RULE ENFORCEMENT REVIEW
KANSAS CITY BOARD OF TRADE
I. INTRODUCTION – PURPOSE AND SCOPE
The Division of Trading and Markets ("Division") has completed a rule enforcement review of the self-regulatory programs of the Kansas City Board of Trade ("KCBT" or "Exchange").1 The purpose of this review was to evaluate the Exchange’s market surveillance, trade practice surveillance, and disciplinary programs for compliance with Section 5a(a)(8) of the Commodity Exchange Act ("Act") and Commission Regulation 1.51. In addition, the Division assessed the Exchange’s trade monitoring system for compliance with Section 5a(b)(1) of the Act and the Exchange’s audit trail system for compliance with Section 5a(b)(2) of the Act and Commission Regulation 1.35.
The review covers the period of January 1, 1997 to December 31, 1997 ("target period"). The Division’s previous review of the Exchange’s rule enforcement program was presented to the Commission on November 30, 1994 ("1994 Review").2 That review examined KCBT’s audit trail, trade practice surveillance, and disciplinary programs. In the 1994 Review, the Division found that KCBT had an adequate audit trail program, and made five recommendations to KCBT related to its trade practice surveillance and disciplinary action programs: (1) expand trade practice investigations to include additional days, interviews of all interested parties, and documentation of informal interviews; (2) articulate in investigation reports all pertinent facts developed during an investigation; (3) include on its investigation log information related to an investigation referred to the Complaint Committee, such as referral dates, committee decision, etc.; (4) impose monetary sanctions in cases of repeat violations, or describe fully their reasons for doing otherwise; and (5) include in its Complaint Committee minutes the committee’s rationale for not proceeding with a case referred by the Department of Audits & Investigations ("A&I" or "Compliance"). By letter dated December 16, 1994, the Exchange responded affirmatively to all of these recommendations, although the Division believes that further improvement is still needed.
During an on-site visit to the Exchange in March 1998, Division staff tape-recorded interviews with senior A&I officials.3 The Division also conducted a review of Exchange documents that included, among others, the following:
Computer reports and other documentation used routinely in the conduct of trade practice surveillance and market surveillance;
Selected trade practice investigation, market surveillance, and disciplinary action files;
One-minute trade timing accuracy reports, and trading cards and order tickets from selected firms for selected dates;
Trade practice investigation, market surveillance, disciplinary, and floor surveillance logs;
Minutes of meetings of the disciplinary committees held during the target period; and
Compliance manuals and guidelines.
The Division provided the Exchange with the opportunity to review and comment on a draft of this report on September 10, 1998. On September 14, 1998, Division staff conducted an exit conference with KCBT officials to discuss the report’s findings and recommendations.
III. CURRENT FINDINGS AND RECOMMENDATIONS
A. Market Surveillance Program
The Exchange has an adequate market surveillance program. Exchange staff monitor daily the volume, open interest, price changes, spread relationships, position concentrations among clearing members, large trader positions, and deliverable supplies.
The Exchange also closely monitors clearing members’ positions during the delivery month to ensure that position liquidation occurs in an orderly manner.
The Division has no recommendations in this area.
B. Audit Trail Program
The KCBT’s audit trail captures essential data on trades, including data on unmatched trades and outtrades, as required by Section 5a(b)(1)(B) of the Act.
The KCBT’s audit trail system captures one-minute trade execution times, which are manually recorded by members on their trading cards, with an accuracy rate of approximately 95 percent.
The KCBT has an adequate program to ensure compliance with the Commission’s trading card and order ticket recordkeeping requirements. Exchange members had a 97 percent rate of compliance with the order ticket timestamping requirements, and a similarly high rate of compliance with trading card recordkeeping requirements.
The Division has no recommendations in this area.
C. Trade Practice Surveillance Program
The KCBT has an adequate trade practice surveillance program, which consists generally of computer-assisted surveillance, routinely conducted investigations of members’ trading activity, and floor surveillance.
Investigations examined were thorough and well-documented, and most investigation reports complied with Commission regulations. Several investigation reports, however, did not include sufficient explanation with respect to staff’s rationale for closing certain cases.
All of the 67 investigations opened during the target period were completed within the four-month requirement of Commission Regulation 8.07.
Although the investigation logs now include more information than at the time of the 1994 Review, they still do not indicate the source of certain investigations.
The KCBT should ensure that all investigation reports contain a clear articulation of staff’s rationale for not pursuing further possible accommodation trades and other trade practice violations discovered during routine trade practice investigations, and indicate the source of all investigations on its investigation logs.
D. Disciplinary Program
Two penalties totaling $425 for recordkeeping violations were imposed during the target period. Except for three members who received warning and/or reminder letters, rather than sanctions, for possible recordkeeping violations despite their recidivism, the Division did not find any material inadequacies in the Exchange’s oversight program that would suggest that the Exchange should have levied a larger number of sanctions.
Those disciplinary matters that were referred to disciplinary committees were handled in a timely manner, and findings appeared to be supported by the evidence.
The KCBT should impose monetary and/or other sanctions on members who repeatedly violate the same or similar Exchange rules. Absent extenuating circumstances, which should be explained in the relevant investigation reports, no more than one reminder letter and one warning letter per type of violation should be issued before sanctions are imposed.
IV. SURVEILLANCE OF MARKET ACTIVITY – SECTION 5a(a)(8) AND COMMISSION REGULATION 1.51(a)(1)
Commission Regulation 1.51(a)(1) requires each contract market to maintain a market surveillance program to identify possible congestion or other market situations conducive to possible price distortion. The purpose of the market surveillance program is to detect adverse situations in the markets as they develop and before the markets have been disrupted. An effective program includes monitoring price movements and spread relationships, volume and open interest, clearing member positions, large trader positions, deliverable supplies, and market news and rumors. In addition, each exchange must have a program for the enforcement of speculative position limits for futures and options, as required by Commission Regulation 1.61.
A. Daily Surveillance Program
1. Volume and Open Interest
A&I staff review the "Volume and Open Interest by FCM" computer runs for all KCBT contracts on a daily basis. This report lists the pit trades, exchanges for physicals ("EFPs"), transfers, option exercises, ending positions, long and short positions on a gross basis by customer and house positions of all clearing members in all contract months, and totals of open interest in each contract month. In addition, the "Open Share of Market Report" is reviewed daily for each of the KCBT contracts. This report shows each clearing member’s position and percentage of the market for both long and short positions in each contract. The report displays in order from the largest to the smallest the three largest long and short positions held by clearing members which are then totaled, and a percentage of market share is computed for each contract month.
A&I staff use this report to review daily the three largest long and short positions held by clearing members in the nearby futures month of all KCBT contracts. The three largest long and short position holders are entered on a computer spreadsheet for each contract, starting with the last trading day of the preceding future month and ending on the last trading day of the current future month. For example, for the December 1997 wheat futures contract, the beginning date was September 22, 1997 (the last trading day for the September contract) and the ending date was December 22, 1997 (the last trading day for the December contract).
A&I staff also review all open contract months for a significant change in open interest held by any clearing member.4 If the staff detect a significant change, the position change is examined more closely to determine the possible reasons for the change and the impact on the market, if any. The Division reviewed 20 random days during the target period and found six days where A&I staff contacted clearing members because of large decreases or increases in their daily positions.5 A&I staff wrote brief memos that contained explanations given by the clearing members for the decreases or increases which, in all but one instance, were due to the failure of customer omnibus accounts to furnish timely offsetting position information for the previous day.
2. Monitoring of Expiring Contracts
For expiring contracts, A&I staff monitor the open interest held by each clearing member more closely several days before the first notice day of a delivery month. A&I staff prepare a computer spreadsheet of the three largest long and short position holders and their percentage of open interest and include all EFPs executed by the clearing members for each trading day and the type of commercial business. A clearing member who is one of three largest long or short position holders will remain on the spreadsheet for the remainder of the liquidation period even if it is not one of the three largest holders on any given day. Any clearing member with an open position of 100 contracts or more is also included on this list.
On the first notice day of the wheat contract, A&I staff send liquidation notice letters to remind the clearing members of the delivery date and last trading day of the expiring futures month. Throughout the delivery month, A&I staff routinely ask the clearing members their intentions to make or take delivery and remind them that an orderly liquidation is expected. A&I staff track daily the convergence of the cash and futures prices to determine whether the expiring future is liquidating in a reasonable manner. In their convergence calculation, the staff use basis data, transportation costs, storage, interest, and delivery costs. Further, A&I staff closely monitor the deliverable supply reports to ensure that such supplies exist at the delivery points.
For the western natural gas contract, A&I staff notify those clearing members with open positions one week prior to the last trading day and ascertain whether the clearing members have transportation agreements on file. Clearing members must have a copy of the agreement on file before the last trading day.6 Because the KCBT’s Value Line contracts are cash-settled, there are no delivery-related issues associated with their expiration.
For all option contracts, A&I staff send a liquidation letter to the clearing members who have long in-the-money positions a week before the last trading day of the expiring options month.7 A "Report of Exercises" is produced daily by the clearinghouse which shows each clearing member’s option positions that were exercised and the opposite clearing members. An "Exercise Trade Register" report is produced if option positions were exercised during the previous business day. This computer run shows the clearing member, premium, quantity bought and/or sold, and the exercise dollar amount, plus any difference. All of these reports are reviewed by A&I staff to ensure the proper exercise of the option positions. For the option exercises on the last trading day, A&I staff review these computer runs to ensure that all in-the-money options were exercised by the clearing members. According to KCBT Rules 2515.03, 2615.01, and 2818.06, all in-the-money options expiring after the close of business on the last trading day will automatically be exercised unless instructions to the contrary are delivered to the Clearinghouse by 4:00 p.m. on the last trading day. A&I staff have not found any problems with the clearing members exercising the in-the-money options since these rules became effective in March 1996.
3. Price Changes and Inter-Market Relationships
A&I staff compile daily the price changes for KCBT futures contracts from the previous trading day. A&I staff record the changes between the closing prices for the current day and the preceding day, starting with the preceding expired contract; between the current day’s and previous day’s closing prices for the nearby and next deferred contracts; the spread differential for each day of the current month and the next deferred contract; and the spread differentials between the Value Line nearby futures month, deferred months, and the cash indexes at related securities exchanges.
A&I staff also record daily the price movements of the wheat futures at the KCBT, Chicago Board of Trade, and Minneapolis Grain Exchange. The price movements are tracked from the last trading day of the preceding expired contract month to the last trading day of the current future month. The difference between each day’s closing price for the nearby contract and its closing price on the last trading day of the preceding expired month is entered on a computer spreadsheet. A&I also tracks the price movements of the Value Line and Mini Value Line contracts, Value Line Spot Index, S&P 500 futures and spot indexes, New York Stock Exchange Composite Index futures and spot indexes, and the Dow Jones futures and spot indexes. Price movements for the natural gas contracts at the KCBT and New York Mercantile Exchange are also compiled daily.
By tracking these price movements, A&I staff are able to detect any price movements that are out of line with the other exchanges, while taking into account external factors, such as weather, economic news, domestic or foreign market crises. If A&I staff detect a significant difference in the price relationships, they will investigate further to determine possible reasons for the difference and attempt to evaluate the effect on the market and particularly the nearby month. Any event causing a price discrepancy, including the information source, will be noted on the spreadsheet for the day when the event occurred.
4. Reportable Positions and Deliverable Supplies
On a daily basis, A&I staff receive reportable open position reports on CFTC Form ‘01 for Value Line, Mini Value Line, and natural gas contracts from the clearing members for the previous business day. A&I staff verify the accuracy of the ‘01 reports by checking a clearing member’s position as reflected on the report against the open position as reported by the clearinghouse. Staff then enters the total position by month for each individual customer on the "Reportable Position Sheet." If A&I staff note any discrepancy between the Form ‘01 and the clearinghouse report, they will contact the clearing members to determine the cause of the error and request a corrected form, if warranted.
A&I staff receive large option trader reports from clearing members on a weekly basis.8 This report contains the reportable option positions for the wheat, Mini Value Line, and natural gas option contracts. A&I staff identify the reportable omnibus accounts and contact the appropriate omnibus account to determine if any customers are reportable within the omnibus account. If such reportable customer accounts exist, then A&I staff obtain a large option trader report from the omnibus account owner.
A&I staff compare the large option trader reports to the positions obtained from the clearinghouse’s daily Form 20.9 If a discrepancy is detected, the staff contact the clearing member and request a corrected form. In addition, the clearinghouse produces the "Wheat/Mini Value Line/Western Natural Gas Options Delta Position Large Trader Report," which lists the traders who have reached the reporting level for options, and includes the delta/futures equivalent position. A&I staff also obtain a CFTC 102 report from the respective clearing members when an account becomes reportable. The form contains all pertinent account identification information, such as the person or entity who owns the account, the person(s) who have financial and/or trading control over the account, type of account, commodities traded, etc. This form is then submitted to the Commission’s Kansas City regional office.
The Exchange receives deliverable stock reports weekly from the 17 "regular" elevators in the Kansas City market in Kansas City and Hutchinson.10 From these reports, the Exchange issues a weekly composite of the total deliverable grades (excluding Commodity Credit Corporation ("CCC") stocks), total non-deliverable grades/ungraded, and total CCC stocks for Kansas City and Hutchinson elevators.
Further, the Exchange receives, by facsimile, daily stock reports from the "regular" elevators, which include the gross amount of wheat and other types of commodities in storage or for which warehouse receipts are held as of the previous day’s close of business. The gross amount (per commodity) is posted on the trading floor each morning along with the increase or decrease from the previous business day. When the weekly deliverable stock report is compiled, the daily and weekly numbers are compared to determine if any discrepancies exist. If any are found, they are immediately reported to the Senior Vice President of the Exchange. The Division did not find any material market surveillance issues that required further action by A&I staff on the random days selected for review during the target period.
B. Enforcement of Speculative Position Limits
As part of the daily surveillance program of reviewing the volume and open interest reports, A&I staff also review the clearing members’ open positions for potential speculative limit violations.11 As the first notice day approaches, A&I staff intensify their reviews to identify the position holders who are near or over the spot-month limits. The clearing members with potential speculative limit violations are notified and are instructed to take action to reduce the positions immediately. A&I staff continue to monitor these positions closely to ensure that they are reduced to required levels. If a clearing member has filed for an exemption, A&I staff will not take any action against a position holder who exceeds the limit.
Although the Exchange’s marketplace is approximately 75 percent commercial business (hedgers) and 25 percent non-commercial (speculators), speculative position limits can be exceeded, as was the case on two occasions during the target period.12 Both instances involved floor traders who exceeded the speculative limit in December 1997 wheat on November 26, 1997, the first notice day for the December contract. Both members received warning letters from EA, dated December 1, 1997, for exceeding the speculative limit in the KCBT wheat futures contract.13 One member informed the EA staff and the Exchange as soon as he had discovered that his December position was over the speculative limits on the first notice day and immediately reduced his position on the following day. The other member was holding warehouse receipts taken on delivery in a previous future, and therefore was not in violation of the speculative limits because he was hedging a cash market position represented by the receipts. A&I staff did not take action in these two cases since the traders’ breach of the limits in one case was resolved within a day, the other was justified, and both traders had already received warning letters from EA for exceeding the limit.
C. Conclusions and Recommendations
The Division’s review of KCBT’s routine market surveillance program indicates that the Exchange has adequate monitoring procedures. A&I staff monitor daily the volume, open interest, price changes, spread relationships, position concentrations among clearing members, large trader positions, and deliverable supplies. Further, A&I staff closely monitor the clearing members’ positions during the delivery month to ensure that position liquidation occurs in a timely and orderly manner.
A&I staff also review daily all clearing members’ open positions, which includes comparing position sizes against speculative limit levels. During the target period, two floor traders breached the speculative limit on the first notice day for the December wheat futures contract. Commission staff sent the traders warning letters, and A&I staff did not take further action because both traders either had justification for their position or liquidated their position below the speculative limit for the spot month on the following day.
Based upon the foregoing, the Division has no recommendations in this area.
V. AUDIT TRAIL – SECTION 5a(b) AND COMMISSION REGULATION 1.35
A. Essential Trade Data – Section 5a(b)(1)
Section 5a(b)(1) of the Act requires that an exchange’s audit trail be able to capture essential data on the terms, participants, and sequence of transactions, including relevant data on unmatched trades and outtrades. To meet this requirement, KCBT Rule 1115.00 requires each member to record all trade executions for customer and personal accounts on a trading record promptly upon the purchase or sale of any contract. The trading record must contain the member’s trading initials, clearing member code, date, execution time to the nearest minute, quantity, commodity, contract month, price, opposite member, opposite clearing member, and, for option contracts, strike price and put or call indicator.
The KCBT trading record is typically a trading card which contains all of the trade data that must be submitted to the clearinghouse for matching and clearing. KCBT members use three different kinds of trading cards, and each are two-sided, with buys on one side and sells on the other. First, "personal trading cards" are used by KCBT members to record their personal trades. These cards are required to be pre-printed with the members’ trading initials and a card sequence number. The broker’s clearing member is handwritten on each personal trading card. Second, "brokerage cards," which do not contain pre-printed sequence numbers, are used to record executions for house and customer accounts; order tickets are generally not used to record fill information. A broker typically has a brokerage card for each clearing member for which he or she fills customer orders. Third, instead of using brokerage cards in the first instance to record house and customer fills, three or four members use "master cards," and then have the trade information transcribed on to separate brokerage cards, one per clearing member. These brokerage cards, along with personal trading cards and other brokerage cards, are collected by clearing members at each 30-minute interval.14
Trade data are submitted by clearing firms to the clearinghouse throughout the day through computer terminals located on the trading floor, or by computer-to-computer linkup. Trades must be submitted for clearing within 45 minutes after each 30-minute trading period.15 The trade matching process occurs continuously throughout the day, beginning at 8:30 a.m. The clearing system matches trades that agree on quantity, brokers, month, price, and clearing firms. The clearing system identifies unmatched trades, termed "cutouts" at the KCBT.16 Trades can be entered and errors corrected throughout the day until each contract’s first reconciliation report is distributed to clearing firms: 2:15 p.m. for wheat futures and options, and 4:00 p.m. for Value Line futures and Mini Value Line futures and options and western natural gas futures and options. After that time, no new trades can be entered into the clearing system, and firms have two hours to correct any errors on trades already in the system. Clearing firms can change, through clearinghouse terminals, only the data for their own unmatched trades.
A Daily Out-Trade Audit Report is received by A&I each day from the clearinghouse. This report contains a record of all cutouts, corrections, and busted trades from the previous trading day. Busted trades that are resolved before the opening on the following day are cleared as "as of" trades.17 All "as of" trades are reviewed by A&I by comparing the trade price to the previous day’s time and sales.
Based upon the foregoing, the Division concludes, as it has in past reviews, that the continuous trade data submission and matching system at the KCBT significantly reduced the number of intra-day unmatched trades at the Exchange. Such trades generally represent less than one percent of trading volume. The Division finds that the KCBT’s audit trail captures essential data on trades, including data on unmatched trades and outtrades, as required by Section 5a(b)(1)(B) of the Act.
B. One-Minute Timing Compliance – Section 5a(b)(2)
Under Section 5a(b)(1)(B) of the Act, an exchange’s audit trail system must be able to capture essential data on trades, including data on unmatched trades and outtrades. Section 5a(b)(2) requires that the audit trail system of each contract market accurately record the times of trades in increments of no more than one minute in length and the sequence of trades for each floor trader and broker.18 In addition, Commission regulation 1.35(g) requires that the trade execution time be obtained and stated in increments of no more than one minute on an exchange’s trade register.
To meet these audit trail requirements, the Exchange, as stated above, requires that both parties to a trade manually record the minute of trade execution on their trading cards. The time of execution and other recorded trade data are then entered into the clearinghouse trade matching system and are used to create the Time Audit Report ("TAR"), which is the KCBT’s Regulation 1.35(e) trade register. In order to verify the accuracy of the one-minute execution times recorded by members, the Exchange routinely uses the TAR, which includes, among other things, all trade times and prices and indications of possible timing errors. Specifically, there are six error codes that identify inaccurate trade execution times on the TAR: Bought Side-No Trade ("B-NT"), Sold Side-No Trade ("S-NT"), No Quote at This Price ("B-NT/S-NT"), Time Out of Limits ("TOL"), Bought Side-Untimed Trade ("B-UT"), and Sold Side-Untimed Trade ("S-UT").19 The Exchange enforces its one-minute timing requirement and calculates its accuracy rate by using these codes.
For purposes of this Review, the Division requested that the Exchange provide data on the percentage of accuracy of its one-minute execution times pursuant to Commission Regulation 1.35(e), as specified in Regulation 1.35(g) and (i)(2), for all Exchange markets on two representative trade dates in each month of the target period.20 The timing accuracy rate for these dates, including spread transactions, was approximately 95 percent.21 Therefore, the Division believes that the KCBT complies with the trade time recordation requirement of Section 5a(b)(2) of the Act.
C. Audit Trail Components: Order Tickets and Trading Cards – Commission Regulations 1.35(a-1)(2)-(4) and 1.35(d)
Pursuant to Commission Regulation 1.35(a-1)(2)(i), each contract market member or its designated person receiving a customer’s order on the floor of an exchange must prepare a written record of the order in non-erasable ink, including the account identification and order number. The member then must timestamp the order to reflect the date and time, to the nearest minute, that it is transmitted to or received on the exchange floor ("entry time"). When execution price is reported from the floor, the order must be timestamped again, pursuant to Commission Regulation 1.35(a-1)(4) ("exit time"). KCBT Rule 1115.00 and Resolution 11-1130.00-1 require member compliance with these requirements.
Commission Regulation 1.35(d) requires that members record purchases and sales on a trading card or other record, which must include the member’s name, opposite member’s identification, clearing member’s name, date, execution time, commodity, quantity, price and delivery month. Further, members must record purchases and sales in non-erasable ink, in exact chronological order of execution, on sequential lines of the trading card without skipping lines between trades, and must cross out any remaining lines on the trading card. Trades made during the exchange’s opening and closing periods also must be identified.
In addition, Commission Regulation 1.35 requires that trading cards contain pre-printed identification information and sequence numbers to distinguish one member’s cards from another’s, to permit the sequencing of cards, and to differentiate each card prepared by a member from other cards for no less than a one-week period. Trading cards also must be submitted to the clearing member within 15 minutes of designated trading intervals not exceeding 30 minutes beginning with the opening of each trading session, and each member must use a new trading card at the beginning of each 30-minute interval.22 The Exchange conducts quarterly reviews of trading cards and order tickets by randomly selecting a three-day period each quarter, and examining all trading cards and order tickets submitted by all members during that period.23
1. Order Tickets
In order to evaluate compliance with order ticket recordkeeping and timestamping requirements, the Division's Contract Markets staff in the Kansas City regional office examined 102 floor order tickets from two clearing firms on two active trading days (one per firm) during the target period.24 The Division found that all 102 order tickets contained a pre-printed order number and an account identification. One clearing firm identified customers by an internal code or number or by name on 26 of 85 order tickets, and account numbers were used on the other 59 orders. The second firm used account numbers to identify both customer and house accounts. All orders were written in non-erasable ink.
Ninety-nine of the 102 order tickets (97 percent) contained the requisite entry and exit timestamps. However, five options order tickets from one of the firms had only two timestamps, instead of the three (entry, transmission for execution, and exit) required for options orders by Regulation 1.35(a-1)(1). If those five orders are included among those missing required timestamps, then 92 percent of order tickets meet the timestamping requirements.
2. Trading Cards
During its quarterly reviews, the Exchange examines all trading cards collected for compliance with the trading card recordkeeping requirements of Regulation 1.35(d). To determine independently the compliance of KCBT members with those requirements, the Division’s Kansas City staff examined all 277 trading cards (224 personal trading cards and 53 brokerage cards) submitted by the 40 members who filled orders for the same two firms on the same two dates selected for the order ticket review. The Division also found a high rate of compliance with these requirements.
Specifically, only nine trades on eight trading cards (three percent) were either missing the trade time or had it written illegibly; two cards (one percent) did not show the future month for a trade; three cards (one percent) did not show the opposite clearing firm for a trade; two cards contained trades out of sequence; two cards, both from the same member, had lines skipped between trades; and three cards had multiple trades recorded on the same line. In addition, only 10 cards (four percent) did not have a line or other indicator distinguishing trades executed on the open or close; one card did not have unused lines marked through; two cards were used in more than one 30-minute interval; and 13 cards (five percent) were not submitted to clearing within 15 minutes of the end of the appropriate 30-minute interval. In addition, each of the 224 personal trading cards reviewed contained the members’ pre-printed trading initials, clearing firm initials, and card sequence numbers,25 as well as the commodity, price, quantity, and opposite floor member. Finally, members used their personal trading cards in sequential order during the trading day, all cards were written in non-erasable ink, and option trades contained the appropriate put or call indicator.
[Alternative positive phrasing: Ninety-seven percent of the cards [or ___ percent of trades] reviewed had [no errors in the recordation of] a one-minute trade time. ____ percent of the trades showed the futures month, ___ percent showed the opposite clearing firm, and ___ percent of the spread trades were marked with a spread indicator. Two hundred seventy-five cards (99 percent) had the trades recorded in sequence, and the same number had no lines skipped. Two hundred seventy-four cards (99 percent) had no more than one trade recorded per line, 267 (96 percent) had a line or other indicator distinguishing trades executed on the open or close, and 276 (99 percent) had unused lines marked through. Two hundred seventy-five cards (99 percent) were used in only one 30-minute trading interval, and 264 (95 percent) were submitted to clearing within 15 minutes after the end of the appropriate 30-minute interval.]
D. Conclusions and Recommendations
The Division’s review of the one-minute trade execution times recorded by KCBT members during the target period found that the accuracy rate for those times was approximately 95 percent. The Division also found that that the KCBT’s audit trail captures essential data on trades, including data on unmatched trades and outtrades, as required by Section 5a(b)(1)(B) of the Act.
With regard to recordkeeping compliance, the Division found that the KCBT has an adequate program to ensure members’ compliance with the Commission’s trading card and order ticket content requirements. Specifically, the Exchange reviews trading cards and order tickets routinely as part of its quarterly audit trail reviews. During the target period, the Exchange conducted four of these reviews, which were well-documented and completed in a timely fashion. The Division also conducted its own examination of trading cards and order tickets, which revealed a high rate of compliance by KCBT members with the Commission’s recordkeeping requirements.
Based upon the foregoing, the Division has no recommendations in this area.
VI. TRADE PRACTICE SURVEILLANCE – SECTIONS 5a(a)(8) AND 5a(b) AND COMMISSION REGULATIONS 1.51(a)(2), (4), (5) AND (6)
Section 5a(a)(8) of the Act requires each exchange to enforce all bylaws, rules, regulations and resolutions made or issued by it or by the governing board or any committee. Section 5a(b) of the Act requires each contract market to maintain and use a system to monitor trading to detect and deter violations of the contract market’s rules committed in the making of trades. Under Section 5a(b)(1), such a 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 violations committed in making trades; and floor surveillance.
In addition, Commission Regulation 1.51 has long required that each exchange use due diligence in maintaining a continuing program for the surveillance of trading practices on the floor of the exchange; for the investigation of customer complaints and other alleged or apparent violations of the exchange bylaws, rules, regulations, and resolutions; and for such other surveillance, record examination, and investigation as is necessary to enforce exchange bylaws, rules, regulations, and resolutions.
A. Compliance Staff
A&I is responsible for the financial, market, trade practice, audit trail, and floor surveillance activities of the Exchange. A&I is directed by the Vice President – Compliance ("VP-Compliance") who supervises one Manager of Compliance (who also functions as the lead investigator), two investigators, and one accountant. The A&I staff is the same size as it was at the time of the 1994 Review.26 Overall, the Division believes that, for the purposes of Section 5a(b)(1)(E), the Exchange has adequate staff to develop and prosecute disciplinary actions.
B. Trade Practice Surveillance
1. Computer-Assisted Surveillance
A&I staff monitor trading practices by reviewing the TAR for each contract daily. The Exchange’s computer system performs certain edit functions based on predetermined parameters aimed at identifying possible trade practice violations. Trades that fall within one or more of the parameters are flagged on the TAR with error codes indicating the possible violation.27 The possible violations include activity such as trading ahead of a customer order, accommodation and wash trading, money passes, and errors such as invalid spread and cross trades (referred to as "ring" trades at the KCBT). A&I decides on a case-by-case basis whether to open an investigation based upon activity identified by an error code. The error codes and related parameters are the same as at time of the 1994 Review, as are the procedures for the daily review of the TAR, ring slips, and other trading activity reports by A&I.28
Two additional computerized reports reviewed on a daily basis by A&I staff are the "Time & Sales Verification Against Trades Report" and the "Give-Up Average Price Residual Summary Report for Executing Firm." The Time and Sales Verification Against Trades Report lists all unmatched quotes and unmatched trades. A&I staff check all unmatched quotes with the then-current market price and daily highs and lows to ensure that erroneous price quotes were not disseminated to the public.29 The Give-up Average Price Residual Summary Report for Executing Firm, which was developed when the clearinghouse implemented a new give-up system in early 1996, lists all trades filled by an executing clearing member that were transferred that day to a give-up clearing member(s) at the trade price or at an average price.30 The report also includes the original trade executed in the pit at the original prices, and the subsequent transfer trade at the original price or at the average price with the residual amount.31 A&I staff examine each average price order ticket to verify that it was designated as an average price order at the time of acceptance, and that the confirmation indicates that the trade price is an average price. In addition, A&I staff ensure that the written authorization, or "give-up agreement," is on file for each of the participating clearing members. All clearing members are required to have a give-up agreement on file with the Exchange.
Division staff examined the TAR reviews conducted by the Exchange on six days over the course of the target period.32 The Exchange’s files contained handwritten notations on TARs, indicating that the trades were reviewed, and relevant trading documents, including ring, insertion, and cancellation slips that were stapled to the reports. In this regard, A&I staff verify the slip information with the TAR, and check for the required signature by the respective pit chairperson. A&I staff typically wrote on the TAR the information obtained from related order tickets and/or trading cards to verify whether a floor broker traded ahead of a customer’s order or whether a ring trade was executed properly. The staff also included descriptions of the order ticket information, such as the timestamps and order instructions.
2. Trade Practice Investigations
The Exchange’s surveillance program also includes routine trade practice investigations ("TPIs"). A routine TPI is a review of a member’s trading activity for possible trading abuses over a designated period of time, usually three to five days.33 The Exchange’s goal is to perform one routine TPI on each member every year, though it focuses particularly on conducting TPIs on the 30 to 40 most active members. A&I staff will also single out for routine TPIs those members who have exhibited particular problems with trade timing or other issues, as revealed by the daily TAR review. All routine TPIs are conducted on a surprise basis, i.e., members do not receive advance notice that their activity on particular days will be reviewed.
During a routine TPI, A&I staff will review all of the targeted members’ trades from the TPI period. In particular, all possible trade practice violations flagged on the TAR are reviewed, and relevant trading cards and order tickets are obtained. For all possible violations that remain unresolved or unexplained after the supporting documents have been examined, A&I evaluates each as to whether a reasonable basis exists for finding that a violation occurred. If that is deemed to be the case, A&I will issue a reminder or warning letter, or refer the matter to the Exchange’s Complaint Committee for consideration of charges, depending upon its severity.
In addition to routine TPIs, the Exchange conducts "special investigations," which can include follow-up from a TPI, investigations of unusual trading activity observed other than in a TPI (including from floor surveillance), Commission referrals, and investigation of member or customer complaints. The quarterly audit trail reviews are also classified as special investigations.
In the 1994 Review, the Division recommended that the Exchange include in its investigation logs information related to the referral of an investigation to the Complaint Committee, such as referral dates, committee decision, action taken, and date of the action. The Division found that this information is now included on the logs, with the exception of the dates of any reminder or warning letters, or no action notices issued to the relevant member.34 However, as the Division found in the 1994 Review, the logs do not reflect the source of any special investigations other than those opened from Commission referrals, although this information is available in the investigation reports included in the file. The Division continues to believe that this information should be maintained on the log for ease of reference and to facilitate, for managerial purposes, the tracking of investigations by type.
3. Floor Surveillance
Floor surveillance at the KCBT is conducted by the VP-Compliance, the Manager of Compliance, and by the two staff investigators. Surveillance is done on the open and close in each market, usually for 15 to 20 minutes each time, though A&I personnel will stay on the floor longer if a market is exceptionally busy. Investigators also conduct floor surveillance for a random 15-minute period in the middle of the day. Each A&I staff member who does floor surveillance is primarily, but not exclusively, responsible for one pit or market. While conducting floor surveillance, A&I staff will, among other things, look to see who is trading with whom, monitor spread differentials, and check for possible disclosure of orders. In addition, during the delivery period, Exchange staff pay particular attention to firms with large positions to see whether they are increasing or decreasing their positions, and at what prices they are trading. A&I staff also look to see if clerks are performing their duties properly (i.e., not soliciting business or engaging in other prohibited activities), and to ensure that orders are written up and timestamped properly, and trades are properly reported and checked.
The Exchange maintains a daily floor surveillance log which shows, for each commodity and option, the investigator’s initials, date, time of surveillance on the open and close and of the random surveillance, and any material observations. Any action taken by A&I staff as a result of observations made during floor surveillance is detailed in Floor Surveillance Reports which are referenced in the log. The Floor Surveillance Report lists the date, staff member, time of observation, person or firm observed, possible violation, any prior instances of similar conduct, action taken (including summaries of conversations between A&I staff and members about the observed conduct), and the investigation number if the matter is examined further.
Of the 17 Floor Surveillance Reports prepared by Exchange staff during the target period, nine involved wheat futures and eight involved natural gas futures. For example, one report, concerning possible trading after the close, led to the opening of a full investigation of two members. Three other reports, concerning two other members trading outside the pit or while on the telephone, were combined with another investigation (from a Commission referral regarding the same infractions) involving the same two members.35 The first investigation resulted in the issuance of a no-action notice due to a lack of firm evidence, while the second was referred to the Exchange’s Complaint Committee, which determined not to prosecute the violations because they were first offenses. Instead, warning letters were issued to the two members.
C. Adequacy and Timeliness of Investigations
As stated above, A&I staff initiates and conducts investigations, other than routine TPIs, when information obtained indicates that a possible violation of KCBT rules may have occurred. These "special investigations" may be derived from floor surveillance, TAR reviews or reviews of other computerized records, or external sources that include Commission and National Futures Association ("NFA") referrals or member or customer complaints.
During the target period, A&I opened a total of 67 investigations, of which 55 (82 percent) were routine TPIs, and 12 (18 percent) were special investigations. Of the special investigations, eight were quarterly audit trail reviews (one per quarter for clearing members and for traders), three resulted from TAR reviews and/or floor surveillance, and one was a Commission referral. The Division conducted an in-depth review of the adequacy of 25 of the 67 investigations, and reviewed the investigation reports for each of the 67 investigations. The Division found that the investigations were generally thorough and well-documented, and that each file included an index of its contents, a summary of the investigation procedures (with the dates each step was completed), spreadsheets, workpapers, summaries of interviews, letters notifying the subject member of the investigation and its results, and a copy of the investigation report.
The Division also found that the investigation reports, in response to a 1994 Review recommendation, have been expanded to include an analysis of each suspect trade. The analysis generally sets forth A&I staff’s rationale for whether the suspect trade should be pursued further. In the 1994 Review, the Division found that the Exchange’s investigation reports did not contain an articulation of the facts developed by staff to support staff’s conclusions for finding that no possible violations occurred.36 In particular, the reports lacked the specificity needed to understand A&I’s rationale for closing the case. Although the Exchange has made progress in remedying this deficiency, the Division found several investigation reports in the present review that still need further elaboration with respect to staff’s analysis of possible violations.
Specifically, in the course of routine TPIs performed during the target period, Exchange staff identified 62 possible instances of accommodation trading where the time difference between the trades was less than one minute. However, for 24 of those 62 trades, the only reasons cited in the investigation reports for closing the cases were the time difference between the trades, and the fact that "no other unusual activity with the trades" was noted. Because the close proximity in time between trades may, in fact, be indicative of accommodation trading, additional explanation should have been included in the investigation reports.
The Division found that the Exchange’s investigations were completed in a timely manner. All of the 67 investigations opened during the target period were closed within the four-month requirement in Commission 8.06.37 Six investigations opened late in the target period were still open when it ended, but were subsequently closed within four months.
D. Conclusions and Recommendations
The Division found that the Exchange maintains an adequate trade practice surveillance program, which consists of computer-assisted surveillance, routine TPIs, special investigations, and floor surveillance. The Exchange’s investigations were generally thorough, well-documented, and completed in a timely manner. Interviews of members were held where appropriate, investigation files contained relevant documentation, and most investigation reports complied with Commission Regulation 8.07. However, the Division found several investigation reports that did not include sufficient explanation with respect to staff’s conclusion to close particular cases. The Division also found that although the investigation logs now include more information than at the time of the 1994 Review, they still do not indicate the source of special investigations, other than the quarterly audit trail reviews and Commission referrals.
Based on its review, the Division recommends that KCBT:
Ensure that all investigation reports contain a clear articulation of staff’s rationale for not pursuing further possible accommodation trades and other trade practice violations discovered during routine trade practice investigations, and indicate the source of all special investigations on its investigation logs.
VII. DISCIPLINARY ACTIONS – SECTION 5a(b) AND COMMISSION REGULATION 1.51(a)(7)
Under Section 5a(b) of the Act, an exchange must use information gathered through its trade monitoring system to bring appropriate disciplinary actions and to assess 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.38 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.39
B. Sanctions Imposed
The Division reviewed the Exchange’s investigation logs (which list any disciplinary action taken as the result of an investigation), disciplinary committee minutes, and the Regulation 9.11 disciplinary action notices issued by the Exchange reflecting disciplinary actions taken during the 12-month target period. During the target period, the KCBT took two disciplinary actions, each against one member for floor recordkeeping violations. One member was fined $225 for failing to mark through unused lines on his trading card, and the other was fined $200 for failing to submit personal trading cards to clearing within 15 minutes of the end of each 30-minute period. Both members also agreed to cease and desist from any future similar violations.40 In two other cases, a possible trading ahead violation based on a TAR review and a Commission referral of possible trading outside the pit, three members were referred to the Complaint Committee, which determined in both instances that a reasonable basis existed for finding a rule violation, but that prosecution was not warranted. Warning letters were issued in both cases.41
The two members who were sanctioned for floor recordkeeping violations had received warning letters for similar rule violations prior to the target period, and the trader who was sanctioned for failing to submit his trading cards in a timely fashion received a second warning letter in 1997 for the same conduct. However, three other traders who received warning and/or reminder letters in 1996 and during the target period for audit trail-related violations were not sanctioned, despite their recidivism. The explanation given by the Exchange for not sanctioning these members was that their error percentages had decreased from investigation to investigation. The Division found, though, that one of the members’ error percentage had in fact increased, and another’s, despite a decrease, remained above the ten percent threshold used by the Exchange for determining when a violation warrants disciplinary or other action. In its review of the Exchange’s investigation files, the Division discovered that the former member had consistently been in violation of recordkeeping requirements yet had not received any sanction other than a warning letter in 1996 or 1997.42
In the 1994 Review, the Division stated its belief that, "absent mitigating circumstances, … the Exchange should issue no more than one reminder and one warning letter to members, and that monetary sanctions should follow thereafter." The Division continues to believe that the Exchange should impose monetary sanctions on those members who repeatedly commit the same type of recordkeeping or other violation. The Exchange’s practice of issuing a series of warning letters in these instances is not an effective deterrent or incentive for these traders to change their behavior. It also does not reflect the seriousness of recordkeeping violations, which affect the quality of an exchange’s audit trail, and can thus compromise its ability to detect and deter unlawful trading activity.
C. Timeliness of Disciplinary Proceedings
Commission Regulation 8.09 requires that an exchange disciplinary committee promptly review each investigation report and, if the committee determines that additional investigation or evidence is needed, promptly direct the enforcement staff to conduct further investigation. Within 30 days of receiving a completed investigation report, an exchange disciplinary committee must also either (1) determine that no reasonable basis exists for finding a violation or that prosecution is otherwise unwarranted and direct that no further action be taken or (2) determine that a reasonable basis exists for finding a violation which should be adjudicated and direct that the alleged violator be served with a notice of charges.43
The Complaint Committee met three times during the target period and reviewed four special investigations involving five members. In every instance, the Complaint Committee met within eight days of receiving the report from A&I and reached its decision on the day of the meeting. In the two instances where the Complaint Committee decided to issue a notice of charges, the notice was issued two weeks after the meeting. In each case the respondents submitted settlement offers one week later, and those offers were reviewed and accepted by both the Complaint Committee and BCC within 10 days of their submission. In the two cases where the Complaint Committee found that a reasonable basis existed for finding a violation but that prosecution was not warranted, warning letters were issued to the subject members within 15 days of the Complaint Committee meeting. Thus, KCBT’s Complaint Committee acted well within the 30-day time period set forth in Commission Regulation 8.09.
D. Conclusions and Recommendations
Based upon its review, the Division found that two disciplinary sanctions were imposed at KCBT during the target period, both for recordkeeping rule violations. The Division found a number of KCBT members who were given warning letters during the target period for recordkeeping rule infractions about which they had previously received warnings. In the Division’s view, the failure to sanction members who repeatedly violate the same or similar rules renders the Exchange’s disciplinary program less effective. The Division also found, though, that when disciplinary matters are referred to disciplinary committees, disciplinary action is taken in a reasonably timely manner, and findings appear supported by the evidence.
Based on its review, the Division recommends that KCBT:
Impose monetary and/or other sanctions on members who repeatedly violate the same or similar Exchange rules. Absent extenuating circumstances, which should be explained in the relevant investigation reports, no more than one reminder letter and one warning letter per type of violation should be issued before sanctions are imposed.
1 Rule enforcement reviews prepared by the Division are intended to present an analysis of an exchange’s overall compliance capabilities for the period under review. Such reviews deal only with programs directly addressed in the review and do not assess all programs. The Division’s analyses, conclusions, and recommendations are based, in large part, upon the Division’s evaluation of a sample of investigatory cases and other exchange documents. This evaluation process in some instances identifies specific deficiencies in particular exchange investigations or methods but is not designed to uncover all instances in which an exchange does not address effectively all exchange rule violations or other deficiencies. Neither is such a review 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 A copy of the 1994 Review can be found in Appendix 1.
3 Transcript of March 2, 1998 interview with Joe Ott, Vice President, Compliance and Jeff Hughes, Manager of Compliance, hereinafter cited as "Transcript p. __." The complete transcript can be found in Appendix 2.
4 Significant change is defined as an abrupt increase or decrease in the total open interest in any one or more clearing members’ positions or an abrupt switch from a long to a short position, or vice versa.
5 The six days were: July 24, July 29, August 28, September 2, November 17, and November 24, 1997.
6 Rule 2733.00, Confirmation of Transportation, requires a clearing member to obtain a copy of a signed written transportation service agreement with a pipeline serving the Waha delivery point at least ten business days prior to the last trading day of the expiring contract. For any long or short position established fewer than ten business days from the last trading day, a clearing member must obtain a written transportation service agreement by the close of business the following day. Such transportation agreement and any alternative arrangements must be dated no later than ten business days prior to the last trading day.
7 A&I requires the clearing members to sign and date the liquidation letters to acknowledge that they have received the notification. The purpose of the letter is to remind clearing members that in-the-money option positions will be automatically exercised pursuant to Exchange rules, unless those positions are liquidated prior to contract expiration.
8 EA will be changing its reportable position requirements (projected to be completed in the next several years) in that all firms will report their positions for both futures and options on a daily basis to the Commission. EA will then compile the reportable position information and release it to the exchanges. Therefore, A&I staff may not be performing this type of surveillance when the next rule enforcement review is conducted. See 62 Fed. Reg. 24026 (May 2, 1997).
9 Form 20 is a gross-position report submitted daily by each clearing member which shows, by commodity and delivery month, all open contracts carried over from the previous business day, the contracts bought and sold during the current business day, and all contracts open at the close of business.
10 Regular elevators have satisfied the Exchange’s requirements for financing, facilities, capacity, and location. They have been approved as acceptable for delivery of the hard red winter wheat against the futures contract.
11 A&I staff receive a list of reportable positions generated by EA in the Kansas City regional office on a weekly basis. They utilize this report as an extra tool to check for open position discrepancies and speculative limit violations.
12 Section 150.02 of the Commission’s regulations sets forth the position limits for KCBT hard winter wheat. The Exchange has established the position limits for Value Line futures, and Mini Value Line and natural gas futures and options. The position limits can be found in Rule 2415.02 and resolutions RES25-2521.01-1, RES26-2621.01-1, and RES27-2714.00-1.
13 Sending a warning letter is EA’s first step after identifying a violation of speculative position limits.
14 Master cards, pursuant to KCBT Rule 1115.00, are subject to trading card recordkeeping requirements. A discussion of those requirements is found infra at pp. 18.
15 On March 12, 1998, the clearinghouse board of directors decided to increase this deadline from 45 to 60 minutes after each 30-minute period, retroactive to March 1, 1998. This action was taken because some of the larger firms were finding it difficult to meet the 45-minute deadline.
16 At the KCBT, all trades that remain unmatched at the end of the trading day are busted by the clearinghouse, resulting in no outtrades.
17 An "as of" trade is one where the trade date will reflect the date of the original trade and not the date when the trade is resolved and cleared. On average, there is less than one "as of" trade per month at the KCBT.
18 As a small-volume exchange, KCBT has been exempted under Section 5a(b)(5) of the Act from the heightened audit trail requirements of Section 5a(b)(3).
19 A description of the six timing error codes may be found in Attachment A.
20 The Division specified that those dates should include January 6, March 26, May 1, July 11, September 30, and November 17, 1997.
21 The Exchange calculated its accuracy rate using a methodology consistent with that used in all previous rule enforcement reviews of the KCBT, i.e., a trade is considered accurate if it is timed at the Time and Sales print, or plus or minus one minute of the print.
22 The types of trading cards in use at the KCBT are described supra at pp. 14-15.
23 These reviews alternate on a quarterly basis between full- and limited-scope. The limited-scope reviews are used chiefly to follow up on members who received reminder or warning letters, or who were referred to the Complaint Committee, as a result of the prior quarter’s review.
24 This represents all of the order tickets on those two days from the two clearing firms; one that clears predominantly customer business, and one that clears both locals’ and customer trades.
25 If a member runs out of pre-printed sequenced trading cards, he must submit cards to Compliance so that the trading initials can be written on by one of its staff members. Compliance staff initials these cards and keeps a log of the pre-printed numbered cards to ensure that members do not use the same numbered cards within one week.
26 A description of the Exchange’s Compliance staff members and their duties can be found in Attachment B.
27 These error codes and related parameters are described in Attachment C.
28 Other computer-generated reports used for surveillance purposes are described in Attachment D.
29 The TAR is also used by A&I staff as a source of possible explanations for unmatched quotes, which may be related to timing, spread, or trade practice errors identified on the report.
30 The clearinghouse installed a new trade matching system, TEMS ("Trade Entry Match System"), which went on-line on February 1, 1996. A give-up system, GUAPS ("Give-Up Average Price System") was added to TEMS at the end of February 1996. GUAPS allows clearing members to enter a block of trades for several customers that are later transferred to other designated clearing members at an average price computed by the clearinghouse system. In this connection, KCBT Rule 1120.02 allows an average price to be confirmed to a customer as the result of a give-up trade of a group of customer orders executed at different prices, provided that: (1) every order in the block is for the same commodity and month (and for options, put or call and strike price); (2) each order is designated at the time of acceptance as an average price order; (3) the FCM executing the order identifies it with the symbol "G" on the trading record; (4) the average price is determined by the clearinghouse according to the prescribed formula; and (5) the confirmation and monthly statement sent to the customer indicate that the price is an average price.
31 The residual amount is the amount left over after the average price is calculated and then rounded to the nearest price increment. (Buy orders are rounded up and sell orders are rounded down.) The residual must be paid to the customers, except that residuals of less than one cent may be retained by the clearing member. KCBT Rule 1120.02(d).
32 The six days were those specified in the Division’s rule enforcement review letter, dated January 14, 1998, for calculating the percentage of accuracy of one-minute times of execution. These dates were: January 6, March 26, May 1, July 11, September 30, and November 17, 1997.
33 The number of days covered by a routine TPI depends on the volume of trading done by the member being reviewed. A&I staff prefer to have a minimum of 100 trades to examine per member. Transcript pp. 167-68.
34 Generally, reminder letters may be issued by A&I when a member has violated a trade practice rule for the first time or when error rates are greater than five percent but not more than ten percent in an audit trail review. A warning letter may be issued by A&I, the Complaint Committee, the BCC, or the KCBT Board when a member has violated a trade practice rule for the second time or when audit trail error rates are greater than ten percent. A no-action notice is a notice from A&I to an Exchange member informing him or her that A&I has concluded an investigation into his or her trading activity and determined that no action by the Exchange is warranted.
35 This commission referral did not concern specific instance of wrongdoing, but rather was questioning the practice of some KCBT Natural Gas brokers of trading while on the telephone and/or outside of the pit, in violation of KCBT Rules 1110.00 and 1177.00.
36 Commission Regulation 8.07 requires that the final investigation report contain the reason the investigation was initiated, a summary of the complaint, if any, the facts developed during the course of the investigation, and the staff’s conclusions and recommendations.
37 Commission Regulation 8.06 requires than an investigation generally be completed within four months, except when significant reason exists to extend it beyond that time frame. Significant reasons may include the complexity of the matter, as well as the number of documents required to be analyzed in order to determine properly if a rule violation occurred.
38 Contract Market Rule Enforcement Program guideline No. 2, 1 Comm. Fut. L. Rep. (CCH) ¶ 6430 (May 13, 1975).
39 KCBT’s disciplinary procedures are described in Attachment E.
40 Although this is a small number of sanctions for a 12-month period, except for three recidivist members, discussed below, who should have received sanctions rather than warning and/or reminder letters, the Division has identified no material inadequacies in the Exchange’s trade practice surveillance or disciplinary programs that would suggest that the Exchange should have levied additional sanctions during the target period. In addition, the Division found no trade practice abuses in the course of its own oversight activities, and the Exchange received no customer or member complaints during the target period. The Division also notes that because the KCBT is a small exchange, most of whose business comes from commercial grain houses, it is less likely to experience the sorts of abuses that may occur at larger exchanges that also have significant retail business. Based on these factors, the low dollar amount and number of sanctions imposed by the Exchange has not been addressed through a recommendation.
41 In the trading ahead case, a broker appeared to sell one contract of wheat for her personal account at a better price than for four customer orders that she was given immediately prior to the opening. However, the Complaint Committee determined not to issue charges based on the fact that the member did not usually do brokerage, admitted her mistake, and already had made cash adjustments to the customers. The possible trading outside the pit violations involved two brokers in the natural gas pit who, while on the telephone with their customers, may have executed trades just outside of the pit. Both brokers claimed that they were in fact in the pit at the time of execution, and the Complaint Committee determined not to issue charges.
42 After the close of the target period, in July 1998, this member was referred to the Complaint Committee for audit trail violations and submitted a settlement offer of $550, which was accepted by the Complaint Committee and the Business Conduct Committee ("BCC").
43 A notice of charges is the equivalent of the Exchange’s complaint and states the conduct in which the member is alleged to have engaged, the rule violation alleged, any predetermined penalty, and the member’s rights with respect to a hearing. Commission Regulation 8.11.