SEC Fines CBOE $6M for "Systemic Breakdowns" in Oversight

The Securities and Exchange Commission (SEC) charged the Chicago Board Options Exchange (CBOE), one of the largest U.S. options exchanges, with failure to police illegal short selling activities, the regulatory agency announced yesterday.

The SEC fined the CBOE and an affiliate, C2 Options Exchange, $6 million for various breakdowns in its regulatory and compliance functions as a self-regulatory organization. CBOE agreed to pay the fine without admitting wrongdoing and agreed to implement remedial measures to settle the SEC’s charges.

In its release, the SEC said that CBOE demonstrated an overall inability to enforce Reg. SHO against a member firm, which was identified as OptionsExpress in today’s Wall Street Journal. The financial penalty is the first assessed against an exchange for violations related to its regulatory oversight, said the financial watchdog.

"The proper regulation of the markets relies on SROs to aggressively police their member firms and enforce their rules as well as the securities laws," commented Andrew J. Ceresney, Co-Director of the SEC's Division of Enforcement in yesterdays announcement. "When SROs fail to regulate responsibly the conduct of their member firms as CBOE did here, we will not hesitate to bring an enforcement action."

From today’s Wall Street Journal:

The investigation found that CBOE, which operates the nation's largest options market, had close ties to optionsXpress Inc., the broker that handled the suspect trades and one of its biggest customers, according to people familiar with the probe. Regulatory officials at CBOE helped the firm craft a response to an SEC inquiry into the trading activity, according to the order. CBOE neither admitted nor denied the SEC charges but agreed to the settlement, a censure and a cease-and-desist order, the SEC said. CBOE failed to adequately enforce Reg. SHO because its staff lacked a fundamental understanding of the rule. CBOE investigators responsible for Reg. SHO surveillance never received any formal training. CBOE never ensured that its investigators even read the rules. Therefore, they did not have a basic understanding of a failure to deliver.

According to the SEC's order, CBOE received a complaint in February 2009 about possible short sale violations involving a customer account at a member firm. CBOE began investigating whether the trading activity violated Rule 204T of Reg. SHO. However, CBOE staff assigned to the case did not know how to determine if a fail existed and were confused about whether Reg. SHO applied to a retail customer. CBOE closed its Reg. SHO investigation later that year.

The SEC’s order accuses the CBOE of interfering with the enforcement division staff’s Reg SHO investigation of the same member firm. “CBOE assisted that member firm by taking the unprecedented step of providing information for, and edits to, the member firm’s Wells submission to the Commission, an inquiry into its trading activity. According to the order, information and edits provided by CBOE resulted in the member firm providing inaccurate and misleidng information.

The SEC also said that CBOE investigators responsible for Reg SHO surveillance never received any formal training. According to the SEC's order, CBOE received a complaint in February 2009 about possible short sale violations involving a customer account at a member firm. CBOE began investigating whether the trading activity violated Rule 204T of Reg. SHO. However, CBOE staff assigned to the case did not know how to determine if a fail existed and were confused about whether Reg. SHO applied to a retail customer. CBOE closed its Reg. SHO investigation later that year.

The fine against CBOE is the latest in a series of regulatory actions against exchanges out of concern that they are not policing their markets due to conflicts-of-interest in running their own for-profit businesses.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio