The Commodity Futures Trading Commission unanimously voted yesterday to take the first steps toward tighter surveillance of trading on the floor of commodity exchanges, a move most major exchanges are almost sure to resist.
The tighter surveillance would make it easier for the regulatory body and the self-regulatory exchanges to ensure that no broker trades for his or her account before taking care of customer orders.
During times when futures prices rise or fall sharply, a customer could lose a large amount of money if the floor trader's account took precedence over the customer's order.
An attempt to take a similar tightening step was quashed in 1979, mainly because of opposition from the industry.
The commission directed its staff to come up with proposals that would require the commodity exchanges to develop a reporting system that would enable regulators to reconstruct the sequence of trading quickly and accurately -- what regulators call the "audit trail."
CFTC Commissioner Fowler C. West, a major proponent of improving the audit trail, said that if there is no way to force floor traders to report more quickly and accurately the trades they make on their own behalf, then the five-member commission should consider prohibiting floor traders from trading both for themselves and as brokers for public investors.
Under so-called dual trading, floor traders are never supposed to trade for themselves before they trade for a customer, so that the customer always gets the advantage of the best price.
But it can be difficult, or sometimes impossible, for auditors to determine whether a broker made trades in the order that is mandated. A trade made for a customer is recorded almost immediately after it is made. But when a floor broker trades on his own behalf, he must merely record the half hour in which the trade took place. For example, whether the trade was made at 10:01 a.m. or 10:29 a.m., the trader would only have to report that it took place between 10 a.m. and 10:30 a.m.
West, in a statement to the commission, said that it is difficult, if not impossible, to reconstruct trading under the current system "even if the current 30-minute bracketing requirements are adhered to by those in the pit -- which they are not."
In 1979, the commission gave up on an attempt to require traders to record their own trades within one minute after they occurred. On securities exchanges, such as the New York or American stock exchanges, trades are recorded almost immediately after they occur.
But futures traders argue that in the hurly-burly of trading pits it would be impossible for them to record the trades they make on their own behalf.
Andrea Corcoran, director of the CFTC's division of trading and markets, told the commissioners yesterday that when the CFTC first proposed more rigorous audit trail procedures in 1975, the technology might not have been available, as the exchanges argued. But there has been a "dramatic" improvement in computer technology since then, she said.
Corcoran said that the nature of the futures industry has also changed markedly. In 1975, the bulk of the trading was in agricultural commodities. Now, she said, the huge number of financial futures contracts has attracted a number of investors who are used to trading in securities where audit trails are more stringent and where trading abuses can be more easily sorted out.
She said her staff would do its best to develop proposed rules by the end of the year.
Commissioner William Seale said that tighter surveillance procedures would not only cut down on abuses in the dual trading system but also would make it easier for regulators to detect other infractions, such as cross-trading and "wash" trading.
In cross-trading, two traders cut private deals between themselves rather than through "public outcry" on the trading pit floor. Wash trading is a device brokers use to make it seem as if there is more trading volume in a futures contract than there is. In wash trades, neither broker involved gains or loses, but the number of contracts traded rises.