Wednesday, May 09, 2018

SEC correctly found no jurisdiction over market makers' improper fee petition

By Rodney F. Tonkovic, J.D.

A Seventh Circuit panel has affirmed the SEC's dismissal of a petition seeking damages from various securities exchanges for improper fees for lack of jurisdiction. The court deferred to the Commission's conclusion that the Exchange Act does not provide jurisdiction over lawsuits initiated by private parties. In addition, the petition sought only an accounting, and a refund, of improper fees, which are not cognizable claims under the relevant provisions (CBOE v. SEC, May 7, 2018, Flaum, J.).

Citadel I. In late 2015, the Seventh Circuit upheld the dismissal of a lawsuit brought by Citadel Securities, LLC and other market makers against several options exchanges. The suit alleged that the exchanges had improperly assessed fees (known as "payment for order flow" or PFOF) for options trades and sought to recover the improperly-charged fees. The court concluded that Citadel, which had not attempted to bring the matter before the SEC, had not exhausted all available administrative remedies before turning to the courts for relief.

Before the SEC. Following Citadel I, certain securities firms (the "Market Makers") filed a petition with the Commission against the Chicago Board Options Exchange and Nasdaq. The Market Makers alleged that over a ten-year period the exchanges had improperly charged millions of dollars in fees under PFOF programs. The petition asked the Commission to compel the exchanges to provide a full accounting of the fees and to either award damages in that amount or order disgorgement of the improper fees.

The Commission held that it lacked jurisdiction to review the petition. According to the Commission, Exchange Act Section 19(d) did not apply because the petition did not allege that the exchanges had denied or limited access to any service. The Commission also lacked jurisdiction because the Market Makers are private parties seeking damages. Under Section 19(h)(1), the Commission may commence an administrative disciplinary action against an exchange, but the section does not authorize claims by private parties. Making a distinction between monetary penalties and damages, the Commission found further that the Exchange Act says nothing about its power to award damages in private actions. The CBOE then appealed to the Seventh Circuit.

No jurisdiction. Before the Seventh Circuit, the parties disagreed about whether the court must defer to the Commission's conclusion that it lacked jurisdiction under the Exchange Act. The precise issue, the court said was whether the Exchange Act grants the SEC "jurisdiction to resolve a private-party dispute requesting the repayment of improper PFOF fees." In a nutshell, the petition involved private parties seeking damages for an alleged rule violation, and the Exchange Act does not speak to this issue, the court said.

The court then concluded that the Commission's interpretation of the relevant statutes was reasonable under Chevron. First, Section 19(h)(1) provides the Commission only with discretionary authority to conduct an enforcement proceeding and to sanction an exchange for a rule violation. This, the Commission "sensibly" concluded, does not provide jurisdiction over lawsuits initiated by private parties. And, the court continued, the petition sought only an accounting, and refund, of improper fees, which are not cognizable claims under Section 19(d).

The court then disagreed with the exchanges' argument that the SEC's holding conflicts with Citadel I. That holding, the court explained, was limited, and "addressed only the broad strokes of the Exchange Act in relation to PFOF rule violations, and not ... the particular nuances of SEC jurisdiction over specific petitions." Citadel I, the court said in conclusion, does nothing to detract from the Commission's reasonable conclusion that it lacked jurisdiction under the Exchange Act.

The case is No. 16-3423.