The VIX Is Fixed?! Judge Shah Remains Unconvinced

It’s been more than a few months since the last post in this series, but that doesn’t mean that things have been quiet over in the Northern District of Illinois. To the contrary, this post is here to give you not, one, not two, but three key updates: the outcome of motion to dismiss 2.0; exactly what’s going on on the appeals front; and just who those Doe defendants might be.

And if you need a quick review of past events before we get started, you might want to take a look at our past posts on the Griffin & Shams paper on the manipulation of the Chicago Board Options Exchange’s (CBOE) Volatility Index (VIX); the consolidated class action complaint; defendant’s motion to dismiss, and plaintiff’s opposition papers; briefing on a motion for expedited discovery; and Judge Shah’s decision on the first motion to dismiss.
The VIX is Fixed?! A Preview of the Tricks
The VIX is Fixed?! A Complaint is Remixed
The VIX is Fixed?! Defendants Request this Suit be Nixed
The VIX is Fixed?! Plaintiffs Would Like Some Discovery Real Quick
The VIX is Fixed?! Plaintiffs Think Their Charges Should Stick
The VIX is Fixed?! Judge Shah Says This Complaint must be Kicked

Second Time Lucky for the CBOE

After dismissal of the consolidated class action in May 2019 (see the decision here, and our write-up here), Judge Shah gave Plaintiffs just three weeks to amend their pleading. After requesting a brief extension, Plaintiffs duly filed their consolidated amended class action complaint on July 19, 2019—and, subsequently, a corrected consolidated amended class action complaint on August 23, 2019 (that’s a mouthful, so for the rest of this post I’ll be using “Amended Complaint”). CBOE’s motion to dismiss followed shortly thereafter, on August 28, 2019, with opposition and reply papers being filed in October and November, respectively.

In dismissing the first complaint, Judge Shah found that, “though CBOE may have designed a process with features that made it vulnerable to manipulation, the facts alleged in the complaint do not support the conclusion that CBOE knew about these flaws at the time it designed the VIX enterprise or that it purposefully designed the market to facilitate manipulation.” That failure to demonstrate intent was fatal to the first complaint. The Amended Complaint attempted to address this gap by focusing on CBOE’s knowing design a flawed index and related products (i.e. the VIX Options and VIX Futures), and of methodologies which, Plaintiffs argued, the CBOE intended to cater to the “replication” needs of a privileged portion of its clientele, and which knew was riddled with flaws that “would invite manipulation.” Plaintiffs further expanded its prior allegations of CBOE’s knowledge of the exploitation of its system by the Doe Defendants, explaining that CBOE itself used certain data patterns to identify manipulation in other markets—and that the same patters were present in the VIX. To counter the court’s initial determination that showings of loss causation in the there first complaint (namely, that manipulation was rampant and that Plaintiffs traded in the relevant market at the artificial prices) was insufficient, Plaintiffs developed and set out models sufficient to show which settlement processes were manipulated, and in which direction, and applied the results to their own trade data; this allowed them to identify specific days on which their transactions were negatively—and artificially—impacted.

Unfortunately—or fortunately, from CBOE’s perspective—Plaintiffs’ amended allegations were still not enough to make their claims stick. In January, Judge Shah issued a decision dismissing all of Plaintiffs’ claims against CBOE, holding that Plaintiffs’ securities fraud claims failed to show and (a) intent on CBOE’s part, and (b) a direct link between Plaintiffs’ losses and CBOE’s actions. Specifically addressing the design process, the court held that “the mere existence of these features [i.e. short settlement windows, two-zero-bid system, etc.] is not enough to suggest that CBOE knew that they would lead to fraud.” As to the CBOE’s knowledge of manipulation by the Doe Defendants, the court simply held that none of the allegations regarding CBOE’s access to and review of its own data was sufficient to support an inference that CBOE knew about the Does’ manipulation of the settlement process—and indeed, that “the complexity of plaintiffs’ complaint establishes that the ongoing manipulation was not ‘so obvious’ that CBOE ‘must have been aware of it.’” As Judge Shah dismissed all counts with prejudice, this appears to be the end of the line for the investors claims against the CBOE–at least until the Seventh Circuit has had it’s say.

A Second Opinion, Please.

As might be expected, Plaintiffs have appealed the dismissal of their claims against CBOE. Notably, Plaintiffs’ notice of appeal—filed May 19, 2020—identifies not just the January 27, 2020 dismissal of Plaintiffs’ Amended Complaint, but also the court’s original order of dismissal, from May 2019, as subjects of the appeal.

The opening brief, filed on June 29, 2020, presents two questions for consideration by the Seventh Circuit: (1) whether the Amended Complaint sufficiently alleged both causation and actual damages under the Commodities Exchange Act, and (2) whether the Amended Complaint sufficiently alleged a strong inference of scienter and loss causation under Section 10(b) of the Securities Exchange Act. CBOE’s responsive filing is due July 29, 2020.

The Wheels of Discovery Grind Slowly

Amid the flurry of briefs and orders concerning the survival of the claims against CBOE, one might be forgiven for forgetting that the CBOE is not, in fact, the only defendant in this case. Both of Plaintiffs’ complaints leveled accusations at many unnamed—and, at that point, unknowable—“Doe” Defendants, all of whom were accused of taking advantage of the CBOE’ flawed design to engage in widespread price manipulation. The denial of Plaintiff’s motion for expedited discovery was the subject of an earlier post (see here), but it would appear that the investors are having a bit more luck on the discovery front in recent days.

On February 20, 2020, two of the plaintiffs (LJM Partners and Two Roads Shared Trust) jointly filed a motion seeking expedited discovery from the CBOE, and, on April 21, 2020, the court granted Plaintiffs leave to serve subpoenas (note that the individual complaints of LJM Partners and Two Roads Shared do not name CBOE as a plaintiff), but directed that the parties meet and confer regarding the scope of the information requests. After service of the subpoenas on April 23, the parties met and conferred as directed—but apparently without much success, as, on May 12, 2020, the parties filed a joint status report requesting the opportunity to brief their respective positions regarding the scope of the subpoenas. CBOE filed a motion to quash the subpoenas, arguing, as they did on the previous discovery motions, that the information sought went far beyond that necessary for the mere identification of the Doe parties, and was instead a poorly-veiled attempt to obtain information necessary to prove the merits of the case.

Judge Shah’s order, issued June 3, 2020, recognized that “some steps of the process overlap with some investigation of the merits,” but ultimately found that the purpose of the subpoena was to identify the Doe Defendants, and thus did not constitute impermissible merits discovery. The order did narrow the scope of the subpoena, limiting the required production to certain agreed-upon options and dates, and further permits delay of production until the terms of a confidentiality order have been entered.

And with that, I’ll wrap up this installment of The VIX is Fixed, with promises to return with updates real quick.

This post was written by Alexandra M.C. Douglas.

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