By letters dated January 7, 2000, through June 6, 2000, the Merchants’ Exchange of St. Louis, L.L.C. (“MESL” or “Exchange”), a Missouri for-profit limited liability company, applied to the Commodity Futures Trading Commission (“Commission”) for designation as a contract market for the automated trading of deliverable Illinois Waterway and St. Louis Harbor barge freight futures contracts. The Exchange’s application also included various proposed rules necessary to the establishment of a contract market.

MESL has contracted with the Board of Trade Clearing Corporation (“BOTCC”) to provide all clearing and settlement services for its contracts. MESL also has contracted with the National Futures Association (“NFA”) to perform several of the Exchange’s self-regulatory duties, including investigating and prosecuting trade practice violations and conducting market surveillance in conjunction with an Exchange employee. Exchange Cubed, LLC (“Exchange Cubed”) would act as MESL’s technology service provider. International Business Machines Corp. ("IBM") has licensed an existing automated trading system that would be modified to serve MESL’s purposes, the “MESL System,” to Exchange Cubed. Exchange Cubed, in turn, has contracted to provide the MESL System to the Exchange. IBM also would act as a facility operator for the host equipment and would provide user support.

The Commission has not previously approved MESL as a contract market in any commodity futures contract or option.1 Accordingly, in addition to the terms and conditions of the two proposed futures contracts, the Exchange has submitted to the Commission a proposed trade-matching algorithm, procedures and rules pertaining to MESL governance, disciplinary and arbitration procedures, trading standards, recordkeeping requirements, and various other materials to meet the requirements for a board of trade seeking initial designation as a contract market.

II. Procedural History

The Commission published a Federal Register notice on February 1, 2000, requesting comments on MESL’s proposed application by April 3, 2000 (65 FR 4805). The Commission received four comment letters, all supportive of the Exchange’s application.² Through several letters dated January 27 through June 6, 2000, MESL provided the Division of Trading and Markets (“Division”) with additional information regarding MESL’s rules and the MESL System, and has amended its contract market designation application and rules to address questions posed by Division staff. In addition, by letter dated April 6, 2000, NFA described the trade practice surveillance, market surveillance, and disciplinary programs that it would operate for MESL.³

III. Commodity Exchange Act and Commission Regulations

As a contract market, MESL would be subject to the Commodity Exchange Act (“Act”) and to the same Commission regulatory provisions as any other futures exchange that the Commission has designated as a contract market. The Division has concluded that MESL’s proposed rule provisions would address each Commission regulation that requires a contract market to adopt and enforce certain rules. For those provisions of the regulations requiring MESL to take certain actions, the Exchange has submitted to the Commission affirmative representations in each instance.

The chart appended to this memorandum as Appendix A lists separate provisions of the Commission’s regulations requiring a contract market to: (1) adopt and enforce a specific rule or rules or (2) take certain actions. The left column lists the specific regulatory provisions, the middle column summarizes the provisions, and the right column sets forth how MESL would address each requirement. In some instances, certain regulatory provisions would not be applicable to MESL. In those instances, the right column of the Chart explains why the regulatory provision would not apply, and what MESL would do in the alternative, if applicable.⁴

IV. Governance

A. MESL Structure and Ownership

Pursuant to MESL’s Operating Agreement, the Exchange would operate as a for-profit Missouri limited liability company.⁵ Although MESL’s owners would hold all equity interest and voting rights in the Exchange, trading privileges would not be attendant to ownership. Those owners wishing to trade on the Exchange would be required to apply for trading privileges and successfully complete the standard Trading Privilege Holder (“TPH”) approval process described below.⁶ Conversely, TPHs only would be granted trading privileges and would have no Exchange governance authority or equity interests.⁷

Under the Missouri Limited Liability Company Act, all owners of a limited liability company are deemed “members” of the company. TPHs who were not owners would not sign MESL’s Operating Agreement, and thus, would not be “members” of the Exchange under Missouri law. MESL’s proposed rules, however, would deem TPHs to be “members” for purposes of applying the Act.⁸

MESL is wholly-owned by Mr. Ivan Bartling (REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT),⁹ Mr. Ross Tweedy (REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT), and American Milling, L.P. (REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT). REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.¹⁰ REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.¹¹ REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.

The Division has analyzed MESL’s ownership structure, and the various relationships within that structure to determine whether it would present a potential for any abuse of power or information that would be inconsistent with the Act or the Commission’s regulations.¹² REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT. MESL has indicated, however, that Mr. Bartling, REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT, Mr. Tweedy, and American Milling L.P. may trade on the Exchange. In order to address the potential that these individuals and entities might use their ownership influence to ascertain confidential information from the Exchange, MESL has agreed to establish an appropriate wall between itself and these individuals and entities. Specifically, MESL has represented that the aforementioned individuals and entities would be prohibited from access to any MESL position, market, or surveillance information. MESL’s rules and Operating Agreement also would serve to protect, material nonpublic information in accordance with Commission Regulation 1.59.¹³

B. MESL’s Board of Managers and Officers

1. General

The Exchange’s Board would be responsible for managing the property and business of MESL, including such actions as setting compensation for officers and employees, setting transaction fees, and approving TPH applications. In addition, the Exchange’s Board would be responsible for approving any amendments to MESL’s Operating Agreement and revisions and additions to MESL’s Rules.

Section 5.03(b) of MESL’s Operating Agreement provides that the Board would be comprised of five Managers, one of whom shall be Mr. Jump or his nominee, and one whom shall be the Exchange President. The three remaining Managers are selected by a majority vote of MESL’s owners. The Exchange’s current Managers include Mr. Jump, Mr. Stewart, Mr. Tweedy, Mr. Bartling, and James Hickey. Mr. Jump has been elected to serve as Chairman of the Board. Under MESL’s Operating Agreement, Managers would hold office until resignation, death, or removal for cause.

2. Board Composition

Commission regulations set forth requirements regarding service on, and composition of, a self-regulatory organization’s (“SRO”) governing board. For instance, Commission Regulation 1.63 generally requires contract markets to adopt rules which, among other things, prohibit persons from serving on governing boards if they were found, within the three prior years, to have committed a disciplinary offense.¹⁴ MESL Rule 204 would satisfy this regulation by requiring that no individual may serve on the Board or any Exchange committee if, in the last three years, he or she was found guilty of a disciplinary offense, is suspended from trading, or has had a registration revoked or is suspended from serving on a governing board under federal laws.

MESL Rule 202 would satisfy Regulation 1.64’s governing board composition requirements by mandating that at least 20 percent of the Board be “Public Managers” and specifically requiring that the Board be elected so as to satisfy the diversity requirements set forth in Commission Regulation 1.64. Accordingly, at least one Manager from MESL’s initial five-person Board must qualify to serve as the public Manager. MESL has represented that Mr. Hickey would be the public Manager. Although Mr. Hickey does not have direct experience in the futures industry, he has a vast amount of business experience.¹⁵ The remaining four managers all have considerable experience in various aspects of the futures industry and currently hold positions that can be deemed to satisfy the remaining diversity requirements of Regulation 1.64.¹⁶

3. Meetings

MESL’s Operating Agreement provides that the Board would have regularly scheduled quarterly meetings. In addition, special meetings may be called by or at the request of the Chairman, the President, or a majority of the Managers. Unless waived, at least one day notice of such a meeting must be given by the person or persons requesting the meeting. At any meeting at which a quorum was present, the act of a majority of the Managers present would be an act of the Board.¹⁷

MESL Rule 212 would satisfy the requirements of Commission Regulation 1.69 by providing that no member of the Board (or Exchange oversight or disciplinary committee) could vote on any matter in which the named party in interest was the Board member or his or her employer, employee, or any other person that had a business, employment, or family relationship with the Board member that would warrant abstention. Further, no Board member could vote on an action that would not be submitted to the Commission for prior approval if the member knowingly had a direct or substantial financial interest in the result of the vote, based on positions held, whether on the Exchange or elsewhere, either personally or at an affiliated firm. Consistent with Regulation 1.69, MESL Rule 212 would establish procedures for determining whether a Board member must abstain from deliberating or voting in any particular matter.

4. Executive Committee

Pursuant to MESL’s Operating Agreement and MESL Rule 207, the Board has established an Executive Committee comprised of the Chairman and President to manage the Exchange’s day-to-day operations, including executing and implementing previously established Board policy and recommending new policy.¹⁸ In addition, the Executive Committee would be responsible for reviewing TPH applications.

MESL has contracted with NFA to perform an initial review of TPH applications and to conduct appropriate background checks. The respective application would then be reviewed by the Executive Committee and referred to the Board with its recommendation. The Executive Committee would base its recommendation on its evaluation of the applicant’s character, financial standing, and trading background.

The Executive Committee also would have the responsibility to: (1) monitor TPH and Authorized Trader ("AT") compliance with Exchange rules;¹⁹ (2) inquire into the business conduct of TPHs and ATs and require detailed financial reports of any TPH relating to its trading activity; (3) hear disciplinary appeals; (4) recommend suspension of a TPH if it determines that there are substantial questions as to whether a financial emergency exists regarding the particular TPH; and (5) prohibit trading by a TPH which is excessive in view of its capital.

5. Officers

The Exchange initially would have a President, Secretary, and Treasurer appointed by the Board to fulfill the duties of these offices as described in MESL’s Operating Agreement and as determined by the Board. The Board also would have the authority to add additional officers as it deems appropriate. Officers would serve at the pleasure of the Board and may be removed with or without cause if the Board deems such removal to be in the Exchange’s best interests.

MESL’s Operating Agreement provides for indemnification of any person who becomes party to any legal proceedings as a result of their being an officer, director, employee, or agent of MESL. MESL would not, however, indemnify its officials for civil monetary penalties imposed by the Commission under Section 6b of the Act.²⁰

6. Emergency Actions

MESL Rule 419 would authorize the President, with the concurrence of at least a two-thirds vote of the Managers, to place into immediate effect temporary rules for up to 30 business days in response to an emergency.²¹ Among the actions that could be taken would be the suspension of trading, the ordering of liquidation-only trading, the modification of delivery terms and conditions, and the modification of trading hours. Such emergency rules could be effectuated without prior Commission approval and without compliance with the non-emergency rule review provisions of Section 5a(a)(12)(A) of the Act and Commission Regulation 1.41. MESL rules also would authorize the Exchange to take various actions in response to physical emergencies, which would include any circumstance which could have a severe or adverse effect upon MESL’s physical functions. Examples of a physical emergency would include a fire, bomb threats, substantial inclement weather, power failures, communication breakdowns, and computer or software malfunctions.²² The Division believes that MESL Rule 419 would be consistent with the requirements of Commission Regulation 1.41(f) and (g) which govern exchange temporary emergency rules and physical emergencies, respectively.

C. Arbitration

MESL has contracted with NFA to initially administer all arbitrations -- TPH v. TPH and TPH v. customer.²³ Pursuant to MESL Rule 801, MESL would adopt NFA’s Code of Arbitration and Member Arbitration Rules. NFA’s jurisdiction would be set forth under MESL Rule 802. With respect to controversies between TPHs, MESL Rule 802(a) would provide the Board with jurisdiction to determine whether a controversy arose from Exchange business and, therefore, should be referred to NFA.²⁴

V. Access to the MESL System

A. Trading Privilege Holders

Access to the MESL System would be limited to holders of MESL trading privileges, TPHs, and their authorized representatives, ATs.²⁵ Pursuant to MESL Rule 304, trading privileges only could be obtained by applicants that: (1) were clearing members; (2) had a clearing arrangement with a clearing member; or, (3) had an account with a firm that has a relationship with a clearing member. Therefore, in order for a non-clearing member to become a TPH able to enter orders into the MESL System, it must either obtain authorization from a clearing member willing to guarantee those transactions or enter into an arrangement with a person that has such authorization from a clearing member. Under such an arrangement, the clearing member would assume financial responsibility for all such guarantees. Only BOTCC clearing members would be eligible to act as MESL clearing members.

An entity or individual seeking to become a TPH would be required to complete and file a comprehensive application with the Exchange. The MESL application for TPH status would require significant disclosure regarding financial standing, including net worth and prior bankruptcies; relationships with commodities and/or securities exchanges, including the agencies that regulate them; involvement in civil or administrative litigation and criminal convictions; and general character and background information.²⁶ It also would require an applicant to meet certain other criteria, such as sufficient capital, and an affirmative representation that he or she is not subject to a statutory disqualification under the Act. At the discretion of MESL, applicants seeking TPH status might also be required to produce trading suitability letters from employers or others attesting to the applicant’s trading knowledge or background.²⁷

Although MESL's Board would have the ultimate authority to approve applicants, MESL would contract with NFA to initially review TPH applications and to conduct appropriate background checks. MESL's Executive Committee would be responsible for evaluating each TPH applicant's character, financial standing and trading background, and subsequently making a recommendation to the Board to approve or disapprove each application.²⁸ A favorable vote of a majority of the entire Board would be necessary to approve an applicant recommended by the Executive Committee. A TPH applicant approved by the Board would receive trading privileges upon payment of a $1,000 fee and signing an agreement to abide by the Exchange's rules.²⁹ Pursuant to MESL Rule 304, a TPH applicant that was rejected by the Board would not be eligible for another vote on its application during the six months immediately following such rejection.

TPH interests would be non-transferable, non-assignable and could not be sold or leased.³⁰ Under MESL Rule 306, TPHs could have their trading privileges suspended, revoked, limited, conditioned, restricted or qualified, if, in the sole discretion of MESL's Executive Committee, such action would be in the Exchange's best interest.

B. Authorized Traders

The trading privileges of certain TPHs (an FCM, IB or CTA only) also could be exercised by authorized employees designated as ATs.³¹ Each TPH would be responsible for monitoring its ATs' compliance with MESL rules, as well as any other pertinent regulatory requirements. Toward this end, MESL would require each entity TPH to list all ATs on its TPH application and to warrant that its ATs would observe and be bound by Exchange rules. In addition, the Exchange would require each AT to consent to abide by MESL's rules by signing a "Jurisdictional Consent" form.

The Jurisdictional Consent form would not address regulatory requirements but, pursuant to MESL Rule 508, each TPH would be responsible for determining whether its ATs required Commission registration. Under the Commission's current policy, an AT would be required to register with the Commission as an Associated Person (“AP”) of his or her employer only if such AT handled customer orders other than in a strictly clerical capacity. If, however, an AT that handled customer orders in a strictly clerical capacity also entered orders for the proprietary account of his or her employer on a discretionary basis, the AT would be required to register with the Commission as an AP.³² Pursuant to MESL's rules, TPHs would have significant supervisory responsibilities with respect to their ATs.³³ Further, MESL's TPH application process would require a TPH to provide MESL with an attestation that none of its ATs would be subject to a statutory disqualification under the Act. Each TPH also would have a continuing duty to ensure that any AT hired in the future was not subject to a statutory disqualification.

C. Trading Privilege Holders with Customer Accounts

A TPH would be required to be a Commission registrant if he or she executed trades for customer accounts.³⁴ All TPHs trading for customer accounts must exercise due diligence in the handling and execution of their customer orders.³⁵

In accordance with the provisions of Commission Regulation 1.35, MESL would require a TPH to prepare an order ticket for every customer order that could not be entered into the MESL System immediately upon its receipt.³⁶ A TPH, however, would be required to enter that customer order as soon as practicable given market conditions. For example, a customer order could be made contingent upon the execution of a separate order, and therefore, its entry would not be supportable by the MESL System at the time it was received. Thus, it would be the responsibility of a TPH that accepted a customer order involving a complex trading strategy to ensure the proper execution of such orders by transmitting all the instructions necessary to accomplish such trades into the MESL System as soon as practicable.

VI. Order Entry & Execution

A. Overview

Like other Commission-approved automated trading systems, MESL would anonymously match orders in accordance with an algorithm that would prioritize bids and offers on the basis of best price (which would have first priority) and time (which would have second priority), respectively.³⁷ The quantity and price of each and every limit order entered into the MESL System would be available for observation to market participants upon order entry.³⁸

B. Types of Orders

The MESL System would permit the entry of market and limit orders.³⁹ In addition, the System would accept fill-or-kill and immediate-or-cancel contingent orders.⁴⁰ MESL also has proposed to permit counterparties to enter into bona-fide Exchange of Futures for Physicals ("EFPs") through the Exchange.⁴¹

C. Trade-Matching Algorithm

The specific system entry and trade-matching requirements for each type of order would be established by MESL Rule 407. The algorithm, as it relates to various types of orders, would operate as follows:

1. Limit Order Algorithm

a. All limit orders entered into the MESL System would identify quantity and price, as well as the time period during which the order would remain open.⁴² MESL limit orders would be filled and executed in the sequence in which they were received on an "or better" basis. As such, limit orders, upon receipt, would be recorded and logged into the server as they were received and would be assigned order entry times to the nearest one-thousandth of one second.⁴³ Therefore, if a limit order to buy was entered at a price that was greater than the best "offer to sell," that limit order would act like a market order until all available "offers to sell" that were at or below the limit price were filled or the quantity of the order was filled.

b. A limit order having the best price would be assigned price priority. If more than one order had the best price, then the best price order that also held time priority would be executed first.

c. An order would not lose time priority if an order with a better price was subsequently entered into the MESL System; that order would, however, lose price priority.

d. Example:

Assume limit bids were placed at the following prices, times, and quantities:

Time            Price            Bids          Offers

Trader A       9:00           72.00          3 limit

Trader B       9:01           72.05          2 limit

Trader C       9:02           72.10          1 limit

· In this scenario, Trader C's order would have price priority over the orders of Traders A and B, and Trader B's order would have price priority over Trader A's order.

Further assume that at 9:03 Trader D enters a limit offer at 72.00 for four contracts. The MESL System would execute the following transactions.

Time          Price          Quantity

C-D Trade               9:03         72.10               1

B-D Trade               9:03         72.05                2

A-D Trade               9:03         72.00                1

· Trader D’s limit offer of four would be executed at 72.00 or better. Following the rules of price/time priority, Trader C’s bid for one contract at the highest price, 72.10, would be matched against Trader D’s limit offer of four contracts.

· Trader B’s bid for two contracts at 72.05 would then be matched against the remaining three contracts of Trader D’s offer. Two of Trader D's contracts would be matched, one would remain.

· One of Trader A’s bid of three contracts at 72.00 would be matched against the remaining contract of Trader D’s limit offer.⁴⁴ Although Trader A’s bid would meet the terms of the limit offer (at 72.00 or better), and has time priority, it does not have price priority over B's and C's respective orders, and would be the last to be matched.

2. Market Order Algorithm

a. A market order (also called an “at best” order) would be filled at the best price(s) available in the market at the time of order entry. A market order would be rejected by the MESL System if, at the time of the order's entry, no opposite limit order existed in the relevant contract and contract month. Accordingly, market orders only would be matched with pending limit orders and could not be matched with other market orders. Each market order would be filled to the quantity available at the time the order was entered and any unfilled portion of the market order would be cancelled immediately.

b. By definition, a market order would have price priority over any pending limit order(s) on the same side of the market because its assigned price(s) would be determined by the price(s) of pending limit order(s) on the opposite side of the market at the time of entry.

c. Example:

Assume limit offers were placed at the following prices, times and quantities:

Time          Price          Bids          Offers

Trader A     10:01         72.00                         3 limit

Trader B     10:02         71.95                         2 limit

Trader C     10:03         71.90                         1 limit

Trader D     10:04         71.85                         1 limit

Next, assume that at 10:05 Trader E entered a market order to buy three contracts. The MESL System would execute the following transactions:

Time              Price              Quantity

D-E Trade   10:05             71.85                 1

C-E Trade   10:05             71.90                 1

B-E Trade   10:05             71.95                 1

· Trader E's market order would be matched with the pending limit offers according to their price priority. Accordingly, Trader E's order to buy three contracts would first be matched against Trader D's limit offer of one contract at 71.85.

· One of Trader E's two remaining contracts would then be matched against Trader C's limit offer of one contract at 71.90.

· Trader E's remaining contract would then be matched against one of Trader B's limit offers of two contracts at 71.95.⁴⁵

· The remaining unfilled quantity of Trader B’s limit offer and the entirety of Trader A's limit offer would remain in the MESL System and would be eligible for matching. If Trader E’s bid only had been partially filled, the remaining, unfilled portion would have been canceled automatically.

3. Fill-or-Kill Algorithm

a. A fill-or-kill order must be executed in its entirety upon entry into the MESL System, and if not immediately executed, it would be cancelled. A fill-or-kill order must specify price and quantity and only could be matched against a corresponding limit order(s).

b. Example:

Assume that limit bids and offers were placed at the following prices, times and quantities:

Time                  Price                  Bids                  Offers

Trader A     11:56                  1.45                 5 limit

Trader B     11:57                  1.50                                          10 limit

Trader C     11:58                  1.55                                          10 limit

Trader D     11:59                  1.50                                          10 limit

Further, assume that at 12:00 Trader E entered a fill-or-kill buy order at 1.55 for 30 contracts. The MESL system would execute the following transactions in order:

Time                  Price                  Quantity

E-B Trade     12:00               1.50                      10

E-D Trade     12:00               1.50                      10

E-C Trade     12:00               1.55                      10

· Trader E's fill-or-kill buy order of 30 contracts at 1.55 entered at 12:00 would be immediately matched and executed in its entirety opposite Traders B, C and D.⁴⁶ Because Trader E entered a fill-or-kill limit order, Trader E's order is executed on an "or better" basis with ten contracts opposite Trader B at 1.50, ten contracts opposite Trader D at 1.50 and ten contracts opposite Trader C at 1.55.

4. Immediate-or-Cancel Algorithm

a. An immediate-or-cancel order would be an order that specified price and quantity, and must be executed in whole or in part upon entry into the MESL System.

b. In contrast to a fill-or-kill order, which must be executed immediately in whole upon entry into the MESL system or the entire order would be canceled, only that portion of an immediate-or-cancel order that was not immediately executed upon entry would be canceled.

c. Example 1:

Assume limit bids and offers were placed at the following prices, times and quantities:

Time                  Price                  Bids                  Offers

Trader A     11:00                  1.50                  20 limit

Trader B     11:01                  1.60                                          30 limit

Further, assume that at 11:02 Trader C entered an immediate-or-cancel ("IOC") buy order at 1.55 for forty contracts.

· While Trader C's immediate-or-cancel buy order at 1.55 would have price priority over Trader A's limit order at 1.50, Trader C's order would be immediately cancelled because there was no prevailing offer in the MESL System at the price designated in Trader C's order.

d. Example 2:

Assume that the pending orders do not change from Example 1 and at 11:03 Trader C enters another immediate-or-cancel buy order at 1.60 for 40 contracts.

The MESL System would execute the following transaction:

Time                  Price                  Quantity

B-C Trade   11:03                  1.60                      30

· Trader C's immediate-or-cancel buy order would be matched with Trader B's limit offer of 30 contracts at 1.60.

· The unfilled portion of Trader C's immediate-or-cancel buy order, the remaining ten contracts, would then be canceled automatically.

D. MESL System Opening

The Exchange has proposed an 8:30 a.m. daily market open for both of its barge rate futures contracts.⁴⁷ MESL Rule 403 would provide that the opening price for each trading day would be based on all orders entered into the MESL System prior to the relevant contract's market open, thereby establishing an equilibrium value.⁴⁸ All orders that had been entered into the MESL System up to 8:29 a.m. of each trading day would be eligible for matching at the open.⁴⁹ All new orders entered during the period between 8:29 a.m. and 8:30 a.m. would not be eligible for matching at the open and would not be included in the opening equilibrium calculation, but would be eligible for matching immediately upon conclusion of the open.⁵⁰

The following is an example of the proposed market opening equilibrium matching for MESL contracts with assumed buy and sell order quantities at a number of prices:⁵¹

Buy Order Volume	Buy Order Quantity	Price	Sell Order Quantity	Sell Order Volume
0	0	1.603	90-lot	240
5	5-lot	1.602	70-lot	150
12	7-lot	1.601	50-lot	80
22	10-lot	1.600	20-lot	30
67	45-lot	1.599	0	10
127	60-lot	1.598	10-lot	10
227	100-lot	1.597	0	0

In this example, trades would be possible between the prices of 1.598 and 1.602, inclusive. By comparing “buy order volume” to “sell order volume” it is clear that: (1) at prices of 1.599 and below, there would be greater volume to buy than to sell; and, (2) at prices of 1.600 and above, there would be greater volume to sell than to buy. The equilibrium range, dictated by the pressure between buy and sell volume, would be set between 1.599 and 1.600.

Once an equilibrium range had been determined, the MESL System would fix an opening price. In the above example, the opening price would be set at 1.600 because that would be the price level at which total “trade volume” would be greatest.⁵² At the market open, all orders that were eligible for matching at 1.600 would be filled at that price. Accordingly, the entire ten lot sell order at 1.598 would be filled at 1.600 (receiving a better fill); while the 20-lot sell order at 1.600 would only receive a fill of 12 contracts at 1.600 (receiving requested fill).⁵³ Moreover, the five lot buy order at 1.602, the seven lot buy order at 1.601 and the ten lot buy order at 1.600 would all receive complete fills at 1.600.

All buy and sell orders would be eligible for matching at the open based on their price and time priority. As noted above, price priority would always be assigned to the order with the best price. If more than one order existed at that price, time priority would govern each order's individual execution. Time priority would always be assigned to the first order at a price that bettered the market when it was received by the MESL System. Only one buy order and one sell order would possess time priority at any given time. An order would lose price priority, but not time priority, when an order at a better price was entered into the MESL System.

E. MESL System Closing

MESL has proposed a daily market close of 4:00 p.m. MESL Rule 404 would provide for the establishment of a closing price based on the last transaction executed during the closing range.⁵⁴ Generally, the closing price would be the price of the last matched trade of the trading session. If, however, there were no transactions executed during the last 30-seconds of the trading session, the period between 3:59:30 p.m. and 4:00 p.m., the closing price would be determined by the last trade prior to the closing range, if such price was between the final best bid and final best offer of the closing range.⁵⁵ Alternatively, if there were no transactions executed during the closing range or no trade that qualified as a closing-price trade prior to the closing range, the closing price would be based on either: (1) the price of the last order to buy, if the order's price was above the last transaction executed on the MESL System (or opening price); or (2) the price of the last order to sell, if the order's price was below the last transaction executed on the MESL System (or opening price). If there were no trades executed during the trading session, then the closing price would be set at the opening price.⁵⁶

MESL contends that the price of the last trade would be an appropriate means of establishing a closing price because it would be the most representative snapshot of the market price. MESL believes that the last trade price only would be inappropriate if there was a subsequent higher bid or lower offer, which would then be more representative of the market. In an orderly market, basing the market's closing price on a single transaction would not appear to be problematic. As a safeguard, MESL has proposed to reserve the right to set its daily closing price at any level that it deems appropriate to maintain the orderly administration of the market. MESL believes that this procedure would address those instances, in thinly-traded forward months, where aggressive bids or offers on the close may be lacking.

F. Exchange of Futures for Physicals

MESL would permit counterparties to enter into bona-fide EFPs through the Exchange.⁵⁷ EFP transactions entered into after 6:00 p.m. on any given trading day would be reported to the Exchange no later than 6:00 p.m. of the following business day. MESL proposed Rule 418 would permit a bona-fide EFP of any size to be negotiated at any price that was mutually agreeable to the transacting parties.

MESL has represented that it would circumscribe the conditions under which EFPs could be executed and would provide participants with procedures dictating how to document those noncompetitive transactions.⁵⁸ Specifically, one party to an EFP must be the buyer of a cash commodity, as well as the seller of futures, and the counterparty must be the seller of a cash commodity, as well as the buyer of futures. For every EFP transaction, MESL would require that the dollar value of the underlying cash commodity be the equivalent of the dollar amount of the cash commodity represented by the underlying futures portion of that transaction. EFPs would be cleared through BOTCC and designated in the Exchange's records as noncompetitive transactions. MESL Rule 418 would require clearing members to an EFP transaction to maintain and produce, upon request, documentation of the underlying cash component.⁵⁹

Moreover, it would be the responsibility of the clearing member that receives the futures position of an EFP transaction to report that transaction to MESL. This reporting requirement would be on an "as soon as practicable" basis, but in no event later than 6:00 p.m. of the same trading day. The reporting clearing member also would have an obligation to maintain all pertinent information regarding the EFP, including the identity of the parties, commodity, price, volume, delivery month, date and approximate time of transaction. MESL states that it would ensure that all required information, including an EFP designation and a customer type indicator identifier ("CTI"), were properly recorded by the Exchange on the same trading day that the transaction was reported.

In connection with MESL's rule enforcement program discussed below, NFA routinely would perform a review of selected EFP trades and their supporting futures and cash documentation to determine whether the EFP trades were bona fide transactions and were executed within MESL's prescribed guidelines. NFA also would review this sample to ensure that there were only two parties involved in the transaction and that there was a reasonable price and quantity correlation to the futures and cash being exchanged. An exception report would be generated to identify any EFP transactions that were executed for contracts outside of the relevant delivery month. Any EFP transactions executed at a price outside of the trading range for that day's trading session at or prior to the time of execution also would be identified.

EFP transactions would be subject to the same review as all other MESL trading activity and unusual activity would result in a trade practice investigation.⁶⁰ The Exchange represents that, in addition to NFA's routine EFP review, NFA would examine EFPs annually, pursuant to Commission Regulation 1.51(a)(3), as part of the Exchange's recordkeeping rule enforcement program. MESL has represented that should it determine that more frequent reviews were warranted, NFA would alter its review schedule and would perform "spot-checks" of EFPs, the frequency of which would depend on numerous factors, including but not limited to the volume of EFP transactions. Consistent with current industry practice, MESL would publicly report, as trade data, all EFP transaction information. EFP trade data would appear as part of its Open Interest Reports published on the morning after the EFPs' trade date.

MESL's rules would satisfy the requirements of the Commission's regulations with respect to the execution and documentation of EFP transactions, and would exceed those requirements inasmuch as MESL Rule 418 would establish the elements of a bona-fide EFP on MESL in accordance with the previously expressed views of the Division regarding these transactions. ⁶¹

G. Dissemination of Trade Data

MESL is currently in discussions with various trade data dissemination vendors regarding its barge freight futures contracts. DTN, Bridge, and Reuters currently disseminate information for MESL’s barge freight cash market. It is expected that these same information services would disseminate trade data from MESL barge freight futures markets as well. MESL has represented that it would not begin trading until it has an agreement in place with an established price dissemination vendor.

H. Open and Competitive Nature of the MESL System

The Division believes that MESL's automated trading system would not be inconsistent with any provision of the Act or Commission regulations. Commission Regulation 1.38 requires open and competitive execution, but it recognizes that there is more than one way to accomplish this end:

[a]ll purchases and sales of any commodity for future delivery, and of any commodity option, on or subject to the rules of a contract market shall be executed openly and competitively by open outcry or posting bids and offers or by other equally open and competitive methods, in the trading pit or ring or similar place provided by the contract market, during the regular hours prescribed by the contract market…

Moreover, Section 12 of the Act, as amended, 7 U.S.C. § 16 (1999),⁶² directs the Commission to "facilitate the development and operation of computerized trading as an adjunct to the open outcry auction system." While the MESL System would not provide for open outcry, it would allow for open access to the system by all holders of trading privileges. In addition, the MESL System would promote competitive trading by applying a trade-matching algorithm that uses non-discretionary rules of priority to execute transactions.

VII. Clearing and Settlement

MESL has proposed to outsource its clearing function to BOTCC. Under this arrangement, all MESL trades would be cleared by BOTCC clearing members through BOTCC.⁶³ MESL would pay BOTCC a fee for clearing services and would reimburse BOTCC for all costs related to the modification of BOTCC systems for this purpose. MESL trades would be cleared in accordance with proposed BOTCC rules for MESL ("BOTCC/MESL Rules") that mirror procedures and requirements that BOTCC currently applies to trades it clears for CBOT and MidAm.⁶⁴

Under the proposed clearing arrangement, MESL would indemnify BOTCC against loss relating to its clearing services. The clearing indemnification agreement between MESL and BOTCC would require MESL to provide BOTCC with a letter of credit, a financial guarantee, and an insurance policy or similar form of third-party guarantee. In return, BOTCC would guarantee, through the principal of substitution and novation, MESL's cleared trades in a manner similar to the guarantee that it currently provides for CBOT and MidAm trades.⁶⁵ Under BOTCC/MESL Rule 510, only BOTCC clearing members would be eligible to clear MESL transactions. Any BOTCC clearing member desiring to clear MESL transactions, however, would be required to sign a supplemental agreement with BOTCC that would account for MESL transactions.

During the trading day, the MESL System would transmit matched trade data to BOTCC within approximately one half-hour of the execution of each MESL trade.⁶⁶ Upon each trade match, MESL would immediately send electronic trade data to the pertinent clearing member.⁶⁷ By approximately 8:00 p.m. of each business day, BOTCC's clearing system would produce clearing member reports for that trading day's activity and make the reports available to clearing members via computer. Based upon that trade data, the clearing system would generate initial, variation, and maintenance margin requirements, and would transmit appropriate margin instructions to the approved depositories by 7:30 a.m. the following business day. The approved depositories would confirm to BOTCC their acceptance of the obligation to complete the funds transfers specified in the margin instructions by 8:30 a.m. that same day.

REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT.⁶⁸

VIII. Compliance and Surveillance Program

Commission Regulation 1.51 requires that each contract market use “due diligence in maintaining a continuing affirmative action program to secure compliance” with various provisions of the Act, the Commission’s regulations, and the contract market’s own rules. In order to satisfy this requirement, MESL has contracted with NFA to carry out its self-regulatory responsibilities with respect to its trade practice and financial surveillance programs. NFA also would assist MESL in operating its market surveillance and disciplinary programs.⁶⁹ Under the terms of MESL and NFA’s agreement, in addition to paying NFA a start-up fee of REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT, MESL would pay NFA REDACTED MATERIAL SUBJECT TO CONFIDENTIAL TREATMENT. This type of fee arrangement should ensure that continuous surveillance would be conducted in an appropriate and consistent manner.

MESL also has retained Delbert Heath to serve as its Administrator of Investigations and Audits (“Administrator”). Mr. Heath, a MESL employee, would act as a liaison between NFA and the Exchange and, as discussed below, would work closely with NFA in conducting market surveillance. He also would be responsible for overseeing NFA’s work with respect to its performance of MESL’s self-regulatory obligations.⁷⁰

The Division notes that Commission Regulation 1.59(b)(1) subjects contract market employees to a total trading prohibition in futures contracts "traded on . . . the employing contract market" and that Regulation 1.59(a)(2) defines employee to mean "any person hired or otherwise employed on a salaried or contract basis" by an SRO. The Division believes that because MESL has contracted with NFA to provide the Exchange with compliance and surveillance services, those NFA employees involved in providing these services to MESL should be considered "employees" of MESL for the purpose of applying Regulation 1.59, and thus, should be prohibited from trading any MESL product.⁷¹

MESL would be the first contract market designated by the Commission that had contracted with an independent third party to perform most of its SRO obligations.⁷² The Commission contemplated such a situation, however, when enacting Commission Regulation 8.05. Specifically, Regulation 8.05(a) provides that an exchange enforcement staff may consist of “persons hired on a contract basis.” Commission Guideline No. 2 (1 COMM. FUT. L. REP. (CCH) Section 6430 (May 13, 1975)) provides guidance concerning what the term “due diligence” means in the context of an exchange satisfying its rule enforcement obligations. Guideline No. 2 states, among other things, that “if an exchange relies upon persons other than its employees to carry out its rule enforcement program, it is nevertheless the exchange’s responsibility to ensure that its obligations under the Act are met.”

In this regard, NFA would prepare and provide to MESL quarterly reports detailing the number and types of exception reports generated, the number of investigations commenced, the status of each investigation, and the nature of the violations alleged to have been found. As discussed below, MESL’s Administrator also would communicate regularly with NFA regarding trade practice and market surveillance and investigations. Similar to any other exchange, MESL would be subject to periodic rule enforcement reviews conducted by Commission staff. As part of MESL’s first rule enforcement review, the Division would examine carefully the development and implementation of NFA’s trade practice violation detection and market surveillance strategies, in addition to implementation of MESL’s disciplinary program.

A. Audit Trail

1. Overview

The Division believes that MESL’s audit trail would capture and retain sufficient trade-related information to permit NFA to detect trading abuses and to reconstruct all transactions. Customer orders would be tracked from time of receipt through fill allocation. The uninterrupted stream of timing information that the MESL System would collect regarding the various events which occurred as a result of every order entry and trade would enable NFA to reconstruct accurately an entire day’s trading activity. This reconstruction would include not only executed transactions, but all events, including the entry of each order, in the sequence of occurrence, timed to the nearest one-thousandth of a second.

With respect to order tickets, for those orders that were entered immediately into the MESL System, an electronic order ticket would be generated that captured the time of entry and included a unique order number. For those orders that could not be entered immediately into the MESL System, a written order ticket would have to be prepared that included the account designation, date, and time of receipt, and all other information required under MESL Rule 412.⁷³

An order would not be accepted by the MESL System unless it was entered with complete information including the full terms of the order and the identification codes for the associated TPH. The execution time of each trade would be recorded to the nearest one-thousandth of a second. Further, no order or trade information input into the MESL System could be altered without leaving a permanent record of the original data, the TPH or AT that made the change, and the exact time of the change.

MESL’s electronically-recorded data would be maintained in a single record as required by Commission Regulation 1.35(e) and would be viewable in the form of three separate logs. These logs would be preserved for five years. The “Order Transaction Log” would list the exact time to the nearest thousandth of a second of each order entry made by a TPH or AT and would show such information as order date, order number, account designation, CTI code, clearing member, commodity, contract month and year, quantity, type of order (buy/sell), qualifiers (market/limit, etc.) and price. This record also would contain data regarding the entry of every order into the MESL System regardless of whether it resulted in a trade.

The “Execution Transaction Log” would contain information similar to that in the Order Transaction Log, but only would contain the information specifically pertaining to each executed transaction such as execution time, buying clearing member, selling clearing member, transaction code, and transaction reference number. The “Changes to Executed Transactions Log” would contain the record of each change made to any aspect of a completed trade, except for unalterable match-critical data such as price, time, commodity, and month.

2. Review and Utilization of Trading Information

NFA would conduct annual back office audit trail and recordkeeping reviews of TPHs for which MESL would act as the designated SRO ("DSRO"). During the course of these reviews, NFA would select a group of TPHs and focus on their entries recorded in MESL’s Order Transaction Log and Execution Transaction Log. To ensure that the scope of the testing would be broad enough, NFA might choose to review all trades for a single trading day to confirm whether the orders were handled in accordance with the applicable MESL rules.

The trade times which constituted the original record of each transaction would be assigned automatically to each entry and event by the MESL System. Since these times would be unalterable, they would be presumptively accurate. MESL would not need to review trade-timing information to verify their accuracy, but instead, would confirm the level of compliance of individual TPHs with MESL and Commission requirements that each order be properly documented.

B. Trade Practice Surveillance

1. Automated Surveillance

a. Overview

NFA would utilize an automated system to perform MESL’s trade practice surveillance. This system would consist of an array of Windows-based applications that would operate in a client-server environment.⁷⁴ The heart of NFA’s system would be a relational database that would contain all MESL data relevant to the surveillance process.⁷⁵ The system also would include a database management application and a set of database analysis tools to help sort through the data and highlight patterns or anomalies. As discussed below, these tools would allow NFA to generate interactive exception reports that would allow analysts to drill down from summary data provided in an exception report to more specific trade data. Analysts also would have the ability to manipulate data and modify parameters.

NFA’s automated surveillance system would not be limited to transaction-by-transaction analysis, but also would identify patterns and new relationships, and would provide NFA with the capability to compile aggregate TPH and AT trading profiles. The profiles would track the distribution of personal and customer trades (e.g., 80 percent customer trades and 20 percent personal trades), the products usually traded, trading patterns, and performance.⁷⁶ Profiles would be linked to TPH and AT identifiers so that analysts could access particular profiles whenever suspicious trading activity was recognized. In addition, deviations from established profiles such as unusual profit patterns, drastic changes in overall volume, or unusual concentrations of trading activity between the same counterparties would signal the need for a detailed review of the component trading activity.

Similar to profiling, NFA also would have the capability to identify the degree of correlation among data. For example, NFA could review for a correlation of market activity between the Illinois Waterway and the St. Louis Harbor barge freight futures contracts by large traders. Specifically, an analyst could review a large trader’s positions and his or her profit and loss in both contracts to determine if two traders had a pattern of activity together that was unusual.

b. Exception Reports

NFA would utilize its analytical tools to create exception reports primarily based on CTI codes. NFA staff explained to Commission staff that NFA would modify the CTI categories set forth in Commission Regulation 1.35(e) in order to have a category that totally isolated personal trades.⁷⁷ Under Commission Regulation 1.35(e), a CTI 1 includes personal trades and all discretionary trades. Under NFA’s CTI categories, a CTI 1 only would include personal trades. Discretionary trades would be a CTI 2, 3, or 4, depending upon for whom the trade was executed.⁷⁸ NFA believes that isolating personal trades would enhance its capability to identify potential trade practice violations with respect to electronic trading and would contribute to better user profiles.

NFA’s automated surveillance system would generate the following exception reports for the surveillance of MESL trading: (1) Direct Trading Ahead of Customers; (2) Indirect Trading Ahead of Customers; (3) Direct Crossing; (4) Indirect Crossing; (5) Prearranged Trading; (6) Wash Trading; (7) Direct Money Passing; (8) Indirect Money Passing; (9) Counterparty Trade Percentages; (10) Marking the Close; (11) Transfer Trades; (12) Trade Cancellation; (13) EFPs; and (14) User Log-on and Log-off.⁷⁹ A detailed description of each report can be found in Appendix C.⁸⁰

When applicable, the reports would distinguish between “agency” and “non-agency” trading.⁸¹ For example, the Direct Trading Ahead of Customers Report would have one report for agency trading and another report for non-agency trading. The agency and non-agency reports would be generated using similar parameters but would focus on different CTI codes.

NFA would utilize corresponding report writing software to distribute these exception reports to analysts. The software would include a scheduling feature which would enable NFA’s automated surveillance system to generate reports automatically and to distribute them to designated analysts according to a set schedule. Once received, analysts could reconfigure report data and focus on the desired level of detail in order to meet their own specific analytical needs.

2. Non-automated Surveillance and Investigations

NFA would review trading around certain market events such as news accounts, price gaps, and price run ups, for possible rule violations. NFA also would provide resources to accept Commission referrals and information and complaints from anonymous or disclosed individuals regarding questionable market activity. In addition, NFA would work with MESL’s Administrator to keep abreast of any market information received by MESL. This information would be tracked in conjunction with NFA’s other surveillance activities and NFA would investigate any patterns of questionable activity.

NFA and MESL’s Administrator also would have access to the MESL System’s “supervisory screens.” These real-time screens would show all orders, including status, placed during the trading session; all rejected orders; and all log-on information for users logged-on during the trading session. In addition, NFA surveillance staff and MESL’s Administrator could drill down from a particular trade to see all information entered for both sides of a trade. The supervisory screens also could be used to view all activity for a particular TPH or AT.

If NFA identified potential trade practice violations or problems, NFA would commence an investigation and notify MESL’s Administrator. Among other things, MESL’s Administrator would be responsible for NFA oversight with respect to its operation of MESL’s trade practice surveillance program. In this regard, MESL has represented that its Administrator initially would review all exception reports and communicate with NFA’s compliance staff on a regular basis regarding the data identified on the reports, initiating investigations, and ongoing investigations.

C. Market Surveillance

Market surveillance responsibilities would be shared by NFA and MESL’s Administrator. In this regard, MESL’s Administrator would be responsible primarily for conducting “market supervision,” which would include monitoring real-time trading, day-to-day trading activity, open interest, and the cash markets. If the Administrator identified any problems, the matter would be referred to NFA for further investigation and possible disciplinary action.

To perform its market surveillance responsibilities, NFA would, among other things, subscribe to news services and maintain an ongoing dialogue with other exchanges. NFA also would use an automated market surveillance system that utilized real-time data to monitor market prices as well as concentrations of large trader positions. Specifically, for each contract, NFA would monitor: (1) the basis relationship between the MESL product and the corresponding cash market; (2) the price relationship between the MESL product and any related products traded on MESL or another exchange; and (3) the spread relationship between different months in the same MESL product. Statistical parameters would flag anomalies in each of these three areas and NFA would place special emphasis on ensuring that the applicable basis level converged as a contract neared expiration. NFA also would compile for each market a profile that would include information about the average size trades and other relevant market information.

Upon receiving large trader positions from MESL daily, NFA’s automated market surveillance system would aggregate all positions held by related parties. Once compiled, NFA would monitor large trader positions for concentrations of ownership and potential collusive or concerted activity by market participants. In addition, NFA would monitor for compliance with all necessary position limits, and, if applicable, for traders who exceed designated position accountability levels.⁸² NFA’s automated market surveillance system also would monitor and generate reports to analyze holdings and guard against corners and squeezes.⁸³ If special market situations were to occur, NFA’s automated market surveillance system would generate market movement alerts.⁸⁴

With respect to delivery of an expiring contract, NFA would maintain data that identified the last trading day, the first delivery day, and the last delivery day for the nearest contract month. As delivery dates approached, NFA staff would coordinate with MESL’s Administrator and large trader positions would be analyzed and traders would be contacted, if necessary. NFA or MESL’s Administrator also would contact speculative traders who remained in the market beyond the fifth business day prior to the last trading day. In addition, large hedge traders would be contacted to inquire about their plans to offset positions and potential delivery intentions. If a trader planned to make or take delivery, NFA would assess his or her ability to fulfill such obligations. NFA also would obtain information on the deliverable supply of a given commodity. If it appeared that market participants could obtain or sell the same commodity at a more beneficial price in the cash market, large traders would be contacted to inquire as to why they considered it advantageous to maintain their position in the futures market.

D. Financial Surveillance

With respect to financial surveillance, Commission Regulation 1.52(c) allows an SRO to delegate its financial examination and surveillance responsibilities to a DSRO for any member-FCM or member-IB that is a member of more than one SRO. NFA would perform MESL’s financial surveillance and examination obligations with respect to those FCMs or IBs for which MESL would act as the DSRO. In this regard, NFA has represented that it would perform the auditing and financial surveillance functions required by applicable Commission regulations and interpretations. These functions would include conducting annual examinations of MESL member firms for which MESL was the DSRO, reviewing periodic financial statements submitted by such firms, and monitoring daily customer funds held in segregation by those firms.

MESL Rule 507 would require all TPHs, including those that were not Commission registrants, to maintain minimum net worth requirements established under MESL’s rules or by the Board. In this regard, TPHs would be required to file annual financial statements with the Exchange and to demonstrate continued compliance with the applicable requirements when requested by the Exchange. TPHs also would be responsible for notifying MESL’s President immediately whenever they knew that their net worth had fallen below the Exchange’s minimum requirements. Until the time when such a TPH demonstrated to the Board that it was in compliance with the Exchange’s minimum net worth requirements, the TPH would be prohibited from engaging in Exchange transactions except for closing open positions.

E. Disciplinary Matters

MESL’s disciplinary process would be comprised of two stages, investigation and prosecution. As explained above, NFA would be responsible for conducting trade practice and market surveillance investigations. Pursuant to MESL and NFA’s agreement, NFA also would prosecute cases before a MESL disciplinary committee. Accordingly, once NFA’s Compliance Department determined that it appeared likely that an investigation would result in a referral for disciplinary action, an NFA attorney would be assigned to the matter. Appeals of disciplinary decisions would be heard by MESL’s Executive Committee.⁸⁵

MESL’s disciplinary committees would include a Business Conduct Committee (“BCC”) and a Hearing Committee. The BCC would be comprised of members of NFA’s own Business Conduct Committee and one MESL representative. Similarly, the Hearing Committee would be comprised of members of NFA’s Hearing Committee and one MESL representative. MESL’s rules would permit both the BCC and the Hearing Committee to appoint panels to consider matters rather than requiring that an entire committee consider a matter.⁸⁶

MESL’s disciplinary rules and procedures would be substantially the same as NFA’s disciplinary rules. Under MESL Rule 703, if NFA determined that there was reason to believe that a MESL requirement was violated, a written investigation report would be submitted to the BCC.⁸⁷ Within 30 days of receiving an investigation report, the BCC would determine whether there was a reasonable basis to believe that a violation occurred. If such a determination was made, a complaint would be issued. If the BCC found that a violation may have occurred but prosecution was otherwise unwarranted, it could issue a warning letter. The BCC also would have the alternative of sending a matter back to NFA for further investigation.

If the BCC issued a complaint, MESL Rule 705 would require that the complaint state each MESL rule alleged to have been violated and each act or omission that constituted the alleged violation. Furthermore, the respondent would be advised that unless a written answer was filed within ten business days of the date of the complaint, the failure to answer would be considered an admission of the facts and legal conclusions stated in the complaint. Failure to request a hearing within the same ten-day time period would be deemed a waiver of a hearing unless good cause was demonstrated.⁸⁸ MESL Rule 706 would provide that, with the exception of a summary TPH or AT responsibility action, a respondent may be represented by an attorney at any stage of an investigation or the disciplinary process.⁸⁹

MESL’s rules provide specific procedures for each step of a full disciplinary action, including pre-hearing procedures, Hearing Committee procedures, the issuance of written decisions, the negotiation and acceptance of settlement agreements, appeals, and the imposition of various penalties. For example, under MESL Rule 709, prior to a hearing, a respondent would be entitled to examine all of the evidence relied upon by NFA or relevant to the complaint. MESL Rule 710 would provide the respondent with the right to appear personally at a hearing and to call and to examine all witnesses.⁹⁰

Permissible penalties under MESL Rule 715 that could be imposed include: (1) a termination or suspension of trading privileges; (2) a bar or suspension for a specified period from association with a TPH; (3) a censure or reprimand; (4) a monetary fine, not to exceed $1,000,000 per violation; and (5) an order to cease and desist.⁹¹ MESL Rule 714(a) would permit a respondent to appeal a Hearing Committee decision to MESL’s Executive Committee by filing a written notice within 15 days after the date of the decision. Under MESL Rule 714(b), the Executive Committee also could review a Hearing Committee decision on its own motion. NFA also could file a petition to appeal a Hearing Committee decision to the Executive Committee, the granting of which would be discretionary by the Executive Committee.

F. Conclusion

The Division believes that MESL has proposed a satisfactory plan for operating effective trade practice surveillance, market surveillance, financial surveillance, and disciplinary programs. Among other things, MESL would: (1) delegate to NFA adequate power to detect, investigate, and take action with respect to rule violations; (2) make use of collected data for real-time monitoring and for post-event audit and compliance purposes to prevent market manipulation; (3) provide a clear framework for ensuring the financial integrity of transactions entered into through MESL; (4) enact rules to deter trading abuses; and (5) establish procedures for impartial disciplinary committees empowered to discipline, suspend, and expel members.

IX. System Security, Vulnerability, and Operational Issues

A. System Overview

The Commission’s Office of Information Resources Management (“OIRM”) has examined the MESL System for consistency with the International Organization of Securities Commissions’ ("IOSCO") ten Principles for the Oversight of Screen-Based Trading Systems for Derivative Products (“IOSCO principles”).92 As part of its review, OIRM requested that MESL respond to a set of questions based upon the IOSCO principles. MESL responded to those questions by e-mails dated May 19 and 23, 2000. OIRM reviewed MESL’s responses and had several follow-up conversations with MESL; Exchange Cubed; and IBM, the provider of the MESL System.⁹³

The MESL System is based upon a trading system and matching engine that was first employed by a European equities exchange in 1989. Since then the system has evolved and been modified to meet the needs of other European equities and futures exchanges.⁹⁴ IBM has made minor modifications to an operational version of this application that would enable the system to provide a trading and reporting environment that would be suitable for U.S. futures and option trading.

MESL also has contracted with IBM to act as facility operator for the host equipment and to provide end-user support for customers, roles in which it has extensive experience. The centralized servers and communications equipment would be housed in an existing full-service commercial data center in Toronto, Canada. That data center currently hosts applications for a variety of large commercial enterprises with operational requirements that are similar to or exceed those of MESL.⁹⁵ The data center operator provides physical security for the systems it hosts through the use of access control systems and surveillance cameras, hazardous condition detection, reaction, and notification systems, and multiple power sources. Logical security would be provided for the MESL System through the use of operating system access controls, application-level authentication and access restrictions, and communication firewalls.

IBM also operates a call service center (“CSC”) in Toronto, Canada that would provide toll-free phone support for traders and other market participants. CSC operations are highly integrated with those in the Data Center, and therefore would provide an effective means for responding to trouble calls and otherwise facilitating communications with users. The CSC employs automated systems for problem tracking, support escalation, and notification processes.

A major financial information vendor, Bridge, whose existing private network already extends to many of MESL's prospective customers, would provide the Wide Area Network (“network”) over which the MESL System would be accessed. Strengths of the network configuration include reliability, security and performance.

One or more TPH servers and AT workstations connected to them would provide TPHs and ATs access to the MESL System. Those servers and workstations would be configured with hardware settings and software provided by MESL and must be registered with the Exchange in order for users to gain access to the MESL System. User access would be restricted to individuals registered with MESL using registered equipment with which they have been associated. TPHs would be responsible for management of the equipment and its users. The functionality of the TPH server would enable a TPH to centralize management of the authorization and assignment of its ATs’ trading privileges.⁹⁶

The standard configuration of equipment at the premises of a TPH would include two TPH servers, a variable number of AT workstations, and two distinct communication paths between that equipment and the host. In the event of the failure of either server or its communications path, all communications between the host and the TPH would automatically move to the remaining operational path. Coupled with the robustness of the host platform and the network, this configuration would provide a highly reliable trading environment.

Although MESL would not initially maintain a disaster recovery site, the high level of reliability provided by the features and configuration of the MESL System’s components would reduce significantly the likelihood of the occurrence of a disastrous situation. In the unlikely event of a disaster that would require a trading halt, MESL has devised detailed plans to manage the notification and trade management processes related to forced shutdown and restart of the trading environment.

The capacities of the host computer and network facilities of the MESL System have been demonstrated to exceed considerably the level necessary to support projected initial trading volume. Components of the MESL System would be sufficiently scalable to enable MESL to easily increase system capacity to accommodate growth.

B. System Security and Data Integrity

IBM’s facility and the equ