CBOE Will Pay $6M Penalty Over SEC Charges Alleging Failure to Enforce Trading Rules

The Chicago Board Options Exchange, which is the largest options exchange in the United States, has consented to pay $6 million penalty to settle Securities and Exchange Commission charges accusing it of not fulfilling its obligation to enforce trading rules and failing to stop one firm member from engaging in abusive-short selling. The exchange is settling and taking corrective action but is not admitting to/denying wrongdoing.

While CBOE is an SRO (self-regulating organization), the SEC has wide oversight over trading. This is the first penalty that an exchange is paying for purported regulatory oversight failures. The Commission is also censuring the exchange, which means a tougher sanction could result if the alleged violation occurs again.

According to the regulator, in 2008, CBOE transferred the monitoring of member firms’ compliance via a rule for curbing abusive short-selling practices to a different department. This, contends the SEC, hurt the exchange’s ability to enforce the rule. (Short-selling involves a trader betting that a stock will drop in value. Short-sellers borrow the shares of a company, sell them, and then purchase them when the stock fails, giving them back to the lender while keeping the price difference. Unfortunately, too much short-selling focusing on weak companies can cause them to fail, inciting market volatility.)

The SEC’S securities settlement with CBOE was announced approximately a couple of weeks after the agency imposed a $10 million against Nasdaq, for the latter’s alleged computer failure and decisions that are being blamed for the botches that occurred when Facebook issued its public offering in 2012. That fine is the biggest one ever imposed against an exchange for “poor systems and decision makings,” which are said to have occurred prior to and during the Facebook IPO.

Confusion arose on May 18, 2012 because of errors in the computer programming of Nasdaq, which were compounded with the 496,000 orders that came in when trading began that day. Brokers contacted Nasdaq after Facebook began trading to say that they did not know how many shares they had bought. Within a little over a couple of hours, executives at Nasdaq determined that they did not execute tens of thousands of orders that were placed. (According to The New York Times, Knight Capital’s CEO even sent an email asking that there be a pause in trading so those involved could regroup and fully comprehend their exposure. Executives, at Nasdaq, however, disregarded the request and continued with trading, which only caused the confusion to grow.)

Last month, Nasdaq’s chief executive Robert Greirfield put out an open letter stating that the exchange had implemented new safeguards so that such problems would not happen again. Additionally, Nasdaq consented to pay $62 million to the brokers that suffered financial losses because of what happened during the Facebook IPO. UBS (UBS), however, claims it lost $356 million because of Nasdaq’s mistakes. The financial firm plans to pursue more money via arbitration.

NASDAQ to pay $10 million fine over Facebook IPO, New York Times, May 29, 2013

Chicago Board Options Exchange

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