Prosecution: Snaring the Chicago 46

For those who think show trials are limited to Stalin's Russia or Deng's China, welcome to present-day Chicago.

Last summer, U.S. Attorney Anton Valukas announced the indictment of 46 participants in Chicago's commodities and financial futures exchanges. Arrayed and beaming behind him for the benefit of the cameras were U.S. Attorney General Richard Thornburgh, FBI Director William Sessions, and Commodity Futures Trading Commission Chairman Wendy Gramm.

The well-attended press conference resembled grammar school "show and tell" more than an exercise of government. It featured stacks of press releases and colorful biographies of the defendants. The media event served its purpose, resulting in a front-page story (above the fold) in the next day's New York Times. But contrary to the impression created by the news coverage and by the hundreds of thousands of dollars spent on the case, most of the infractions involved were quite minor. In fact, the cost of the investigation far exceeded the cost of the alleged crimes.

My experience during nearly 30 years in the commodities business and my conversations with some of the indicted traders and their lawyers, friends, and relatives lead me to conclude that the exchanges are under siege by government prosecutors whose targets are completely arbitrary. I wasn't one of those indicted, but I easily might have been. That's why I must remain anonymous. In the course of filling scores of weekly reports and recording tens of thousands of annual transactions, I'm sure I've made some mistakes. And anyone in such a vulnerable industry who publicly criticizes the U.S. attorney could find himself at the mercy of unchecked legal power.

The fatal mistake made by the first 46 to be indicted was to stand too close to undercover agents wearing hidden microphones. If the government had provided enough agents and microphones, it could have indicted every single trader. When everyone is guilty, one has to suspect that the law is unjust. Indeed, a close analysis of the charges reveals that they fall roughly equally into four classes, only one of which involves behavior that warrants criminal sanction.

Some traders were doing their jobs and would have been negligent to do otherwise. For example, traders with cross-orders (one to buy and one to sell) often fill them noncompetitively with other brokers rather than through open outcry. This practice benefits the customer, who otherwise would lose a small margin. Yet, to the federal prosecutors, this common practice constituted an indictable offense. As the head of a brokerage firm, I would have fired anyone who didn't violate this rule.

Some traders allegedly violated trivial exchange rules that are generally ignored. An example is "curb trading"—trading after the market closes, which enables a broker to settle odd trades a minute or two past deadline. This practice helps customers by allowing brokers to execute orders more efficiently. Prosecuting this technical violation as a federal crime actually damages exchange efficiency instead of promoting it. (Both curb trading and cross-orders have been legal at exchanges in New York.)

Some traders allegedly violated formal rules and should be punished moderately by the exchanges. For example, the government indicted a broker who allegedly made a trade with a federal agent at a certain price and made other trades at better prices with other pit traders. When the federal agent questioned his allocation, the broker changed the price to the agent's advantage. The broker realized no benefit for himself, and the amount involved totaled about $500. For this technical violation, he was charged with a felony and faces the permanent loss of his livelihood through harsh exchange disciplinary action.

Finally, some traders, allegedly stole from their customers. Such a trader might have received an order to buy soybeans at $6.50 a bushel. But if the market was fast and he filled the order at a lower price, the customer should have received the difference. The unethical trader instead took the difference for himself or arranged to award it to a confederate. This is clearly illegal, and such traders ought to be prosecuted.

Given that only about a quarter of the indictments fall into this last category, the government's tactics in the case were highly questionable. The prosecutors used methods more appropriate for investigating terrorists or contract murderers. Government agents befriended traders, visited their homes, and shared their meals. They attended their parties, played with their children, and won their trust. They deluded the defendants and then ensnared them in order to prosecute what was primarily the moral equivalent of jaywalking.

Some indictments were issued through midnight raids on people's homes, a tactic usually reserved for suspects who are armed and dangerous. Many defendants weren't told the specifics of all the charges against them, enabling prosecutors to negotiate plea bargains on lesser counts by threatening to prosecute additional charges.

The investigation was further tainted by its apparent use as a vehicle for revenge by a large agribusiness firm that had longstanding quarrels with the Chicago Board of Trade. Knowing that government agents were standing nearby, the company repeatedly rushed in orders after the close of trade. To fill those orders—to better serve their customers!—the brokers traded after the market had officially closed, under the observation of federal agents.

Perhaps most alarming of all is the way federal prosecutors manipulated the press to aid their investigation. The Chicago Tribune broke the news of a federal commodities-trading probe last January and followed up with six months of reporting under 20 different bylines. But, as David L. Protess says in a recent issue of Columbia Journalism Review, "What began as a government leak swiftly became a torrent of intrusively gathered news stories that were frequently misleading and sometimes inaccurate.'' Protess claims that the Tribune simply published information leaked by anonymous federal sources. Those sources clearly expected to receive prominent and favorable news coverage. They also hoped to create a panic among traders that would produce a spate of new informants. Protess describes the whole episode as "nothing but leak journalism."

The publicity most obviously serves the interests of Valukas, the U.S. attorney in charge of the case. Prosecutors have always been tempted to prosecute their way into public office. Long-time Illinois Gov. James R. Thompson came to fame as the prosecutor of former Gov. Otto Kerner.

More recently, Rudolph Giuliani parlayed reckless prosecutions into a shot at the mayor's office in New York City. To curb this tendency, it is necessary to stop prosecutors from reaping immediate political benefit from their show trials. Legislation should be enacted to bar federal prosecutors from seeking elected public office for at least five years following their tenure.

Furthermore, we need to rein in the arbitrary prosecutorial power recently unleashed on the futures industry. We can start by limiting the application of the open-ended Racketeer Influenced and Corrupt Organizations (RICO) statute, which Valukas used to literally make a federal case out of marginal violations. RICO was written to aid the prosecution of mobsters, but industrious government lawyers such as Giuliani have turned it into a catch-all. RICO has been used in recent months to prosecute small businessmen who failed to pay state sales taxes, anti-abortion protesters, and, now, commodities brokers. Congress created this monster; it should be hounded to reform it.

In close to three decades in the commodities business, I've witnessed plenty of corruption. But intrusive federal regulations and grandstanding prosecutions won't reduce it. Although the recent Justice Department investigation may end up snaring hundreds of traders, the biggest crooks remain unaffected. For example, many traders in the S&P 500 stock index futures pit are noted among professional brokers for shortchanging customers and cheating their colleagues. Yet traders in that pit were savvy enough to suspect their government-issue colleagues, and the investigation so far has failed to indict a single S&P trader.

There are ways in which the futures industry could clean its own house. The most obvious change, monitoring the competence of brokers, would enhance market efficiency and integrity without requiring massive governmental intervention.

In the process of cheating customers, a dishonest floor trader fills orders badly, just like an incompetent broker. An important indicator of broker incompetence is "slippage," the difference between the market price and the price at which a trade is actually made. In their own interest and as part of their fiduciary responsibility, brokerage firms should review the performance of traders and get rid of those whose transactions show excessive slippage. By moving to eliminate incompetent brokers, the exchanges would also eliminate the dishonest ones.

Until RICO is revamped and federal prosecutors are discouraged from pursuing cases for their publicity value, the show trials will continue. And so will the outrageous investigatory tactics, manipulation of the media, and unchecked ruthlessness and raw ambition flaunted by federal prosecutors in Chicago.

Trader X is the pseudonym of a Chicago commodities trader who served as the head of a major brokerage firm.