In re Chi. Bd. Options Exch. Volatility Index Manipulation Antitrust Litig., No. 18 CV 4171

• Court: United States District Courts. 7th Circuit. United States District Court (Northern District of Illinois)
• Writing for the Court: Manish S. Shah, United States District Judge
• Citation: 435 F.Supp.3d 845
• Docket Number: No. 18 CV 4171
• Decision Date: 27 January 2020
• Parties: IN RE: CHICAGO BOARD OPTIONS EXCHANGE VOLATILITY INDEX MANIPULATION ANTITRUST LITIGATION

435 F.Supp.3d 845

IN RE: CHICAGO BOARD OPTIONS EXCHANGE VOLATILITY INDEX MANIPULATION ANTITRUST LITIGATION

No. 18 CV 4171

United States District Court, N.D. Illinois, Eastern Division.

Signed January 27, 2020

435 F.Supp.3d 853

MEMORANDUM OPINION AND ORDER

Manish S. Shah, United States District Judge

Plaintiffs traded in options and futures contracts tied to the Chicago Board Options Exchange Volatility Index (VIX). VIX options and futures are cash-settled on designated dates. The price at which such an instrument settles is determined by a formula that Cboe designed. Plaintiffs allege that a group of anonymous traders used certain trading strategies to manipulate the process behind that formula, and, as a result, plaintiffs paid more or accepted less for their positions than they otherwise would have. They allege that Cboe knew that this manipulation was occurring, but allowed it to continue to increase profitability. Plaintiffs bring claims against Cboe and the unknown alleged manipulators (as Doe Defendants) under the Securities Exchange Act and Commodity Exchange Act. They also bring a negligence claim. Cboe moved to dismiss the complaint for failure to state a claim. I granted that motion and dismissed the complaint without prejudice as to all counts but the negligence count, which I dismissed with prejudice. Plaintiffs amended their complaint, and Cboe again moves to dismiss all counts against it. For the reasons discussed below, Cboe's motion is granted.

I. Legal Standards

To survive a motion to dismiss under Rule 12(b)(6), a complaint must state a claim upon which relief may be granted. Fed. R. Civ. P. 12(b)(6). The complaint must contain "sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’ " Ashcroft v. Iqbal , 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (quoting Bell Atlantic Corp. v. Twombly , 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007) ). In reviewing a motion to dismiss, a court must construe all factual allegations as true and draw all reasonable inferences in the plaintiff's favor. Doe v. Columbia Coll. Chi. , 933 F.3d 849, 854 (7th Cir. 2019) ; Sloan v. Am. Brain Tumor Ass'n , 901 F.3d 891, 893 (7th Cir. 2018).

When a plaintiff alleges fraud, heightened pleading requirements apply. The plaintiff "must state with particularity the circumstances constituting fraud or mistake." Fed. R. Civ. P. 9(b). A plaintiff must provide "precision and some measure of substantiation" to each fraud allegation. Menzies v. Seyfarth Shaw LLP , 943 F.3d 328, 338 (7th Cir. 2019) (quoting

435 F.Supp.3d 854

United States ex rel. Presser v. Acacia Mental Health Clinic, LLC , 836 F.3d 770, 776 (7th Cir. 2016) ). This requires describing the "who, what, when, where, and how" of the fraud. Id. (quoting Vanzant v. Hill's Pet Nutrition, Inc. , 934 F.3d 730, 738 (7th Cir. 2019) ). Ordinarily, "[m]alice, intent, knowledge, and other conditions of a person's mind may be alleged generally," Fed. R. Civ. P. 9(b). But securities-fraud complaints under the Private Securities Litigation Reform Act must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u–4(b)(2)(A) ; Cornielsen v. Infinium Capital Mgmt., LLC , 916 F.3d 589, 598–99 (7th Cir. 2019).

II. Background

A. Overview

Plaintiffs' claims involve options and futures contracts. An option contract gives the buyer the right, but not the obligation, to buy (a call option) or sell (a put option) a particular commodity or financial instrument at a predetermined price, generally known as the strike price, at a specific time, the expiry date. [271] ¶ 37.¹ A futures contract involves a promise to buy or sell a particular commodity or financial instrument at a predetermined price, also on the expiry date. [271] ¶ 42. VIX options and futures are cash-settled at expiration, meaning the holder of the derivative receives a cash payment (rather than a physical delivery of a stock or commodity). [271] ¶¶ 38, 42–43.

Whether the holder of an option contract exercises it depends on whether the option is "in the money" or "out of the money," compared to the prevailing market price of the option at the time of settlement (the at-the-money price). [271] ¶¶ 39, 41. If an option is in the money, the holder is entitled to a cash payment if she exercises the option. [271] ¶ 39. If an option is out of the money, the holder is not entitled to a cash payment. [271] ¶ 40.

Plaintiffs bring claims against three entities under the umbrella of the Chicago Board Options Exchange. Cboe Global Markets, Inc. (Cboe Global) was the holding company of Cboe Futures Exchange, LLC (Cboe Futures) and Chicago Board Options Exchange, Inc. (Cboe Options). [271] ¶¶ 28–30.

Cboe² owned the VIX, a published number that measured the expected volatility of the S&P 500 (SPX), a weighted index of 500 U.S. stocks. [271] ¶¶ 2, 44, 49. The number was higher when the market was expected to be more volatile in 30 days, and lower when the market was expected to be less volatile in 30 days. [271] ¶ 50. The VIX was sometimes known as Wall Street's "fear gauge." [271] ¶ 2.

Cboe calculated the VIX every 15 seconds throughout the trading day using the midpoint price of real-time SPX option contracts. [271] ¶¶ 50–51, 53. The calculation only used options that expired on Fridays and had more than 23 days and less than 37 days until expiration. [271] ¶¶ 51–52. To determine which SPX options went into the VIX, the calculation started from the strike price that was closest to the at-the-money value. [271] ¶ 53. It then moved in both directions (in and out of the money) until it reached two zero-bid strike prices in a row. [271] ¶¶ 53, 83. This was referred to as the "two-zero-bid rule." [271] ¶ 53.

435 F.Supp.3d 855

B. The New VIX Formula

Replication is the ability to accumulate a portfolio of the components of an index in the same proportion that each component is represented in the index. [271] ¶ 66. The ability to replicate is important for liquidity providers, because it allows them to offset risk. [271] ¶ 53. Until 2003, only four SPX options series were used to calculate the VIX. [271] ¶ 67. All of the SPX options series used were at, or very close to, at-the-money. [271] ¶ 67–68. These series were the most liquid, and thus the most expensive, making it difficult to replicate the VIX. [271] ¶ 68. Cboe wanted to monetize and profit from the VIX. [271] ¶ 69. To that end, it consulted key market participants, who told Cboe that it needed to make the VIX replicable. [271] ¶ 71. In 2003, Cboe improved the VIX's replicability by expanding the number of SPX options series used in the calculation, from four to up to 130. [271] ¶¶ 69–71.

C. VIX Options and Futures

Until 2004, the VIX was just a published figure; investors could not take a position in it or trade on what they expected it to be. [271] ¶¶ 2, 56. In 2004, Cboe created VIX futures, and in 2006, it created VIX options, products that allowed traders and investors to speculate on the volatility of the stock market. [271] ¶¶ 2, 56.³ Both VIX options and futures were cash-settled at expiration, which occurred every Wednesday. [271] ¶ 57.⁴

Cboe determined the settlement value of VIX options and futures by using a process known as the SOQ process. [271] ¶ 57. The settlement price was calculated before the market opened at 8:30 a.m. on expiration days. [271] ¶ 58. The SOQ used a similar formula to the VIX itself, and used the same expanded set of inputs used in the new VIX formula. [271] ¶¶ 57, 69–70. The SOQ formula relied heavily on thinly traded, illiquid, out-of-the-money SPX options that traded in lower volumes than VIX options and futures. [271] ¶¶ 5, 76.

The SOQ process differed from the VIX process in a number of ways: the VIX was calculated every 15 seconds during a trading day, while the settlement price was only calculated on the day that VIX options and futures expired; the VIX only used SPX options that expired within 23–37 days, while the SOQ process used SPX options that expired in exactly 30 days; and the VIX used the midpoint of bid and ask premiums of SPX options, while the settlement value used actual traded prices where possible. [271] ¶ 57 n.6.

D. Alleged Manipulation

Plaintiffs allege that Doe Defendants manipulated the SOQ settlement process in two ways: manipulating the two-zero-bid rule and employing a process analogous to "banging the close." [271] ¶¶ 77–78, 84, 120. Cboe began publishing information about SPX options at 7:30 a.m. on settlement days, and traders had to submit trades for relevant SPX options before 8:20 a.m. [271] ¶¶ 78–79. Traders could manipulate the market by trading certain SPX options (influential in the SOQ process) shortly before 8:20 a.m. on settlement days. [271] ¶¶ 77–79. Because SPX options trade in lower volumes than VIX futures and options, manipulators could move VIX-based settlement values by trading a small number of out-of-the money

435 F.Supp.3d 856

SPX options. [271] ¶¶...