Shultz v. Securities and Exchange Commission

Howard Shultz (defendant) was a market maker registered with the Chicago Board Options Exchange, Inc. (CBOE). The CBOE’s Business Conduct Committee (committee) initiated disciplinary proceedings against Shultz and three other market makers. The committee ultimately charged Shultz and the three other market makers with violating various CBOE rules, including the rule requiring market makers to refrain from engaging in conduct that was inconsistent with just and equitable trading principles and the rule requiring that market makers refrain from engaging in dealings that were inconsistent with a fair and orderly market. The charges stemmed from a series of circular trades on three separate days between Shultz and the other market makers. Specifically, the committee found that on each of the three days, each market maker bought from and sold to another of the market makers the exact same option on Eastman Kodak stock. The transactions all took place within a few minutes, were at the same price, and left each market maker in the same position that he was in prior to the trade. On each day, the price at which the market makers traded was approximately $1 less than the previous sale price. Additionally, on each day, the series of trades was followed by an unfulfilled offer to sell at an even lower price, which became the final offer at the close of the day. The net effect was that the option series traded lower. Shultz had short positions on the option and thereby benefitted from the trading. Shultz requested a hearing before the committee. At the hearing, the CBOE’s director of investigations presented evidence regarding Shultz’s participation in the trading. Shultz denied that the transactions were illegitimate. However, when asked why he entered into offsetting trades at the same dollar amount and then refused to purchase the option when it was for sale at an even lower price, Shultz could not provide an answer. Shultz’s own witnesses conceded that the trading activity was unusual. The committee found that Shultz violated several CBOE rules and assessed a three-week suspension and a $2,500 fine. Shultz petitioned the Board of Directors of the CBOE for review, and the board affirmed the decision. Shultz then petitioned the Securities and Exchange Commission (SEC) for review. The SEC held a hearing and made a de novo determination of the facts and the law. The SEC ultimately affirmed the CBOE’s disciplinary actions and found Shultz’s misconduct clear and convincing. Shultz petitioned the court of appeals for review of the SEC’s decision.