4 U.S. Options Exchanges Settle Price-Fixing Case
Major U.S. options exchanges settled federal price-fixing charges Monday in the second price-collusion case brought against U.S. financial markets since the mid-1990s.
But with the options markets now competing head to head--a sudden industry shift that occurred a year ago--the penalty imposed in the settlement focuses mostly on beefing up industry self-regulation.
The government alleges that four options exchanges maintained an illegal pact for years under which they granted one another exclusive listing rights to options on most blue-chip stocks--stifling competition and inflating prices to investors.
The four targets of a nearly two-year probe--the American Stock Exchange, the Chicago Board Options Exchange, the Pacific Exchange and the Philadelphia Stock Exchange--rule a market where trading has exploded in recent years.
Monday’s dual actions by the Justice Department and the Securities and Exchange Commission represent the second time in the last four years that the federal government has accused major securities markets of what amounts to institutionalized price fixing.
As with the Nasdaq Stock Market’s massive price-fixing case in 1996, investigators said that the options exchanges’ agreement was enforced with threats, intimidation and harassment directed against those who wanted to challenge it.
The exchanges, whose self-regulatory units are supposed to crack down on such abuses, were lax in enforcement, failing to follow up on complaints, authorities said.
The Justice Department also accused the exchanges of acting jointly to restrain the growth of their collective computer capacity, thereby limiting the ability to list options on multiple markets.
“Put” and “call’ option contracts give an investor the right to buy or sell a certain number of shares of an underlying stock for a specific price by a set date. They have become an increasingly popular way to bet on the direction of stocks, industry sectors or broad markets.
The exchanges’ non-compete agreement lasted from at least late 1994 through August 1999, when it collapsed almost in a matter of hours after the CBOE and then the Amex began listing the heavily traded options of Dell Computer Corp., which until then had been the coveted “property” of the Philadelphia exchange.
Philadelphia immediately retaliated by listing some of the CBOE’s and the Amex’s most popular options. As the battle escalated, the Pacific Exchange was drawn in.
The Justice Department filed an antitrust lawsuit against the exchanges Monday and simultaneously announced a proposed settlement barring them from future anti-competitive deals and outlining steps they must take to make their markets fairer to investors.
The SEC censured the exchanges and ordered them to spend $77 million collectively over the next two years to beef up their surveillance and enforcement operations. That represents more than a 50% annual increase in self-regulatory spending for the exchanges, authorities said.
Also Monday, the Amex, the CBOE and a number of options market makers reached a tentative, $76.7-million settlement of a class-action lawsuit brought by investors who said that the non-compete arrangement cost them money.
Under the proposed settlement, the CBOE will pay $16 million, the Amex $14 million and the market makers the remainder, according to a lawyer involved in the case. The New York Stock Exchange and a handful of other options markets have declined to settle and remain defendants, the lawyer said.
The Pacific and Philadelphia exchanges settled separately last May, agreeing to pay $4.5 million and $2.8 million, respectively.
In the federal case, no individuals were censured, no fines were imposed and no criminal charges brought. The exchanges agreed to accept the government’s action without admitting or denying wrongdoing.
Those terms prompted New York securities lawyer Bill Singer, a former regulator and sometime industry critic, to decry the action as a mere slap on the wrist.
“How can you have misconduct but nobody at fault?” Singer asked.
But SEC enforcement chief Richard H. Walker defended the agency’s approach, calling the exclusivity arrangement “a collective, institutional failure.”
As a practical matter, it would have been extremely difficult to prove a conspiracy case against exchange executives, and it did not seem useful to “pick on small fry,” such as market makers or dealers who might have harassed colleagues who pushed for a more competitive system, Walker said.
William Brodsky, chief executive of the CBOE, said the CBOE welcomed the enforcement actions, which “will help ensure that all exchanges will now be on a more equal regulatory footing.”
Notre Dame finance professor Robert H. Battalio said it’s difficult to quantify how much investors may have gained from the collapse of the exclusivity pact in 1999.
He said the best evidence that investors have benefited is that there has been a redistribution of market share among the exchanges since August 1999. Options traders wouldn’t switch from one exchange to another unless they thought they were getting a better deal, Battalio explained.
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Options Trading Booms
Trading volume in stock “put” and “call” option contracts has mushroomed in recent years. Year-to-date volume already is
easily on pace to surpass the full-year total for 1999. Trading
volume, in millions:
2000*: 431.7 million stock option contracts
* Through August
Source: Options Industry Council
