Futures Markets:

Strengthening Trade Practice Oversight

GGD-89-120: Published: Sep 7, 1989. Publicly Released: Sep 7, 1989.

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James L. Bothwell
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Pursuant to a congressional request, GAO assessed the Commodity Futures Trading Commission's (CFTC) and futures exchanges' effectiveness in deterring, detecting, and punishing trade practice abuses.

GAO found that: (1) futures exchanges did not always independently, precisely, and completely time all trades; (2) improved trade timing could eliminate trading information manipulations that give noncompetitive trades the appearance of competitive execution; (3) although the exchanges attempted to reconstruct trade sequences through audits, control weaknesses existed in each exchange that allowed dishonest brokers opportunities to manipulate timing; (4) the exchanges planned to develop electronic audit trail systems to record transactions using hand-held terminals, but they did not plan full implementation for over a year and did not know the extent to which they would use the systems to control abuses; (5) although CFTC reviewed the exchanges' surveillance programs, it did not review system documentation, test screening programs to determine whether the systems operated as intended, or require independent documentation assessments; (6) the number and severity of disciplinary actions varied by exchange but generally increased between 1984 and 1989; and (7) CFTC used investigative and disciplinary action information to judge specific exchange decisions, but did not formally analyze trends or compare results across exchanges, since there were no uniform definitions to classify actions involving floor trade practice abuses.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: Improved trade-timing requirements, including specified implementation dates, are written into pending CFTC reauthorization legislation. Futures exchanges have already begun to design and evaluate automated trade-timing devices that will provide independent, precise, and complete timing of trades.

    Recommendation: CFTC should direct the exchanges to independently, precisely, and completely time each trade and specify a time frame for meeting this requirement. Timing should be independent of the other trading data supplied by floor participants. Time recording should include the precise time the broker receives and records as executed each order, as well as the precise execution of times of noncustomer trades. CFTC should give the exchanges flexibility in deciding how to meet the requirement, but should also establish firm implementation dates.

    Agency Affected: Commodity Futures Trading Commission

  2. Status: Closed - Implemented

    Comments: CFTC approved a legal interpretation to require that futures exchanges retain for 5 years documents on automated transaction-related systems, including electronic trading, order routing, and surveillance systems and hand-held trade entry terminals. The records will document steps taken to identify vulnerabilities, establish safeguards, and otherwise ensure the systems' accuracy and reliability.

    Recommendation: CFTC should require exchanges to maintain complete documentation of automated surveillance systems.

    Agency Affected: Commodity Futures Trading Commission

  3. Status: Closed - Implemented

    Comments: CFTC has adopted 10 principles for developing standards for automated trading systems. However, CFTC noted that its technical capability may fall short of that recommended because of limited resources and other priorities. CFTC has also taken steps to develop a formal policy for automated system assessments.

    Recommendation: CFTC should expand its reviewing and testing of exchange automated surveillance systems, or require that they be independently reviewed and tested, to determine whether they are operating as intended.

    Agency Affected: Commodity Futures Trading Commission

  4. Status: Closed - Implemented

    Comments: The Joint Compliance Committee accepted its Disciplinary Action Subcommittee's proposed categories of rule violations at its April 1991 meeting and it has been adopted by all the self-regulatory organizations. The action taken is not fully responsive because no definition of trade practice investigation has been provided. They have now developed a definition of trade practice investigation.

    Recommendation: CFTC should establish milestones for completing definitions of trade practice violations and trade practice investigations so that they can be consistently differentiated from other types of rule violations and so that the definitions are uniform across exchanges.

    Agency Affected: Commodity Futures Trading Commission

  5. Status: Closed - Implemented

    Comments: CFTC is working toward fully addressing this recommendation. CFTC now has a disciplinary action notice database and is waiting for a few more months of data before doing analyses.

    Recommendation: CFTC should begin making formal trend and comparative analyses of exchange investigations and disciplinary actions.

    Agency Affected: Commodity Futures Trading Commission


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