In Re: Chicago Board Options Exchange Volatility Index Manipulation Antitrust Litigation

UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF ILLINOIS

EASTERN DIVISION

IN RE: CHICAGO BOARD OPTIONS No. 18 CV 4171

EXCHANGE VOLATILITY INDEX

MANIPULATION ANTITRUST LITIGATION Judge Manish S. Shah

MEMORANDUM OPINION AND ORDER

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 (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 (2009) (quoting Bell Atl. Corp. v.

Twombly, 550 U.S. 544, 570 (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.” Anchor Bank, 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

1 Throughout the complaint plaintiffs refer to Cboe generally, without specifying which Cboe

entity acted.

2 Bracketed numbers refer to entries on the district court docket. Referenced page numbers

are taken from the CM/ECF header placed at the top of filings. Plaintiffs’ joint amended

complaint is [140].

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 Choe listed for trading. Jd. { 49. Only SPX Options with more than 23 days and

fewer than 37 days to expiration were used in the calculation. Jd. 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.

4] 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:

Application of the Two-Zero Bid Rule

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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. J 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 designated

three Lead Market Makers for both SPX Options and VIX Options. Id. ¶ 59. Cboe

kept the identities of these Lead Market Makers confidential. Id. ¶ 61. Lead Market

Makers (and Designated Primary Market Makers for weekly SPX Options) could

participate in the SOQ with both orders and non-binding quotes; all other market

participants could participate only through orders, which are binding offers. Id.

¶¶ 61–62. Certain market makers were given steep discounts for quoting out-of-the-

money SPX Options. Id. ¶ 60 n. 14. When there was no opening trade for SPX Options

during the settlement window for VIX Options and Futures, and thus no price to

incorporate, the opening price was the average of an SPX Option’s bid and ask price

determined at the open at 8:30 a.m. Id. ¶ 63. Cboe then executed the SPX Options

orders at market-clearing prices and removed remaining unexecuted orders. Id. The

auction clearing prices for SPX Options expiring in exactly 30 days were then used

as part of the calculations to settle VIX Options and VIX Futures expiring that

calculation day. Id. Shortly after Cboe created VIX Options, it also created a new set

of products which allowed investors to buy shares (ETFs) and notes (ETNs), the value

of which was directly linked to the value of the VIX or related products. Id. ¶ 64. They

traded on a national securities exchange like a security. Id.

Cboe long promoted VIX Options and Futures as effective investments. Id.

¶¶ 66, 68. Cboe’s website encouraged investors to use VIX Options and Futures to

“seek diversification, hedge or capitalize on volatility or efficiently generate income.”

Id. ¶¶ 66–67. It advertised the VIX as “a leading measure of market expectations of

near-term volatility” and stressed that the “addition of weekly expirations … offers

volatility exposures that more precisely track the performance of the VIX Index.” Id.

¶ 69. In 2007, Cboe launched a branding campaign to “communicat[e] to the world

that CBOE is a vital necessity in the options marketplace for which there is no

substitute.” Id. ¶ 71. In 2012, Cboe advertised that VIX Options provided investors

“targeted trading strategies around market news and events.” Id.

B. Vulnerability to manipulation

Some people have criticized the settlement process for the VIX Options and

Futures as being ripe for manipulation. Id. ¶ 74. Plaintiffs allege that the Doe

Defendants took advantage of this vulnerability and routinely manipulated the cash-

settlement values for VIX Options and Futures. Id. ¶ 73. Certain features of the

settlement process made it especially susceptible to manipulation. Id. ¶ 74. For

example, the settlement process depended on the value of thinly traded, illiquid

financial instruments—out-of-the-money SPX Options—which traded in far lower

volumes than VIX Options and Futures. Id. ¶ 76. This allowed Does to make a small

number of out-of-the-money SPX Options trades and have a disproportionate impact

on the settlement values of the VIX Options and Futures. Id. ¶ 77. Though it took

place in the morning, this strategy is similar to what’s commonly referred to as

“banging the close.” Id. The ability to manipulate the market was amplified by the

fact that manipulators only needed to move the market for a very short period to have

an effect. Id. ¶ 78. Cboe began publishing information at 7:30 a.m. and required all

strategy orders for SPX Options to be made within fifty minutes, meaning the

manipulators only needed to move the market shortly before 8:20 a.m. to have an

effect. Id. The infrequency of VIX settlements further exacerbated the problem. Id.

Had Cboe made the SOQ settlement window longer, during normal market hours, or

more frequent, it would have been more difficult for manipulators to affect the

market. Id.

Similarly, manipulators were able to exploit the two-zero bid rule by spreading

bids out across strike prices to ensure there were never two or more consecutive zero-

bid puts ahead of any strike prices the manipulators wanted the SOQ process to

include. Id. ¶ 82. Cboe’s formula further magnified the effect of the manipulation. Id.

¶¶ 84–87. In May 2017, two professors published a research paper, detailing patterns

that were consistent with manipulation. Id. ¶ 88.

C. Cboe’s Rules

As a board of trade, Cboe was required to establish rules to prevent abusive

trade practices. Id. ¶ 143. Cboe’s Rule 8.7 required market makers to “contribute to

the maintenance of a fair and orderly market” and not “enter into transactions or

make bids or offers that are inconsistent with such a course of dealings.” Id. ¶ 144.

Cboe also required that trading-permit holders not

effect or induce the purchase, sale or exercise of any security for the purpose of

creating or inducing a false, misleading, or artificial appearance of activity …

or for the purpose of unduly or improperly influencing the market price of such

security … or for the purpose of making a price which does not reflect the true

state of the market.

Id. Cboe’s Rule 601 further prohibited manipulation by providing,

[n]either a Trading Privilege Holder nor any of its Related Parties shall engage

or attempt to engage in any fraudulent act or engage or attempt to engage in

any scheme to defraud, deceive or trick, in connection with or related to any

trade on or other activity related to the Exchange or Clearing Corporation.

Id. And Rule 603 stated,

[a]ny manipulation of the market in any Contract is prohibited. Orders entered

into the CFE System for the purpose of generating unnecessary volatility or

creating a condition in which prices do not or will not reflect fair market values

are prohibited and any Trading Privilege Holder (including its respective

Related Parties) who makes or assists in entering any such Order with

knowledge of the purpose thereof or who, with such knowledge, in any way

assists in carrying out any plan or scheme for the entering of any such Order,

shall be deemed to have engaged in an act detrimental to the Exchange.

Id. These rules signaled to investors that the VIX was safe and show, plaintiffs allege,

that Cboe must have known about, or recklessly disregarded, the Doe Defendants’

manipulation.

III. Analysis

Cboe moves to dismiss all of plaintiffs’ claims against it. Cboe argues plaintiffs’

Securities Exchange Act claim is precluded, that Cboe’s status as a self-regulatory

organization entitles it to immunity, and that plaintiffs have otherwise failed to

allege the requisite elements of a claim, including loss causation and scienter. Cboe

argues plaintiffs’ Commodities Exchange Act claim fails because it is too general and

because plaintiffs have failed to plausibly allege actual damages and bad faith. For

similar reasons, Cboe asserts, plaintiffs have failed to plead a claim for secondary

Commodities Act liability. Finally, Cboe argues plaintiffs’ negligence claim is

preempted or otherwise inadequate.3

A. Standing

Plaintiffs have alleged Article III standing. To have standing, a plaintiff must

have (1) suffered an injury in fact that is concrete and particularized and actual or

3 Cboe also argues that the Does’ manipulation is insufficiently alleged, but I do not reach

that argument.

imminent, (2) fairly traceable to the challenged action of the defendant, and (3) likely

to be redressed by a favorable decision. Lujan v. Defenders of Wildlife, 504 U.S. 555,

560–61 (1992). Plaintiffs have alleged that Cboe and the Does manipulated the VIX,

causing plaintiffs—who purchased and sold VIX-related products—to lose money.

Damages would remedy that injury, and at this stage, this is enough. See RK Co. v.

See, 622 F.3d 846, 851 (7th Cir. 2010). Plaintiffs have standing to pursue their claims.

B. Securities Exchange Act

Plaintiffs allege Cboe Exchange, Inc. and Cboe Global4 manipulated the VIX

marketplace in violation of the Securities Exchange Act by designing a settlement

process that was susceptible to manipulation and by failing to prevent Doe

Defendants from taking advantage of those vulnerabilities. Section 10(b) of the

Securities Exchange Act forbids: (1) the “use or employ[ment] … of any …

manipulative or deceptive device,” (2) “in connection with the purchase or sale of any

security,” and (3) “in contravention of” SEC “rules and regulations.” 15 U.S.C. § 78j(b).

Rule 10b–5 makes it unlawful for any person to: (a) “employ any device, scheme, or

artifice to defraud,” and (c) “engage in any act … which operates or would operate as

a fraud or deceit upon any person, in connection with the purchase or sale of any

security.” 17 C.F.R. § 240.10b–5 (2004). To state a claim for market manipulation,

plaintiffs must allege (1) manipulative acts, (2) damage, (3) caused by reliance on an

4 Plaintiffs do not bring a Securities Exchange Act claim against Cboe Futures, see [192] at

28 n. 16, and do not allege Cboe Futures took any action “in connection with the purchase or

sale of any security.” See 15 U.S.C. § 78j(b). There is no aider and abettor liability under the

Securities Exchange Act. Central Bank of Denver, N.A. v. First Interstate Bank of Denver,

N.A., 511 U.S. 164 (1994).

assumption of an efficient market free of manipulation, (4) scienter, (5) in connection

with the purchase or sale of securities, (6) using the mail or any national securities

exchange facility. ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 101 (2d Cir.

2007).

1. Immunity

Self-regulatory organizations—such as Cboe Exchange, see 15 U.S.C.

§ 78c(a)(26)—and their officers are entitled to absolute immunity from private suits

“when they perform their statutorily delegated adjudicatory, regulatory, and

prosecutorial functions.” Weissman v. Nat’l Ass’n of Secs. Dealers, Inc., 500 F.3d 1293,

1296 (11th Cir. 2007). Absolute immunity allows public officials who are entrusted

with sensitive tasks to carry out their responsibilities without the concern of a future

damages suit. In re NYSE Specialists Securities Litigation, 503 F.3d 89, 95 (2d Cir.

2007). Because self-regulatory organizations perform “a variety of regulatory

functions that would, in other circumstances, be performed by a government agency,”

and for which the government would enjoy immunity, courts extended absolute

immunity to self-regulatory organizations when performing regulatory tasks.

Barbara v. N.Y. Stock Exch., Inc., 99 F.3d 49, 59 (2d Cir. 1996).

But exchanges are also private entities that engage in non-governmental

activities to serve their private business interests. Weissman, 500 F.3d at 1296 (citing

SEC Release No. 34–50700, Concept Release Concerning Self-Regulation, 69 Fed. Reg.

71,256, 71,261–262 (Dec. 8, 2004) (noting that self-regulatory organizations face

growing business pressure that “can create a strong conflict between [their]

regulatory and market operations functions”)). Because self-regulatory organizations

are only immune for performing delegated functions, courts must determine whether

immunity applies on a case-by-case basis. In re NYSE, 503 F.3d at 96. The doctrine

“is of a rare and exceptional character,” and the party seeking immunity bears the

burden of demonstrating it is warranted. Id. (quoting Barrett v. United States, 798

F.2d 565, 571 (2d Cir. 1986)). When deciding whether a self-regulatory organization

is entitled to immunity, courts apply a functional test, considering “the nature of the

function performed, not the identity of the actor who performed it.” See In re NYSE,

503 F.3d at 96 (quoting Forrester v. White, 484 U.S. 219, 229 (1988) (holding that a

state court judge did not have § 1983 immunity for his decision to demote and dismiss

a probation officer)). Neither motive, nor reasonableness, is considered. See In re

NYSE, 503 F.3d at 95–96.

As a self-regulatory organization, Cboe is immune from suit where the alleged

misconduct concerns instituting disciplinary proceedings, enforcing rules and

regulations and general oversight over members, interpreting securities laws and

regulations, and referring exchange members to the SEC or other government

agencies. See Standard Inv. Chartered, Inc. v. Nat’l Ass’n of Securities Dealers, Inc.,

637 F.3d 112, 116 (2d Cir. 2011). Because this conduct is immune, plaintiffs cannot

base their claim on Cboe’s failure to enforce rules prohibiting manipulation or

decisions not to discipline those who manipulated the market. Cboe argues that

plaintiffs’ claim inevitably stems from these regulatory actions. But at this stage, I

draw all inferences in plaintiffs’ favor and frame their claim—to the extent possible—

as one based on Cboe’s non-immune acts. When it designed the SOQ settlement

process, created and promoted the VIX-related products, and listed those products on

the exchange, Cboe acted in its private capacity. The SEC would not create, advertise,

or make available proprietary products if Cboe did not exist, so Cboe is not entitled

to immunity for doing so. See Opulent Fund v. NASDAQ Stock Mkt., Inc.¸ 2007 WL

3010573, at *5 (N.D. Cal. Oct. 12, 2007). Cboe did not create and administer the VIX-

related products because of any statutorily delegated duty. It sought to further its

private interests of attracting investors and increasing trading to generate fees. See

id. at *5 (holding Nasdaq was not immune from claims alleging it miscalculated the

Nasdaq-100 price because it chose to create that market and disseminate that

information); Weissman, 500 F.3d at 1299 (holding an exchange’s advertisements

promoting a certain stock are not entitled to immunity); In re Facebook, Inc. IPO

Securities and Derivative Litigation, 986 F.Supp.2d 428, 455–47 (S.D.N.Y. 2013)

(holding that an exchange is not immune for statements made touting its technology

and trading platforms because they did not relate to its delegated responsibilities).

And though the SEC approved some of Cboe’s actions, which shows that the

SEC acted in its capacity to regulate Cboe, it does not follow that Cboe’s conduct was

regulatory. Whether Cboe’s non-immune conduct gives rise to a Securities Act claim

is a separate question, but dismissal is not warranted solely on immunity grounds.

There may be a statute of repose defense to aspects of plaintiffs’ claim; for example,

the design of the VIX occurred more than five years before this lawsuit. See 28 U.S.C.

§ 1658(b). But plaintiffs allege ongoing conduct, some of which continued well past

the deadline. Plaintiffs “need not anticipate and attempt to plead around defenses.”

United States v. N. Trust Co., 372 F.3d 886, 888 (7th Cir. 2004). Because it is not clear

from the complaint that plaintiffs’ claim is barred by the statute of repose, dismissal

at this stage based on the statute of repose is unwarranted.

2. Preclusion

Cboe argues that the Securities Exchange Act precludes plaintiffs’ claim

because the SEC approved many aspects of the VIX enterprise, including the opening

auction procedures, the listing of VIX options, the SOQ settlement process and

accompanying rules, the shift from an order book official to an automated trading

platform, and the transition to weekly listings of VIX Options. See SEC Release No.

34-49798 (June 3, 2004); SEC Release No. 34-49563 (Apr. 14, 2004); SEC Release No.

34-49698 (May 13, 2004); SEC Release No. 34-52367 (Aug. 31, 2005); SEC Release

No. 34-55874 (June 7, 2007); and SEC Release No. 34-75501 (July 21, 2015).

Regulatory approval of an action does not automatically preclude a private right of

action; it depends on what Congress, when passing the relevant statute, intended.

See, e.g., S. Austin Coalition Cmty. Council v. SBC Commc’ns, Inc., 274 F.3d 1168,

1170 (7th Cir. 2001) (noting that Congress granted only certain regulators the

authority to immunize a merger from an antitrust lawsuit and concluding that

because the FCC and DOJ were not among those with that authority, their approval

did not foreclose plaintiff’s claims). In determining congressional intent as to

preclusion, traditional rules of statutory interpretation apply. POM Wonderful, LLC

v. Coca-Cola Co., 573 U.S. 102, 112 (2014).

In arguing that the SEC’s approval of its conduct precludes plaintiffs’ claims,

Cboe relies on antitrust cases, in which the Court has recognized that the SEC’s

approval of certain acts may preclude a plaintiff’s antitrust claim where there is a

“plain repugnancy between the antitrust and regulatory provisions.” Credit Suisse

Securities (USA) LLC v. Billing, 551 U.S. 264, 272 (2007). But it would be odd to apply

this preclusion principle within a single statutory scheme. Cboe points to no cases

where a court has found preclusion under similar circumstances, where one provision

precludes another from the same regulatory regime.5

Even assuming preclusion can be found under such circumstances, the two

provisions, as applicable here, are not clearly repugnant. Though it involved two

separate statutes, the Court’s reasoning in POM Wonderful is instructive. There, the

Court held that the Food, Drug, and Cosmetic Act does not preclude a private party

from bringing a Lanham Act claim challenging a food label as misleading. POM

Wonderful, 573 U.S. at 115. The Court reasoned, “[w]hen two statutes complement

each other, it would show disregard for the congressional design to hold that Congress

nonetheless intended one federal statute to preclude the operation of the other.” Id.

Though Congress intended for the SEC to oversee and approve an exchange’s

proposed rule changes, see 15 U.S.C. § 78s(b)(1), it also implied a private right of

5 In City of Providence, the Second Circuit did not reach this issue, but noted, “when a plaintiff

challenges actions of [a self-regulatory organization] that are in accordance with rules

approved by the SEC, the challenge may be precluded because it would conflict with

‘Congress’s intent that the SEC, with its expertise in the operation of the securities markets,

make the rules regulating those markets.’” City of Providence, Rhode Island v. Bats Global

Mkts., Inc., 878 F.3d 36, 50 n. 5 (2d Cir. 2017) (quoting Lanier v. Bats Exch., Inc., 838 F.3d

139, 155 (2d Cir. 2016)). For the reasons discussed, in these circumstances, no such conflict

arises.

action, recognizing that manipulation may occur despite the rules designed to prevent

it and allowing private individuals who are harmed by manipulation to bring lawsuits

to recover their losses. Like the FDCA (which gives the government nearly exclusive

enforcement authority) and the Lanham Act (which relies on injured competitors to

file lawsuits), the private right of action and SEC oversight offer different

mechanisms to further same broad goal: preventing manipulation. Those two

different mechanisms complement each other, and so preclusion is not warranted.

Where, as here, plaintiffs allege that the exchange participated in the

manipulation, the SEC may not have foreseen that risk when approving the

exchange’s rules, and so allowing a private suit to go forward does not undermine the

agency’s decision. See POM Wonderful, 573 U.S. at 115 (“The FDA, however, does not

have the same perspective or expertise in assessing market dynamics that day-to-day

competitors possess.”). Allowing plaintiffs to pursue a manipulation claim against

Cboe—as they could against any other manipulator, despite the SEC’s determination

that the VIX enterprise contained adequate safeguards—does not frustrate

Congress’s intent that the SEC regulate these markets. It allows for the SEC to

establish procedures up front to prevent future manipulation and provides recourse

for individuals who are harmed when manipulation occurs despite the SEC-approved

safeguards.

3. Loss Causation

A private plaintiff bringing a claim for securities fraud must prove that the

defendant’s fraud caused an economic loss. 15 U.S.C. § 78u–4(b)(4). Allegations that

a plaintiff purchased a security at an inflated price, alone, are insufficient to state a

misrepresentation claim under the Act. Dura Pharm. v. Bruodo, 544 U.S. 336, 346–

47 (2005). Inflated prices do not harm buyers unless there is a subsequent price drop,

so trading at an inflated price does not necessarily result in a loss. Id. at 342–46.

Plaintiffs bring a manipulation, not misrepresentation, claim. But the same

principle applies, and they must identify both sides of a transaction to show that they

suffered a loss. Given the nature of a manipulation claim, plaintiffs are less likely to

have access to certain facts necessary to plausibly state a claim, leading some courts

to relax pleadings standards. See ATSI, 493 F.3d at 102 (“A claim of manipulation,

however, can involve facts solely within the defendant’s knowledge; therefore, at the

early stages of litigation, the plaintiff need not plead manipulation to the same degree

of specificity as a plain misrepresentation claim.”); Sharette v. Credit Suisse Intern.,

127 F.Supp.3d 60, 78 & 103 (S.D.N.Y. 2015). But plaintiffs have access to information

about their own trades. They should be able to identify transactions where they lost

money, and so in this context, relaxing the pleading standard is not necessary.

And though plaintiffs allege ongoing manipulation, they do not assert that the

manipulation caused constant inflation or suppression; rather, they allege the

manipulation varied in direction depending on what was most advantageous to Does

at a given time. So even if the manipulation was constant, based on the timing of a

given plaintiff’s trades, she may not have suffered a loss. 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. The named plaintiffs’ declarations list, for each of their transactions:

the security, whether they bought or sold, the date, the quantity, and the price. See

[141]–[149], [168]–[169]. But they do not identify specific transactions that resulted

in a loss from the manipulation, and so, they have not plausibly alleged loss

causation. And to the extent any plaintiff class members did not hold their options

through settlement, their loss is even less directly linked to the SOQ manipulation,

and plaintiffs have not alleged loss causation as required to state a claim.

4. Reliance

Cboe argues plaintiffs failed to allege reliance (also known as transaction

causation). The Supreme Court has established a rebuttable presumption of reliance

in two situations. The first, established in Affiliated Ute Citizens of Utah v. United

States, 406 U.S. 128 (1972), provides that “if there is an omission of a material fact

by one with a duty to disclose, the investor to whom the duty was owed need not

provide specific proof of reliance.” Stoneridge Inv. Ptnrs., LLC v. Scientific-Atlanta,

Inc., 552 U.S. 148, 159 (2008). The second, the fraud-on-the-market doctrine, applies

to statements that become public. Id. Because public information is reflected in the

price of a security, one can assume that the investor who bought or sold at the market

price relied on the statement. Id. The Court has never addressed whether either of

these presumptions applies to manipulation claims. See CP Stone Fort Holdings, LLC

v. Does, No. 16 C 4991, 2017 WL 1093166, at *5 (N.D. Ill. Mar. 22, 2017).

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. See Fezzani v. Bear, Stearns & Co. Inc., 716 F.3d 18, 21 n. 2 (2d Cir.

2013) (“There may thus be some merit to a modified presumption of reliance in

market manipulation cases because reliance by investors on a misrepresentation of a

price as being set by an active, arms-length market may be presumed.”); ATSI, 493

F.3d at 101 (listing “reliance on an assumption of an efficient market free of

manipulation” as an element of a market-manipulation claim); Ploss v. Kraft Foods

Group., Inc., 197 F.Supp.3d 1037, 1059 n. 11 (N.D. Ill. 2016) (noting that “reliance on

a direct misrepresentation is not necessary. … [T]hat the market relies on the

transactions to signal true, rather than manipulative demand—is all that is

necessary” to plead reliance for a Commodities Exchange Act claim). Applying this

presumption, plaintiffs have alleged reliance.

5. Scienter

The Private Securities Litigation Reform Act requires that a plaintiff plead

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). This requires that the

inference of scienter be “more than merely plausible or reasonable—it must be cogent

and at least as compelling as any opposing inference of nonfraudulent intent.”

Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 314 (2007) (“Tellabs I”).

The critical question, then, is whether it is more likely that Cboe either intended to

deceive, manipulate, or defraud investors when it designed the VIX-related products,

promoted them, and listed them on its exchange (its non-immune conduct), or

whether Cboe was merely careless in failing to respond appropriately. See Pension

Trust Fund for Operating Engineers v. Kohl’s Corp., 895 F.3d 933, 939 (7th Cir. 2018).

Cboe first argues plaintiffs have failed to identify who, within Cboe, acted with

the requisite intent. Though it is not enough to refer “generally to the collective

knowledge” of a corporation’s employees, “it is possible to draw a strong inference of

corporate scienter without being able to name the individuals who concocted and

disseminated the fraud.” Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702,

708–10 (7th Cir. 2008) (“Tellabs II”). Plaintiffs allege that the VIX was uniquely

important to Cboe’s success. Assuming manipulation was constantly occurring in

Cboe’s most lucrative market, as plaintiffs allege, it can be inferred that someone in

Cboe’s management knew about the manipulation and authorized the continued

offering and advertising of the VIX. This is more than a general reference to Cboe’s

collective knowledge.

A plaintiff can plead a strong inference of scienter by alleging facts showing

either: (1) a motive and opportunity to commit fraud or (2) strong circumstantial

evidence of conscious misbehavior or recklessness. ATSI, 493 F.3d at 99. Recklessness

is “an extreme departure from the standards of ordinary care … to the extent the

danger was either known to the defendant or so obvious that the defendant must have

been aware of it.” Tellabs II, 513 F.3d at 710 (quoting In re Scholastic Corp. Secs.

Litigation, 525 F.3d 63, 76 (2d Cir. 2007)).

Cboe does not dispute that it had the opportunity to commit the manipulation

alleged. To allege motive, a plaintiff must assert that the defendant “benefitted in

some concrete and personal way from the purported fraud.” Novak v. Kasaks, 216

F.3d 300, 307–08 (2d Cir. 2000). A generalized motive common to all corporate

executives, such as the motive to pretend nothing is wrong to avoid a loss, does not

create a strong inference of scienter. Kohl’s Corp., 895 F.3d at 939–40. Plaintiffs

acknowledge this principle but argue that the “extreme importance of the VIX

franchise to Cboe” went beyond a generalized profit motive. [192] at 36. I disagree.

Though the VIX franchise was especially lucrative to Cboe, 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. Compare Sharette, 127 F.Supp.3d

at 94–95 (noting defendants’ incentive to strengthen relationships with hedge funds,

whose business was much more lucrative than other investors, evidenced motive),

with Kohl’s Corp., 895 F.3d at 939–40 (concluding that executives’ motive to overlook

misclassifications on a balance sheet and pretend nothing was amiss was a motive

common to all executives and insufficient to raise a strong inference of scienter).6

Though the VIX franchise was an important source of profit for Cboe, the

manipulation itself was not. Plaintiffs have not alleged that Cboe benefitted in any

additional way by attracting the business of market makers. Instead, plaintiffs allege

generalized profit motivations, which are not enough to establish a strong inference

of scienter.

6 Plaintiffs also cite Anschutz Corp. v. Merrill Lynch & Co. Inc., 785 F.Supp.2d 799 (N.D. Cal.

2011). But there, the plaintiff alleged that the scheme not only allowed the defendant bank

to earn underwriting fees but also provided insurance against losses to its portfolio and could

not be explained by legitimate investment aims. Id. at 817.

As circumstantial evidence of Cboe’s scienter, plaintiffs assert that Cboe had

full access to relevant trading data and that it reviewed that data—as it was obligated

to do—for signs of manipulation. Because the VIX was so central to Cboe’s success,

and because even public data showed signs of manipulation, the most compelling

inference, plaintiffs assert, is that Cboe was aware that the VIX was being

manipulated. Plaintiffs also allege that the SEC has previously fined Cboe for

prioritizing its business interests over its regulatory interests by allowing short

selling to occur and argue this makes it more likely Cboe acted with scienter here.

[140] ¶¶ 161–64. Finally, plaintiffs argue that Cboe’s design of the SOQ calculation

process (including the use of out-of-the-money SPX Options, the two-zero bid rule,

and restricted access to anonymous participants), along with its removal of the Order

Book Official and granting of special privileges to select market participants, make it

in increasingly likely that Cboe knew about the manipulation.

Taking these allegations together and in the light most favorable to plaintiffs,

they are not enough to suggest that Cboe intended to manipulate the market. Though

Cboe may have designed a process with features that made it vulnerable to

manipulation, the facts alleged in 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. And showing that fraud

occurred does not support an inference that Cboe must have, therefore, intentionally

or recklessly created a market susceptible to manipulation. See Pugh v. Tribune Co.,

521 F.3d 686, 694 (7th Cir. 2008) (rejecting a similar “fraud by hindsight” theory of

scienter). Plaintiffs go one step further than the plaintiffs in Pugh and explain why

the design features of the VIX were, in fact, prone to manipulation. But this is still

insufficient to show that Cboe included those features to facilitate manipulation. A

more compelling inference is that Cboe (like the SEC, who approved nearly all aspects

of the design) thought it included adequate safeguards.

Cboe’s alleged knowledge of the Does’ manipulation does not combine with its

knowledge of vulnerabilities to strongly suggest an intent to defraud. Plaintiffs allege

two layers of manipulation, the Does’ manipulative trading and Cboe’s manipulative

market structure. Cboe must have scienter with respect to its conduct (aiding and

abetting the Does is not enough). While knowledge of a statement’s falsity may allow

an inference of scienter in a misrepresentation case, see, e.g., Tellabs II, 513 F.3d at

709–10, Cboe’s knowledge of the Doe Defendants’ manipulation is not enough to infer

that Cboe acted with the requisite intent for its conduct. Knowing that certain market

participants acted fraudulently through one course of conduct does not suggest that

the exchange intended to cheat through its behavior. Passive acquiescence is just as

strong an inference. As a result, plaintiffs have not adequately pled a strong inference

of Cboe’s scienter.

C. Commodities Exchange Act

The Commodities Exchange Act provides,

A registered entity that fails to enforce any bylaw, rule, regulation, or

resolution that it is required to enforce by section 7, 7a–1, 7a–2, 7b–3, or 24a

of this title, … shall be liable for actual damages sustained by a person who

engaged in any transaction on or subject to the rules of such registered entity

to the extent of such person’s actual losses that resulted from such transaction

and were caused by such failure to enforce or enforcement of such bylaws,

rules, regulations, or resolutions.

7 U.S.C. § 25(b)(1)(A). Section 7(d) outlines core principles for contract markets,

including that the “board of trade shall have the capacity and responsibility to

prevent manipulation … through market surveillance, compliance, and enforcement

practices and procedures.” 7 U.S.C. § 7(d)(4).7

1. Specificity

Cboe first argues that plaintiffs do not identify any particular failure to enforce

a particular rule, instead making “a broadside attack on Cboe’s disciplinary program,

alleging Cboe should have enforced ‘a number of particular rules’ against unspecified

violators, causing hypothetical deterrence effects on other unspecified violators.”

[203] at 26. Though plaintiffs allege that Cboe repeatedly violated rules it was

required to enforce, its allegations are not so general that they fail to state a claim.

Plaintiffs list Rules 601 and 603, both of which are applicable to Cboe Futures and

prohibit market manipulation. Plaintiffs further assert that by allowing

manipulation to take place, Cboe failed to enforce those rules. Cboe argues plaintiffs’

allegations are more general than any previously successful 22(b) claim. This

matters, Cboe argues, because without alleging a specific rule violation, it is

impossible to assess whether the circumstances warranted enforcement, whether

7 Cboe points out that there is no direct private right of action under 7 U.S.C. § 7 (also referred

to as Section 5). But plaintiffs bring a claim under 7 U.S.C. § 25(b) (also referred to as Section

22), which does provide a private right of action. Section 25(b) references § 7, and plaintiffs’

allegations regarding the core principles in § 7, therefore, are relevant to their § 25(b) claim.

enforcement would have made any difference, and if lack of enforcement was done in

bad faith. But I read plaintiffs’ complaint as alleging that each time a Doe Defendant

manipulated the VIX Futures, Cboe failed to enforce its rules prohibiting

manipulation. This is sufficiently concrete to assess whether Cboe’s conduct

otherwise rises to the level of a Commodities Exchange Act violation.

2. Bad Faith

A plaintiff bringing a Commodities Exchange Act claim “must establish that

the registered entity … acted in bad faith in failing to take action or in taking such

action as was taken.” 7 U.S.C. § 25(b)(4). Whether plaintiffs have adequately pled bad

faith depends in part on whether Cboe, in causing plaintiffs’ injury, was exercising a

discretionary power. If an exchange injures a trader through exercise of a

discretionary power—such as instituting an emergency resolution or interpreting its

own rules—then the plaintiff must plausibly allege that the exchange acted

unreasonably or that it had an improper motivation. Bosco v. Serhant, 836 F.2d 271,

278 (7th Cir. 1987) (“Discretion implies latitude for judgment, and commodity

exchanges must not be deterred from exercising judgment by the prospect of heavy

liability if they make a mistake.”). If “an exchange’s regulation imposes a duty that

the exchange should know is being flouted, the exchange is acting wrongfully—in an

attenuated sense, perhaps, but one sufficient” under the law. Id. (holding a

reasonable juror could conclude the exchange acted in bad faith where a trader

violated the exchange’s own rules requiring that orders be made in writing and

indicate the customer’s designation).

Plaintiffs allege that Cboe acted in bad faith in failing to enforce Commodities

Exchange Act regulations and its own rules prohibiting manipulation. Cboe argues

that enforcing these rules and regulations was discretionary and that plaintiffs have

failed to allege that it acted unreasonably or pursuant to an improper motivation.

The regulations provide that Cboe “shall list on the contract market only contracts

that are not readily susceptible to manipulation” and that it “shall have the capacity

and responsibility to prevent manipulation, price distortion, and disruptions of the

delivery or cash-settlement process through market surveillance, compliance, and

enforcement.” 7 U.S.C. § 7(d)(3), (4). In arguing that preventing manipulation is

discretionary, Cboe points out that “[u]nless otherwise determined by the

Commission by rule or regulation,” it has “reasonable discretion in establishing the

manner in which it complies” with these principles. 7 U.S.C. § 7(d)(1)(B).

Even assuming enforcing the regulations constitutes a discretionary function,

plaintiffs have plausibly alleged that Cboe also failed to enforce its own rules

prohibiting manipulation, including Rules 601 and 603, and that those rules are not

discretionary. While an exchange has discretion to interpret its own rules, where a

market participant violates a rule—and the exchange knows (or should know) about

the violation—the failure to enforce suggests wrongfulness. Bosco, 836 F.2d at 278.

Cboe points to nothing in the text of Rules 601 or 603, or elsewhere, showing that

their enforcement is discretionary, and plaintiffs have adequately alleged that Cboe

acted in bad faith in failing to enforce them.

3. Actual Damages

To bring a claim under the Commodities Exchange Act, a plaintiff must have

suffered “actual damages” from the defendant’s manipulation. 7 U.S.C. § 25(b)(1). For

the same reasons that plaintiffs have not pled loss causation, they have not alleged

they suffered actual damages as the Commodities Exchange Act requires. Without

identifying both sides of a transaction, plaintiffs have not shown they lost money and

have not plausibly alleged they suffered actual damages. Because plaintiffs do not

assert that the market was constantly suppressed or inflated, their general

allegations that they must have been harmed at some point are insufficient to state

a claim. See In re LIBOR-Based Financial Instruments Antitrust Litigation, 962

F.Supp.2d 606, 620 (S.D.N.Y. 2013).

4. Secondary Liability

In addition to Cboe Futures’ primary liability, plaintiffs allege Cboe Global and

Cboe Options aided and abetted Cboe Futures and Does in violating the Commodities

Exchange Act. The act provides that any person “who willfully aids, abets, counsels,

commands, induces, or procures the commission of, a violation of any of the provisions

of this chapter, or any of the rules, regulations, or orders issued pursuant to this

chapter … may be held responsible for such violation as a principal.” 7 U.S.C. § 13c(a).

To state a claim for aiding and abetting liability under the Commodity Exchange Act,

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. Damato v. Hermanson, 153 F.3d 464,

473 (7th Cir. 1998).

Plaintiffs argue that because Cboe Global and Cboe Options knowingly

benefitted from the ongoing manipulation, it does not matter whether they wanted

Does to manipulate its market. Plaintiffs’ reliance on Kohen v. Pacific Inv. Mgmt. Co.,

244 F.R.D. 469 (N.D. Ill. 2007), for this proposition is misplaced. There, the court

merely inferred from the totality of the circumstances—including allegations that the

defendant fund had accumulated unprecedented positions at suspicious times,

combined with the fund’s awareness that it had the ability to influence prices—that

the fund had intended to manipulate prices. Id. at 482–84. Plaintiffs do not similarly

allege anything suspicious about Cboe Global’s or Cboe Option’s actions. To state a

claim for aiding and abetting liability, plaintiffs were required to allege that

defendants intended to further the primary violations, and they have failed to do so.

Plaintiffs also bring a principal-agent liability claim against all defendants.

See 7 U.S.C. § 2. (“The act, omission, or failure of any official, agent, or other person

acting for any individual, association, partnership, corporation, or trust within the

scope of his employment or office shall be deemed the act, omission, or failure of such

individual, association, partnership, corporation, or trust, as well as of such official,

agent, or other person.”). To the extent plaintiffs allege that Cboe Global and Cboe

Exchange are liable as agents of Cboe Futures—because defendants are related

corporations who should be able to sort out their own involvement—plaintiffs need

not specify, at this stage, which defendant was responsible for which acts. See Jepson,

Inc. v. Makita Corp., 34 F.3d 1321, 1328–29 (7th Cir. 1994). But the claim against

Cboe Global and Cboe Exchange as agents fails for the same reasons as the

underlying claim against Cboe Futures. To the extent this claim alleges that the Cboe

entities are liable for the acts of their employees, it too fails for the same reasons as

the underlying claim. Plaintiffs have failed to allege secondary liability claims.

D. Negligence

Plaintiffs bring an ordinary negligence claim against Cboe, alleging Cboe owed

them a duty of reasonable care in designing, testing, and promoting the VIX

calculation process, the SOQ settlement process, VIX Futures, VIX Options, and SPX

Options. [140] ¶¶ 241–42. Plaintiffs withdraw their negligence claims with respect to

VIX and SPX Options,8 leaving only their claim based on VIX Futures.

Cboe argues the Commodities Exchange Act preempts plaintiffs’ negligence

claim. “A federal law may preempt a state law expressly, impliedly through the

doctrine of conflict preemption, or through the doctrine of field (also known as

complete) preemption.” Boomer v. AT&T Corp., 309 F.3d 404, 417 (7th Cir. 2002).

“Congress did not intend to preempt the field of futures trading,” nor did it expressly

preempt state-law claims. Am. Agric. Movement, Inc. v. Bd. of Trade of City of Chi.,

977 F.2d 1147, 1155 (7th Cir. 1992). But the Commodities Exchange Act preempts

conflicting state-law claims, which includes those that bear upon the actual operation

8 Cboe argues that SLUSA warrants dismissal of the entire complaint, not just plaintiffs’

Securities Act claims. See Goldberg v. Bank of America, N.A., 846 F.3d 913, 919–920 (7th Cir.

2017) (Flaum, J., concurring). Because dismissal is warranted for the other reasons

discussed, I do not address this argument.

of commodity futures markets. Id. at 1156. In other words, “[w]hen application of

state law would directly affect trading on or the operation of a futures market,” it is

preempted; when “the application of state law would affect only the relationship

between brokers and investors or other individuals involved in the market,

preemption is not mandated.” Id. at 1156–57.

In American Agriculture Movement, the court held that the Commodities

Exchange Act preempted the plaintiff’s state-law breach of fiduciary duty and

negligence claims against the Chicago Board of Trade for implementing an emergency

resolution. Id. at 1157. It reasoned that allowing plaintiff to bring its state-law claims

would frustrate Congress’s intent to bring the markets under a uniform set of

regulations. At the same time, the court acknowledged that different states impose

dissimilar fiduciary duties upon brokers, which may affect private relationships. But

because subjecting private relationships to varying standards would not hamper the

efficient operation of the futures market, the act would not preempt those claims.

Cboe argues that plaintiffs’ negligence claim would clearly affect trading on or

operation of a futures market. In response, plaintiffs argue that the preemption

inquiry mirrors the immunity analysis, and because Cboe was not acting as a

regulator, there is no preemption. See In re Facebook, 986 F.Supp.2d at 454 n. 15

(noting “preemption precludes allowing state law claims that arise from actions taken

by Defendants in their regulatory capacity as agents of the government or even

actions ‘incident to the exercise of regulatory power’” (quoting NYSE Specialists, 503

F.3d at 98)). But the two inquiries are not one in the same. Compare City of

Providence, 878 F.3d 36 (holding an exchange is not immune for providing co-location

services, proprietary data feeds, and complex order types), with Lanter, 838 F.3d 139

(holding the Securities Exchange Act preempts a breach-of-contract claim where the

SEC has approved the use co-location services, proprietary data feeds, and complex

order types). Because the SEC approved much of the design process that forms the

basis for plaintiffs’ negligence claim, subjecting Cboe to conflicting state negligence

regimes, even though that conduct is non-regulatory, would run counter to

congressional intent that markets be subject to uniform standards. Subjecting Cboe

to varying standards would hamper the efficient operation of the futures market, and

so the Commodities Exchange Act preempts plaintiffs’ negligence claims. Because

plaintiffs’ negligence claim is preempted, I do not reach Cbhoe’s alternative arguments

that plaintiffs failed to state a claim and that recovery is barred by the economic loss

doctrine.

IV. Conclusion

Defendants’ motion to dismiss [184] is granted. Plaintiffs’ negligence claim is

dismissed with prejudice, but the other claims are dismissed without prejudice and

with leave to file an amended complaint. Any amended complaint must be filed by

June 19, 2019, and a status hearing is set for June 14, 2019 at 9:45 a.m.

ENTER:

LAS AL.

Manish 8. Shah

United States District Judge

Date: May 29, 2019

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