In re Chi. Bd. Options Exch. Volatility Index Manipulation Antitrust Litig.

• Decision Date: 29 May 2019
• Docket Number: No. 18 CV 4171,18 CV 4171
• Citation: 390 F.Supp.3d 916
• Parties: IN RE: CHICAGO BOARD OPTIONS EXCHANGE VOLATILITY INDEX MANIPULATION ANTITRUST LITIGATION
• Court: U.S. District Court — Northern District of Illinois

390 F.Supp.3d 916

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 May 29, 2019

MEMORANDUM OPINION AND ORDER

Manish S. Shah, United States District Judge

The Chicago Board Options Exchange created the Volatility Index to measure stock market volatility. It also created VIX-related products, including futures and options, that allow investors to trade on their predictions of the market's volatility. Plaintiffs bought and sold VIX-related products on Cboe's exchanges and now argue that Cboe designed the VIX enterprise in a way that allowed anonymous traders to manipulate the market for their own benefit. Cboe knew about this manipulation of its most profitable venture, plaintiffs assert, and chose not to stop it, prioritizing its own profits over its duty to maintain a fair market. Plaintiffs allege that they lost money as a result and bring Securities Exchange Act and Commodities Exchange Act claims against Cboe, as well as a negligence claim. Plaintiffs bring similar claims against unknown Doe Defendants and allege that the Does violated the Sherman Act through their manipulative trading. Cboe moves to dismiss all claims plaintiffs bring against it, and for the reasons discussed below, the motion is granted.

I. Legal Standards

A complaint must describe the claim in sufficient factual detail to give the defendant fair notice of the claim and the grounds on which it rests. Dura Pharmaceuticals, Inc. v. Broudo , 544 U.S. 336, 346, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). It must also "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, 672, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (quoting Bell Atl. Corp. v. Twombly , 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007) ). When a plaintiff alleges fraud, heightened pleadings requirements apply, and the plaintiff "must state with particularity the circumstances constituting fraud or mistake." Fed. R. Civ. P. 9(b). This requires "describing the ‘who, what, when, where, and how’ of the fraud." AnchorBank, FSB v. Hofer , 649 F.3d 610, 615 (7th Cir. 2011) (quoting Pirelli Armstrong Tire Corp. Retiree Medical Benefits Trust v. Walgreen Co. , 631 F.3d 436, 441–42 (7th Cir. 2011) ). Ordinarily, "[m]alice, intent, knowledge, and other conditions of a person's mind may be alleged generally," Fed. R. Civ. P. 9(b), but the Private Securities Litigation Reform Act requires that securities-fraud complaints "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 (7th Cir. 2019).

II. Background

Plaintiffs are individuals and companies who bought or sold various products related to Cboe's¹ proprietary VIX, which measures market volatility. [140] ¶¶ 15–25.² They allege that Cboe designed the index with features that made it susceptible to manipulation, that the Doe Defendants exploited those features to consistently manipulate the market, that Cboe knew about it and chose not to act (in violation of its own internal rules), and that plaintiffs lost money as a result.

A. An Overview of the VIX

Defendant Cboe Global Markets, Inc. was a publicly traded holding company of, among other entities, defendants Cboe Futures Exchange, LLC and Cboe Exchange, Inc. Id. ¶ 26. The S&P 500 index, known as the SPX, was a weighted index of 500 U.S. stocks from different industries and widely regarded as the leading benchmark of the overall U.S. stock market. Id. ¶¶ 42–43. Cboe was the exclusive provider of options on the SPX, offering a range of SPX Options, including those with morning and afternoon settlements, weekly options, end-of-month options, and mini SPX options. Id. ¶¶ 43–44. An option contract gives the buyer the right—but not the obligation—either to buy (a call option) or sell (a put option) a commodity or financial instrument at some specified time, at an agreed price–the strike price. Id. ¶ 35. A contract that involves a promise to buy or sell at a certain price on a fixed date is a futures contract. Id. ¶ 40. Whether the owner of an option exercises it usually turns on whether the option is in the money or out of the money. Id. ¶ 37. An option is in the money if the owner would be entitled to payment if she chose to exercise it; an out-of-the-money option is one where the owner would not get a payment if exercised. Id. ¶¶ 37–38. A substantial portion of Cboe's trading volume and transaction fees came from SPX Options. Id. ¶ 44.

Cboe created its own index (called the VIX), to measure the expected volatility of the S&P 500. Id. ¶¶ 1–2. The VIX Index was meant to provide an instantaneous measure of how much the market thought the S&P 500 would fluctuate over 30 days. Id. ¶ 49. The VIX was determined by referencing the prices of SPX Options because the prevailing quotation levels of SPX Options indicated the market's expectations of future stock price volatility. Id. ¶ 48. Initially, the VIX was only a benchmark figure; there was no way for investors to take a position in it. Id. ¶ 54. But in 2004, Cboe created VIX Futures, and two years later it created VIX Options, to allow participants to make investments based on market volatility. Id . The VIX quickly became Cboe's most profitable venture, and today it is widely known as the U.S. stock market's "fear gauge." Id. ¶¶ 1, 54.

Because the VIX was a financial index, not a physical good, all VIX Options and Futures were cash-settled. Id. ¶ 5. When VIX Options or Futures expired, Cboe made a series of calculations to determine who owed whom money and how much. Id. Cboe calculated the VIX using only standard SPX Options (which expired on the third Friday of each month) and weekly SPX Options (which expired on all other Fridays) that Cboe listed for trading. Id. ¶ 49. Only SPX Options with more than 23 days and fewer than 37 days to expiration were used in the calculation. Id. Those options were then weighted to yield a constant, 30-day measure of expected volatility of the S&P 500 Index. Id.

The VIX was calculated every 15 seconds throughout the trading day and was based on bid and ask premiums at various strike prices for different SPX Options. Id. ¶ 51. To determine which SPX Options to use, the calculation process began with the strike price closest to the prevailing at-the-money value and moved in both out-of-the-money directions until it reached two zero-bid strike prices. Id. The two-zero bid rule ensured that the SPX put and call options used to determine the value of the VIX were drawn from those for which there had not been two or more zero bids in a row, as illustrated below:

                                                 included in VIX                                                    included in VIX
                  Put Strike     Bid Premium     Ask Premium      calculation?       Call Strike     Bid Premium    Ask Premium      calculation
                     1380             01             0.2               Yes              2100            0.05           0.15               Yes
                     1375             01             0.15              Yes              2120              0.           0.15               No
                     1370            0.05            0.35              Yes              2125            0.05           0.15               Yes
                     1365              0             0.35              No               2150              0             0.1               No
                     1360              0             0.35              No               2175              0            0.05               No
                     1355            0.05            0.35            Excluded           2200            0.05           0.05            Excluded
                                                                  following two                                                      following two
                                                                    zero bids                                                          zero bids
                     1350            0.05            0.15                               2225            0.05            0.1
                     1345              0             0.15                               2250              0            0.05
                

Id. ¶¶ 51–53. Before 2003, the VIX was calculated based on a small range of strike prices for puts and calls of options on the S&P 100, clustered around an at-the-money price. Id. ¶ 54 n. 12.

Investors could only exercise VIX Options at expiration, which since mid-2005 occurred every Wednesday (before 2005 expirations were monthly). Id. ¶ 55. VIX Futures were also cash-settled at expiry, through the same process—the SOQ process—as VIX Options. Id. That process was similar, but not identical, to the process used to calculate the VIX itself. Id. Cboe conducted the SOQ settlement process using a Hybrid Opening System, which found a single clearing price that maximized the number of contracts that could be traded within the SOQ price range. Id. ¶ 56. Before September 2007, Cboe employed an Order Book Official who worked with market makers through the SOQ process. Id. ¶ 57. As Cboe prepared to take itself public, it shifted toward automation and removed that position. Id. Cboe officials received warnings that this would expose the SOQ process to the risk that unreasonable orders that did not reflect prevailing market conditions would influence the calculation. Id.

A lot of control over the bidding and trading process for SPX Options was vested in Cboe-appointed Lead Market Makers. Id. ¶ 58. Cboe required Lead Market Makers to "provide continuous electronic quotes" in certain situations. Id. ¶ 58. All market makers could participate in the SOQ, but Lead Market Makers were obligated to enter opening quotes for SPX Options if no one else did. Id. ¶ 60. Cboe initially designated two Lead Market Makers for SPX Options, and by 2014 it...