Usually, each mill has their own grading system. Its something they developed which gives them the best profit and treats the logger fairly.
The USFS has developed a grading system. It seems to work for some people, but it isn't widely accepted. They have also run a bunch of yield tests on many different species. I find that grade yield will vary from different areas, so a grade yield should also be used by a mill using the system. Here's an overview of their system: http://www.fpl.fs.fed.us/documnts/fplrp/fplrp063.pdf
I have seen sawlogs graded as prime, select, choice, #1, #2, #3, pallet, and tie. It all has to do with length, size, defect and location of the defect. Most #1 logs have a minimum diameter. They may vary by species, with the more valuable species having a smaller diameter.
Defect placement is often more important than size. Large knots will drop a log grade. They won't even make tie logs, since they don't make good ties. Defect that is at the end of the log can be trimmed back. Defect in the middle of the face would have to be small in order to pull good grade. Quite often one or two small defects can be positioned to come off in an edging strip.
Things like double heart, sweep, seams and splits have to be considered in grade. Too much sweep will always drop the grade of the log, no matter how nice. It will also reduce volume.
Usually the large mills in your area will steer the prices and the grade of logs. If you can get their grade sheet, that should help you in how they are grading logs. Right now, grade is pretty stiff at the lumber end, so that should filter back to the log end.
Sawyers make good log graders and buyers. They usually know what the inside of a log looks like better than most.