Barry v. Cboe Global Mkts., Inc.

Barry v. Cboe Global Mkts., Inc.

Opinion

 [*621]  Easterbrook, Circuit Judge. This appeal requires us to determine whether Cboe (an initialism used by the Chicago Board Options Exchange and its affiliates) violated the Securities Exchange Act of 1934 or the Commodity Exchange Act by trading options and futures based on a number, called VIX, designed to estimate the near-term volatility in the Standard & Poors 500 Index of stocks.

Plaintiffs are traders who contend that unknown entities (the "Doe Defendants") bought or sold options on the Wednesdays that the VIX contracts settled, in order to affect the VIX and increase their profits at the expense of honest traders. The Doe Defendants have not been identified, leaving the plaintiffs (who we call the Traders)  [*622]  to proceed against Cboe (as we call all three defendants). The Traders' claim under the Securities Exchange Act is that Cboe knew that scoundrels could take advantage of the formula for determining VIX on the settlement dates. The Commodity Exchange Act claim is that Cboe failed to enforce [**3]  rules forbidding manipulation. The district court dismissed the Traders' initial complaint but allowed them to try again. 390 F. Supp. 3d 916 (N.D. Ill. 2019). Then it dismissed the Traders' amended complaint with prejudice. 435 F. Supp. 3d 845 (N.D. Ill. 2020). Claims against the Doe Defendants are technically open, but the district court entered a judgment under Fed. R. Civ. P. 54(b) wrapping up the litigation against Cboe.

VIX, which is short for Volatility Index, began life as a number computed by Cboe and posted every 15 seconds. The number rises when the Standard & Poors Index is expected to become more volatile in the coming 30 days and lower when it is expected to become less volatile. Initially the calculation rested on options prices in just four stocks. (Under the Black-Scholes option-pricing formula, anticipated volatility can be inferred from the behavior of options prices, if the market is competitive.)

In 2003 Cboe made VIX more reliable and replicable (or so it thought) by increasing the number of options in the formula from 4 to 130. The Traders say that this change enabled traders to buy or sell out-of-the-money options strategically and affect the VIX at slight cost to themselves. In 2004 Cboe created futures contracts based on the VIX, and in 2006 it created [**4]  options contracts. As the Traders see things, the creation of these derivative instruments made it possible for manipulators to make money by last-minute trades in thinly traded options among the large number that affect the index. The Traders say that this possibility has been realized and point to a study finding suspicious patterns of trades and price movements. John M. Griffin & Amin Shams, Manipulation in the VIX?, 31 Review of Financial Studies 1377 (2018). But the Traders do not say that Cboe knew in 2003, 2004, or 2006 that this would happen; nor do the Traders say that Cboe is bound to agree with the conclusions in the Griffin & Shams paper. Instead they say that Cboe should have known that including more options in the process of determining VIX increases the risk of manipulation and that, when unusual patterns developed, Cboe should have taken more rigorous enforcement actions. The Traders acknowledge that Cboe did take some enforcement actions, but they call them inadequate.

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