From the October 01, 2006 issue of Futures Magazine • Subscribe!

CBOT/CBOE at it again

As the New York Stock Exchange and Arca Ex demonstrated, a merger can be a relatively quick and painless shortcut to becoming a publicly traded company. Perhaps that is what the Chicago Board Options Exchange (CBOE) had in mind as it negotiated a merger with the Chicago Board of Trade (CBOT).

In late August, however, merger talks between the CBOE and CBOT broke down and the CBOT filed a lawsuit to secure “full consideration” for CBOT members, who hold CBOE exercise rights in the event of the CBOE issuing publicly traded stock. CBOT members launched CBOE in 1973 and were granted exercise rights. Those rights were challenged as the CBOT went for profit, but the two exchanges agreed to decouple the exercise right so it could be traded like a membership, although a CBOT member would need to retain all the associated class A shares to utilize the exercise right. Whether or not that right should be translated to an equal share allocation as a CBOE membership is the bone of contention.

“To be able to exercise, you have to own all the pieces,” explains Harold W. Lavender, an associate member at the CBOT. To exercise your CBOE option, you must have 27,000 shares of CBOE stock, a trading right and the C share. “It’s going to be hard to refute [the CBOE] argument that the exercise right has now become a C share in-and-of itself, which needs to be combined with the other pieces to be exercisable,” he says. “Ultimately, they will come up with a percentage, or a dollar amount or a number of shares…obviously $100,000 wasn’t enough.”

The lawsuit has induced the CBOE to postpone filing its S-4 with the Securities Exchange Commission until after the exercise right issue is resolved.

“They are going to have to agree to some terms on that exercise right,” says Richard H. Repetto, partner and senior research analyst at Sandler O’Neill & Partners L.P. He adds that other than the cost of litigation, the suit will not directly impact the CBOT, but that the issue will need to be resolved before the CBOE can go public. “This highlights how valuable being a member of an exchange can be,” he adds.

One of the major issues is valuation, and the parties are reportedly far apart. For example, in May of 2005, the CBOE secured a $50 million line of credit to purchase exercise rights from CBOT members through a Dutch auction. At a price of $100,000 each, only 68 exercise rights were secured, leaving 1,334 exercise rights in the hands of CBOT members. In late August, a full CBOE membership sold for $1.4 million. At least 50 full memberships have changed hands this year and 37 of them sold for more than $1 million. The CBOE currently has 931 full members, and there are an additional 1,332 exercise rights held by CBOT full members.

According to a letter from CBOE Chairman William Brodsky’s office, no decisions have been made by the CBOE board to deny or minimize financial consideration for those CBOT seat holders who own those exercise rights. The CBOE has been operating as for-profit corporation since January, but has not completed the process of demutualization. Representatives for each exchange declined to comment.

By Chris McMahon

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