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Judge Tosses Claims of Wall Street ‘Fear Index’ Manipulation

A federal judge dismissed investor class-action claims that the Chicago Board Options Exchange knowingly allowed Wall Street traders to manipulate a key measure of stock market volatility.

CHICAGO (CN) – A federal judge dismissed investor claims that the Chicago Board Options Exchange knowingly allowed Wall Street traders to manipulate a key measure of stock market volatility.

Pedestrians walk past the New York Stock Exchange, Tuesday, Nov. 20, 2018. Stocks are skidding Tuesday as weak results from retailers and mounting losses for big technology companies push the market back into the red for the year. (AP Photo/Mary Altaffer)

“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,” U.S. District Judge Manish Shah said in a 32-page opinion published Wednesday.

Last year, an anonymous whistleblower sent a letter to U.S. regulators claiming that large trading firms were manipulating the CBOE’s Volatility Index (VIX), Wall Street’s most widely followed gauge of future stock market volatility.

The letter said that a flaw in the calculation of the VIX allowed 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% plunge in February 2018.

The Financial Industry Regulatory Authority and Securities and Exchange Commission opened investigations based on the allegations, but the agencies have since made no announcement about their findings.

Taking matters into his own hands, lead plaintiff John Pels filed a federal class action against CBOE Global Markets, CBOE Exchange, CBOE Futures Exchange and unnamed John Doe trading firms.

“There is abundant evidence that the John Doe defendants have colluded to manipulate VIX and, in doing so, have reaped hundreds of millions (if not billions) of ill-gotten profits due to their holdings of derivatives linked to VIX,” the complaint stated. (Parentheses in original.)

Pels accused the CBOE of being aware of the manipulation while allegedly turning a blind eye because it is a major profit generator.

But Judge Shah dismissed the investors’ claims on Wednesday, finding that the evidence is not sufficient enough to show that CBOE intended to manipulate the market.

Even if the CBOE knew of the trading firms’ allegedly fraudulent 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,” Shah said. “Passive acquiescence is just as strong an inference.”

In September, the CBOE announced that it is testing the use of artificial intelligence software to enhance surveillance of the VIX settlement auctions and catch nefarious traders more quickly, but it did not offer any specifics about its plan.

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