CBOE 2013 versus BSE 1993

Earlier this week, the US SEC imposed a fine on the Chicago Board Options Exchange (CBO) for conduct reminiscent of what used to happen in the Bombay Stock Exchange (BSE) two decades ago. In the early 1990s, the BSE board was dominated by broker members, and allegations of favouritism, conflict of interest and neglect of regulatory duties were very common. At that time, many of us believed that these were the kinds of problems that the US SEC had solved way back in the late 1930s under Chairman Douglas. India might have been six decades behind the US, but it is widely accepted that security market reforms in the 1990s solved this problem in India, though this solution might have created a different set of problems.

The SEC order reveals problems at the CBOE which are very similar to those that the BSE used to have in the early 1990s:

• The SEC order concerns the CBOE’s treatment of a member firm whose CEO was a member of CBOE’s Board of Directors and sat on CBOE’s Audit Committee (para 30 and 60). Incidentally, if you glossed over these two sentences while reading the entire 32 page order, you would completely miss this crucial fact. The SEC clearly did not want to highlight this issue at all and does not mention it in its press release.
• “Not only did CBOE fail to adequately detect violations and investigate and discipline one of its members, CBOE also took misguided and unprecedented steps to assist that same member which was under investigation by the Commission’s Enforcement Division staff and failed to provide information to Commission staff when requested.” (para 22)
• The CBOE helped the member firm to respond to a notice from the SEC by providing it with a summary of its (CBOE’s) investigative file despite knowing that CBOE investigations, and information obtained from other regulators during those investigations, were to be kept confidential. The member firm asked CBOE to provide “review, modification and insight” into its response to the SEC notice and the CBOE edited the response and emailed the “redlined” edits to the member firm. (para 34-35)
• When informed that the CBOE Department of Member Firm Regulation planned to issue a notice to this member firm for operating a non-registered dealer, CBOE’s former President and Chief Operating Officer asked that the notice not be issued until after an upcoming meeting with the member firm’s CEO (para 60).
• “CBOE made several financial accommodations to certain members [including the above member], and not to others, that were not authorized by existing rules. ... The accommodations were made for business reasons and were authorized by senior CBOE business executives who lacked an understanding of CBOE’s legal obligations as a self-regulatory organization.” (para 65 and 66)
• “CBOE staff responsible for the Exchange’s Reg. SHO surveillance never received any formal training on Reg. SHO, were instructed to read the rules themselves, did not have a basic understanding of what a failure to deliver was, and were unaware of the relationship between failures to deliver and a clearing firm’s net short position at the Depository Trust and Clearing Corporation (‘DTCC’). ... In fact, the investigator primarily responsible for monitoring the Reg. SHO surveillance from the third quarter 2009 to the second quarter 2010 had never even read the rule in its entirety, but only briefly perused it.” (para 14)

In financially regulation, no problems are permanently solved – potential problems just remain dormant ready to resurface under more favourable conditions.

Posted at 2:29 pm IST on Sat, 15 Jun 2013         permanent link

Categories: exchanges, regulation

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