By Mark S. Nelson, J.D.
The Commission, in a matter of first impression, determined that an exchange’s decision to apply the clearly erroneous standard in an appeal of a decision by the exchange’s business conduct committee constituted an unfiled and unapproved rule change and could not be employed in disciplinary proceedings unless the exchange either obtained Commission approval to use the standard or was exempt from such requirement. The case arose from allegations by the regulatory unit of the Chicago Board Options Exchange, Inc. that ABN AMRO Clearing Chicago LLC violated the SEC’s market access rule. The Commission reached its conclusion about use of the deferential standard despite CBOE’s avowed decades-long use of that standard without prior SEC objection (In the Matter of the Application of ABN AMRO Clearing Chicago LLC, Release No. 34-83849, August 15, 2018).
Deferential review standard is a rule. In the proceeding before the CBOE Board, CBOE’s regulatory unit had pressed for a de novo standard of review, while ABN AMRO urged use of a deferential clearly erroneous standard. A majority of CBOE’s Business Conduct Committee (BCC) had previously found that CBOE’s regulatory unit failed to show a violation by ABN AMRO. The CBOE Board applied a deferential standard, found that ABN AMRO had violated the SEC’s market access rule, remanded the matter for determination of a sanction, and then, on further appeal, upheld the sanction because the BCC did not abuse its discretion.
The Commission swiftly found the clearly erroneous standard applied in the ABN AMRO matter to be a “rule” for purposes of the Exchange Act for two reasons: (1) the review standard was generally applicable and “integral” to CBOE’s enforcement regime; and (2) the review standard was “fundamental” to “a material aspect” of CBOE’s disciplinary proceedings. The Commission next rejected arguments that CBOE’s deferential review standard fell within two exceptions to the requirement that the exchange seek Commission approval for a rule change.
First, the Commission determined that CBOE’s deferential standard was not “reasonably and fairly implied” by the “text, structure, and meaning in context” of the CBOE’s Commission-approved rule, which speaks of the CBOE Board affirming, reversing, or modifying decisions of the BCC. The Commission concluded that this language meant the CBOE Board would exercise “plenary” or “de novo” review of disciplinary matters.
The Commission next rejected application of the “concerned solely with administration” or “housekeeping exception.” The Commission noted that standards of review in disciplinary proceedings go to the heart of an exchange’s operations and, thus, are unlike the ministerial functions intended to be captured by the exception.
The Commission also rejected many other arguments posed by ABN AMRO and CBOE, including that the Commission should acknowledge CBOE’s interpretation of its own rules (the Commission said it has ultimate authority to interpret an exchange’s rules), and that the presence in other exchanges’ rulebooks of deferential standards augurs in favor of CBOE also using such standards (the Commission reiterated that the contents of other rulebooks does not absolve an exchange of seeking approval for its own rules).
Narrow result, remand, and de novo review. According to the Commission, remand of the matter to the CBOE Board is appropriate because the Commission is unable to uphold the CBOE Board’s findings because the deferential standard used by the board should have been the subject of a rule change proposal and because remand is appropriate when the wrong standard of review has been applied. In this context, the Commission also rejected ABN AMRO’s argument that remand would be impermissibly retroactive. Specifically, the Commission said it was not reversing precedent in this matter but instead deciding a question of first impression. The Commission also explained that its decision focuses on “who” decides a matter while not touching the rights and obligations of any party, so the decision would not function in a retroactive manner in pending matters.
On remand, the CBOE Board must apply a de novo standard of review. However, the Commission clarified what that standard means because ABN AMRO had asked the Commission to impose numerous requirements (e.g., board panels should have one or more attorneys) on how the CBOE Board should implement a non-deferential review standard. For one, the Commission noted that individual board members are not required to review the record, nor are they barred from using the services of subordinates or relying on analyses conducted by others. Moreover, a de novo decision need not deal with all findings or legal conclusions presented so long as it deals with “material points” and states the board’s reasoning. Thus, due process requires only that the CBOE Board issue a “neutral, detached, and independent judgment” or, in other words, the board must render its own judgment without deference.
Lastly, the Commission observed that its decision “is a narrow one” and finds only that CBOE failed to get Commission approval for a rule change to apply a deferential standard of review in disciplinary proceedings. The Commission left for another day three questions: (1) the underlying merits issues in the ABN AMRO matter; (2) how the Commission would rule if presented by an exchange with a rule change proposal to apply a deferential standard of review; and (3) whether all exchanges must adhere to uniform review standards. The Commission had requested additional briefing on some of these questions.
The release is No. 34-83849.