and GNMAS). The Commission and others have found that trading activity (hedge and speculative) tends to concentrate on one exchange. However, the Commission has taken the position that it will not prejudge the merits of each individual proposal relative to competing alternative contracts, but that traders can decide which contract better meets their hedging and pricing needs. In that regard, the review process is designed to assure that each proposed contract meets the requirements of the Act (that it can reasonably be expected to be used for hedging or pricing and that the terms are appropriate for such uses).

Fourth, some contracts have never been listed for trading (e.g., gold coins, unleaded gas, and the S&P consumer staple index). This may be due to, for example, insufficient floor space for trading. Moreover, is some cases where the exchange has listed the contract for trading, the exchange and the brokerage community may not have devoted sufficient resources (financial or otherwise) to educate potential users about the benefits of the contract.

ECONOMIC JUSTIFICATIONS STANDARDS

Mr. SMITH. Does the large number of dormant contracts indicate that your economic justification standards for contract market designation must be improved?

Ms. PHILLIPS. The Commission does not believe that the economic justification standards for contract market designation should be altered. Those standards effectively assure that each proposed conract can serve an economic function, based upon our analysis of the potential hedging and pricing uses of the contract. As noted above, the success or failure of a contract is often determined by factors other than contract design.

Moreover, to address problems associated with the recommencement of trading in dormant contracts with inappropriate terms, the Commission has adopted Regulation 5.2. That regulation defines a dormant contract as one in which no trading has occurred in any future listed for trading for a period of six complete calendar months. Once a futures contract becomes dormant, the exchange may not list or permit trading to recommence in that contract until the Commission approves an exchange rule to list additional trading months. The exchange must provide an economic justification of the proposal that addresses any alterations to the contract terms and changing market conditions.

ADEQUATE STAFFING FOR MARKET SURVEILLANCE AND ANALYSIS

Mr. SMITH. I believe that you are not requesting any increase in your market surveillance staff or in your market analysis staff. With the continued growth in futures trading and the ever increasing number of contracts, how can you effectively carry out your responsibilities with existing staff?

Ms. PHILLIPS. Due to a static level staff, we believe that the number of new contracts and rule changes requiring economic review during fiscal years 1984 and 1985 will tax our capacity. This will be due in part to the introduction of a pilot program in agricultural options which Congress encouraged and new statutory provisions stipulating the time allotted to CFTC review of all rule

changes and designations. In order to achieve its overall statutory objective in view of these factors, the Commission has had to make certain adjustments. First, the staff has been required to give priority to those rule changes and designations based on the statutory deadlines, rather than on the basis of exchanges priorities or the expeditious processing of the more straightforward submissions. Under this method of operation, the overall backlog of items awaiting economic review may increase. Second, CFTC's discretionary review of existing contracts normally must be limited to those cases where contract terms have a clear likelihood of causing market disruptions. Finally, the Commission has recently delegated authority to the staff to approve directly certain new material or routine amendments to contract terms. However, it is too early to judge whether this procedure will appreciably impact the review process in terms of resource savings.

The maintenance of an adequate market surveillance program is based on the assumptions that (1) under the option pilot program, new options predominantly will be on futures contracts rather than on physical commodities, (2) the number of new options contracts admitted to the pilot program will be limited, (3) many of the new futures contracts will have the cash settlement feature, and, most significantly, surveillance will receive increased ADP support. The increased ADP support, in the form of expanded software development as well as more advanced hardware availability, is essential to maintaining the effectiveness of the program. Although the number of markets monitored by individual surveillance economists is expected to increase, additional ADP support will increase the efficiency of the market surveillance staff, provide improved access to the futures and options data base, and facilitate more sophisticated analyses of market behavior. Accordingly, it is essential to the market surveillance function that the Commission receive the level of funding for ADP which it has requested for the Centralized Administration Program. In addition, the Commission has been encouraging the exchanges to assume more responsibility in market surveillance and monitoring of large traders.

EXPANDED USE OF ADP CAPABILITIES

Mr. SMITH. I believe that your request for increased ADP facilities is responsive to a longstanding need. Your justifications state that you intend to use these expanded computer capabilities in market surveillance and trade practice investigations. How effective can the computers be in either market surveillance or trade practice investigations so long as floor transactions are not accurately time-stamped?

Ms. PHILLIPS. The Commission's market surveillance program is concerned primarily with issues of potential price manipulation or other major market disturbances and with enforcement of speculative limits. This program requires analysis of futures positions, cash market supply and demand conditions and price relationships over extended periods of time. The time-stamping of floor trades to the nearest minute, therefore, is not a critical issue in the market surveillance program.

With respect to trade practice investigations, i.e., inquiries into selected transactions executed on the floor of an exchange to determine whether improper or unlawful activities, such as trading ahead of customers' orders or wash trading, have occurred, the Commission's expanded ADP facilities will permit the Commission's investigative staff to identify more readily possible illegal trading activity and aid in the initiation of its trade practice investigations (TPIs). The Commission's system will be designed to permit the retrieval of significant trading data, sorted in various forms, so that market activity may be monitored and analyzed more efficiently.

It is important to note that the greater part of the Commission's proposed ADP systems for the enforcement program will be utilized primarily as a reference source for the identification of possible illegal trading activity and the initiation of investigations. Computers are the most effective tool for locating, in the thousands of futures trades executed each day, trading activity that should be investigated further for evidence of wrongdoing. Computer sorting of exchange data in its present form, showing the bracket period of all trades, can save thousands of hours of investigative work. The Commission's experience using computers in investigations, though limited, strongly supports this conclusion.

Investigations, however, require data from a variety of sources. After the initial review of exchange data, the staff also must assemble the underlying hard-copy documentation, such as floor orders, broker trading cards, and futures commission merchant (FCM) time records for orders and clearing data in an attempt to pinpoint the actual time of execution of the order or orders in question. Although the recordation of the time of execution to the nearest minute would certainly ease the actual investigative stage of a TPI, the Commission believes that the accurate recordation of trades within the thirty-minute brackets required under Commission rule 1.35 does not necessarily dilute these primary purposes of the Commission's computer system, i.e., identification of trading abuses and initiation of TPIs.

TRADE TIMING PROCEDURES

Mr. SMITH. What efforts, if any, are being made to require the exchanges to implement procedures that accurately show time of execution?

Ms. PHILLPS. In October 1980, following extensive study of the technical and practical feasibility of implementing a one-minute timing requirement for the execution of transactions on the nation's commodity exchanges, the Commission determined that it was not technically feasible to require one-minute time-stamping at that time. In lieu thereof, the Commission adopted a requirement that floor traders, at a minimum, denote the time of trades in bracket periods of no more than thirty-minutes in length. The contract markets were authorized, upon specific Commission approval, to institute any superior time-sequencing method developed.

Three exchanges with relatively low volume, the Kansas City Board of Trade, the Minneapolis Grain Exchange and the New York Mercantile Exchange, have adopted trade timing systems

which are superior to thirty-minute brackets. In addition, Commission regulations require exchange members to time-stamp orders originating off the floor both when they reach and leave the trading floor. The practical effect of the latter requirement is to enable the exchange or the Commission to determine more accurately when a transaction on the floor actually takes place. Through pit reporting systems, each exchange maintains and makes available price changes in each contract as they occur throughout the day which helps in the tracing of transactions. Clearing data provides matched trade records. The exchanges have different types of systems to maintain their price and trade data depending on the size of the exchange, volume and operating systems. Thus, sequenced trade data is derived in different ways from different exchanges.

Finally, pursuant to Commission rule 1.35, the contract markets are required to submit bracket accuracy reports to the Commission upon the request of the Division of Trading and Markets, and to show how such data is used in the exchange's affirmative monitoring program. In addition, the Division of Trading and Markets, in its reviews of the rule enforcement procedures of the larger exchanges, has examined the accuracy of bracket information and has notified the exchange if improvements were needed. The effective implementation of any recommended improvements will be the subject of a subsequent rule enforcement review. In these rule enforcement reviews, the Commission also has monitored how well the exchanges keep up with new technology which would improve their monitoring of executions and general surveillance.

Mr. TRAXLER. If the gentleman will yield, I suggest we recess for this vote and then return. We will be back in 15 minutes. While we are away, will you please meditate on the question as to whether or not the Congress should ban futures trading in cattle.

Ms. PHILLIPS. Yes, sir.

[Recess.]

INTRODUCTION OF NEW EXECUTIVE DIRECTOR

Mr. TRAXLER. Could I ask Chairman Phillips: Would you perhaps introduce to us your designated Executive Director who may be present with us today?

Ms. PHILLIPS. Yes, sir, I will be delighted to. Molly Bayley, whom I believe is sitting in the back of the room, is our new Executive Director; she will be beginning, I believe, on the 2nd of April.

Mr. TRAXLER. I am not sure it was wise to invite her to these hearings; after today she may be seeking other employment. We want to welcome her and wish her the best.

CATTLE FUTURES

Mr. TRAXLER. What do you think? There are some state cattlemen's associations that I have talked to about that question, of banning futures trading in cattle. Should we do that? Should the Congress do that or shouldn't it? This committee can't do it, so it is an academic question. Should it be done or shouldn't it be done? Ms. PHILLIPS. That question has certainly been the subject of widespread debate, both at the state level and at the national level, with respect to the cattlemen's associations. For our part, we would

approve and allow contracts to continue to trade if they serve an economic purpose. Specifically, if the contracts are used for commercial hedging, or if they are used for price basing, and certainly if they are not contrary to the public interest.

Now, there are arguments on both sides, and I would point out that I do understand that a couple of the state organizations have sought to seek a ban on futures, but in the most recent National Cattlemen's Association meeting, that question, or that resolution, was turned down, and so at least through that organization we have heard the counterarguments presented.

For our part, we have looked at the markets on a regular basis, and we do see that they are being used for commercial hedging purposes, and so those contracts certainly meet the requirements of our statute.

Mr. TRAXLER. Moving on

Mr. SMITH. Before you leave that, could I ask something?
Mr. TRAXLER. Certainly.

A RESOLUTION OF THE NATIONAL CATTLEMEN'S ASSOCIATION

Mr. SMITH. Just so the record is clear on this. Somebody from the National Cattlemen's Association told you that the national cattlemen's meeting passed a resolution opposing doing anything with futures?

Ms. PHILLIPS. No. In fact, I think that the resolution that they passed-and I certainly don't have it in front of me, was a very positive kind of resolution. In fact, they were seeking to encourage the enforcement of exchange rules, and to seek increased education and research.

Mr. SMITH. Just so we can kind of keep the record straight, my understanding is that a year or two years ago, the National Cattlemen's Association passed a resolution to do some studies, and they went out and did some studies and they brought them back in. At this years national meeting, the membership was so dissatisfied, they turned down that report which said everything is fine.

After a convention fight, finally more than two states, something like nine states have a resolution now that wants it abolished, they finally got rid of it by saying, well, we are going to have another study, and we are going to ask the CFTC to cooperate. We are going to ask people to get us some better information to find out why so many people are dissatisfied. So I don't think the record ought to indicate the National Cattlemen are satisfied at all.

Ms. PHILLIPS. I think it is true that they are undertaking a broader based study, so I think that is absolutely correct.

Mr. SMITH. I think it would be the least that can be said that there are a large number of cattlemen that think that futures contracts are certainly not serving the purpose, an economic purpose for the average cattle feeder. From the last figure we have, it is my understanding that 3 percent of the cattle feeders now feed 78 percent of the cattle.

This change has occurred so fast we can't believe what has happened. Part of the reason for this rapid change is that we had a cattle futures contract designed specifically to help the 50,000