Securities Regulation Daily VIX manipulation suit against Cboe tossed again
Tuesday, January 28, 2020

VIX manipulation suit against Cboe tossed again

By Amy Leisinger, J.D.

The plaintiffs failed to provide additional allegations sufficient to show that Cboe promoted products based on its volatility index despite knowledge of price manipulation.

The Northern District of Illinois has again dismissed a lawsuit alleging that the Chicago Board Options Exchange enabled price manipulation in products based on Cboe’s volatility index (VIX). According to the court, the plaintiffs failed to plead loss causation or scienter to support their Exchange Act fraud claim and also failed to allege damages in order to state a claim under the Commodity Exchange Act. The court did, however, again reject Cboe’s argument that it enjoyed absolute immunity from the lawsuit as a self-regulatory organization (In re Chicago Board Options Exchange Volatility Index Manipulation Antitrust Litigation, January 27, 2020, Shah, M.).

VIX and alleged manipulation. Sometimes known as Wall Street’s "fear gauge," the VIX is a benchmark index based on S&P 500 options that reflects expected market volatility in the near term. While the VIX cannot be traded directly, Cboe offers futures, options, and exchange-traded funds tied to the VIX. These products are cash-settled, with options expiring on a weekly basis.

The plaintiffs, traders in VIX-based products, filed a lawsuit alleging that certain features of the settlement process made it especially susceptible to manipulation but that Cboe chose not to enforce its rules against manipulation so it could continue to profit from the VIX products. Specifically, the complaint alleged violations of the Exchange Act antifraud provisions and the CEA and brought claims against both Cboe and anonymous "Doe" defendants that allegedly manipulated the settlement values for VIX options and futures by manipulating the two-zero-bid rule and employing a process analogous to "banging the close." The district court rejected Cboe’s contentions that it had absolute immunity and that the action was precluded in connection with SEC approval. However, the court dismissed the fraud claim for failure to plead scienter and loss causation and the CEA claim for failure to plead actual damages, with leave to amend.

Immunity or preclusion. Cboe argued that the Exchange Act claim should be dismissed based on the absolute immunity afforded to self-regulatory organizations, but the court disagreed. Adhering to its original rulings, the court stated that. while SROs are entitled to immunity when they perform their statutory functions, exchanges are also private entities that act in their own interests. When promoting VIX products, designing the settlement process, and listing the products, Cboe acted in its private capacity, according to the court. The court also remained unmoved by Cboe’s argument that the securities fraud claim was precluded because the SEC approved aspects of the VIX enterprise.

Fraud allegations. The court again found that the plaintiffs faltered on establishing loss causation. To state a private claim for securities fraud, the plaintiffs must allege a causal connection between Cboe’s fraudulent conduct and their alleged losses. However, the plaintiffs have not plausibly alleged that the "Doe" defendants’ manipulation caused them to lose money because they do not identify in which direction manipulation occurred or how it caused harm in any specific trade, according to the court.

The complaint also failed to plead with particularity facts giving rise to a strong inference of scienter, the court explained. The plaintiffs primarily focus on Cboe’s alleged recklessness, both in changing the VIX formula and allowing manipulation to continue, but fail to demonstrate facts allowing a strong inference that Cboe knew that the new formula was vulnerable to manipulation at the time of design, "let alone that Cboe deliberately made those choices because it intended the formula to be manipulated," the court stated. The complaint shows a generalized profit motive common to business entities, according to the court, and the more compelling inference is that Cboe pursued a profit motive by making the VIX replicable and that any manipulation that occurred was unintentional or negligent. The exchange itself must have participated in fraud, and the plaintiffs do not plead that Cboe conspired or assisted in any manipulation by the "Doe" defendants, the court stated.

CEA claim. The court likewise dismissed the plaintiffs’ claim under Section 25(b) of the CEA, which imposes liability on an exchange for damages caused by its failure to enforce its rules. The complaint’s allegations are sufficient to support the inference that Cboe was acting in bad faith when it should have known about manipulation and did nothing to enforce its rules, the court stated. However, the plaintiffs fail to allege actual damages because they do not identify specific transactions, the direction of manipulation, or whether they gained or lost on settlement, according to the court. Further, the allegations that enforcement would have stopped manipulation are too speculative to be plausible, and, in any case, if the plaintiffs suffered damages, it was caused by the "Doe" defendants’ manipulation, the court stated.

The court dismissed the entirety of the amended complaint with prejudice.

The case is No. 18 CV 4171.

Attorneys: Aaron L. Brody (Stull, Stull & Brody) for David Quint. Jonathan David Cogan (Kobre & Kim LLP) for DRW Holdings, LLC. Gregory M. Boyle (Jenner & Block LLP) for CBOE Exchange, Inc. and CBOE Global Markets, Inc.

Companies: DRW Holdings, LLC; CBOE Exchange, Inc.; CBOE Global Markets, Inc.

MainStory: TopStory ClearanceSettlement CommodityFutures Derivatives Enforcement ExchangesMarketRegulation FraudManipulation IllinoisNews

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