Wall Street's so-called fear index has allegedly been manipulated by traders causing "systemic risk to the entire equity market", according to a letter claiming to be from a whistleblower sent to US regulators.
The letter, which was sent via lawyers, urges the US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) to investigate "rampant manipulation" on the Vix index, which tracks volatility on the S&P 500.
The anonymous whistleblower has "held senior positions at some of the largest investment firms in the world", wrote Jason Zuckerman and Matt Stock from Washington-based Zuckerman Law. He "wishes to remain anonymous to protect his career" but will talk to regulators, the letter said.
"We urge a prompt investigation of this matter before the consequences of this market manipulation risk to threaten not only the stability of financial markets but also have dramatic economic consequences."
The alleged manipulation by unnamed firms has led to "multiple billions in profits" at the expense of both institutional and retail investors, using a flaw in the index products, the letter alleges.
"The flaw allows trading firms with sophisticated algorithms to move the Vix up or down by simply posting quotes on S&P options and without needing to physically engage in any trading or deploying any capital."
The Vix and other volatility index offshoots have come under renewed scrutiny after last week's dramatic equity market sell-offs.
The Vix briefly broke above the $50 mark last week as chaos took hold on stock markets following fears that higher inflation will push central banks to tighten monetary policy faster than previously expected.
It comes after a period of becalmed markets, with volatility falling to historic lows for an extended period of time.
A spokesman for the CBOE, which runs the Vix, said: "We take our regulatory responsibilities and the oversight of our markets very seriously.
"This letter is replete with inaccurate statements, misconceptions and factual errors, including a fundamental misunderstanding of the relationship between the Vix Index, Vix futures and volatility ETPs, among other things.
"As a result of these errors, we feel the conclusionary statements contained in this letter lack credibility."