lost confidence in these market places. As a matter of fact, these "defaults" of about $5 million in the potato contract approximate 1/100,000th of the total annual transactional value ($600 billion) of all domestic futures trading. Moreover, the daily volume of trading in futures contracts has been generally rising in the midst of this publicity, particularly at the Chicago Board of Trade. As I have previously stated, this situation was an "invidious game of chicken." The situation is reflective of two little rich kids who played on opposite teams and who decided they didn't have to play by the rules of the game, because they owned the ball. So they split the ball in half and went home, leaving the Exchange to declare the winner and the Commission to pick up the pieces. Obviously, if all participants in the futures markets were to deliberately choose to ignore the rules of the game, utter chaos would ensue. The absurd result of this would be that we would have to provide a CFTC official to go along with every registrant's license.

In a more serious vein, it is too early to fully evaluate all of the ramifications of the potato default. The potato situation demonstrates that there are inherent problems in market contexts involving heavy trading, large positions and a dwindling deliverable supply. We know this and, through the foresight »of Congress, we now have the ability to actually change contract terms and conditions. In fact, we were in the process of doing just that to the Maine potato contract-when the default occurred. In addition, through economic research provided for by Congress, we should be able to foresee other comparable occasions as they might appear in the future. Furthermore, with our new power to actually change exchange rules, we have the authority to provide for an overall better market mechanism.

What we do know is that many of the broad issues presented by the potato problem directly impact upon issues which the Commission is presently considering. With the new focus provided by Congress, we are presently reforming our entire "reporting" system, including the definition of "hedging", as well as considering revised aggregation rules. The new reporting system will enable us to be better informed of market action without necessitating additional paperwork by the industry and hopefully by government. And since Congress provided us with a new professional enforcement staff, we can now move into an “afterthe-fact" situation as we are now doing in Maine potatoes.

Apparently some of the potato traders (still a very small part of the futures marketplace) were oblivious to the new direction of Congress and the new determination of this Commission. Perhaps they thought that Congress had just reshuffled the alphabet in creating C.F.T.C. from the former C.E.A. Though we did not prevent this "default", the fact of default does give us occasion to dispel any such thought on the part of these traders. And, for the future and after we have acted in this situation, I state as I have for this past year, that our presence will not only aid in clearing up occasional economic difficulties in the markets but will also increase the public's protection and confidence in those markets. I should add one thought-the Act does contemplate a large measure of self-regulation by the industry. With our limited resources, we must continue to have the cooperation of exchanges, brokers and all market participants to do the job.

In conclusion, we believe that the overall effects of the potato default will include a reevaluation of the adequacy of the rules of all exchanges, a reassessment of the sufficiency of all exchange rule enforcement programs as well as a soul searching analysis of the self-regulatory role of exchanges and our oversight responsibilities in similar situations.

Mr. RICHARD B. LEVINE,

COMMODITY FUTURES TRADING COMMISSION,
Washington, D.C., May 27, 1976.

President, New York Mercantile Exchange,
New York, N.Y.

DEAR MR. LEVINE: As you are aware, the Commission is gravely concerned about defaults in the delivery of May Maine potatoes futures contracts on the New York Mercantile Exchange (the "Exchange"). Accordingly, the Commission has authorized an immediate, full scale investigation of all aspects of the events surrounding the default, including but not limited to, the activities of the Exchange and its officials in enforcing Exchange rules, the compliance by member firms of the Exchange with the Commodity Exchange Act, as amended (the "Act"), and the actions and alleged justifications of both the longs and shorts which brought about the situation.

The law requires, and the Commission expects, the Exchange to pursue its own independent investigation of the matter and forthwith to provide the Commission with a report of its findings and the actions to be taken by the Exchange to punish any persons found to have violated Exchange rules.

We wish to advise you that we regard this matter as one of the utmost importance; so much so that we have diverted investigators and economists from other pressing duties at the Commission to participate in this investigation. We expect and require the full cooperation of the Exchange, its officials and member firms. While we would like to be in a position promptly to take enforcement action which would place responsibility on those at fault (as well as take prompt regulatory action which would prevent a situation of this sort from occurring again), an investigation of this magnitude will, of necessity, take time to complete. Nonetheless, we will proceed expeditiously and hope to complete our investigation as soon as possible.

There are, however, two other aspects of the situation which also require your immediate attention-each involves the terms and conditions of the Maine potato futures contract and what must be done to prevent situations of this sort from occurring again:

1. The Commission believes that the May 1977 Maine potato futures contract (currently on the board for the 1976 crop year) should be traded for liquidation only. The May contract has traditionally presented a problem because of the inability of traders to ascertain deliverable supply at that time of year. The Commission strongly urges that the Exchange take appropriate action to remove the current May contract from trading; such trading ban to continue until such time as the other issues involving the contract terms and conditions (discussed below) can be resolved.' If the Exchange does not take the recommended action by June 2, 1976, the Commission will promptly consider whether trading in all potato futures contracts on the Exchange should be halted under the Commission's emergency powers-Section 8a (9) of the Act-or, alternatively, whether the designation of the Exchange for trading in potato futures should be suspended or revoked-Sections 5b and 6(a) of the Act.

2. As you are aware, the Commission staff has for some time been concerned about the general terms and conditions of the Maine potato contract traded on the Exchange, and has discussed fundamental changes in those terms and conditions with Exchange officials continuously since the Commission granted designation to the Exchange as a contract market for potatoes (July 18, 1975). The Commission monitors the terms and conditions of contracts of sale to be executed on or subject to the rules of a designated contract market for purposes of ascertaining whether designation should continue in effect. Because of the current situation, such fundamental changes must now be implemented. Accordingly, at a minimum, the Commission hereby requests that the Exchange submit proposed changes in the terms and conditions of its potato contract 3 with respect to such matters as:

A. Deliverable supply.-The deliverable supply must be expanded. It has been suggested that this can be accomplished by lifting the "Maine grown" provision and by increasing the number of varieties deliverable on the contract.

1 Reference is made to item F on page 4 hereof. That item expresses the staff view that justification for continuation of a May contract in potato futures is necessary. 2 Submission under Section 5a (12) of the Act of an Exchange plan to trade the May 1977 Maine potato futures contract for liquidation only will constitute the requisite action.

3 The Commission understands that members of the Exchange staff will meet on these matters with members of the Commission staff today and expects a response to the matters raised by June 2, 1976. Subsequently, submissions pursuant to section 5a (12) of the Act will, of course, be required.

B. Delivery points.-The adequacy of the number of delivery points and their individual and collective ability to handle sufficient deliveries to avoid price distortions must be improved.

C. Transportation. The contract terms limiting deliveries to rail cars do not reflect the current shipping pattern in the cash market and should be expanded to allow truck delivery.

D. Inspection procedures.-The inspection procedures must be reviewed and improved to assure that they do not act as a restriction on supply or as an impediment to delivery.

E. Delivery pack. The acceptability of the existing delivery pack provision is questionable. There is a very limited movement of potatoes in straight loads and a rapidly declining rate in 50 pound bags.

F. Delivery months.-There is a serious question as to whether there is an adequate supply of potatoes generally available to allow the continuation of a May contract.

Concurrent with the submission of the revised contract, a plan outlining how positions in the currently existing contracts will be liquidated or transferred to the new contract must be submitted.

If such changes are not promptly submitted to the Commission, the Commission will then either (i) institute proceedings to suspend or revoke the Exchange's designation for trading in potato futures under Section 5b and 6(a) of the Act, or (ii) specify to the Exchange, pursuant to Section 8a (7) of the Act, the changes to be effected, on the Exchange's behalf, in the terms and conditions of the contract of sale for potatoes to be executed on or subject to the rules of the Exchange. If alternative (ii) is adopted and such terms and conditions are not thereafter promptly implemented by appropriate submission to the Commission, the Commission will hold a hearing, as required by Section 8a (7) of the Act, to ascertain whether the changes specified by the Commission "are necessary or appropriate for the protection of persons producing. handling, processing or consuming... [potatoes] or for the protection of traders or to ensure fair dealing in . . ." potato futures traded on the Exchange.

Furthermore, in light of what has occurred, several other more general rules of the Exchange probably will require modification or change. You should discuss with Thomas A. Russo of our Trading and Markets Division what changes the Exchange deems appropriate. That Division will concurrently begin its own review and discuss with you what changes it deems appropriate.

Members of the staff of the Commission will be in direct contact with you with respect to our investigation. William R. Schief, the Director of the Commission's Division of Enforcement, will be in charge of the investigation. Dr. Mark Powers, the Director of the Commission's Division of Economics and Education, will be in charge of matters relating to contract terms and conditions. Very truly yours,

WILLIAM T. BAGLEY,
Chairman.

COMMODITY FUTURES TRADING COMMISSION,
Washington, D.C., May 27, 1976.

Re New York Merchantile Exchange Rule 51.14.
Mr. RICHARD B. LEVINE,

President, New York Mercantile Exchange,
New York, N.Y.

DEAR MR. LEVINE: This is in response to a letter of May 24, 1976, to me from Mr. Maurice Mound, Counsel for the New York Mercantile Exchange (“NYME" or "Exchange"). Mr. Mound attached to that letter a resolution to be proposed to the Board of Directors of the NYME. This resolution would amend certain sections of Rule 51.14 (b) of the NYME and implement certain other provisions of that Rule, and was submitted to the Commission for its approval pursuant to section 5a (12) of the Commodity Exchange Act, as amended (“Act”).* It

*Rule 51.14(b) of the NYME currently states:

"When there is a default in delivery by a seller, the President, or a broker appointed by him, shall buy in the cash market for the account of the delinquent and deliver to the buyer an amount of potatoes equal to the quantity in default. If the cost of such purchase is in excess of the contract delivery price, the difference shall be paid by the delinquent through the Clearing House, and in all cases the delinquent shall pay to the Clearing House a penalty of at least $100.00 per contract, as determined by the Clearing House Committee, plus any brokerage charge and/or expenses incurred by the Clearing House on the purchase and delivery plus a penalty to be paid to the buyer of an amount sufficient to reimburse him for any proven loss occasioned by the default."

is also my understanding that the Exchange is requesting expedited approval of the resolution as submitted.

Rule 51.14(b) presently provides that, in the instance where there is a default in delivery by a seller, the President of the NYME shall buy in the cash market for the account of the delinquent seller and deliver to the buyer an amount of potatoes equal to the quantity in default. In the proposed resolution forwarded by Mr. Mound, it was stated that Rule 51.14(b) has three elements of damages: where a seller is in default in delivery he is required to make the following payments:

(1) Ordinary damage is payable to the buyer amounting to the excess of the cost of purchasing deliverable potatoes on the cash market plus the cost of delivering them to the buyer over the contract delivery price;

(2) Special damages to reimburse the buyer for any provable additional loss occassioned by the default;

(3) A penalty of at least $100 per contract payable to the Clearing House. Thus, a defaulting party would be subject, pursuant to the terms of Rule 51.14(b), to "ordinary damages," "special damages" and a "penalty." Under the present provisions of Rule 51.14 (b), “ordinary damages" to be paid by the defaulting party would be that amount by which the cost of the purchase of potatoes by the President plus the cost of delivery "is in excess of the contract delivery price." Any "penalty" or "special damages" to be paid by the defaulting party would be determined by the Clearing House Committee of the Exchange. The proposed resolution (1) would delete the requirement that the President purchase potatoes to satisfy contracts on which the seller has defaulted; (2) sets forth a settlement procedure as an alternate method of computing ordinary damages to be paid to the buyer by the seller since delivery cannot be made; and (3) sets forth certain procedures for implementing the "special damages" and "penalty" provisions of Rule 51.14(b)."

The Division has considered your request that the resolution submitted by the Exchange be recommended for expedited approval. The Division has determined that it will be unable to recommend that the Commission expedite approval of the resolution pursuant to section 5a (12) of the Act, since it is the Division's belief that the subject matter of the resolution is more appropriately within the emergency authority of the Exchange. This determination by the Division has been discussed with the Commission and the Commission has concurred in this determination. As you are aware, section 5a (12) of the Act requires the Commission to review each rule, including exchange resolutions, in order to determine that such rules are "not in violation of the provisions of the... [Commodity Exchange Act] or the regulations of the Commission thereunder. . . ." The resolution as submitted presents three complex procedures to be implemented by the Exchange. Specifically the resolution sets forth procedures to be utilized by the Exchange in determining the amount of ordinary damages, special damages and penalty to be paid by the sellers defaulting on the recent May Maine potato contract. It is the Division's belief that a determination that the procedures outlined in the resolution as submitted were "not in violation" of the Commodity Exchange Act or the regulations thereunder would require a detailed study by the Commission's staff. Such a study should not be done hastily.

In considering whether to recommend to the Commission that the resolution submitted be treated expeditiously, the Division has also considered the power of the Exchange to take whatever action the Exchange deems necessary pursuant to its emergency authority.* In that connection, Rule 23.19(a)(1) of the Exchange provides that:

"Whenever as a result of any exceptional contingency not provided for in the By-laws or Rules, an extraordinary situation arises whereby the rigid enforcement of contracts or of the By-laws or Rules would be grossly at variance with just and equitable principles of trade or the public interest, the Board of Governors by a majority vote of the entire Board may accord relief in such manner as in its judgment the exigencies of the situation may demand, with due regard to the rights of both buyer and seller and to the best interests of the Exchange."

In this connection, the proposed resolution submitted to the Commission stated that: the Board finds that the provisions of Rule 51.14 (b) respecting the purchase of potatoes by the President and delivery thereof to the buyer cannot be performed with respect to the May 1976 potato futures contract and that an emergency exists which makes it necessary to .. [provide] for another method of protecting the aggrieved party at the expense of the offending party.