviewing investigations, handling compliance issues in the Vice President's absence, and special projects. The second experienced investigator has a degree in agricultural economics and began his employment with the Exchange in March 1994 as a member of the Exchange Room staff. He joined Compliance as a staff investigator in August 1994. This investigator is also the Trading Floor Supervisor and, as such, has responsibility for the training of new Exchange Room staff, as well as overseeing floor operations during the trading session. He devotes approximately 80 percent of his time to A&I matters and 20 percent to floor operations.
The remaining three investigators joined Compliance during the target period. One received a degree in finance and began his employment with the Exchange in June 1997, also as a member of the Exchange Room staff. He became a Compliance investigator in August 1997. The fourth and fifth investigators both have degrees in economics and were hired in January and June 1998, respectively.
The very high turnover rate among investigators and the relative inexperience of the new investigators contributed significantly to delays in completing investigations of possible trading and other types of violations, as discussed below. Lengthy delays in completing investigations have a deleterious effect on the overall effectiveness of an exchange's rule enforcement program because, among other things, prompt investigation and disciplinary action are necessary to discourage further violations of exchange rules. In this connection, the Division believes that the MGE should examine the underlying reasons for the large number of staff departures over the target period. This examination should include an analysis of the Exchange's Compliance Division budget to ensure that, among other things, competitive compensation and benefits are being offered to retain qualified investigators.8
B. Trade Practice Surveillance
The Exchange's trade practice surveillance program generally consists of daily and monthly reviews of its trade register and other surveillance reports and daily floor surveillance. The Time Audit Report ("TAR"), the Exchange's trade register, and the Broker Error Type Report ("BETR") are the principal surveillance reports used to identify possible trade practice abuses and other trading irregularities.9 The TAR is a single report that combines the details of all futures and option trades with time and sales data. The report also contains error codes based on preset selection parameters that indicate possible substantive and trade timing rule violations that are reviewed by Compliance investigators.10 For example, error codes such as "ACC," "WSH," "BTA," and "STA" represent, respectively, transactions that may involve accommodation trading, wash trading, buy side trading ahead, and sell side trading ahead, while codes such as "BUT" and "SUT" indicate that a buyer or seller did not record a time of execution.11 The BETR, which is derived from the TAR, reflects a summary of each member's error codes and is produced and reviewed on a daily and monthly basis.
Under the Exchange's guidelines for initiating investigations, if the review of the daily BETR discloses that a member has a combined error code rate of 10 percent or more of his or her daily trades, staff conducts a review of the member's error-coded transactions. Notably, as recommended in the Division's 1996 Review, an investigator also can review a member's error codes, regardless of the threshold level, based on his or her analysis of the types of error codes revealed. In reviewing error codes, staff requests and reviews trading documents relating to each error code and annotates its findings directly on the TAR. If a possible trading abuse is uncovered after reviewing the documents, an investigation is initiated.
Compliance supplements its daily review with a review of the monthly BETR and utilizes the monthly report as a basis for examining further a member's trading activity. Members with a monthly combined error rate of five percent or more may be targeted for investigation if they are not already the subject of an investigation based on the daily 10 percent threshold. These investigations are opened at the discretion of the Vice President. The guidelines also call for investigations to be initiated if a member executes a customer trade without the proper registration and MGE membership; if a member or customer complaint or a Commission referral is received; and at the direction or request of the President of the Exchange and/or a committee, such as the Business Conduct Committee ("BCC").
Compliance maintains an investigation report that summarizes the details of each investigation. The report lists the file number assigned to the investigation, the source of the investigation, the member or clearing member under investigation, the initiation date, the date the investigation is submitted for supervisory review, the actual completion date, the initials of the staff investigator assigned to the case, the scope of the investigation, the rules and/or regulations violated, and any disciplinary action taken. Over the course of the target period, this surveillance resulted in 58 investigations opened, some of which are discussed below with respect to their thoroughness and adequacy.
C. Floor Surveillance
Staff investigators conduct floor surveillance during the openings and closings of all contracts and at three randomly selected times during the trading session. One staff investigator typically is present on the trading floor for 20 minutes at the opening and for 45 minutes at the close, which includes the post settlement session. There is no established time for floor surveillance during the trading session; rather, the length of surveillance is based on trading activity and market conditions at the time.
While conducting floor surveillance, staff investigators look for indications of, among other things, disclosure of orders, illegally executed ring (cross) trades, noncompetitive trading, improper bidding or offering, trading before the opening or after the close, and trades not executed by open outcry. In addition, staff monitors compliance with recordkeeping requirements, such as the manual recordation of execution times and the timestamping and collection of trading cards.
All floor surveillance activities are recorded in a "market log" by staff investigators. The market log lists the date and time period when floor surveillance was conducted, the number of brokers in the various pits at the time, possible trading infractions observed, and comments about market activity. Staff investigators also record the badge numbers of brokers present in a pit during several one-minute periods over the course of floor surveillance in a "pit population log." The pit population log is maintained as a record that can be used by Compliance, if necessary, to verify that a broker was in a particular pit at the time of a trade that is under investigation.
Staff investigators prepare five market and five pit population logs each day, one each during the open, the close, and at the three randomly selected times during the trading session. In addition, one market and one pit population log is prepared by the Exchange Room staff during the day. Therefore, a total of six logs of each type are prepared daily. Division staff reviewed 72 market and 72 pit population logs from 12 randomly selected trade dates during the target period and found that the logs reflect that floor surveillance was conducted during the openings, closings, and at random times during the day.12
During the target period, two investigations were initiated as a result of floor surveillance. Investigation #98-I-0010 was opened on February 16, 1998, and investigation #98-I-0021 was opened on April 24, 1998. Both involved improper bidding and offering in the pit and remained open at the close of the target period.13
D. Adequacy and Timeliness of Investigations
The Division found that Exchange investigations should be completed in a more timely manner.14 Forty-five investigations were closed during the target period, 20 of which were opened prior to the target period and 25 of which were opened during the target period. Twenty of the 45 investigations (44 percent) were completed within four months; seven (15 percent) were completed between four and six months; and 15 (33 percent) were completed between six months and one year. The three remaining investigations that were closed during the target period took more than one year to complete. In addition, at the close of the target period, 44 investigations remained open. Thirteen of the 44 investigations (30 percent) were open for less than four months; seven (16 percent) were open between four and six months; 14 (32 percent) were open between six months and one year; eight (18 percent) were open between one and two years; and two were open more than two years.15
The vast majority of the investigations that remained open beyond one year at the end of the target period (seven of the 10), including the oldest investigation open for 781 days, involve possible recordkeeping violations, non-reporting of trades, fictitious bids and offers, and clearing and delivery violations. These types of investigations typically are not complex in nature, do not require extensive analysis, and thus should be completed in a timely fashion. The three remaining investigations open beyond one year involve possible substantive violations, such as trading ahead of a customer, accommodation trading, wash trading, and improper transfer trades. These investigations were open for 739, 701, and 410 days, respectively, as of the close of the target period.16 Although these cases involve possible substantive violations, the Division could not identify significant reasons for their extended tardiness.
The Division reviewed 22 of the 45 investigations closed during the target period and the Exchange's log of open investigations and found that most of the delays in closing investigations can be attributed to four factors: (1) high staff turnover; (2) lengthy supervisory review; (3) delays in the reassignment of investigations upon the departure of staff members; and (4) Compliance staff time spent on other assignments, such as special projects and committee work. Fourteen of the 22 randomly-selected investigations were open beyond four months, and 13 of those 14 files contained memos to the files that indicated "unanticipated or unusual circumstances," such as training of new staff, participating in task force committees, and developing new contracts, as the reasons for the delays.17 In addition, eight of the14 files indicated that completion delays occurred because of lengthy time lags between first-line supervisory review and final review and sign-off by the Vice President.18 In this regard, based on a review of the eight file cover sheets,19 the Division found that the time between supervisory review and final review ranged from 74 days (#97-I-46) to 279 days (#97-I-06). The average time for review was 172 days or about six months.
Finally, the Division found that 15 of the 44 investigations open at the close of the target period were assigned to staff who left the Exchange prior to the completion of the investigations. Thirteen of these investigations were open beyond four months at the close of the target period. Three have been open between four and six months, four have been open between six months and one year, five have been open between one and two years, and one has been open beyond two years. On average, these investigations have been open for 328 days at the close of the target period. The Division believes that reassignment of an investigation should be done promptly in those instances where an investigator leaves the Exchange so that an investigation can be completed in a timely manner.
The Division is concerned generally that exchange investigations be completed in a timely manner for three reasons. First, as stated earlier, the Division believes that prompt investigations lead to prompt disciplinary actions, which are necessary to discourage continued violations of the same or similar rules. Second, unduly long delays often prove detrimental to the quality of an investigation and to an exchange's case because over time witnesses tend to forget or cannot recall the precise circumstances under which trades in question took place. Third, evidentiary trading documents necessary to the success of a case may have been misplaced or otherwise are unable to be located.
The Division recognizes that delays in completing investigations in a timely manner can occur from time to time due to unanticipated circumstances, such as high staff turnover and special projects. However, the assignment of special projects or training of new staff should not interfere with the normal functioning of the Compliance Division. By retaining qualified investigators, hastening the time between supervisory review and final review, and promptly reassigning investigations, the Exchange should be able to improve significantly its performance in this area.
During the target period, the Exchange opened 58 investigations. Twenty-two of the 58 (38 percent) resulted from routine reviews of the Time Audit Report; 14 (24 percent) resulted from routine trading card/order ticket reviews; 12 (21 percent) resulted from daily and/or monthly BETRs; five (nine percent) resulted from floor staff observations of decorum and dress violations by members of the Exchange room enforcement committee; two (three percent) resulted from A&I staff floor surveillance; one each resulted from a "delegate" review20 and a Division referral and one was categorized as "miscellaneous."
The Division reviewed the thoroughness and adequacy of the 22 closed investigations it randomly selected in conjunction with its timeliness analysis. Based on this sample, the Division found that, although many investigations were not completed in a timely manner, MGE staff conducted appropriate analyses and investigations were generally thorough and well documented. The Division notes, however, that most of the investigations were not of a complex nature. In addition, investigation files contained, among other things, copies of the relevant TARs, time and sales reports, computer-generated surveillance reports, pertinent underlying trading documents, workpapers, exhibits, summaries of interviews, and an investigation report, as required by Commission Regulation 8.07. The investigation reports reflected the reason the investigation was initiated, the facts surrounding the questionable trading activity, and staff's conclusions and recommendation as to whether any disciplinary action should be taken. The investigation report also summarized previous similar rule violations and disciplinary actions taken.
E. Conclusions and Recommendations
During the target period the Exchange experienced a very high turnover rate among its investigators. This severely impacted the overall level of staff expertise and, along with other factors, resulted in a significant number of investigations not being completed in a timely manner. Lengthy delays in completing investigations have an adverse impact on the overall effectiveness of an exchange's rule enforcement program because, among other things, prompt investigation and disciplinary action are necessary to discourage further violations of exchange rules. In addition, long delays often prove detrimental to the quality of the investigation and to a compliance department's case because over time witnesses tend to forget or cannot recall the precise circumstances under which trades in question took place.
At the close of the target period, the Exchange had eight investigations open between one and two years, and two open beyond two years. Seven of the ten investigations, including the oldest open for 781 days, are not complex in nature, do not require extensive analysis, and therefore should be completed in a much more timely fashion. Two of the three remaining investigations open beyond one year involved possible substantive violations, such as trading ahead of a customer, accommodation trading, and wash trading, and one involved possible improper transfer trades. These investigations were open for 739, 701, and 410 days, respectively, as of the close of the target period. Although these cases involve possible substantive violations, the Division could not identify any appropriate justification for their extended tardiness.
With the exception of the timeliness problem, the Exchange generally maintains an adequate trade practice surveillance program. Compliance investigators review daily the Exchange's trade register, which flags suspicious trades for further inquiry, and other computerized reports, in order to identify potential violations. Flagged trades that reach a particular threshold level, and those that do not reach that level but by their nature are deemed suspicious by a Compliance investigator, become the subject of formal investigations. These also represent two of the criteria for opening an investigation that are articulated in written guidelines that the Exchange enhanced in response to a Division recommendation in the prior rule enforcement review of the MGE. In addition, the Exchange conducts floor surveillance at various times during the trading session.
The Exchange's surveillance efforts resulted in the generation of 58 investigations of possible rule violations, including two from floor observations, during the target period. Notwithstanding the length of time needed to complete investigations, a review of 22 of the 45 investigations closed during the target period, most of which were not complex, revealed that appropriate analyses were conducted and that investigations were generally thorough and well documented.
Based upon these findings, the Division recommends that the Exchange:
V. Disciplinary Actions - Section 5a(b) and Commission Regulation 1.51(a)(7)
Under Section 5a(b) of the Act, an exchange's trade monitoring system must include appropriate disciplinary actions and meaningful penalties against violators. In addition, Commission Regulation 1.51(a)(7) requires that each exchange use due diligence in maintaining a continuing affirmative action program which results in prompt, effective disciplinary action for violations of exchange rules. When reviewing disciplinary programs, the Division considers, among other factors, the support for findings made in disciplinary actions, the adequacy of sanctions imposed, and the timeliness of the procedures.21 The Division also assesses compliance with Commission Regulations 8.09 and 8.17, which require, respectively, that disciplinary committees review investigation reports in a timely manner and issue either a notice of charges or a written decision stating the reasons why no further action will be taken and that hearings be convened promptly after reasonable notice.
A. Disciplinary Committees and Procedures
The Exchange has two primary disciplinary committees, the Futures Trading Conduct Committee ("FTCC") and the Business Conduct Committee ("BCC"). The FTCC has jurisdiction over all matters concerning futures and options trading, including consideration of possible trading violations, while the BCC has jurisdiction over all other potential violations, such as registration issues, position limits and margins. The FTCC and BCC members are approved by the Board of Directors ("Board").
The FTCC consists of seven members, of whom five are appointed by the Chairperson of the Board and two are ex officio, the Chairperson of the Board and the Exchange President. The BCC is comprised of seven members. Four of the members are appointed by the Chairperson of the Board. Three are ex officio, the Chairperson of the Board, the Chairperson of the Clearing House Committee and the Exchange President. The procedures detailed below generally are applicable to both Committees, as well as to deliberations by the Board. A Committee member may not participate as a member of the Committee if the Committee member has a financial, personal, or prejudicial interest or concern in the matter before the Committee. The Committees determine whether any of their members has such an interest or concern.22
Upon receiving an investigation report, the appropriate Committee may direct A&I staff to gather additional information, close the investigation because no reasonable basis exists for taking disciplinary action, issue a notice of charges, or send a reminder or warning letter. The notice of charges sets forth the alleged violative conduct, the rules and regulations believed to have been violated, and advises the respondent of his right to a hearing.23 The respondent has 10 days to file a written response and to request a hearing. Failure to respond within that time frame is deemed to be an admission of the charges and a waiver of the right to a hearing. At the discretion of the appropriate Committee, A&I may be given authority to negotiate and/or enter into a settlement with the respondent after a notice of charges has been issued.
Following a hearing, the Committee may close the case based upon its findings that no violations occurred or may take disciplinary action. If after a hearing conducted by the Committee, the Committee finds that there has been a violation, the Committee may issue a letter of reprimand, a suspension from membership, a monetary fine, or a recommendation to the Board for expulsion. Any suspension of 30 days or more, any fine of $10,000 or more, or any expulsion is subject to approval by the Board.24
The respondent can appeal the findings or penalty imposed by the Committee to the Board. However, appeals are heard at the discretion of the Board. The Board's decision on the appeal is based on the record of the Committee hearing. If the respondent does not file an appeal, the penalty becomes effective on the date set forth in the Committee's decision.
The Exchange has also established summary procedures under Regulation 2004.01 for the enforcement of most decorum violations, such as improper dress, smoking, gambling, and any other conduct or activity determined by the Board to be detrimental to a professional business environment on the Exchange floor.25 Unless a hearing is requested within 10 calendar days, failure to pay the scheduled fine within 30 days after the penalty is imposed will automatically double the amount of the fine. If the increased fine is not paid within 60 days after the original fine was imposed, the BCC may, without hearing, revoke or suspend floor privileges.
Possible decorum violations involving disorderly conduct and abusive language are not handled on a summary basis. These violations are investigated by the Compliance Division and may be referred to the BCC or FTCC for further action. The first infraction that involves physical contact or abusive or derogatory language is punishable by a fine of up to $500. If a second infraction occurs within two years of the first infraction, the BCC will forward a recommendation to the Board that the individual involved be suspended for a period of up to two weeks. The Board may also recommend that a fine be imposed.26
B. Adequacy of Sanctions
The Exchange did not refer any trade practice investigations to the FTCC during the target period. Consequently, because there were no sanctions levied for substantive trading violations over the 12-month review period, the Division is unable to evaluate fully the effectiveness of MGE's disciplinary program. A Notice Of Charges, however, was issued by the BCC after the target period as a result of investigation #98-I-0011, which was opened during the target period. In that case, the BCC charged a delegate member with violation of MGE rules for executing trades for an account other than his personal account without the benefit of owning a full membership.27 A hearing was waived by the delegate member, and the delegate member's settlement offer of $750 was accepted. A non-trade practice investigation, also open during the target period and referred to the BCC after the target period, resulted in a $50,000 fine against a member firm for reporting violations.28
Although there were no substantive trading violations considered by the FTCC, the Division did find that the Exchange issued staff reminder and warning letters to two brokers who had received multiple previous letters for possible violations of the same rule. The rule, 725.01, requires that members must report each trade to the market observer. The Division believes that monetary penalties or suspensions, rather than continued disciplinary letters, are essential successfully to curb recidivism.
Specifically, in one instance, investigation #97-1-0024, two brokers were investigated for possible violations of Rule 725.01 on April 18, 1997. The Exchange issued staff warning letters to both members on November 14, 1997, notwithstanding the existence of very disparate disciplinary histories among the brokers with respect to this particular rule. One member had received only one previous letter for possible violation of Rule 725.01, while the second had received a reminder letter in 1993, received three warning letters in 1994 and 1995, and was verbally reminded by the Vice President in June 1996 of the importance of complying with the rule.
In addition, in 1996, the latter member was fined $300 by the FTCC for the same violation, and in June 1998, no action was taken against the broker for the same violation since he had just received a warning letter for the April 18, 1997 occurrence. Given this broker's record of continued noncompliance, Division staff believes that the Exchange did not take appropriate disciplinary action by reverting back to a staff warning letter in November 1997 and by taking no action in June 1998. In circumstances such as this, progressively higher monetary penalties or suspensions would be a more effective self-regulatory response than the continued issuance of disciplinary letters.
In the second matter, investigation #97-I-0033, another broker received staff warning letters on November 18 and 24, 1997 for possibly violating Rule 725.01. These warning letters were issued despite the fact that previous staff warning letters for the same violation were issued on April 7, 1997, September 18, 1996 and November 30, 1994, and staff reminder letters were issued on November 24, 1993, September 22, 1992, and April 13, 1992. In addition, the broker received one staff reminder letter and one staff warning letter shortly after the close of the target period.29 Finally, in investigation #97-I-0009, a staff warning letter was issued on February 17, 1998 to an MGE clearing member for timestamping and clearing submission violations notwithstanding that it represented the firm's eighth warning letter for timestamping deficiencies and its ninth warning letter for clearing submission violations.30 The staff warning letter was issued for infractions noted during a review of the firm's trading activity of February 4, 1997. Sanctions are issued to deter future violations and to encourage compliance with MGE rules and regulations. The instances cited above demonstrate that the issuance of staff warning letters were not an effective deterrent based on the continued noncompliance with the same rules and regulations. Accordingly, the Division believes that the Exchange should establish written guidelines or promulgate rules which would severely limit the number of disciplinary letters that can be issued before the issuance of more meaningful sanctions, such as monetary penalties or suspensions.
C. Conclusion and Recommendation
The Exchange did not refer any trade practice cases to a disciplinary committee during the target period. Therefore, the Division is unable to evaluate fully the effectiveness of MGE's disciplinary program. However, the Division did find that the Exchange issued multiple staff reminder and warning letters for the same violation to three recidivists, rather than issuing monetary or other sanctions to deter continued violations. In this regard, the MGE needs to assess more meaningful penalties against repeat offenders.
Based on the foregoing, the Division recommends that the Exchange:
1 Rule enforcement reviews prepared by the Division are intended to present an analysis of an exchange's overall compliance capabilities for the target period under review. These reviews deal only with the programs directly assessed in the reviews and do not assess all programs. The analyses, conclusions and recommendations are based, in large part, on the evaluation of a sample of investigatory cases and other documents. This evaluation process, in some instances, identifies specific deficiencies in particular exchange investigations or methods, but it is not designed to uncover all instances in which an exchange does not address effectively all exchange rule violations or other deficiencies. Neither are such reviews intended to go beyond the quality of the exchange's self-regulatory systems to include direct surveillance of the market, although some direct testing is performed as a measure of quality control.
2 Copies of the 1995 and 1996 Reviews can be found in Appendix 1.
3 A copy of MGE's October 9, 1996 response letter can be found in Appendix 2.
4 A combination of random sampling and experienced judgment was used by Division staff in selecting files for review.
5 In February 1997, the Compliance Director's title was changed to Vice President, Market Regulation, by the Exchange President. The title change formally identifies additional duties the Vice President has assumed over time, such as responsibility for submission of proposed and amended rules and comment letters to the Commission that have an impact on the MGE.
6 The term "Exchange Room" refers to the Exchange's trading floor.
7 The four investigators that left the Exchange were relatively inexperienced. The first investigator was hired in November 1996 and left after seven months; the second investigator was hired in May 1997 and left after five months; the third investigator was hired in November 1996 and left after 13 months; and the fourth investigator was hired in September 1997 and left after 10 months.
8 Section 5a(b)(1)(E) of the Act requires that exchanges maintain and utilize a trade monitoring system to identify exchange rule violations and that exchanges should make the commitment of resources to such system necessary for that system to be effective in detecting and deterring violations, including adequate staff to develop and prosecute disciplinary actions.
9 Sample copies of the TAR and BETR can be found in Appendix 3.
10 To comply with the Commission's one-minute trade timing requirement, MGE members manually record trade execution times to the minute on trading cards for personal trades or on order tickets for customer trades. In this connection, in 1995, the Commission granted the Exchange a "small exchange" exemption from the Commission's dual trading restrictions.
11 These and other error codes are described in greater detail in Appendix 4.
12 Division staff reviewed logs for the following trading days: July 24, August 15, September 15, October 29, November 24, and December 3, 1997, and January 8, February 9, March 16, April 27, May 8, and June 18, 1998.
13 Both investigations were subsequently closed on December 31, 1998. Staff warning letters were sent to two individual members and one member firm for recordkeeping violations.
14 Commission Regulation 8.06 requires that an investigation be completed within four months, except when significant reason exists to extend the investigation beyond that time frame. Significant reasons may include the complexity of the matter, as well as the number of trade documents required to be analyzed in order properly to determine if a rule violation occurred.
15 The 10 oldest investigations are nos. 96-I-0018, -0024, and -0028, and nos. 97-I-0014, -0020, -0025, -0026, -0029, -0030, and -0031. All but one of the investigations, 96-I-0018, have been closed subsequent to the target period.
16 See investigation nos. 96-I-0024, -0028, and 97-I-0030.
17 See investigation nos. 97-I-0006, -0009, -0011, -0016, -0018, -0023, -0024, -0033, -0035, -0037, -0039, -0045, -0046, and 98-I-0003. The lone exception was investigation 97-I-0033, which was opened on June 9, 1997. The staff investigator assigned to the investigation submitted his findings to the Compliance Supervisor on August 22, 1997. The staff investigator terminated his employment in September 1997 before the investigation was closed. A memorandum dated November 13, 1997 prepared by the Supervisor states that an investigator was not reassigned and that the investigation was completed by the Supervisor himself. Further, the memorandum states, without elaboration, that the investigation was not completed within the four-month deadline because the Supervisor was occupied with other issues of importance.
18 See investigation nos. 97-I-0006, -0011, -0016, -0018, -0023, -0024, -0039, and -0046.
19 The file cover sheet provides dates of significant events, such as when a document request is issued. A staff investigator initials and dates the line labeled "investigator" on the cover sheet when he submits his initial findings to the Compliance supervisor. This is only considered an initial submission since the file may be returned to the staff investigator if further analysis is warranted. The Compliance Supervisor initials and dates the line labeled "reviewer" on the cover sheet when the file is submitted to the Vice President for final review. Once again this may not be a final submission since the file may be returned to the Compliance Supervisor for further analysis. The Vice President also initials and dates the line labeled "reviewer" when the investigation is complete and requires no additional work. When the Vice President initials and dates the line labeled "approval," this signifies that the investigation is officially closed. The Division notes that only one investigation, #97-I-0006, was returned by the Vice President for additional analysis. Therefore, it appears that the need for additional analysis was not a reason for the delays.
20 At the Exchange, a member or member firm may assign the rights and privileges of membership to an individual "delegate." Under MGE Rule 372.00, membership privileges are conditioned by a number of requirements. MGE Rule 372.00.E states that a delegate is not entitled to register a membership for a firm or corporation unless the delegate is employed by the firm or corporation for which the delegate wishes to register and that the firm or corporation is authorized to trade at the Exchange. MGE Rule 372.00.H states that a delegate is limited to trading for his/her own account and may not act as a broker under MGE Rule 321.03. These specific sections of MGE Rule 372.00 were cited in investigation 98-I-0011. The investigation remained open at the close of the target period, but has subsequently been completed. The delegate was issued a $750 fine for violating Rules 321.03 and 372.00. See discussion, infra, at pp. 23-24.
21 Contract Market Rule Enforcement Program Guideline No. 2, 1 Comm. Fut. Rep. (CCH) ¶ 6430 (May 13, 1975).
22 MGE Rule 264.01 Business Conduct Committee: Qualifications Of Members; MGE Rule 265.01 Futures Trading Conduct Committee: Qualifications Of Members; and MGE Rule 606.00 Hearing On Charges: Qualifications Of Directors Or Members Of Hearing Committees To Serve. Effective March 4, 1999, exchanges will be required to amend existing conflict of interest rules to comply with new Commission Regulation 1.69 (Voting by Interested Members of Self-Regulatory Organization Governing Boards and Committees). Regulation 1.69 establishes guidelines and factors to be considered in determining whether an exchange committee member is subject to a conflict of interest which could potentially impinge on his or her ability to make fair and impartial decisions in a matter and, thus, should abstain from participation in committee deliberations and voting. In order to address possible hardships that Regulation 1.69 may impose on smaller exchanges, such as the MGE, the regulation provides for an exemption, on a case-by-case basis, for such exchanges. See 64 FR 16 (January 4, 1999).
23 MGE Rule 607.00 Hearing On Charges: Time And Place Of.
24 MGE Rule 600.00 Enforcement Of Rules And Punishment For Violations; MGE Rule 605.00 Charges: Hearing By Board Of Directors Or By Hearing Committee; MGE Rule 613.00 Punishment: Imposition Of; and MGE Rule 615.00 Determinations Of The Board Or Hearing Committee: Record And Notice Of.
25 The following fine schedule is in effect for such violations: First Violation: Letter of Reprimand; Second Violation: $25; Third Violation: $100; Fourth Violation: $300; Fifth Violation: $500 and/or a one day suspension. The fine schedule is based on a two-year time period. If a member has committed a violation but is free of any violations for a period of two years, the fine schedule reverts back to a first violation as applied to the member.
26 MGE Regulation 2004.02.
27 MGE Rules 321.03.A Acting As Broker On The Exchange, and MGE Rule 372.00.H Delegation. See n. 20, supra, at p. 17.
28 In June 1998, an investigation was opened to review stocks of grain data submitted by a member firm in May 1998. Due to the large quantities that were erroneously reported, A&I forwarded the case to the BCC. The BCC met on July 17, 1998, and found that the firm's inaccurate reporting and erroneous information caused concern and confusion among market participants. Based on the inaccurate and erroneous submissions, the BCC found that the integrity of the stock reports issued by the Exchange was compromised. The BCC charged the firm with violating MGE Rules 901.00.B Records, Reports, Visitation Of Premises Required By Commodity Exchange Act, and Rule 901.01 Information And Access To Records And Reports by The Minneapolis Grain Exchange. The firm submitted an offer of settlement on July 31, 1998 in the amount of $50,000. The settlement became effective August 20, 1998.
29 A staff reminder letter was issued on August 28, 1998 (#97-I-0064), and a staff warning letter was issued on August 31, 1998 (#97-I-0038).
30 The timestamping cases were investigation nos. 89-I-0055, 93-I-0023, 94-I-0018, 94-I-0033, 96-I-0010, 96-I-0043, and 97-I-0034. The clearing submission investigations were nos. 90-I-0066, 91-I-0029, 91-I-0065, 92-I-0023, 92-I-0030, 94-I-0033, 94-I-0039, and 96-I-0043.