CBOE to pay US$6 million SEC penalty

According to the SEC, the exchange suffered “various systemic breakdowns” in its regulatory and compliance functions as an SRO, including a failure to enforce, or even fully comprehend, rules to prevent abusive short selling. Specifically, it says that the CBOE failed to adequately detect violations of the short selling rules; failed to investigate and discipline one of its members; and, also “took misguided and unprecedented steps” to assist that firm when it became the subject of an SEC investigation, including, that it failed to provide information to SEC staff when requested, and went so far as to assist the firm in drafting a submission to the SEC, some of which was “inaccurate and misleading”.

The regulator’s order notes that the “CBOE failed to adequately enforce [short selling rules] because its staff lacked a fundamental understanding of the rule.” It says that CBOE investigators responsible for surveillance never received any formal training, and that it never ensured that its investigators even read the rules.

Additionally, the SEC says that the CBOE had a number of other regulatory and compliance failures at various times between 2008 and 2012. It alleges that the exchange failed to adequately enforce its firm quote and priority rules for certain orders and trades, as well as the registration rules. It says it also provided unauthorized “customer accommodation” payments to some members and not others without applicable rules in place, resulting in unfair discrimination. And, that the CBOE and its affiliate, C2 Options Exchange, failed to file proposed rule changes with the SEC when certain trading functions on their exchanges were implemented.

The SEC reports that after began its investigation, the CBOE and C2 responded by engaging in voluntary remedial efforts, and that this was taken into account in negotiating the settlement. Among other things, it says that the CBOE reorganized its regulatory services division; hired a chief compliance officer and two deputy chief regulatory officers; updated its policies and procedures; increased the regulatory budget and hiring; implemented mandatory training; and, hired a third-party consultant to review its short selling rule enforcement program; among other things.

The CBOE issued a statement indicating, “In addition to working proactively with the SEC throughout its investigation, we voluntarily launched our own exhaustive, internal assessment of regulatory and compliance practices across our entire organization, assisted by third-party consultants and independent outside counsel. 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.”

The commission notes that, after considering these remedial efforts, it decided not to impose limitations upon the activities, functions or operations of the CBOE. It says that the financial penalty agreed to in this case 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.

“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 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.”