CBOE hit with $6 million fine by SEC for regulatory failures

Helped member firm optionsXpress fill out responses to SEC

From the SEC:

Washington D.C., June 11, 2013 – The Securities and Exchange Commission today charged the Chicago Board Options Exchange (CBOE) and an affiliate for various systemic breakdowns in their regulatory and compliance functions as a self-regulatory organization, including a failure to enforce or even fully comprehend rules to prevent abusive short selling. 

 CBOE agreed to pay a $6 million penalty and implement major remedial measures to settle the SEC’s charges.  The financial penalty is the first assessed against an exchange for violations related to its regulatory oversight.  Previous financial penalties against exchanges involved misconduct on the business side of their operations.

 Self-regulatory organizations (SROs) must enforce the federal securities laws as well as their own rules to regulate trading on their exchanges by their member firms.  In doing so, they must sufficiently manage an inherent conflict that exists between self-regulatory obligations and the business interests of an SRO and its members.  An SEC investigation found that CBOE failed to adequately police and control this conflict for a member firm that later becamethe subject of an SEC enforcement action.  CBOE put the interests of the firm ahead of its regulatory obligations by failing to properly investigate the firm’s compliance with Regulation SHO and then interfering with the SEC investigation of the firm.

 According to the SEC’s order instituting settled administrative proceedings, CBOE demonstrated an overall inability to enforce Reg. SHO with an ineffective surveillance program that failed to detect wrongdoing despite numerous red flags that its members were engaged in abusive short selling.  CBOE also fell short in its regulatory and compliance responsibilities in several other areas during a four-year period.

“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,” said Andrew J. Ceresney, Co-Director of the SEC’s Division of Enforcement.  “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.” 

 Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit, added, “CBOE’s failures in this case were disappointing.  The public depends on SROs to provide a watchful eye on their exchanges and market activities occurring through them.  They must have strong compliance cultures and adequate and dedicated compliance resources to ensure that they do not stray from their bedrock obligation to provide rigorous self-regulation.”

According to the SEC’s order, CBOE moved its surveillance and monitoring of Reg. SHO compliance from one department to another in 2008, and the transfer of responsibilities adversely affected its Reg. SHO enforcement program.  After that transfer, CBOE did not take action against any firm for violations of Reg. SHO as a result of its surveillance or complaints from third parties.  Reg. SHO requires the delivery of equity securities to a registered clearing agency when delivery is due, generally three days after the trade date (T+3).  If no delivery is made by that time, the firm must purchase or borrow the securities to close out that failure-to-deliver position by no later than the beginning of regular trading hours on the next day (T+4).  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. 

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