SEC puts exchanges in sights charging CBOE regulatory lapses

Compliance Cultures

“SROs must have strong compliance cultures and adequate and dedicated compliance resources to provide the first line of defense,” SEC Commissioner Luis Aguilar said in prepared remarks for a conference published on May 8. “However, when SROs fall short, the SEC needs to stand ready to take action.”

The CBOE was fined after its staff was found to have interfered with a three-year SEC investigation of short selling at a member firm, OptionsXpress Inc., according to yesterday’s order. The settlement came four days after an administrative law judge ruled the Charles Schwab Corp. unit helped facilitate sham transactions that violated U.S. securities laws known as Regulation SHO.

OptionsXpress broke SEC rules between 2008 and 2010, according to the regulator’s statement. Schwab bought the company in 2011.

“This settlement marks a significant step in putting the SEC matter behind us,” CBOE said in an e-mailed statement. “All actions either required or recommended by the SEC, as well as those resulting from our rigorous self-review, have been or are now being implemented.”

SEC Investigation

Gail Osten, a spokeswoman for the Chicago-based market operator, declined to comment beyond the statement. CBOE said in a filing in February that it expected to pay as much as $10 million to settle the SEC’s investigation.

OptionsXpress and its chief financial officer, Thomas E. Stern, helped a client conduct trades designed to fake compliance with laws prohibiting so-called naked short sales, where investors sell a stock they don’t possess in hope of profiting from declines, according to a June 7 ruling by Brenda P. Murray, the chief administrative judge for the SEC.

Murray found that OptionsXpress allowed the trades knowing the shares would never be delivered and that the practice was illegal. After the judgment, OptionsXpress lawyer Stephen Senderowitz maintained the firm did nothing wrong and said it was considering an appeal. The actions occurred prior to the firm’s purchase by Schwab.

During the investigation, the SEC found that employees of the CBOE didn’t know enough about the short-sale law to enforce it, according to the SEC statement. Not only did they fail to detect violations, they “took misguided and unprecedented steps” to assist the firm that was under investigation.

Adequate Training

Staff members didn’t have adequate training in securities law and CBOE never ensured that they had read the appropriate rules, the order said. It cited the exchange for failing to respond quickly enough to requests for information.

“The Chicago Board Options Exchange failed to fulfill its fundamental responsibilities as an SRO and exchange,” according to the SEC order. “CBOE’s failures were not mere oversights or technical violations, but a systemic breakdown in several of its regulatory and compliance responsibilities.”

The first monetary penalty secured by the SEC against an exchange was announced on Sept. 14, when NYSE Euronext agreed to pay $5 million to settle charges of compliance failures that gave certain customers a head start on trading information.

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