Class Calls Out Manipulation of Key Volatility Index

CHICAGO (CN) – Not waiting for regulators to finish their investigation, an investor brought a federal class action Tuesday that accuses the Chicago Board Options Exchange of allowing the so-called fear index to be manipulated for years, costing billions of dollars in losses.

The Financial Industry Regulatory Authority and Securities and Exchange Commission opened investigations into such allegations last month after a letter detailing widespread abuses was sent to the institutions by an anonymous whistleblower.

Claiming to have “held senior positions at some of the largest investment firms in the world,”  the whistleblower reported that a flaw in the calculation of the CBOE’s Volatility Index (VIX), Wall Street’s most widely followed gauge of future stock market volatility, allows trading firms to manipulate the volatility index by posting quotes for S&P 500 options without actually trading.

The whistleblower further claimed that such manipulation was at least partially responsible for the stock market’s 10 percent plunge in February.

While the agencies have made no announcement about their findings so far, investor Jeffrey Tomasulo took matters into his own hands Tuesday.

Represented by the firm Korein Tillery, Tomasula brought a federal class action against the CBOE Exchange, CBOE Global Markets, CBOE Futures Exchange, and unnamed financial institutions that carried out the index manipulation.

“Essentially, the John Doe defendants use their CBOE-granted privileged access to the S&P 500 options market and their high-frequency trading algorithms to manipulate the VIX Index calculation in concert, and, by doing so, generate massive profits for their much larger positions in VIX Futures and VIX Options,” the complaint states.

Tomasulo says manipulation of the index has caused billions in losses to average investors since 2009, and that CBOE actively colluded in the scheme.

“CBOE intentionally designed its products, operated its platforms, and formulated the method for calculating VIX in a manner that could be collusively manipulated in a single, narrow period of time with even low-premium trades by the John Doe defendants, and especially by the John Doe defendants who were given status as SPX Options market makers by CBOE,” the complaint states.

A representative for the CBOE meanwhile called Tomasulo’s without merit. “We vehemently deny the allegations in this complaint leveled against Cboe, which are without merit,” the representative said in a statement. “As this is ongoing litigation, we have no further comment at this time.”

Tomasulo says CBOE’s complicity is further shown by the fact that it continues to allow trading of the VIX index, despite having reason to suspect that big market players are abusing their privileged access for their own advantage.

CBOE allegedly profits from the scheme because the ability of the traders to manipulate the index has led to the proliferation of VIX-tied financial instruments, increasing CBOE’s revenues and transaction fees.

There are at least 18 active financial products that track VIX futures, with a combined market cap of $3.4 billion, according to the complaint.

Alleging violation of the Sherman Act and the Commodity Exchange Act, the class seeks and an injunction.

The class is represented by George Zelcs with Korein Tillery in Chicago.

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