[Federal Register: March 4, 1999 (Volume 64, Number 42)]
[Page 10450-10452]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]



Chicago Board of Trade Petition for Exemption From the Dual
Trading Prohibition in the U.S. Treasury Bond Futures Contract Traded
on the Project A Electronic Trading System

AGENCY: Commodity Futures Trading Commission.

ACTION: Order.


SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
granting the petition of the Chicago Board of Trade (``CBT'' or
``Exchange'') for exemption from the prohibition against dual trading
in the U.S. Treasury Bond futures contract traded on its Project A
electronic trading system.

DATES: This Order is to be effective February 26, 1999.

FOR FURTHER INFORMATION CONTACT: Andrew S. Baer, Attorney-Advisor,

[[Page 10451]]

Division of Trading and Markets, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st St., NW, Washington, DC 20581;
telephone (202) 418-5490.

SUPPLEMENTARY INFORMATION: On January 31, 1998, the Chicago Board of
Trade (``CBT'' or ``Exchange'') submitted a Petition for Exemption from
the Dual Trading Prohibition for its affected U.S. Treasury Bond (``T-
Bond'') futures contract \1\ as traded on the Exchange's electronic
trading system, Project A. Upon consideration of this petition and
other matters of record, the Commission hereby finds that CBT meets the
standards for granting a dual trading exemption contained in Section
4j(a) of the Act and Commission Regulation 155.5 with regard to Project
A T-Bond futures.\2\

    \1\ An ``affected contract market'' is a contract market with an
average daily volume equal to or in excess of 8,000 contracts for
each of four quarters during the most recent volume year. Commission
Regulation 155.5(a)(9). See Section 4j(a)(4) of the Commodity
Exchange Act (``Act''). Under Section 4j(a) of the Act and
Regulation 155.5(b), the dual trading prohibition applies to each
affected contract market. The Commission, therefore, must consider
separately each affected contract market. As noted by the Commission
in promulgating Regulation 155.5, a contract market trading on an
exchange floor will be considered separate from a contract market in
the same commodity trading on a screen-based system such as Project
A. See 58 FR 40335 (July 28, 1993). Therefore, Project A T-Bonds
must be considered independently of the CBT's floor-traded T-Bond
contract market, which was included in the Exchange's exemption
petition for its affected open outcry contract markets.
    \2\ The burden to prove that the exemption standards of the Act
and Commission regulations are met rests exclusively on the contract
market. The dual trading provisions set forth in Section 4j of the
Act and the standards for trade monitoring systems provided in
Section 5a(b) of the Act were enacted as part of the Futures Trading
Practices Act of 1992 (``FTPA''). Pub. L. 102-546, 101, 106 Stat.
3590 (1992). The FTPA's legislative history makes clear that the
burden to prove that the exemptions standards are met rests upon the
contract market. For instance, the 1992 House-Senate Conference
Committee stated that ``a board of trade may satisfy the initial
burden of demonstrating that each of its designated contract markets
complies with trade monitoring system requirements of section 5a(b)
of the Act, subject to requests for further information by the
Commission, by showing that it has maintained an ongoing record of
compliance with those requirements.'' H.R. Conf. Rep. No. 102-978 at
53 (1992). The Conference Committee adopted the 1991 House Bill's
(H.R. 707) dual trading provisions, with amendments relating to
exemptions. Id. at 50. The 1991 Senate Bill (S. 207) similarly
placed on the exchange the burden to demonstrate the ability of its
systems to meet the standards and reiterated the view, previously
expressed in the 1989 Senate Bill (S. 1729), that an exchange has
the best access to its own records and therefore is in the best
position to show that its systems are effective and satisfactory. S.
Rep. No. 102-22 at 32 (1991); S. Rep. No. 101-191 at 39-40 (1989).

    Subject to CBT's continuing ability to demonstrate that it meets
applicable requirements, the Commission specifically finds that CBT
maintains a trade monitoring system for Project A which is capable of
detecting and deterring, and is used on a regular basis to detect and
deter, all types of violations attributable to dual trading and, to the
full extent feasible, other violations involving the making of trades
and execution of customer orders, as required by Section 5a(b) of the
Act and Commission Regulation 155.5. The Commission further finds that
CBT's trade monitoring system for Project A T-Bonds includes audit
trail and recordkeeping systems that satisfy Sections 4j(a)(3) and
5a(b) of the Act and Commission Regulations 1.35 and 155.5.\3\

    \3\ 17 CFR 1.35, 155.5. Section 4j(a)(3) requires the Commission
to exempt a contract market from the prohibition against dual
trading upon finding that the trade monitoring system in place at
the contract market satisfies the requirements of Section 5a(b),
governing audit trails and trade monitoring systems, with regard to
violations attributable to dual trading at such contract market. If
the trade monitoring system does not satisfy the requirements,
Section 4j(a)(3) requires the Commission to deny the exemption or in
the alternative to exempt a contract market from the prohibition
against dual trading on stated conditions upon finding that there is
a substantial likelihood that a dual trading prohibition would harm
the public interest in hedging or price basing and that corrective
actions are sufficient and appropriate to bring the contract market
into compliance with the standards set forth in Section 5a(b).
Regulation 155.5(b) prohibits floor brokers from dual trading in an
affected contract market unless that contract market is exempted
under Regulation 155.5(d).

    With respect to each required component of the trade monitoring
system, the Commission finds as follows:
    (a) Physical Observation of Trading Areas--The requirements of
Section 5a(b)(1)(A) of the Act are not relevant to Project A trading,
insofar as Project A is a computerized, screen-based system and
therefore has no floor.
    (b) Audit Trail and Recordkeeping Systems--The Exchange's trade
monitoring system for Project A T-Bonds satisfies the audit trail
standards of Section 5a(b)(1)(B) of the Act in that it is capable of
capturing essential data on the terms, participants, and sequence of
transactions. The requirements of that Section regarding the capture of
relevant data on unmatched trades and outtrades are not relevant to
Project A trading, as unmatched trades and outtrades cannot occur on
the Project A system. The Commission further finds that CBT accurately
and promptly records the essential data on terms, participants, times
(in increments of no more than one minute in length), and the sequence
of Project A trades through a means that is unalterable, continual,
independent, reliable, and precise, as required by Section 5a(b)(3) of
the Act. This includes the real-time submission of trades to clearing
as they are matched by the system. Consistent with the guidelines to
Commission Regulation 155.5, the Commission also finds that CBT has
demonstrated the use of Project A T-Bond trade timing data in its
surveillance systems for dual trading-related and other abuses.
    The audit trail produced by Project A for T-Bond futures includes
trade execution times that are presumptively 100 percent accurate
(barring computer malfunction) and precise to within 1/100th of a
second. All trades are also recorded in the exact sequence of
occurrence. Among other things, the order ticket timestamps required by
Regulation 1.35(a-1) are automatically furnished by the system,
independent of the person making the trade, as is the order number.
Project A also automatically records the time at which a terminal
operator enters an order, the time when an order is matched to make a
trade, the time the system generates a confirmation message to a
terminal operator, and the time of any changes to an order. Once
entered, orders and records of changes to orders are unalterable and
cannot be deleted. If an order cannot be entered immediately upon its
receipt by a terminal operator, the order is recorded on a written
order ticket, timestamped, and then entered when possible. For every
Project A order, either this order ticket timestamp or the order entry
time recorded by the system acts as the broker receipt time required by
Section 5a(b)(3)(B) of the Act.
    CBT satisfies the requirements of Section 5a(b)(1)(B) of the Act by
maintaining an adequate recordkeeping system that is able to capture
essential data on the terms, participants, and sequence of transactions
executed on Project A. The Exchange uses such data as well as
information on violations of such requirements on a consistent basis to
bring appropriate disciplinary actions relating to Project A trading.
    (c) Surveillance Systems and Disciplinary Action--As required by
Sections 5a(b)(1) (C), (D) and (F) of the Act, CBT uses information
generated by its trade monitoring and audit trail systems on a
consistent basis to bring appropriate disciplinary action for
violations relating to the making of trades and execution of customer
orders on Project A. In addition, CBT assesses meaningful penalties
against violators.
    On a daily basis, CBT reviews computerized surveillance exception
reports to detect dual trading-related and other trading abuses on
Project A. All relevant trade data are included in these reports. The
exception reports are

[[Page 10452]]

designed to identify such suspicious activity as trading ahead,
frontrunning, trading against, crossing orders, and wash trading. Since
the introduction of side-by-side (simultaneous Project A and open
outcry) trading of T-Bonds in September 1998, CBT has begun using a
specialized exception report designed to identify certain trading ahead
violations that use both the Project A and open outcry markets. The CBT
has stated that it intends to develop systems and programs that
integrate surveillance of its Project A and open outcry markets. The
Exchange should be diligent in pursuing this process.
    From January, 1997 through December, 1998, the Exchange initiated
21 investigations into all types of possible abuses on Project A, nine
of which had been closed as of December, 1998. One of those nine was
closed within the four-month objective set forth in Commission
Regulation 8.06, and another three were closed within four to six
months. Thus, only 44 percent of those Project A investigations opened
and closed during 1997-98 were closed within six months. If CBT cannot
complete its Project A investigations within the objective set by
Regulation 8.06, it should provide the reasons why such investigations
require more than four months to complete. Based on examination of its
computerized surveillance reports, CBT initiated four dual trading-
related investigations during that period, one of which resulted in
referral to a disciplinary committee. As of December 1998 that case was
still pending. In other Project A-related disciplinary actions, the
Exchange levied $20,000 in fines, imposed one ten-day suspension, and
issued four reprimands.
    (d) Commitment of Resources--The Commission finds that CBT meets
the requirements of Section 5a(b)(1)(E) by committing sufficient
resources for its trade monitoring system relating to Project A,
including automating elements of such trade surveillance system, to be
effective in detecting and deterring violations. CBT also maintains an
adequate staff to investigate and to prosecute disciplinary actions.
    Accordingly, on this date, the Commission hereby grants CBT's
Petition for exemption from the dual trading prohibition for trading on
Project A of its electronically traded U.S. Treasury Bond futures
    For this exemption to remain in effect, CBT must demonstrate on a
continuing basis that it meets the relevant statutory and regulatory
requirements. The Commission will monitor continued compliance through
its rule enforcement review program and any other information it may
obtain about CBT's program.
    The provisions of this Order shall be effective on the date on
which it is issued and shall remain in effect unless and until it is
revoked in accordance with Section 8e(b)(3)(B) of the Commodity
Exchange Act, 7 U.S.C. 12e(b)(3)(B). If other CBT contracts
electronically traded on Project A become affected contracts after the
date of this Order, the Commission may expand this Order in response to
an updated petition that includes those contracts.
    It is so ordered.

    Dated: February 26, 1999.
Jean A. Webb,
Secretary to the Commission.
[FR Doc. 99-5335 Filed 3-3-99; 8:45 am]

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