Snakes in The Pits

By Christine Gorman

For six months Chicago's commodities traders had been nervously waiting for the big shoe to drop. The FBI announced last January that its agents had quietly penetrated the trading pits at the Chicago Board of Trade and the Mercantile Exchange and found them to be full of snakes. Since then the bureau's investigation -- the most extensive ever conducted into any financial market -- has been proceeding, not so quietly, as more than a dozen traders have been pressed into cooperating with the Government. Last week, with FBI director William Sessions and U.S. Attorney General Dick Thornburgh in Chicago for the occasion, the results were finally announced: 46 traders (out of some 6,000) at the two institutions were indicted on charges ranging from defrauding customers to tax evasion to racketeering.

And there's more to come, warned Thornburgh, saying, "This probe is part of an expanding Department of Justice crackdown on white-collar crime in all its various guises, from Wall Street to LaSalle Street to Main Street. The activities uncovered at these exchanges, the largest of their type in the world, cannot be tolerated."

Significantly, 18 of the traders were charged under the often criticized Racketeer Influenced and Corrupt Organizations Act. Originally passed by Congress in 1970 to combat organized crime, RICO is increasingly being used as a battering ram against the clubby defenses of financial institutions. Because it allows prosecutors to seize all assets -- including homes, salaries and pensions -- of those indicted, many people facing a RICO count offer to inform on their former colleagues in exchange for leniency. Last week Anton Valukas, the U.S. Attorney who supervised the 2 1/2-year probe, advised both Chicago exchanges that if the RICO-charged traders are convicted, the prosecution intends to lay claim to their membership seats, a $7.5 million prize.

Although FBI agents masquerading as brokers spotted some wrongdoing in the pits where U.S. Treasury bonds and Swiss francs are traded, the bulk of the charges are directed at the Board of Trade's soybean pit and the Merc's Japanese yen pit. The yen traders have long been viewed with suspicion by other brokers, while the old clique of soybean traders had a reputation for playing by their own, traditional rules and resisting interference, even from their exchange officials. The Government has accused no fewer than 19 of the 50 soybean brokers and 21 of the 70 yen traders of running their commodities pits like special clubs that illegally fixed their prices and profits, to the detriment of hundreds of customers.

One type of shady deal was "front-running," in which a broker profits from advance information by trading ahead of a customer's order. A crooked broker might receive an order, for example, to buy 250,000 bu. of soybeans at $5.85 a bu. He could easily execute his own order to buy 50,000 bu. first. Later, when the market reacted to the larger order by pushing prices up to $5.95, the trader could sell his contracts, pocketing $5,000 in profits. A second illicit practice uncovered by the feds was "curb trading," in which brokers conspired to consummate deals outside legal market hours "on the curb." Many brokers even "busted" losing trades by simply destroying evidence of the transaction. Such practices represent "more stupidity than conspiracy," says a Board of Trade official. "It's scratch my back and I'll scratch yours, but it's done with the customer's money. You might as well have a gun and a mask."

Since the federal sting was disclosed in January, the exchanges have scrambled to put their houses in order. Disciplinary actions at the Board of Trade have jumped to 119 so far this year, from 55 in the same period last year. During that time, member fines at the Merc have increased eightfold -- to $1.9 million. The day after the indictments were published, the Board of Trade announced it would initiate a $1 million upgrade in its computerized surveillance program as well as triple its minimum fines to $250,000. The Merc's chief, Leo Melamed, pledged "to put the fear of God" into traders.

But eleventh-hour amends are unlikely to save the exchanges from increased regulatory scrutiny. Last week the House Agriculture Committee voted to boost the budget of the Commodity Futures Trading Commission, which oversees the Chicago markets, from $34.7 million to $44.5 million by 1991. And in a step designed to prevent front-running, the committee moved to partly restrict brokers from trading for their own and their clients' accounts at the same time.

Some of the exchanges' critics want to go further. They recommend that Chicago's quaint system of making deals with shouts and hand signals be replaced with automated computerized trading, as has been done in Tokyo and London. "It is time to jettison this Rube Goldberg . . . system and replace it with a sophisticated electronic system that records trades as they happen," said Massachusetts Democrat Edward J. Markey, chairman of the House subcommittee on telecommunications and finance.

What will the future of the futures market be? Valukas says the Government's investigation has just begun. At least one guilty plea is expected this week, and new cases may be opened. "We have made a substantial and long-term commitment to ensure the integrity of the markets," says Valukas. "I'll let the convictions do the talking."

With reporting by Richard Hornik/Washington and William McWhirter/Chicago