Market Makers Sue Major Options Exchanges for Tens of Millions


     CHICAGO (CN) – Citadel Securities and others sued the nation’s major options exchanges, including NYSE, NASDAQ and the Chicago Board Options Exchange, claiming they overcharged market makers millions of dollars in fees for seven years.
     A market maker is a company or person that quotes both buy and sell prices on a financial instrument or commodity held in inventory, to make a profit on the spread.
     Citadel Securities, Group One Trading, Ronin Capital, Susquehanna Securities, and Susquehanna Investment Group sued the Chicago Board Options Exchange, the International Securities Exchange, the NASDAQ OMX PHLX fka the Philadelphia Stock Exchange, the NYSE Arca fka Pacific Exchange, and NYSE the MKT fka NYSE Amex fka American Stock Exchange, in Cook County Court.
     The plaintiffs describe themselves as market makers for the defendants, providing liquidity to the securities market and filling customer orders in exchange for certain trading privileges.
     “This case presents a remarkable situation,” the complaint begins. “In this case, there is no dispute that the exchanges improperly charged fees to the market makers on millions of orders over an approximately seven-year period. Rather, the dispute arises from the exchanges’ assertion that they are entitled to mischarge their members without taking any responsibility for it and without any liability under the law. This court, therefore, is faced with the spectacle of exchanges admittedly charging their members improper fees for approximately seven years and claiming the unfettered right to do so without any consequences or responsibility of any kind.”
     From 2004 to 2011, the exchanges charged market makers fees on all public orders, ranging from $0.10 to $1.00 under its “payment for order flow” program (PFOF). But market-maker to market-maker orders, or orders submitted on behalf of a member’s broker-dealer clients, were not supposed to be subject to the fees, the complaint states.
     “By the fall of 2012, the exchanges were aware that, during the relevant time period, the exchanges had improperly charged the market maker PFOF fees on orders that were not subject to PFOF fees. Specifically, for approximately seven years, one of the exchanges’ prominent member firms had incorrectly marked orders submitted to the exchanges as originating from public customers when in fact those orders were market-maker to market-maker orders, broker-dealer orders or proprietary orders. The subject firm has paid the exchanges $6,388,253 in penalties as well as an unidentified amount of ‘transactions fees’ in connection with its mismarking of orders,” the complaint states.
     The firm that marked the orders incorrectly is not named in the complaint, but the penalty matches a fine that Goldman Sachs paid to the exchanges as part of a settlement last year, Reuters reported on Wednesday.
     The complaint states: “Belatedly, the exchanges now recognize that they were improperly charging PFOF fees on the market makers on the mismarked orders; however, the exchanges have not reimbursed any of the improperly charged PFOF fees to the market makers. In fact, after being approached by the market makers, the exchanges conferred and, acting in concert, refused to reimburse any of the improperly assessed fees to the market makers. The exchanges did not claim that any of the market makers did anything wrong or assert that the PFOF fees were compliant with the exchanges’ rules or fee schedules. Rather, the exchanges simply asserted that they have no responsibility, and cannot be held liable, for improperly overcharging fees, even if it is in violation of their own rules and their own publicly-noticed fee schedules. The exchanges even refused to identify the number of orders affected or the amount of fees wrongly charged.”
     During these 7 years, the Chicago Board of Options Exchange alone collected a total of $637.1 million in PFOF fees, the plaintiffs say.
     They claim the PFOF program also increased the flow of orders, thereby generating transaction fees, which for the Chicago Board of Options Exchange (CBOE) alone reached more than $1.7 billion.
     “According to the CBOE’s findings, the mismarking of orders was the result of two deficient order entry systems used by the Subject Firm during the relevant time period,” the complaint states.
     “The first system was implemented in 2004 and was designed to handle simple options orders. The CBOE found that this order entry system ‘did not include a market maker order origin code’ and ‘defaulted automatically to the customer origin code in the vent a user did not select an origin code.’
     “The second system was implemented in 2008 and was designed to handle complex options orders. The CBOE found that this order entry system ‘was programmed to code all orders with a C [customer] origin code.”
     The plaintiffs claim the exchanges have disavowed responsibility by citing a NYSE rule stating that the exchanges shall not be liable “for any loss, expense, damages or claims that arise out of the use or enjoyment of the facilities or services afforded by the exchange.”
     But “the exchanges’ reliance on these rules is baseless,” the complaint states.
     “The market makers’ financial harm did not arise out of the ‘use of’ or ‘enjoyment’ of the exchanges’ facilities or services. Rather, their financial harm is due to and caused by the exchanges’ assessment of improper fees charged in violation of the exchange’s own fee schedules and the exchanges’ refusal to reimburse those accounts.”
     They seek declaratory judgment holding the exchanges liable for the wrongly assessed fees and restitution of all PFOF fees.
     They are represented by Ellen Wheeler with Foley & Lardner.

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