The VIX Is Fixed?! Judge Shah Says This Complaint Must Be Kicked.

After such a long blogging hiatus, I am back and bursting with a multitude of manipulation-related updates. To keep this post under ten pages, today’s target will be Judge Shah’s decision on the first motion to dismiss in In re: Chicago Board Options Exchange Volatility Index Manipulation Antitrust Litigation. And yes, I said the “first” motion to dismiss – the wheels of justice may turn slowly, but not quite so slowly as this blog has been. Luckily for our readers, this just means that there are fine grinds of not only an order, but an amended complaint and complete motion to dismiss briefing coming your way soon.

Since it has been such a long time since the last post in this series, reader might all benefit from a review of past installments, which cover 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; and briefing on a motion for expedited discovery.
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

And now that we (I) remember what this dispute was all about, time to take a deep dive into the order.


After a detailed overview of the VIX’s function and foundation, Judge Shah launched directly into a pithy review of the standing question. First, the court observed that, to adequately allege Article III standing, plaintiffs must demonstrate (1) that they “suffered an injury in fact that is concrete and particularized and actual or imminent”; (2) that the injury is “fairly traceable” to defendant’s actions; and (3) that the harm is “likely to be redressed by a favorable decision.” It was enough, the court decided, that Plaintiffs alleged Defendant’s manipulation of the VIX, that such manipulation caused them to lose money, and that damages would remedy that injury. Under these facts, “Plaintiffs have standing to pursue their claims.”

Securities Exchange Act

Plaintiffs brought claims against CBOE Exchange, Inc. and CBOE Global under the Securities Exchange Act and regulations, alleging that the CBOE entities manipulated the VIX marketplace by designing a settlement process that was susceptible to manipulation, and then by failing to prevent the yet-unidentified Doe Defendants from taking advantage of those vulnerabilities.
First, the court addressed Defendant’s argument that self-regulatory organizations like the CBOE Exchange are entitled to “absolute immunity” from private suits when they perform their statutorily delegated adjudicatory, regulatory, and prosecutorial functions. Observing that “exchanges are also private entities that engage in non-governmental activities to serve their private business interests,” and that immunity applies only when the self-regulated entity is “performing delegated functions,” the court noted that such immunity determinations must be make “on a case-by-case basis.”

The doctrine is one of “rare and exceptional character,” and one which places the party seeking immunity the burden of demonstrating it is warranted. Under these circumstances, Judge Shah found that the CBOE had not met their burden. Specifically, because CBOE was acting in its private when designing the SOQ settlement process, creating and promoting VIX-related products, and listing those products on the exchange, the court found that it could assume—drawing all inferences in plaintiff’s favor, as it must at the motion to dismiss level—that plaintiff’s claims were based on these non-immune acts, rather than on the CBOE’s regulatory actions.
The CBOE also argued that the Securities Exchange Act precluded plaintiff’s claims because the SEC approved many aspects of the VIX enterprise, including the settlement process. The court failed to find preclusion, however, stating that regulatory approval does not automatically preclude a private right of action unless “Congress, when passing the relevant statute, intended” such preclusion. Noting that the CBOE was unable to point to any cases where a court has found preclusion where, as here, one provision within a statutory regime could precludes another provision within the same system, the court goes on to observe that the two provisions applicable to this case “are not clearly repugnant.” The private right of action and SEC oversight are not in conflict with one another, but “offer different mechanisms to further the same broad goal: fighting manipulation.” For example, “the SEC may not have foreseen [the] risk when approving the exchange’s rules,” so a private suit would not undermine the agency’s decision to approve those rules. Because the two mechanisms are complementary, the court held that preclusion is not warranted.
Loss Causation
Up until now, you may have come away with the impression that this decision was pretty favourable for plaintiffs. Unfortunately, this is the section where the tables start to turn. The court sets the stage in this action with a simple observation that “a private plaintiff bringing a claim for securities fraud must prove that the defendant fraud caused an economic loss,” and goes on to explain that that allegations that a plaintiff purchased a security at an inflated price are insufficient for a misrepresentation claim unless a subsequent price drop results in an actual loss. Giving deference to the fact that Plaintiffs here bring a manipulation claim, not a misrepresentation claim, the court still holds that “the same principal applies,” and Plaintiffs “must identify both sides of the transaction to show that they suffered a loss.” Because Plaintiffs have access to their own trading data, the court reasons, they should be able to identify transactions in which they lost money—and therefore, no relaxation of the pleading standard is necessary. It is insufficient to list, as plaintiffs did, the securities bought or sold, and for what price; “[to] plead loss causation, plaintiffs must identify specific transactions where they lost money, either because they experienced a net loss or because they made less than they would have absent manipulation.” Without identifying specific transactions giving rise to loss, plaintiffs have not adequately plead loss causation.
The court begins this section of its order with a brief overview of the two instances under which a rebuttable presumption of reliance can be established. The first, Affiliate Ute, addresses a situation where there exists an omission of a material fact by one with a duty to disclose. The second, the “fraud on the market” doctrine, applies to public statements, and allows the court to assume that, because public information is reflected in the price of a security, an investor buying or selling at the market price implicitly relied on the statement. First observing that the court has never addressed whether either of these presumptions apply to manipulation claims, Judge Shah held that, “because the manipulation was communicated to the public, in the sense that it was incorporated into the pricing of the securities plaintiffs bought and sold, the principle behind the fraud-on-the-market presumption warrants a presumption of reliance here.” With this presumption taken into account, the Court found that plaintiffs have sufficiently alleged reliance.
The court dedicated several pages to the question of whether or not Plaintiffs have adequately plead scienter. The inference of scienter, the court explains, must be more that “merely plausible or reasonable,” but reach the standard of being “at least as compelling as any opposing inference of nonfraudulent intent.” The “critical question,” then is whether the CBOE intended to deceive or manipulate investors when it designed the VIC-related products, or if they were “merely careless” in failing to respond to manipulation.

The first question is whether or not Plaintiffs have adequately which individuals within the CBOE acted with the requisite intent, because, as Defendants argued, it is not enough to simply refer generally to an organization’s “collective knowledge.” Here, the court found that Plaintiff’s allegations—that the VIX was uniquely important to the CBOE’s success, and it can be inferred that, if near-constant manipulation was occurring in that market, some member of CBOE’s management was aware of the fact and continued market the products despite that—give rise to more than just a “general reference” to the CBOE’s collective knowledge.

A strong inference of scienter can be found where plaintiffs have alleged facts sufficient to show either (1) a motive and opportunity to commit fraud or (2) strong circumstantial evidence of conscious misbehavior or recklessness. The CBOE did not dispute the fact that it had the opportunity to manipulate as alleged, but argued that plaintiffs have failed to allege anything beyond a generalized profit motive for doing so. The court agreed: “CBOE did not enjoy any additional benefit from the manipulation itself. It merely earned the same trading fees it would have for any legitimate transaction.” However, given the court’s comment that “Plaintiffs have not alleged that CBOE benefited in any additional way by attracting the business of market markers,” I think we can all guess what additional facts might appear in Plaintiff’s amended complaint.

Looking at circumstantial evidence of scienter, Plaintiffs argued that the CBOE had full access to all relevant trade information, and that, as it was required to do, it reviewed that data for signs of manipulation. Because manipulation was evident even on the basis of public data, Plaintiffs argue that Defendant’s knowledge of manipulation is the most compelling inference. Even taken together with other similar circumstantial allegations, the court found that they were not sufficient to suggest that the CBOE intended to manipulate the market.

Commodities Exchange Act

Moving on to the Commodities Exchange Act, the Court first addresses Defendant’s argument that Plaintiffs have failed to identify any specific failure to enforce a particular rule. What Plaintiffs did allege was that, by allowing manipulation to take place, the CBOE failed to enforce Rules 601 and 603 of the regulations to the CEA. While Defendants argue that this allegation is more general that any previously successful claim, the Court read the complaint as “alleging that each time a Doe Defendant manipulated the VIX Futures, CBO failed to enforce its rules prohibiting manipulation.” This was, in the eyes of the court, sufficiently concrete.
Bad Faith
In bringing a claim under the Commodities Exchange Act, a plaintiff must establish that the registered entity acted in bad faith, either by their actions or by their failure to act. Whether or not Plaintiffs have adequately pled bad faith, the Court explained, would depend in part on whether CBOE was exercising a discretionary power when it caused the alleged injury. If it was exercising discretionary power, then Plaintiffs are required to plausibly allege that the CBOE acted unreasonably or had an improper motivation.

Plaintiff alleges that the CBOE acted in bad faith in their failure to enforce both the CEA regulations and their own rules prohibiting manipulation. Defendants argue that enforcing such rules is discretionary, and that Plaintiffs have failed to allege that it acted unreasonable or with an improper motive. In this case, Judge Shah sided with the Plaintiffs, observing that “even assuming enforcing the regulations constitutes a discretionary function, plaintiffs have plausible alleged that CBOE also failed to enforce its own rules prohibiting manipulation.” Because enforcement of the CBOE’s own rules are is not discretionary, Plaintiffs adequately allege that the CBOE’s failure demonstrated bad faith.
Actual Damages
The court, in a delightful display of brevity, took care of this factor in ten short lines. Relying on his earlier reasoning, Judge Shah stated again that, “without identifying both sides of a transaction, plaintiffs have not shown they lost money and have not plausibly allege they suffered actual damages.”
Secondary Liability
The argument on secondary liability concerns actions taken by CBOE Global and CBOE Options in aiding and abetting CBOE Futures and the Doe Defendants in violating the CEA. To adequately allege a claim for aiding and abetting liability in these circumstances, Plaintiffs must allege that CBOE Global and CBOE Options (1) knew of the principal’s intent to violate the act; (2) intended to further that violation; and (3) committed some act in furtherance of the principal’s objective.

Plaintiffs tried to argue that, because the two related entities knowingly benefitted from the manipulation, it does not matter whether or not they knew of the Does’ intention to manipulate the VIX. The Court was not interested in that position, stating plainly that “Plaintiffs were required to allege that defendants intended to further the primary violations, and they have failed to do so.”


And that brings us to Plaintiff’s state-law negligence claim, in which they allege that the CBOE owed them a duty of reasonable care in designing, testing, and promoting the VIX calculation process, the SOQ settlement process, and VIX Futures. The CBOE argues that the CEA preempts the negligence claim, because to enforce the negligence claim would bear upon the actual operation of commodities futures markets. Plaintiffs argue, in response, that the preemption inquiry mirrors the immunity analysis, and because CBOE was not acting as a regulator, the CEA does not preempt the claim.

Here, the court sides with Defendants: because the SEC approved of the design process that forms the basis of the negligence claim, that holding the CBOE subject to varied and conflicting state negligence regimes would run counter to the Congressional intent that markets be subject to uniform standards. Permitting state-law negligence claims to proceed would “hamper the efficient operation of the futures market,” and so such claims must be preempted.

And that, dear readers, brings me to the end of this long-awaited blog post. Stay tuned for a review of the [Corrected] Consolidated Amended Class Action Complaint, and feel free to debate in the comments exactly how many names a complaint needs to have.

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

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