THE CHICAGO COMMODITIES SCANDAL : Latest ‘Black Eye’ Brings On a Crisis in Confidence

They’ve heard about the commodity trading scandal in the cornfields of the Midwest and they’re not amused.

“I’m been flooded with calls all day from farmers who don’t want more regulation--they want to close the futures markets down,” said Sen. Bob Kerry (D-Neb.). Rep. Neal Smith (D-Iowa) has had several calls, too, reminding him that “that there’s a whole lot of people who just don’t trust these markets.”

As these gripes suggest, the federal fraud and racketeering indictments of 46 commodity traders announced Wednesday have left Chicago’s two big futures markets facing a tough job of restoring public confidence in their operations. The Chicago Board of Trade and Chicago Mercantile Exchange must also adjust to the prospect of tougher regulation of the pits, even as they fight for the right to continue handling most regulation themselves.

In the past, these markets have shown themselves adept at fighting off threats to their autonomy, despite the perception of some that the boisterous pits are little more than arcane gambling operations. But the scandal, in which traders were accused of conspiring to cheat their customers, is among the gravest challenges the markets have ever faced.

It may become more difficult if federal prosecutors and the FBI begin snaring bigger fish at the Chicago Board of Trade or Chicago Mercantile Exchange.

“They’ve got their work cut out for them, because this is a real black eye,” says Jack Barbanel, head of futures trading at the Gruntal & Co. investment firm on Wall Street.

Most knowledgeable observers don’t expect the scandal to do much damage to the markets’ thriving business. The fast-growing operations are too important to commodity dealers, banks, investment funds, and a full range of other investors who want to transfer risk to those who are willing to shoulder it.

But unless they can satisfy the public, Congress and their customers that their “open outcry” system of trading does not cheat customers, the exchanges risk ending up with the kind of regulation that they fear would make their operations unwieldy. A long-term loss of public confidence could drive business to competing futures markets in Japan, London or elsewhere.

“We don’t underestimate the competition,” said William J. Brodsky, chief executive of the Mercantile Exchange.

Citing the need for tighter regulation, Merc officials Thursday morning announced a series of proposals designed to make it harder for traders to cheat.

The rules would limit so-called dual trading, in which traders can buy and sell futures contracts for themselves and for clients at the same time. Such trading has been criticized because it can allow the trader to give himself a better price on the contract than he gives his client.

Ethics Courses

Under the proposal, which still has to be approved by the Merc’s membership, dual trading would not be allowed in a pit for any given month unless 90% of the recorded trades for that month are shown to be accurate. However, the rule would allow certain exemptions, such as for brokers who received permission from their customers to trade for their own and the customers’ accounts.

The new Merc rules also call for added electronic surveillance of the pits, including the use of video cameras that could track suspected traders, in much the way that Las Vegas casinos observe dealers and gamblers. Merc officials say they don’t intend to use “moles” as the FBI did.

The exchange is also planning to offer ethics courses, and to further upgrade its computerized tracking of trades.

In an emotional speech, Merc Chairman Leo Melamed said the exchange intended to “put the fear of God” into its members. “If we falter . . . we lose our right to self regulation,” he said.

There were signs that the exchanges may lose some of that right already.

The House Agriculture Committee on Wednesday passed a bill that would tighten regulation of the markets, including a ban on dual trading for high-volume contracts unless the exchanges have the proven capability of policing themselves. The Commodity Futures Trading Commission on Wednesday announced its own regulatory changes.

With impressive lobbying might, the futures markets have often fought off attempts to interfere with their autonomy. In the mid-1980s, they stymied an effort to make them stamp all trades at one minute intervals.

‘Tide Should Begin to Shift’

After the October, 1987, stock market crash, they fought off efforts to move regulation of stock-index futures from the CFTC to the firmer regulatory hand of the Securities and Exchange Commission. Stock-index futures are contracts based on basket of stocks; heavy trading in these investments was blamed by some for worsening the crash.

James M. Stone, chairman of the CFTC from 1979 to 1981, predicted that a new era of regulation of the futures markets may be at hand because of the scandal and the stock-index futures’ contribution to the 1987 stock market crash.

“The tide should begin to shift, in Congress and in public opinion,” said Stone, now president of Plymouth Rock Assurance Co. in Boston. “These events are showing that when you have people handling other people’s money, you need regulation and strictly enforced rules. Otherwise the temptation to stray is just too great.”