Chicago Board of Trade Faces Life After Scandal : Commodities: The exchange is seeking ways to prevent the kind of trader fraud that resulted in last year’s federal probe.

On Karsten Mahlmann’s calendar, the new year began Jan. 1, but it took a little longer for the Chicago Board of Trade’s chairman to put 1989 behind him.

Not until earlier this month, when he won a close election to a fourth consecutive one-year term, was Mahlmann certain of majority support among the 3,500 members of the world’s oldest and largest commodity futures exchange.

It was a vote of confidence after a year of scandal that began Jan. 19, 1989, when federal authorities revealed a sweeping investigation of trading fraud at the Board of the Trade and the smaller Chicago Mercantile Exchange, which together account for about 75% of U.S. futures trading volume.

“I can’t remember a tougher year in the seven years I’ve served on the board,” Mahlmann said in an interview.

The probe has resulted in criminal charges against 48 people. Fourteen have pleaded guilty to swindling customers.

A parallel investigation at New York’s four major futures exchanges was disclosed in May but has yielded no indictments yet.

The Board of Trade’s troubles multiplied in July when exchange directors exercised their seldom-used authority to order traders to sell soybean futures, forcing prices lower. The board claimed that it was necessary to prevent one grain company from cornering the market.

The trading-fraud scandal brought cries for reform of the rapidly growing futures industry and has delayed congressional reauthorization of the Commodity Futures Trading Commission, the federal agency that regulates the futures pits. Futures contracts are agreements to buy or sell commodities varying from agricultural products to financial instruments on some future date at a price agreed upon in advance. People trade futures to hedge losses or speculate on future prices.

Amid the intense public scrutiny of the futures markets and their trading practices in the past year, the Chicago exchanges have strengthened policing efforts, stiffened penalties for cheating and proposed reforms that address some concerns raised by the FBI investigation.

But the toughest measures, such as restrictions on dual trading and stricter regulation of broker associations, are yet to come.

Dual trading is the practice among floor brokers of trading for their own accounts as well as customer accounts. Broker associations are groups of independent futures traders who share revenues and pool expenses.

Critics say both practices provide opportunities for traders to defraud customers.

“A lot needs to be done,” said Rep. Glenn English (D-Okla.). “If you review what’s actually been done, we’ve had a good deal more in terms of intentions expressed rather than real action.”

English sponsored a CFTC reauthorization bill that the House passed last year. The measure would sharply curtail dual trading until an exchange demonstrates an ability to better detect wrongdoing.

Senate action on a similar bill is pending.

The CFTC, meanwhile, is seeking public comment on a proposed rule that would limit dual trading but it’s not as tough as the bills in Congress.

The Chicago exchanges defend dual trading as a means of keeping markets liquid when the customer order flow is light, thus reducing price volatility. They bristled when curbs on dual trading were first suggested, but have since indicated acceptance of restrictions that would be lifted when highly accurate trade-auditing systems are in place.

The Board of Trade and Merc are involved in a rare joint effort to develop a hand-held electronic trade-recording device. The machine would replace the traditional paper cards on which commodity traders pencil their trades.

The electronic trading cards would zap the information to exchange computers, theoretically creating a complete, instantaneous record of all trades.

The exchanges have invited proposals for companies to design an electronic trading card and hope to begin testing prototypes on their trading floors this fall.

“It will make detection of abuses a certainty,” said Merc spokesman Andrew Yemma.

But some critics contend that commodities fraud will remain difficult to detect until the exchanges do away with open-outcry trading, a 140-year-old tradition in which traders crowd pits and strike deals through a seemingly chaotic combination of hand signals and shouted bids and offers.

“Verbal orders, executed by shakes, winks, hand gestures, spit and God-knows what, that’s the window of opportunity for fraud,” said former Sen. Thomas F. Eagleton, who quit the Chicago Merc’s board of governors in November. He accused the exchange of trying to protect a former chairman accused of failing to stop two of his employees from defrauding investors.

The Board of Trade and the Merc are working on electronic trading systems to supplement open-outcry trading, but neither exchange plans to phase out the practice, saying it creates the world’s most efficient markets.

The futures industry has enjoyed remarkable growth since the early 1970s, when financial futures were introduced. Volume has soared from 13.8 million contracts traded in 1970 to 267.4 million last year.

Last year’s industrywide volume increase of 8.8% marked the 21st consecutive annual rise.

The Board of Trade’s trading volume fell 3.3% last year, though. Exchange officials blamed it on quieter agricultural markets than in 1988, a drought year.

But John Damgard, president of the Futures Industry Assn. trade group, said industrywide volume probably would have been higher if it weren’t for the fraud scandal.

“There’s clearly been a price to pay for this,” he said, “and the Chicago exchanges are right at the focal point.”