For years, soybean futures at the Chicago Board of Trade took a back seat to flashier new financial products. But last spring`s drought turned the soybean pit into the hottest market around.
Orders deluged the pit as public customers bet that soybean prices would skyrocket. Brightly jacketed traders who had deserted soybeans streamed back in, looking for a once-in-a-lifetime killing in the overheated market.
”I can remember people (on the floor) saying the good times are here again,” said a veteran grain broker. As Barron`s magazine put it, ”Rock `n` roll time was back” in the grain pits.
If the drought-inspired buying frenzy was the best of times for traders on the exchange floor, it was also good news for an FBI agent using the name Richard L. Carlson, who posed as a soybean trader in the government`s unprecedented probe of alleged wrongdoing at Chicago`s futures exchanges.
Carlson lost $91,000 in July, the month when drenching rains ended the bull market, according to trading records. But making money wasn`t his aim. The hectic market was a gold mine for the agent, because fraudulent trading practices are known to flourish when orders pour in and prices are volatile. At such times, floor traders are most likely to break rules, and abuses are hardest to detect, industry sources said.
”The beans were a natural,” said a broker. ”So much was going on that people weren`t going to notice you standing there picking somebody`s pocket.” Added one industry source: ”In some ways, the drought was a blessing for the government investigation.”
The Board of Trade`s soybean pit was the government`s first focus in an investigation that later spread to include another market, the Chicago Mercantile Exchange, and at least five other trading pits. The sweeping, two- year probe has implicated as many as 100 members of the two exchanges, and at least 30 traders have agreed to cooperate with investigators, sources familiar with the inquiry said.
Law enforcement sources have said that at least four agents posing as traders tape-recorded hundreds of conversations that they believe document a variety of schemes through which brokers skimmed money in executing customer orders.
The Merc has said it will conduct its own internal investigation of floor-trading practices, while the Board of Trade has said it will make no comment until it knows details of the investigation.
The government investigation, known by the FBI code-names Operation Sour Mash and Operation Hedgeclipper, is continuing.
Sources famliar with the inquiry have said that two agents-Carlson and another using the name Michael McLoughlin-traded at the Board of Trade. Two others-using the names Randy Jackson and Peter Vogel-traded at the Merc.
In focusing on the soybean pit, the investigation has cast an unwanted spotlight on a trading arena that in some ways represents the blue bloods of Chicago`s rough and tumble futures exchanges.
Traders portray members of the soybean pit as clubbish and relatively older and more sedate than the brash upstarts who dominate the newer financial products.
”The pit is a family place,” said one soybean trader. ”If someone knows your father, it certainly helps in getting started.”
Soybean brokers under scrutiny range from heavy-hitters like Martin Dempsey, 51, who lives in a palatial home and owns a green Jaguar and a red BMW, to John Eggum, 46, and James Nowak, 47, whose simpler suburban lifestlyes contradict the stereotype of the millionaire trader.
Dempsey declined to be interviewed.
Eggum called the inquiry ”unbelievable.”
Nowak was unavailable, but his wife, Ruth, said her husband ”thinks it is more hype than fact. He told them they would have to show him what he did wrong.” She said her husband believes ”the FBI spent all of this money on the investigation and now they have to justify it.”
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To be sure, the soybean pit may not be the primary focus of the federal investigation, or the setting of the most serious abuses.
Sources familiar with the investigation have said the FBI is also scrutinizing trades in the Board of Trade`s Treasury bond and wheat futures pits, as well as the Merc`s Standard & Poor`s 500 stock-index and two currency futures pits.
But the practices in the soybean pit are what prompted the agribusiness conglomerate Archer-Daniels-Midland Co. to complain to federal investigators about corruption at Chicago`s futures exchanges, according to sources familiar with the inquiry.
The sources said that about two years ago Archer-Daniels, of Decatur, became upset over the way its orders were being handled on the floor of the nation`s oldest commodities exchange. After reporting its suspicions to officials in Washington, the company agreed to cooperate in the inquiry.
Carlson started out as a trainee in Archer-Daniels` futures trading subsidiary before coming up with the money to buy his own seat on the exchange.
Sources familiar with the inquiry said that before traders began cooperating, the government was certain most of its indictments would center on activities in the soybean pit. And people in the futures industry claim as many as 60 of the soybean pit`s several hundred traders have received subpoenas, though this could not be confirmed.
Nonetheless, brokerage firm officials said they would be surprised if the government found widespread fraud in the soybean pit.
They said the people working there stand in sharp contrast to the public`s image of the flamboyant, high-rolling trader.
Soybean traders are, first, older on average. ”There are almost the same faces now as 20 years ago,” said one grain trader.
”Family ties help to get started,” said one former trader. ”But trading is based on trust. A new face appears on the floor and you don`t know him, whether he will stand behind his word, and you are less likely to trade with him.”
The pit is also ”gentlemanly” compared with the Board of Trade`s raucous Treasury bond futures pit.
Traders must buy full Board of Trade memberships, which recently cost more than $400,000, to trade soybeans, but they can trade bonds for half that amount by buying associate memberships.
As a result, the bond pit is jammed with younger, more aggressive traders, and there have been numerous incidents of pushing and name-calling. Bond traders arrive as much as 1 1/2 hours before the start of trading to reserve their places in the pit.
That isn`t necessary in the more decorous soybean pit. ”It`s tacitly acknowledged that so-and-so stands there,” said the former soybean trader.
Carlson, the balding, sandy-haired undercover FBI agent, broke into the soybean pit by working as a floor broker for Archer-Daniels` ADM Investors Inc.
Traders describe Carlson as a man of ”quiet class,” who wore a Rolex watch tucked beneath the cuff of his shirt and drove a top-of-the-line Mercedes-Benz. Carlson bought his own seat in December, 1987, for $335,000. At that time, he became a ”local,” a trader who buys and sells futures contracts for his own account rather than for customers.
Carlson stood in the southeast corner of the octagonal soybean pit, close to Eggum and Nowak, other traders said. Traders typically try to stand near brokers so they can take the other side of customer orders.
Last week, the government subpoenaed records of transactions in which Nowak and Eggum traded with Carlson. They also subpoenaed records of Dempsey`s trades.
Sources close to the Board of Trade argue that those who traded with Carlson have been unfairly singled out. ”They`re just average guys,” said a former soybean trader. ”They just happened to be standing next to this guy
(Carlson). That`s where the bomb went off.”
Most abuses in the soybean pit are technical rule violations that don`t hurt customers, defenders of the pit insisted. ”There`s a lot of little picayune stuff that can go on,” said one former soybean trader.
Traders were outraged more than a week ago, when a highly respected soybean broker received a subpoena requesting details of a trade he allegedly made for a brokerage firm. Sources said the veteran trader executed a 100,000- bushel order for the firm after the close of trading.
Such trading, known as ”kerb” or ”curb” trading, is against exchange rules and federal law. But traders claim it doesn`t hurt customers and may be done by a floor broker who has inadvertently forgotten to execute a customer order at the close.
The incident caused many traders to doubt the strength of the government`s case and triggered charges that the investigation was a ”wild goose chase.”
But investigators have uncovered other kinds of abuses in which they believe customers are more clearly hurt, sources said.
In bucketing, for example, a floor broker takes the other side of a customer`s order, either directly or through a confederate known as a bagman. The customer gets a bad price on his order, while the floor broker or his buddy profit at the client`s expense.
For example, a floor broker may have orders to buy and sell one soybean contract, each covering 5,000 bushels of soybeans, at the market price. If the price was $7.50 but has begun to drop, the broker might buy for one customer from his friend at $7.50 and sell for another customer to his friend at $7.49. The buddy is assured of a profit.
Or the floor broker, who is also permitted to trade for himself on futures exchanges under a practice known as dual trading, may pass an order on to a friend who is also a floor broker. The first broker may directly take the other side of the customers` orders.
Traders insist that many of the abuses arise because of costly errors by brokers in hectic trading. Friends help floor brokers to correct the mistakes, taking on losing trades themselves in the process; the floor brokers pay the buddies back by skimming from customers` orders, they said.
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But traders deny that cheating is pervasive. ”People do get greedy,”
said one veteran trader. ”They`ve got a customer deck, and they say I can chip away at every customer order and make myself a fortune. But it`s not real common.”