"Because the member firm has first-line supervisory responsibility for its options activities, the new rules governing member firm internal supervisory controls are perhaps the most important aspect of this enhanced self-regulatory system. I believe that most sales practice abuses can be prevented through effective supervisory controls which have the demonstrated support of top management."
Establishing a strong market surveillance program—which the SEC held to be a responsibility of every exchange SRO—for an entirely new market was a big challenge. Information was key, and the CBOE met a high standard from the start with automated reporting on a next-day basis of trading information, including type of account, buying and selling brokers, clearing firms, transaction times and price information. Such information enabled CBOE officials in 1975 to uncover "tape racing" in which options traders utilized NYSE information obtained prior to public reporting. The CBOE put much effort into a study and a rule proposal, but the SEC opted to require timelier price reporting from the NYSE instead.77
Another of the CBOE's self-regulatory responsibilities was conducting member firm oversight. The exchange developed systems that enabled it to identify such problems as missing paperwork and excessive transactions. In 1976 the CBOE touched off the Marcus Schloss case after discovering that the firm's specialist had been providing kickbacks to another market maker.78
As with other SROs, rule infractions by members were handled through a committee system. At the CBOE, a permanent committee consisting of floor and non-floor members, as well as public representatives, reviewed cases developed by staff. If the committee found cause, it drew up charges and—after an opportunity for a hearing—sanctioned violations through penalties ranging from censure and fines to suspension and expulsion. As the SEC later attested, the CBOE was particularly effective during these early years in using the disciplinary process "to establish ethical and legal guides for the conduct of membership."79
That level of confidence on the part of the SEC took time to develop. In July 1977, concerned about unexpectedly rapid growth and worried about "the appearance of abuses," the SEC imposed a moratorium on any further expansion of the options industry and launched a review of the market, focusing on SRO surveillance and rules. Sullivan and the CBOE made good on a pledge to work closely with the SEC.80
Joseph Sullivan probably found it easier working with the regulators than with the floor members. By 1977, slackening growth and increasing competition had thrown a cloud over the CBOE. The system had been swamped during two mid-1970s bull markets. It was evident that the board broker system was too expensive to be supported by the CBOE. Nevertheless, restructuring initiatives were voted down by members intent on preserving the status quo, and escalating tensions between the floor and the staff were not relieved until a salaried CEO was hired and Sullivan stepped down.81
(77.) December 22, 1978 Report of the SEC's Special Study of the Options Market, 22; April 29, 1976 Market Maker Report on the Issue of Tape Racing, submitted to the Board of Directors of the Chicago Board Options Exchange by the CBOE Market Maker Association
(78.) December 22, 1978 Report of the SEC's Special Study of the Options Market, 490; Wall Street Journal, July 23, 1976, and November 18, 1976.
(80.)> September 16, 1980 "Regulation and Expansion of Options Markets," Address by SEC Commissioner John R. Evans to The "New" Stock Options Market Conference; Quotation from December 22, 1978 Report of the SEC's Special Study of the Options Market, 18; CBOE Annual Report, 1980.
(81.) Chicago Tribune, July 19, 1977; CBOE Annual Reports, 1975, 1977, and 1978; Chicago Tribune, December 6, 1977; New York Times, July 28, 1978; September 1978 Report of the Special Governance Committee to the Board of Directors, Chicago Board Options Exchange
(Courtesy of Stuart Kaswell)
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