From the April 01, 2007 issue of Futures Magazine • Subscribe!

All or nothing on CBOE

If the Securities and Exchange Commission (SEC) approves the rule changes requested by the Chicago Board Options Exchange (CBOE), roughly 1,330 exercise-right privileges (ERPs) held by members of the Chicago Board of Trade (CBOT) would be invalidated. CBOE’s 900 members would then be clear to share in the proceeds of a stock distribution and a possible initial public offering. And the stakes are high.

Just weeks ago, the CBOE filed an S-4 with the SEC and announced record earnings of $257.8 million for 2006, compared with $203 million for 2005, and an after tax profit of $42.3 million, compared with $10.9 million in 2005. And judging from the 131 letters submitted to the SEC Web site, members of both exchanges are ready to brawl.

“This is a matter of agreement that has existed between the exchanges for 30 years and has been the subject of major settlement agreements,” says Nickolas J. Neubauer, former chairman for the CBOT. “There are some people [at the CBOE] who simply have never read these agreements and they just don’t understand how clear they are.” Neubauer, who is urging for a settlement, adds, “No matter what the SEC decides, it will be appealable. And whatever the Delaware court decides, there will be an appeal. This could go on with litigation that is time consuming, costly and uncertain.”

The same battle over the ERPs rages simultaneously in Delaware chancery court, where the CBOT has recently filed a motion for summary judgment in hope of a favorable ruling without a trail.

“Our position continues to be that they never had equity. They never wanted equity for various reasons and so they are not entitled to equity,” says Charles C. Sorsby, president of Sorsby Financial Corp., who owns five CBOE memberships. “And they are saying ‘an agreement is an agreement is an agreement.’ But we never agreed on equity. All we agreed on was trading rights.”

In its S-4, the CBOE detailed its plan to reorganize, demutualize and deny any financial consideration to CBOT members if the CBOT completes its merger with the Chicago Mercantile Exchange (CME), arguing that after that merger, “there will no longer be members of the CBOT who qualify to become or remain members of the CBOE pursuant to the exercise right.” In addition, all CBOE memberships would be converted to shares and former CBOE members would be required to apply for trading permits, a model adopted by the New York Stock Exchange in its demutualization and reorganization process.

“My opinion, as a multiple seat owner, is that it is good for all constituencies and it’s a good deal for the future of the exchange,” says Richard Lund, managing member of TRO Trading LLC, which owns 11 CBOE memberships. He explains that if the exchange were able to add lease income to total revenue, it would be reflected positively in the price/earnings ratio when the CBOE finally does go public. And, noting that competitor International Securities Exchange (ISE) trades at 35 times earnings, he hypothesizes that a CBOE seat owner currently receiving $36,000 in after tax lease revenue per year could reasonably expect an additional $1 million in CBOE stock value. “That’s a no brainer,” he says.

“These exchanges have an amazing amount of upside potential,” says Pete Najarian, co-founder of “It was never a hot-button issue until now,” and, likening the issue to a political or religious debate, adds “you could find some credible arguments on either side.”

Also, the CBOE, Dow Jones and McGraw-Hill have succeeded in returning to Illinois state court a dispute with the ISE over exclusive listing of options on the S&P 500 Index and the Dow Jones Industrial Average. The ISE had removed the case to Illinois federal court, but the federal court later decided it had no jurisdiction over the case and returned it. “We are gratified by today’s decision, which confirms our belief that Illinois state court is the appropriate forum for the resolution of this dispute,” says William J. Brodsky, CBOE chairman and CEO. “Legal precedent in Illinois fully supports CBOE’s position.”

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