CBOE Holdings Inc. (CBOE) became the second exchange operator in a week to report contact from the U.S. Securities and Exchange Commission.
The owner of the country’s biggest options venue said regulators are investigating whether it is complying with the obligations of a self-regulatory organization. Bats Global Markets Inc. (BATS), another U.S. exchange operator, said Feb. 23 that the SEC asked for information about the development of types of orders customers use on its venues.
CBOE owns the Chicago Board Options Exchange, founded in 1973 as the first U.S. market for equity derivatives. As self- regulatory organizations, American exchanges are required to write rules for their markets, monitor trading and ensure that they and their customers aren’t breaking securities laws.
“SROs have the responsibility to devise their own rules and regulations,” James Overdahl, a vice president at NERA Economic Consulting and a former chief economist at the SEC and Commodity Futures Trading Commission, said in a phone interview. “The SEC comes in behind the SRO to make sure they’re enforcing those rules and regulations that are on their books.”
The disclosure was made in Chicago-based CBOE’s annual report from Feb. 28. John Nester, an SEC spokesman, declined to provide further information. Gail Osten, a spokeswoman for CBOE Holdings Inc., declined to comment.
“The SEC is investigating CBOE’s compliance with its obligations as a self-regulatory organization under the federal securities laws,” CBOE said in the filing. “The company is cooperating with the investigation, which is ongoing, and is conducting its own review of its compliance.”
CBOE’s statement could refer to anything from technology glitches to monitoring trading and overseeing its member firms, James Angel, a finance professor at Georgetown University’s business school in Washington, said in a phone interview. It could also relate to “dodgy” activity by a floor trader or how well the exchange monitors trading on its electronic platform, he said.
“It could mean almost anything,” Angel said. “Something at the CBOE has caught the SEC’s attention.”
Bats Global (BATS) in Lenexa, Kansas, said Feb. 23 that the SEC asked for information about the development of order types. The next day, Daniel Hawke, who runs the SEC enforcement division’s market-abuse unit, said the commission is examining equity trading practices that became dominant in the past decade amid a shift to automation.
The SEC faulted Direct Edge Holdings LLC and two electronic venues it operates for having weak controls that led to about $2.8 million in trading losses and a systems outage, the agency said in October. An untested change to a computer code caused Direct Edge’s two exchanges to execute more orders from three members than what they wanted, totaling about $773 million in unwanted transactions, the SEC said.
The SEC’s Office of Compliance Inspections and Examinations conducts “routine and special inspections” of self-regulatory organizations, the Government Accountability Office said in a November 2007 report. Most are examined every one to four years and larger ones more frequently, the report said. OCIE inspects the adequacy of the organizations’ surveillance, investigative and disciplinary programs and how well they comply with their own policies, GAO said.
If OCIE finds that an SRO hasn’t complied with its rules or federal securities laws, it may refer the matter to the SEC’s enforcement division, the GAO report said.
Exchanges used to have a bigger self-regulatory role. A decade ago NYSE and the National Association of Securities Dealers were the primary SROs overseeing trading and the activities of brokers. Changes to SEC rules that increased competition for the NYSE and Nasdaq Stock Market, which NASD formed in 1971, forced both companies to separate some of the regulatory functions from their marketplaces.
The Financial Industry Regulatory Authority was created in 2007 through the combination of NYSE Regulation and NASD. It oversees almost 4,500 brokers.
The shift toward outsourcing certain member oversight responsibilities was also driven by the conversion of member- owned organizations like NYSE Euronext to for-profit public companies. NYSE Euronext and Nasdaq OMX Group Inc., both based in New York, are publicly traded. Bats plans to have an initial offering.
“We are at the crossroads with respect to the status of self regulation,” SEC Commissioner Daniel Gallagher said at a conference in Washington on Jan. 12.
The SEC raised issues in a 2004 paper about whether the responsibilities of SROs should be altered. While that discussion needs updating after the “consolidations, demutualizations and IPOs of various SROs,” the regulatory topics remain the same, Gallagher said. He added that the SEC should “reconsider” the topics raised in 2004.
“The facts on the ground have changed and the SRO model in the U.S. is now nothing but a Hamburger Helper to stretch the SEC budget,” Angel said. “The SEC can never get enough money out of Congress to do its job. By deputizing the exchanges, they leverage their scarce resources.”
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