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The Chicago Board Options Exchange has launched an inquiry into the activities of traders on its markets, examining several years of potential rule violations in the handling of stock-options orders.

The exchange operator's market-regulation division this week contacted firms that do business on the CBOE to review "apparent violations" of rules over a three-year period ended in January, according to a letter CBOE sent to member firms this week.

CBOE Holdings Inc. (CBOE), which runs the biggest U.S. stock-options exchange by volume, separately is being investigated by the Securities and Exchange Commission. Federal authorities are exploring whether CBOE has fulfilled its own regulatory functions to supervise registered trading firms, according to documents CBOE filed with regulators in late February.

CBOE's own inquiry focuses on members' rules that govern the way stock-options orders are prioritized and allocated, including trades involving options on the S&P 500 stock index, according to the letter, a copy of which was reviewed by Dow Jones Newswires.

Many members of the CBOE received a copy of the message detailing the inquiry this week, according to people familiar with the matter, and several recipients said the probe appeared to focus on trading carried out at CBOE's Chicago-based trading pits.

Brokers that carry out options orders initiated by retail traders and asset managers operate under rules for the way trades are carried out on CBOE's floor. Generally, floor brokers representing customer orders in trading pits need to make sure all participants are aware of a potential trade and make the transaction at the best available price, giving priority to the first trader to respond.

The letter's reference to rules concerning options on the S&P 500 suggested that CBOE authorities were looking at activity carried out in the pit set up for those products, according to people familiar with the matter. CBOE's SPX pit is home to the most heavily traded stock index option in the country, which trades at the CBOE exclusively due to a longstanding license with S&P parent McGraw-Hill Cos. (MHP).

Probing the behavior of floor traders deviates from federal regulators' recent focus on electronic trading practices, which has drawn in other major exchange groups. The SEC is examining electronic order types offered by automated exchange companies BATS Global Markets and Direct Edge, the Wall Street Journal has reported, following recent investigations into firms that run private trading platforms known as "dark pools."

Over the last month, two long-serving CBOE employees have departed in the wake of the SEC investigation into its compliance functions. Patrick Fay, CBOE's head of member and regulatory services and a member of its executive team, resigned in mid-March. Linda Gerdes, head of the market regulation department, also left the company last month.

In recent months, CBOE has sought to strengthen its compliance division by filling a raft of positions, including a chief compliance officer, a deputy chief regulatory officer and a chief examiner.

Shares in CBOE settled 1% lower at $27.70 Thursday.

-By Jacob Bunge, Dow Jones Newswires; 312 750 4117; jacob.bunge@dowjones.com

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