<PAGE>
Filed by Board of Trade of the City of Chicago, Inc. (CBOT)
Subject Company -- Board of Trade of the City of Chicago, Inc.
Pursuant to Rule 425 under the Securities Act of 1933
File No. 132-01854
* * * *
The following letter was filed with the Securities and Exchange Commission on
December 11, 2000 and is currently available to CBOT members at the CBOT's
Office of the General Counsel.
December 11, 2000
Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 5th Street, N.W., Room 6507
Mail Stop 0609
Washington, D.C. 20549
Re: SEC Release No. 34-43521; File No. SR-CBOE-00-44;
65 Fed. Reg. 69585 (Nov. 17, 2000)
-------------------------------------------------
Dear Mr. Katz:
The Board of Trade of the City of Chicago, Inc. is pleased to submit
this comment letter on the Proposed Rule Change filed by the Chicago Board
Options Exchange, Inc., SEC Release No. 34-43521, File No. SR-CBOE-00-44. The
Board of Trade, on behalf of its members, has a direct and substantial stake in
CBOE's proposal. On the basis of misinformation about the Board of Trade's
plans to restructure its business operations and misapprehension of the Board of
Trade's current and planned electronic trading practices, CBOE has proposed to
eliminate valuable rights guaranteed by law to 1402 full members of the Board of
Trade. CBOE's actions have no basis in fact or law and violate multiple
provisions of the Securities Exchange Act of 1934. The Commission should
therefore disapprove the Proposed Rule Change under Section 19(b)(2) of the
Securities Exchange Act of 1934.
Commission action at this time on the Proposed Rule Change would also
be premature. The Board of Trade has filed a breach of contract action involving
whether CBOE's
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Jonathan G. Katz
December 11, 2000
Page 2
proposal violates the 1992 contract between CBOE and the Board of Trade. The
1992 contract expressly authorizes either party to bring such suits to enforce
its provisions. The Board of Trade's suit is now pending in state court in
Illinois and is receiving expedited attention. At least until the court acts,
the Commission should preserve its resources and defer consideration of CBOE's
Proposed Rule Change.
SUMMARY OF POSITION
-------------------
CBOE's Proposed Rule Change (Exh. A) would eviscerate important legal
rights of Board of Trade members based upon a mythical "cap" CBOE now claims has
always existed on the number of Board of Trade members who may actually exercise
those rights. Since 1972, Article Fifth(b) of CBOE's Articles of Incorporation
(Exh. B) has guaranteed "every present and future member" of the Board of Trade
the right to become a member of CBOE "notwithstanding any such limitation on the
number of members and without the necessity of acquiring such membership for
consideration or value." That legal right is known as the Exercise Right and was
granted to "every present and future" Board of Trade member when the Board of
Trade created CBOE in 1972.
CBOE and the Board of Trade disagreed about the scope of the Exercise
Right for many years. Ultimately, the two exchanges entered into a contract in
1992 to "clarify and solidify" the Exercise Right of Board of Trade full
members. 1992 Agreement, Q & A, Ques. 1 (Exh. C). That 1992 Agreement confirms
that "only the One Thousand Four Hundred Two (1402) existing
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Jonathan G. Katz
December 11, 2000
Page 3
CBOT Full Memberships shall be deemed to be CBOT Full Memberships entitled to
Exercise Rights under Article Fifth(b). . . ." 1992 Agreement, (P)2(c) (Exh. C).
A Full Member of the Board of Trade is defined by the 1992 Agreement as a member
eligible to trade as a principal and broker in all contracts at the Board of
Trade. (Other classes of Board of Trade Members are eligible to trade as
principal and broker some, but not all, Board of Trade contracts.) Thus, the
1992 Agreement reconfirms that the Exercise Right is held by all 1402 Board of
Trade Full Members.
The 1992 Agreement also provides that the CBOE will interpret Article
Fifth(b) "in accordance with the provisions of this Agreement" and that either
party "may bring suit to enforce the terms of this Agreement and to recover
damages for any breach of this Agreement." (Exh. C (P)(P)4(d) and 6(c)) The
1992 Agreement and an implementing CBOE rule change were submitted to and
approved by the Commission in 1993. (Exh. D) A similar Board of Trade rule
change to implement the 1992 Agreement was filed with and made effective by the
Commodity Futures Trading Commission under the Commodity Exchange Act.
CBOE has issued its Proposed Rule Change now because, according to
CBOE, the Board of Trade's plan to become a for profit company with enhanced
electronic trading capabilities makes it "probable that all 1402 of the present
full members of CBOT, or their lessees, would chose [sic] to exercise to trade
on the CBOE." See 65 Fed. Reg. at 69589. (Today about 710 of the Board of
Trade's 1402 Full Members have exercised their right to become CBOE members at
no cost.) CBOE claims that its trading facilities would be strained beyond
capacity and the value of its
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Jonathan G. Katz
December 11, 2000
Page 4
memberships diluted if all 1402 Board of Trade full members exercised their
legal right to CBOE membership under Article Fifth(b). See ibid. CBOE's purpose
in offering the Proposed Rule Change is to block about half of the 1402 Board of
Trade members that are guaranteed the Exercise Right under Article Fifth(b) from
exercising their right to membership in CBOE.
Ironically, CBOE agrees with the Board of Trade that today 1402
members of the Board of Trade possess the Exercise Right. As the preamble
accompanying CBOE's Proposed Rule Change confirms, CBOE admits that Article
Fifth(b) contains "the right of the 1402 full members of the [Board of Trade] to
become members of CBOE without having to purchase a CBOE membership." 65 Fed.
Reg. 69585 (Nov. 17, 2000). While conceding the existence of that right, CBOE's
legal view is that allowing each of those Board of Trade full members to
exercise that right would be "inconsistent with the language and purpose of
Article Fifth(b) and the 1992 Agreement." 65 Fed. Reg. at 69589. CBOE's
Proposed Rule Change is grounded, as a matter of law, in that central assertion.
According to CBOE, Article Fifth(b) and the 1992 Agreement guarantee the
Exercise Right to each of the 1402 Board of Trade full members unless more than
450-700 of these members want to exercise the Right, in which case CBOE conjures
up a ceiling on the number of members who may actually use their Article
Fifth(b) right to become CBOE members.
CBOE offers no evidence in the language of Article Fifth(b) or the
1992 Agreement to support its assertion. Nor could it. CBOE's legal position can
best be summarized this way. When Article Fifth(b) says "every" member, it
really means "some" members. When Article Fifth(b)
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Jonathan G. Katz
December 11, 2000
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grants the Exercise Right "notwithstanding any such limitation on the number of
[CBOE] members," it really means to impose a limit on the number of exerciser
members. When the 1992 Agreement uses the number "1402," it really means "700 or
less." When the 1992 Agreement uses the word "entitled," it really means "might
be allowed." And the Exercise Right itself is not a legal right at all, but a
selective opportunity that CBOE controls at its discretion. CBOE's Proposed Rule
Change does not "interpret" Article Fifth(b) and the 1992 Agreement; it rewrites
them.
The Commission should reject CBOE's Proposed Rule Change for several
reasons. By barring each of the 1402 Board of Trade full members from exercising
their rights to CBOE membership, CBOE's Proposed Rule Change would prevent each
of those members from competing with other CBOE members on the CBOE floor. CBOE
has not shown, and cannot show, why burdening competition in this manner would
be necessary and appropriate in furtherance of the purposes of the Exchange Act,
especially where exchange rules guarantee that right. Thus, the Proposed Rule
Change violates Section 6(b)(8) of the Exchange Act.
CBOE's Proposed Rule Change also runs afoul of other statutory
provisions. CBOE's view is that since it no longer wants to be bound by Article
Fifth(b), it may "interpret" it away. But the Exchange Act does not allow CBOE
to discard legal rights embodied in exchange rules just because doing so would
suit its purposes. Denying 1402 Board of Trade full members the rights CBOE
admits those members have under Article Fifth(b) is not only inconsistent with
the rules of the exchange in violation of Sections 6(b)(1) and 19(g)(1) of the
Exchange Act, it is incompatible
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Jonathan G. Katz
December 11, 2000
Page 6
with the promotion of just and equitable principles of trade and the public
interest required by Section 6(b)(5). Because the substance of CBOE's proposed
interpretation is inconsistent with the Exchange Act, CBOE's Proposed Rule
Change should not be approved.
Even if the substance of CBOE's proposed interpretation did not
conflict with the Act, the proposed rule could not be approved consistent with
Section 6(b) because it was adopted in violation of CBOE's own rules for
amending the Exercise Right under Article Fifth(b). Article Fifth(b) is an
exchange rule that provides: "No amendment may be made with respect to this
paragraph (b) of Article Fifth without the prior approval of not less than 80%
of (i) the members of the Corporation admitted pursuant to this paragraph (b)
and (ii) the members of the Corporation admitted other than pursuant to this
paragraph (b), each such category of members voting as a separate class." (Exh.
B, Article Fifth(b)) CBOE's Proposed Rule Change would amend the Exercise Right
granted in Article Fifth(b) without any membership vote, much less a class vote
of its Exerciser Members. The Commission should therefore reject the Proposed
Rule Change because the procedure CBOE followed in its adoption violates
exchange rules contrary to Section 6(b)(1) of the Exchange Act.
In addition to violating multiple provisions of the Exchange Act,
CBOE's Proposed Rule Change relies on factual predicates that are simply wrong.
In its attempt to justify its proposed rule, CBOE mischaracterizes: 1) the
Board of Trade's restructuring proposal; 2) electronic trading at the Board of
Trade; and 3) the current ability of exerciser members to trade at both CBOE and
the
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Jonathan G. Katz
December 11, 2000
Page 7
Board of Trade. With respect to restructuring, the Board of Trade is
preparing a Form S-4 Registration statement concerning the Board of Trade's
proposed reorganization and related business plans involving its subsidiary
Electronic Chicago Board of Trade, Inc. We will summarize the basic elements of
the proposed restructuring in this letter as best we can now, with the caveat
that any representations or discussions in the to-be-filed Form S-4 will
override the contents of this letter. When that filing is made with the
Commission, the Board of Trade will ask that the Form S-4 be included in the
record of this proceeding so that the Commission will have an accurate factual
record of the Board of Trade's restructuring for purposes of its consideration
of CBOE's Proposed Rule Change.
With respect to CBOE's other mischaracterizations, CBOE's Proposed
Rule Change is based upon the erroneous assertions that: (1) no exerciser member
may trade on both exchanges; (2) agricultural futures contracts are not
currently traded electronically at the Board of Trade; and (3) nonmembers of the
Board of Trade may not trade any Board of Trade futures contracts
electronically. As has been the case for decades, exerciser members can and do
trade on both CBOE and the Board of Trade. For example, any CBOE exerciser may
currently trade, during the same day, options on the CBOE trading floor, futures
in the Board of Trade's trading pits, and agricultural and financial futures
contracts at night on the Board of Trade's existing electronic trading system,
called a/c/e (the Alliance of the Chicago Board of Trade and EUREX, a Swiss
German electronic futures exchange). Similarly, any exerciser member may
currently place orders by telephone for Board of
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Jonathan G. Katz
December 11, 2000
Page 8
Trade contracts traded in any pit during the trading day while he or she is
physically present at CBOE.
Available technology also currently enables Board of Trade member
firms to give their customers, who are not members of the exchange, electronic
access to Board of Trade contracts on the a/c/e system with minor timing
differences from member trades. Indeed, many Board of Trade member firms
trumpet this technological achievement to their customers through their web-
sites and other public relations media. CBOE's concern that an open access
policy would democratize market access for nonmembers in the future is thus in
many ways already a market reality. If CBOE is complaining that this
combination of technological advancement, open competition and enhanced market
transparency justifies its Proposed Rule Change, its proposal can hardly be
squared with the Exchange Act's public interest and pro-competition mandates.
I. PROCEDURAL STATUS; REQUEST FOR A STAY OF CONSIDERATION.
-------------------------------------------------------
Again, the Commission's consideration of CBOE's Proposed Rule Change
at this time would be premature. CBOE's proposal plainly breaches its 1992
contract with the Board of Trade. The contract reconfirms that 1402 Board of
Trade full members possess the Exercise Right. CBOE's proposal attempts to
eliminate that right for at least half of those full members in blatant
violation of the Agreement by unilaterally interpreting "1402" to mean "700 or
less."
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Jonathan G. Katz
December 11, 2000
Page 9
In CBOE's words, its Proposed Rule Change is an "interpretation of
Article Fifth of the CBOE Certificate of Incorporation as interpreted in" the
1992 Agreement. 65 Fed. Reg. at 69585. While CBOE may properly interpret
exchange rules, the 1992 Agreement is not an exchange rule. It is a binding
contract between two private parties./1/ If CBOE imposes new restrictions on the
Exercise Right that amend or modify that right in any way, CBOE is acting in
breach of the contract. Yet that is just what CBOE's proposal attempts to do.
CBOE asserts that the Board of Trade's planned restructuring and
enhanced electronic trading capabilities somehow empower CBOE to promulgate a
unilateral rewrite of the 1992 Agreement, style that rewrite a rule change,
obtain Commission approval and avoid any breach of contract action. CBOE's
position ignores four specific aspects of the 1992 Agreement.
First, the 1992 Agreement requires CBOE to interpret Article Fifth(b)
"in accordance with the provisions of" the contract. (Exh. C, (P) 4(d) at 7)
Thus, any CBOE interpretation of Article Fifth(b) is constrained by, and must
conform to, the contract's terms.
-------------------------
/1/ CBOE's Memorandum of Law In Support of its Motion to Dismiss filed
December 1, 2000 in the State court contract action contends (at page 4) that
the "SEC approved the terms of the 1992 Agreement, which thereby became
effective as a CBOE rule change in accordance with federal law." The 1992
Agreement is not an exchange rule. It is a contract that among other things
called for the Board of Trade and CBOE each to amend its respective rules and
submit these rule changes to its regulator, the CFTC or the Commission. (Exh. C
(P) 2(d), 4; (P) 3(4), 6) At no time in 1992 did CBOE label the 1992 Agreement a
rule change. Nor did the Board of Trade. Instead, the 1992 Agreement was, and
is, a binding contract between the private parties that clarified the legal
rights of members of one exchange to become members of the other exchange.
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Jonathan G. Katz
December 11, 2000
Page 10
Second, the 1992 Agreement requires CBOE to obtain "the written
consent of the CBOT" if CBOE's existing rule confirming the Exercise Right is to
be "amended or modified in any way" (Exh. C (P) 4(b) at 6-7). CBOE has never
even requested, and the Board of Trade has certainly never provided, that
requisite written consent for CBOE's self-styled Proposed Rule Change.
Third, the 1992 Agreement enumerates three conditions the Board of
Trade must meet if it wants to preserve the Exercise Right after restructuring.
The Board of Trade's restructuring proposal clearly satisfies each of these
conditions:
. following restructuring, the Board of Trade will be an exchange
providing a market in futures contacts;
. following restructuring, the 1402 Board of Trade full members
will be retain their status as members of the exchange; and
. following restructuring, those members -- and only those
members -- will have full trading rights and privileges in all
products on the exchange.
(Exh. C (P) 3(d) at 5-6) Thus, CBOE does not propose to invalidate the Exercise
Right for breaching any of the restructuring conditions under the Agreement.
Fourth, Paragraph 6(c) of the 1992 Agreement authorizes both CBOE and
the Board of Trade to "bring suit to enforce the terms of the Agreement" and "to
recover damages for any breach." Pursuant to this provision, the Board of Trade
has brought suit to enforce its members' rights against CBOE and to have CBOE's
proposal declared inconsistent with, and invalid under, the Agreement. Board of
Trade of the City of Chicago, Inc. v. Chicago Board Options Exchange, Inc. Civ.
Action No. 00 CH 15000, (Cook County Circuit Court, Chancery Division, Oct. 17,
2000.)
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Jonathan G. Katz
December 11, 2000
Page 11
The breach of contract remedy authorized by Paragraph 6(c) recognizes that
disputes could arise between the CBOE and Board of Trade under the Agreement and
provides a specific mechanism for resolving those disputes.
Put simply, whether CBOE's actions comply with the 1992 contract is an
issue for the courts. Whether the Proposed Rule Change complies with the
Exchange Act is an issue for the Commission. At its core, this dispute is a
contract action. The Board of Trade entered into a contract with CBOE in 1992.
We believe CBOE has breached that contract. We are pursuing our rights under
the contract to remedy that breach. Until the state court has ruled on our
contract action, any action by the Commission on CBOE's Proposed Rule Change
would be premature and ill-advised.
If the court agrees with our position and finds CBOE to have breached
the 1992 Agreement, CBOE should withdraw its Proposed Rule Change. If the court
agrees with CBOE and concludes that the Proposed Rule Change does not breach the
1992 Agreement, then and only then, should the Commission consider whether the
Proposed Rule Change should be approved under the Exchange Act. In the interim,
while we await the court's decision, we would urge the Commission to defer
action on the Proposed Rule Change in the interest of preserving its
administrative resources.
CBOE disagrees with this approach to resolving the current conflict
because it claims that our breach of contract action is really nothing more than
a membership dispute that only the
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Jonathan G. Katz
December 11, 2000
Page 12
Commission may resolve. CBOE is incorrect. Our contract action turns on issues
that state courts regularly and appropriately decide by looking at the four
corners of contractual agreements. More importantly, only state courts, not the
Commission, may award the damages remedy for breach that the parties expressly
provided for in Paragraph 6(c) of the 1992 Agreement. Thus, litigating this
contract action in state court is the only means of resolving the current
dispute that is consistent with the Agreement.
II. CBOE's PROPOSED RULE CHANGE.
----------------------------
On October 10, 2000, CBOE submitted to the Commission amendment #1 to
its Proposed Rule Change Relating to an Interpretation of Paragraph (b) of
Article Fifth of its Certificate of Incorporation. That amended Proposed Rule
Change was published for public comment in the Federal Register on November 17,
2000. See 65 Fed. Reg. 69585. According to CBOE, the Proposed Rule Change
substantively concerns "the effect of the proposed restructuring of the CBOE
[sic, Board of Trade] or other action that may be taken by CBOT to change its
trading rules or procedures on the right of 1402 full members of the CBOT to
become members of CBOE without having to purchase a CBOE membership (the
'Exercise Right')." Ibid.
In terms of the Board of Trade's restructuring, the Proposed Rule
Change states that the Board of Trade could restructure as a for profit stock
corporation without affecting the Exercise Right for those "persons who become
stockholders of CBOT in the restructuring as a result of their
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Jonathan G. Katz
December 11, 2000
Page 13
ownership of one of the 1402 full CBOT memberships." 65 Fed. Reg. at 69586. But
those same members would lose their Exercise Right under the Proposed Rule
Change unless they "retain all of the stock and other interests that may be
distributed to them in respect of their full CBOT memberships and continue to
hold all of the trading rights and privileges in respect of CBOT that they held
in their former status as full members of CBOT." Ibid. In other words, if, after
restructuring, any Board of Trade full member sells even one share of the stock
issued by the new for profit Board of Trade, that member would forfeit the
Exercise Right. This amendment we will call the Stock Retention Amendment to the
Exercise Right.
CBOE's Proposed Rule Change would amend the Exercise Right in three
other ways. Each relates to Board of Trade trading practices even if adopted
separate and apart from the restructuring plan. Indeed, in most respects, each
of these trading practices already exists at the Board of Trade today, at least
as a practical matter.
First, under the Proposed Rule Change, the Exercise Right would
"terminate immediately for all 1402 CBOT full members or the stockholder
equivalents of such members (of [sic] their delegates) if, whether as a part of
a demutualization or other restructuring of the CBOT or otherwise, CBOT changes
its trading rules and procedures so as to extend the right to trade all CBOT
products, electronically or otherwise, to persons who are not CBOT Full Members
or the stockholder equivalents of such members (or their delegates). . . ." 65
Fed. Reg. at 69586. This amendment we will call the Customer Access Amendment to
the Exercise Right.
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Jonathan G. Katz
December 11, 2000
Page 14
Second, the Proposed Rule Change would "terminate" the Exercise Right
"immediately" "if . . . CBOT Full Members or the stockholder equivalents of such
members (or their delegates) would be able to trade all CBOT products directly
on CBOT at the same time as they are trading on the Exchange as exerciser-
members." This amendment we will call the Dual Access Amendment to the Exercise
Right.
Third, for reasons that are not clear, CBOE appears to link the Dual
Access Amendment to its complaint that the Board of Trade may "trade all CBOT
products on the electronic trading system, including its agricultural contracts
and other products heretofore traded only by CBOT Full Members on the CBOT open-
outcry trading floor." 65 Fed Reg at 69586. While not technically part of the
Proposed Rule Change, CBOE's preamble claims that "The proposed restructuring of
CBOT and the proposed modification of the way in which agricultural products are
traded will extinguish the Exercise Right, whether implemented together or
separately." 65 Fed. Reg. at 69588. This amendment we will call the
Agricultural Trading Amendment to the Exerciser Right.
CBOE's Proposed Rule Change also contemplates that if the Exercise
Right is extinguished it will propose a plan to address the need for fair and
orderly trading on CBOE without its exerciser members "and at the same time will
be fair to the 1402 former members of CBOT who will have lost their Exercise
Rights." 65 Fed Reg at 69586. That plan will be submitted for approval to
CBOE's membership and the Commission. In the interim period of at least six
months, CBOE would allow those exerciser members who had become CBOE members by
August 28, 2000, to
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Jonathan G. Katz
December 11, 2000
Page 15
retain their membership status. Thus, a Board of Trade full member who today (or
any day after August 28 of this year) exercises his Article Fifth(b) right to
become a member of CBOE would have that right immediately terminated whenever
CBOE divines that the conditions that the Customer Access, Dual Access or
Agricultural Trading Amendments impose on the Exercise Right have been violated.
III. ARTICLE FIFTH(b) AND THE EXERCISE RIGHT.
----------------------------------------
No one disputes that CBOE's Proposed Rule Change concerns Article
Fifth(b) of CBOE's Certificate of Incorporation. Article Fifth(b) provides in
full:
In recognition of the special contribution made to the organization
and development of the corporation by the members of the Board of
Trade of the City of Chicago, a Corporation organized and existing by
Special Legislative Charter of the General Assembly of the State of
Illinois, and for the further purpose of promoting the growth and
liquidity of the Corporation, developing a broad financial base of
dues-paying members, and assuring participation on a continuing basis
of persons experienced in the trading and clearing of contracts for
future purchase or delivery on a central marketplace, every present
and future member of said Board of Trade who applies for membership in
the Corporation and who otherwise qualifies shall, so long as he
remains a member of said Board of Trade, be entitled to be a member of
the Corporation notwithstanding any such limitation on the number of
members and without the necessity of acquiring such membership for
consideration or value from the Corporation, its members or elsewhere.
Members of the Corporation admitted pursuant to this paragraph (b)
shall, as a condition of membership in the Corporation, be subject to
fees, dues, assessments and other like charges, and shall otherwise be
vested with all rights and privileges and subject to all obligations
of membership, as provided in the by-
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Jonathan G. Katz
December 11, 2000
Page 16
laws. No amendment may be made with respect to this paragraph (b) of
Article Fifth without the prior approval of not less than 80% of (i)
the members of the Corporation admitted pursuant to this paragraph (b)
and (ii) the members of the Corporation admitted other than pursuant
to this paragraph (b), each such category of members voting as a
separate class; provided, however, that any amendment to this
paragraph (b) which is required under a final order of any court or
regulatory agency having jurisdiction in the matter may be made in
accordance with the provisions of Article Twelfth covering amendments
to this Certificate of Incorporation generally, without regard to the
above provisions concerning such 80% vote by classes.
(Exh. B)
The history of the Exercise Right is instructive. The Board of Trade
created both CBOE and the Exercise of Right in 1972. Since then, CBOE has
periodically attempted to limit or extinguish the Right, often in response to
market innovations at the Board of Trade. However, at no time since its
creation has the Exercise Right been considered by anyone, including CBOE, to
belong to less than the 1402 Eligible Full Members of the Board of Trade or to
be limited in any of the ways contemplated by the Proposed Rule Change.
A. CBOE's Creation.
----------------
As the Commission is aware, in the early 1970's the Chicago Board of
Trade developed the first centralized market for trading securities options.
The Board of Trade believed that a centralized options market would increase the
trading opportunities of its members, bring in additional revenue, provide
financial stability during "slack" periods in the futures market, and broaden
participation in the future markets. See Formation of a Securities Options
Market: Some
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Jonathan G. Katz
December 11, 2000
Page 17
Questions and Answers, June 1971, Question 1 (Exh. E). To achieve these goals,
the Board of Trade designed and created the Chicago Board of Options Exchange,
Inc.
The Board of Trade initially contemplated that the options exchange
would simply occupy one "ring" on the CBOT's trading floor and that only Board
of Trade members would be eligible for membership. See Board of Trade Options:
Planning Toward Implementation, A Chicago Board of Trade Staff Presentation,
March 1969 at 14-15 (Exh. F). Although the Board of Trade ultimately
established the CBOE as a separate entity for regulatory reasons,/2/ CBOE has
long acknowledged its heritage. See Memorandum, April 10, 1973, from CBOE to
Board of Trade Members (Exh. G) ("The long awaited birth of your CBOE offspring
is now at hand."). CBOE's organizational structure and initial leadership
further evidence its close affiliation with the Board of Trade. The initial
CBOE board of directors was composed almost entirely of Board of Trade members,
and the signatories of CBOE's Certificate of Incorporation were all directors of
the Board of Trade.
CBOE's founders considered various proposals for compensating Board of
Trade members for their efforts in developing the options exchange before they
settled on the Exercise Right as a solution that would both compensate Board of
Trade members and facilitate the growth and liquidity of the new CBOE. Thus, a
royalty arrangement pursuant to which Board of Trade members would receive a
monetary return on their investment in the new options exchange was
--------------------------
/2/ As part of CBOE's creation, the Board of Trade dropped its registration
as a national securities exchange.
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Jonathan G. Katz
December 11, 2000
Page 18
rejected in favor of the permanent right of access guaranteed in Article
Fifth(b) of CBOE's Certificate of Incorporation. As CBOE itself explained:
[T]he decision was that the contributions of the Board of Trade
membership to the development of this new trading medium, and the need
to encourage participation by Board of Trade members in order to make
it viable, called for extending them a right to participate in the
Options Exchange without having to purchase . . . separate
membership[s].
CBOE Director's Orientation Brief, January 1972, at 3 (Exh. H).
In creating the Exercise Right, CBOE and the Board of Trade carefully
considered whether a Board of Trade member's right to membership in the options
exchange should be limited or permanent, a separate personal property right, or
a right "attached" to Board of Trade membership. See Report of Board of Trade
Executive Committee to Board of Directors, November 9, 1971, at 203 (Exh. I).
The planners ultimately decided that the right to CBOE membership should be a
permanent right, inherent in and inseparable from every present and future Board
of Trade membership. Thus from CBOE's inception in 1972 the Exercise Right
constituted one of the core privileges attending Board of Trade membership:
This right to [options exchange] membership, which would be an
integral part of every CBT membership, would simply represent one more
addition to the 'bundle of rights' already inherent in a Board of
Trade membership.
Id. at 6. Although CBOE memberships acquired pursuant to the Exercise Right
were never intended to be sold independent of Board of Trade memberships (i.e.,
a Board of Trade member's right to
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Jonathan G. Katz
December 11, 2000
Page 19
belong to CBOE was not "separately transferable"),/3/ the CBOE organizers did
contemplate that the CBOE right would be transferable as part of the Board of
Trade membership "package." See SEC Form 1, submitted by CBOE, April 24, 1972,
at 3 (Exh. K) ("Board of Trade memberships are transferable, and will carry with
them the right to become a member of the Exchange upon application and
qualification."); see also Exh. C, (P) 1(b) (recognizing that Board of Trade
delegates who possess the delegator member's trading privileges also possess the
Exercise Right).
In short, CBOE has long acknowledged the Board of Trade's goals in
creating the CBOE membership right and the Board of Trade's strong interest in
keeping the right intact:
Various possibilities for detaching, retiring, or otherwise modifying
the CBOE membership right that goes with Board of Trade membership
have been discussed. . . . However, any such change runs counter to
the Board of Trade's original objectives in sponsoring the CBOE's
development: namely, to provide a long-term diversification of
opportunities for Board of Trade floor members.
CBOE Questions and Answers on Legal and Factual Considerations Relevant to an
Offering of Additional Memberships, May 30, 1975, at 2 (Exh. L). More
importantly, CBOE has long recognized the benefit to the exchange of a permanent
Exercise Right that would guarantee Board of Trade members' long-term
participation in the options exchange and thereby facilitate CBOE's growth and
viability by providing it with a pool of experienced participants. See CBOE's
Director's
----------
/3/ See Section 2.5 of the CBOE Constitution (stating that exerciser
memberships may not be sold) (Exh. J).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 20
Orientation Br. at 3 (Exh. H); Report of Board of Trade Executive Committee to
Board of Directors, October 14, 1971, at 2 (Exh. M).
B. Article Fifth(b) of CBOE's Certificate of Incorporation
Guarantees the Exercise Right.
-------------------------------------------------------
Article Fifth(b) guarantees Board of Trade members the legal right to
become CBOE members. In 1990, CBOE itself recognized the binding nature of the
Exercise Right in its statement of purpose accompanying proposed Rule 3.16(c):
The purpose of this interpretation is to assure that the spirit and
the letter of the agreement by which the CBOE was created by the
Chicago Board of Trade ("CBOT"), and by which the CBOT and the CBOE
have conducted their affairs, is maintained.
Notice of Filing of Proposed Rule Change, 55 Fed. Reg. 29 (July 20, 1990)
(emphasis added).
Before CBOE assumed its status as a separate exchange, the Exercise
Right was embodied in a "Transfer Agreement" between CBOE and the Board of
Trade. Pursuant to this agreement, the Board of Trade would transfer all of its
options research and development to CBOE in exchange for CBOE's agreement to
admit all eligible present and future Board of Trade members to the CBOE without
charging a membership fee:
[E]ach such member of [the] Board of Trade who shall apply for
membership on [the] Exchange, if otherwise qualified, shall be vested
with all rights, privileges and obligations of membership on [the]
Exchange.
Transfer Agreement, Sample Draft, October 11, 1971, at 5 (Exh. N). The Executive
Committee of the Board of Trade described the arrangement as follows:
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 21
The essence of this plan . . . is that the Board of Trade's options
'know-how' be transferred to the options exchange in return for a
contractual commitment in perpetuity on the part of the options
exchange to admit to membership, without the purchase of a seat, any
[Board of Trade] member who applies and otherwise qualifies for
[options exchange] membership.
November 9, 1971 report at 6 (see Exh. I).
In an effort to make the membership right described in the Transfer
Agreement even stronger and more permanent, the Board of Trade and CBOE's
emerging leadership agreed to codify the membership right in Article Fifth of
CBOE's Certificate of Incorporation. Article Fifth(b) thus provides:
[E]very present and future member of said Board of Trade who applies
for membership in [CBOE] and who otherwise qualifies shall, so long as
he remains a member of said Board of Trade, be entitled to be a member
of [CBOE] notwithstanding any such limitation on the number of members
and without the necessity of acquiring such membership for
consideration. . . .
(Exh. B). In addition to establishing the perpetual duration of the Exercise
Right, Article Fifth mandates that "Board of Trade exerciser" members be
accorded all the rights and privileges afforded other CBOE members. Article
Fifth(b) (citing "the special contribution made to the organization and
development of [CBOE] by the members of the Board of Trade").
Recognizing that future CBOE members who had paid to acquire CBOE
seats might try to restrict or even prohibit Board of Trade members from
exercising their right to CBOE membership, CBOE and the Board of Trade agreed to
add a provision to Article Fifth(b) specifying
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 22
that, with one narrowly tailored exception, neither the Exercise Right nor
Article Fifth(b) itself could be amended without prior approval of an 80%
supermajority of both CBOE exercisers and non-exerciser members:
No amendment may be made with respect to this paragraph (b) of Article
FIFTH without the prior approval of not less than 80% of (i) the members
of the Corporation admitted pursuant to this paragraph (b) and (ii) the
members of the Corporation admitted other than pursuant to paragraph (b),
each such category of members voting as a separate class; provided,
however, that any amendment to this paragraph (b) which is required under
a final order of any court or regulatory agency having jurisdiction in the
matter may be made in accordance with the provisions of ARTICLE TWELFTH.
. . ./4/
Article Fifth(b) (Exh. B) (emphasis added).
The history of the CBOE membership right and the plain language of Article
Fifth(b) establish that the Exercise Right was granted in perpetuity because of
its importance not only to present and future Board of Trade members, but to the
future growth and success of CBOE. In order to preserve these important goals,
Article Fifth mandates that a supermajority of Board of Trade exercisers must
agree to any amendments to the form, substance, or duration of the Exercise
Right. Any interpretation of Article Fifth(b) that substantively limits or
otherwise alters the Exercise Right must therefore receive the requisite class
vote approvals.
-------------------
/4/ Article Twelfth of CBOE's Certificate of Incorporation provides that CBOE
"reserves the right to amend [its] Certificate of Incorporation . . . provided,
however, that any amendment . . . must, in addition to being approved by a
majority of the members of the Board of Directors, also be approved by a
majority of the members of the Corporation entitled to vote thereon." CBOE
Certificate of Incorporation, Article Twelfth (amended July 5, 1973) (Exh. B).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 23
C. Notwithstanding the Voting Requirements in Article Fifth(b), CBOE Has
Periodically Attempted Unilaterally to Amend the Exercise Right.
---------------------------------------------------------------------
CBOE has long recognized that any attempt to restrict or otherwise amend
the Exercise Right is strictly constrained by the provisions of Article
Fifth(b). In a question and answer memorandum CBOE distributed to its membership
on May 30, 1975, regarding the creation of new CBOE memberships, the question
was raised whether "some alteration of the [Exercise Right] could be
accomplished in connection with the creation of additional seats." Q & A
Regarding Offering of Additional Memberships, May 30, 1975, at 2 (Exh. L). In
answering the question, CBOE noted that "[v]arious possibilities for detaching,
retiring, or otherwise modifying the CBOE membership right that goes with Board
of Trade membership have been discussed." Ibid. CBOE went on to state, however,
that "any such change runs counter to the Board of Trade's original objectives
in sponsoring the CBOE's development" and that, to "protect [the Exercise Right]
against erosion," CBOE's charter mandates that "any change in the right's terms
must be approved by an 80 percent vote of those CBOE members who have acquired
their seat through exercise of the right." Ibid. As CBOE noted in closing,
"[s]uch a majority was intended to be very difficult to attain." Ibid.
Notwithstanding its recognition of the limitations that Article Fifth(b)
imposes on amendments or modifications to the Exercise Right, CBOE has
periodically attempted to limit the Right by adopting new "interpretations" of
Article Fifth(b)./5/ As evidenced by the following
-------------------
/5/ Article Fifth(b) is a CBOE rule. See Securities Exchange Act of 1934,
(S)(S) 3(a)(27);
(continued ...)
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 24
discussion of CBOE Rules 8.7, 3.8(a), 3.16(b) and 3.16(c), CBOE's attempts to
use its interpretive authority to amend the Exercise Right follow a distinct
pattern. Spurred either by general hostility to the Exercise Right or Board of
Trade innovations, CBOE issues an "interpretation" that limits the Exercise
Right and thereby hampers the Board of Trade's ability to compete and serve its
markets' needs. The Board of Trade then files objections to the proposed
interpretation with the Commission and CBOE retreats, knowing that neither
Article Fifth(b) nor the Securities Exchange Act of 1934 permits it to use its
rulemaking authority to amend the Exercise Right.
1. Rules 8.7 and 3.16(b).
---------------------
The circumstances under which CBOE proposed former Rule 8.7 (requiring the
lesser of seventy-five percent of a market maker's transactions or 20,000
contracts per quarter to be executed in person rather than through a floor
broker) and former Rule 3.16(b) (precluding Board of Trade exercisers from
leasing their CBOE trading privileges) follow this pattern. CBOE used its
rulemaking power in an effort to cut back on the Exercise Right only to retreat
in the face of legal challenges by the Board of Trade.
Rule 8.7 and the Clement Dispute. As the Seventh Circuit observed in
Clement v. Securities and Exchange Comm'n, 674 F.2d 641(7th Cir. 1982), the
right to CBOE membership conferred upon Board of Trade members under Article
Fifth would be of "little value" to a Board
-------------------
/5/ (... continued)
3(a)(28), 15 U.S.C. (S)(S) 78c(27)-(28) (defining "rules" of a national
securities exchange to include, among other things, the exchange's
"constitution, articles of incorporation, [and] bylaws").
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 25
of Trade member if "he were expected to be on the floor of the CBOE on a full-
time, or nearly full-time, basis." Id. at 643. CBOE initially addressed this
problem by creating two classes of market maker appointments. The first class
consisted of "principal appointments," which imposed a continuous obligation on
the holder to engage in dealings for his own account whenever there existed, or
reasonably might exist, a demand for market makers in any class of option in
which the holder was a principal appointee. CBOE Rule 8.7(b). The second class
consisted of "supplemental appointments," which were granted to Board of Trade
members who could show that they were "primarily engaged as a trader or broker
on the Board of Trade." CBOE Rule 8.3.02. Unlike primary appointees,
supplemental appointees were required to undertake the obligations of a CBOE
market maker only "in response to a demand therefor from the Board Broker or
Order Book Official that performance of such obligation by other Market Makers
require[d] supplementation." CBOE Rule 8.7(a). In 1973, the SEC approved the two
classes of appointments, which permitted Board of Trade members to reap the
benefit of the Exercise Right while fulfilling their obligations to other
markets. See SEC Release No. 9985, 1 S.E.C. Doc. 11 (Feb. 1, 1973).
Under CBOE's original market maker rules, the Exercise Right had value for
Board of Trade members not only because of the dual class of appointments, but
because the rules provided that, although all market maker transactions had to
be initiated on the floor of the Exchange, a market maker who was on the floor
could place an "unlimited percentage of his orders with floor brokers rather
than fully executing them himself." Clement, 674 F.2d at 643. As the Seventh
Circuit
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 26
observed, these rules enabled Board of Trade members to trade on the CBOT as
well as to "engage in a volume of trading on the CBOE that made [their] market
making economically viable." Ibid. On June 9, 1980, however, CBOE filed a
Proposed Rule Change in which it eliminated supplemental appointments for market
makers and required that a certain part (the lesser of seventy-five percent of a
market maker's transactions or 20,000 contracts per quarter) of a market maker's
transactions be executed in person. See 45 Fed. Reg. 43914, June 30, 1980;
amended August 1, 1980, see 45 Fed. Reg. 51325. The Board of Trade filed a
comment letter with the Commission opposing the Proposed Rule Change on the
basis that it effectively precluded Board of Trade members from exercising their
right to CBOE membership because it eliminated their ability to trade as options
market makers on a part-time basis.
On February 12, 1981, the Commission approved the Proposed Rule Change,
finding that it did not "unfairly affect the membership rights of CBOT members"
because it "merely impose[d] on CBOT members the same obligations imposed on
other CBOE members who register as market makers." 46 Fed. Reg. 13055, February
19, 1981. Board of Trade member Charles B. Clement appealed the SEC's order to
the Seventh Circuit./6/ On April 5, 1982, the court vacated and remanded the
Commission's order approving the new rule. Although the Seventh Circuit did not
rule on the merits of Clement's arguments that the new rule was both
anticompetitive and
--------------------
/6/ On April 14, 1981, Clement petitioned the Commission for a stay, pending
judicial review, of the CBOE's Proposed Rule Change, but the Commission denied
the stay on June 9, 1981, in an order further justifying its prior approval of
the proposed rule. See SEC Release No. 17185, 22 SEC Docket 1156 (May 22, 1981).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 27
discriminatory,/7/ it held that the Commission failed adequately to address
these objections in approving the rule. Specifically, the court noted that the
Commission failed to consider the anticompetitive concern that the rule change
could "result in Clement and other [Board of Trade] members ceasing to trade as
market makers on the CBOE." Clement, 674 F.2d at 646-47 (holding that because
the Commission "assume[d] away any anticompetitive effect" of the rule by
"refus[ing] to recognize that Clement might be precluded, by economic reality,
from acting as a market maker on the CBOE," the Commission's order approving the
proposed rule "must be vacated"). Id. at 647. Following the court's decision in
Clement, the Commission on May 17, 1982, partially approved for a temporary (90
day) period only the portions of the proposed rule that did not pertain to the
in-person trading requirement. See SEC Release No. 18727, 47 Fed. Reg. 21169
(May 17, 1982). Noting that more time was needed for the "Commission and the
CBOE to reevaluate the entire [proposed rule] in light of the Court's opinion,"
the Commission refused to approve the subsection
--------------------
/7/Clement challenged the proposed rule on two primary grounds. First,
Clement alleged that the proposed rule unnecessarily burdened competition in
violation of Section 6(b)(8) of the Exchange Act because, by eliminating the use
of floor brokers in the majority of market maker transactions, it decreased his
trading capacity and thus diminished "open competition among market makers."
Clement, 674 F.2d at 645. Second, Clement argued that the rule unfairly
discriminated among dealers in violation of Section 6(b)(5) of the Exchange Act
because: (1) by imposing a "continuing obligation" on all market makers and
severely limiting the use of floor brokers, it effectively precluded Board of
Trade members from engaging in economically viable market making on the CBOE
floor; and (2) by exempting market makers who trade more than 20,000 contracts
per quarter from the requirement that 75% of all transactions be executed in
person, it discriminated between high and low volume traders. See ibid.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 28
requiring market makers to execute in-person the lesser of seventy-five percent
of their total trading activity or 20,000 contracts in their appointment
classes. See id. at 21170.
In response to the Seventh Circuit's ruling and the Board of Trade's
objections to the anticompetitive nature of the rule, CBOE amended its proposal
to reduce the in-person percentage requirement from seventy-five percent to
twenty-five percent, and eliminated the 20,000 contracts exception for high
volume traders. See SEC Release No. 19203, 47 Fed. Reg. 50790 (November 9, 1982)
(publishing the terms of the amendment). The Commission approved the amended
rule on a one-year pilot basis on June 7, 1984. See 49 Fed. Reg. 23721, 23725.
The amended rule remains in effect, largely because, as CBOE conceded in a
letter to the Commission, the "change in the proposed in-person requirement from
75 percent of options contract volume to 25 percent of transactions [aimed] the
rule more directly at the goal of encouraging market maker presence on the CBOE
floor" and eliminated the burden the original rule placed on Board of Trade
exercisers. Id. at 23722.
Former Rule 3.16 and the Buckley Dispute. Like CBOE's attempt to
adopt the rule at issue in Clement, CBOE proposed former Rules 3.16(d) and
3.16(b) in order to use its rulemaking authority to alter the Exercise Right in
a manner not contemplated by Article Fifth(b).
Rule 3.16(d). When CBOE was created in 1972, neither CBOE nor the
Board of Trade permitted members to lease or delegate their floor access rights.
In 1978, however, CBOE amended its rules to permit the leasing of CBOE seats to
nonmembers for specified periods.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 29
CBOE's leasing rule, then Rule 3.16(d),/8/ which disadvantaged Board of Trade
exercisers by extending leasing privileges only to holders of "transferable"
CBOE memberships,/9/ was approved by the Commission without objection from the
Board of Trade because the final version of the rule was adopted without proper
notice or comment. Although the rule was published for comment in its original
form, the final version limiting the leasing privilege to holders of
transferable memberships was not publicly announced before it was approved. When
CBOE initially submitted proposed Rule 3.16(d) to the Commission on February 28,
1978, the rule provided that CBOE seats could be leased by any "owner of a
membership" and thus did not disadvantage exerciser members of CBOE. In other
words, the original, but not the amended, rule conformed to Article Fifth(b) by
treating Board of Trade exercisers like all other CBOE members. See Form 19b-4A
filed by CBOE on February 28, 1978, regarding File No. SR-CBOE-1978-5. (Exh. O).
By letter to the Commission dated March 7, 1978, CBOE represented that
its February 28, 1978, filing "omitted a few small language changes" which it
had "added to a final draft" that it would resubmit for approval. March 7, 1978,
letter from CBOE to SEC. (Exh. P) One of the "small language changes" involved
modification of the leasing rule to apply only to holders of "transferable"
memberships. CBOE did not inform the SEC that the addition of the term
--------
/8/ The leasing provisions of former Rules 3.16(d) and 3.16(b) are now
incorporated in new Rule 3.17. See SEC Release No. 34-43056, 65 Fed. Reg.
46524-01 (July 28, 2000).
/9/ Board of Trade exercisers hold non-transferable memberships pursuant
to Section 2.5 of CBOE's Constitution.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 30
"transferable" would preclude Board of Trade exercisers from enjoying the
leasing privileges available to all other CBOE members.
On March 8, 1978, CBOE sent the Commission corrected pages of the
Federal Register notice portion of its Form 19b-4A. See March 8, 1978, letter
from CBOE to SEC (Exh. Q). The "corrected" pages limited the leasing privilege
to holders of "transferable" memberships, but CBOE never explained to the
Commission the significance of the change. On March 10, 1978, two days after it
received CBOE's final letter, the Commission announced that CBOE's proposed rule
would be published for comment in the Federal Register. See SEC Release No.
14551 (March 10, 1978). The Commission's announcement described the CBOE rule
amendments as a "means by which CBOE members [could] lease their Exchange
memberships" but did not state that the privilege was limited to holders of
"transferable" memberships. The March 20, 1978, Federal Register publication of
the proposed rule similarly failed to mention this restriction. As a result, the
Board of Trade never received notice of the substantive amendment effected by
CBOE's "small language change[]." March 7, 1978, letter from CBOE to SEC (Exh.
P); see also 43 Fed. Reg. 11629 (March 20, 1978). The limitation on the leasing
privilege was, however, incorporated in the version of the Rule approved by the
Commission on April 25, 1978. See SEC Release No. 14703 (April 25, 1978)
(incorporating the changes but failing to explain the addition of the revised
language).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 31
Because the Board of Trade did not receive public notice of CBOE's
final changes to the proposed rule, it did not challenge the additions when the
rule was adopted in 1978. The Board of Trade did, however, address the issue in
a letter to the Commission dated June 25, 1990, in which the Board of Trade
asked the Commission to rescind its accelerated approval of CBOE's amended
nominee rules. In the context of challenging CBOE's summary adoption of proposed
Rule 3.8(a) permitting only holders of "transferable" memberships to trade using
nominees, the Board of Trade outlined the manner in which CBOE manipulated the
Commission's approval process in 1978 to secure improper approval of former Rule
3.16(d). Faced with the Board of Trade's letter highlighting its previous abuse
of the rulemaking process, CBOE abandoned its discriminatory nominee rule. See
SEC Release No. 34-28246, 55 Fed. Reg. 30772-01 (July 27, 1990)./10/
The Buckley Dispute. In 1979, one year after CBOE adopted former Rule
3.16(d), the Board of Trade granted its members the right to delegate their
floor access rights to the Board of Trade's daytime trading session (the evening
session had not yet been established)./11/ In response
--------
/10/ Former Rule 3.16(d), which was later incorporated into Rule 3.16(b)
and, more recently, into Rule 3.17, prohibited holders of nontransferable (i.e.
exerciser) memberships to lease their CBOE seats. The Board of Trade challenged
the leasing rule on the basis that the "transferability limitation" in Section
2.5 of CBOE's Constitution, pursuant to which Rules 3.16(b) (daytime leasing)
and 3.16(c) (evening leasing) were enacted, refers only to the sale of CBOE
memberships so Board of Trade exercisers should have the same rights as all
other CBOE members to lease their CBOE seats. See Board of Trade Comment Letter
on SRO-CBOE-90-21, 8/10/90 at p. 28, n.13 (Exh. R).
/11/ Since that time, the leasing of both CBOE and Board of Trade seats has
been a commonplace and profitable venture for members and their lessees (called
"delegates" at the Board
(continued . . .)
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 32
to the Board of Trade's decision to permit its members to lease their trading
privileges, CBOE asserted that a Board of Trade member's Exercise Right would
terminate if the member delegated his or her floor access rights. The Board of
Trade challenged CBOE's position, asserting that the Exercise Right remained
with the original member. CBOE then amended its position, claiming that the
Exercise Right shifted to the delegate when a Board of Trade member leased his
or her trading privileges. CBOE's new interpretation was challenged in a lawsuit
by the Board of Trade and Alan Buckley, a Board of Trade member who exercised
his right to CBOE membership in 1973, but whose membership was terminated when
he delegated his daytime trading privileges at the Board of Trade. See Buckley
v. Chicago Bd. Options Exchange, Inc., 440 N.E.2d 914 (Ill. App. 1982).
In his suit, Buckley alleged that a Board of Trade member remained a
Board of Trade member upon leasing and therefore retained the Exercise Right
granted all Board of Trade members under Article Fifth(b). See Article Fifth(b)
(providing that every member of the Board of Trade, "so long as he remains a
member of said Board of Trade," shall be entitled to membership in CBOE).
Specifically, Buckley alleged that CBOE's termination of his membership violated
its own rules, including Article Fifth(b)./12/
--------
/11/ (. . . continued) of Trade).
/12/ Article Fifth(b) is an exchange rule, see 15 U.S.C. (S) 78a(27), with
which CBOE must comply under the 1934 Act, see 15 U.S.C. (S) 78s(g)(1).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 33
Although the court never reached the merits of Buckley's claims,/13/
CBOE did not submit a proposed rule for SEC approval concerning the right of
full member delegates to exercise. Instead, a decade later, CBOE bargained for
the Board of Trade's acceptance of this interpretation in the 1992
Agreement./14/ CBOE did so because it knew that it did not have the power
unilaterally to adopt such an amendment to the Exercise Right through a proposed
interpretation or rule change. CBOE's decision to bargain with the Board of
Trade rather than seek Commission approval of a sure to-be-challenged rule is
yet another example of how CBOE has either abandoned or amended interpretations
limiting the Exercise Right when pressed to defend them under Article Fifth(b)
and the Exchange Act. See Former Rule 3.16(c) (current Rule 3.16(b))
(incorporating the provision of the 1992 Agreement defining Board of Trade
"members" entitled to the Exercise Right as "an individual who is either an
'Eligible CBOT Full Member' or an 'Eligible CBOT Full Member Delegate'").
2. Rules 3.8(a) and 3.16(c).
CBOE's withdrawal of proposed Rules 3.8(a) and 3.16(c) in response to
Board of Trade challenges further demonstrates CBOE's awareness that it may not
unilaterally amend the
----------
/13/ The court dismissed the suit on preemption and exhaustion grounds. See
Buckley, 440 N.E.2d at 920.
/14/ The SEC did approve CBOE Rule 3.16(c) as called for under the 1992
Agreement between CBOE and the Board of Trade, which includes delegates in the
definition of eligible exercisers. See SEC Release No. 34-32430, 58 Fed. Reg.
32969-01 (June 14, 1993).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 34
Exercise Right in a proposed interpretation without violating Article Fifth(b).
In May 1987, in response to an increase in trading volume and customer demand,
the Board of Trade created an evening session for the open outcry trading of
certain futures contracts. Three years later, in May 1990, the Board of Trade
extended its delegation rules to permit members to delegate their floor access
rights to the evening trading session. For purposes of Board of Trade
membership, the delegator would remain a Board of Trade member authorized to
vote, hold Board of Trade offices, and trade in the Board's day session, while
the delegate would possess all of the member's evening trading privileges. In
response to the Board of Trade's expansion of its delegation provisions, CBOE
promulgated two proposed rules - Rule 3.8(a) and Rule 3.16(c) - that purported
to terminate the Exercise Right of Board of Trade members who leased their
evening trading privileges. When the rule changes were published, the Board of
Trade filed a series of objections with the Commission alleging that the
proposed rules: (1) discriminated against CBOE exercisers in a manner proscribed
by federal securities law; and (2) violated Article Fifth(b) by amending the
Exercise Right without the consent of 80% of both exerciser and regular CBOE
members. The content of the proposed rules, and the effect of the Board of
Trade's objections thereto, may be summarized as follows.
Rule 3.8(a). On May 3, 1990, CBOE submitted to the SEC proposed Rule
3.8(a), which authorized all individual CBOE members except those holding "non-
transferable" (i.e., exerciser) memberships to conduct business on the CBOE
through a designated nominee. The SEC requested comments on the proposed rule,
but granted accelerated approval of CBOE's proposal 16
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 35
days before the comment period closed. The Board of Trade nonetheless filed a
comment objecting to the new rule's arbitrary restriction of nominee powers to
non-exerciser members. Specifically, the Board of Trade argued that, in
discriminating between Board of Trade exercisers and other CBOE members, CBOE
failed to follow its own rules and thereby violated the federal securities laws.
Following the Board of Trade's filing of its objections with the SEC,
CBOE withdrew the challenged version of Rule 3.8(a) and instead adopted a new
version of the Rule that does not permit individual members, whether or not they
acquired their membership pursuant to the Exercise Right, to trade through
nominees. See SEC Release No. 34-28246, 55 Fed. Reg. 30772-01 (July 27, 1990)
(eliminating the "ability of an individual owner or lessee of a transferable
membership to authorize a nominee to represent his or her membership").
Rule 3.16(c) and the Arbor Dispute. On May 2, 1990, CBOE filed with
the SEC a revised paragraph (c) to Rule 3.16. Under the new rule, neither Board
of Trade members who leased their daytime or evening floor access privileges at
the Board of Trade nor their lessees could exercise the right to CBOE membership
guaranteed by Article Fifth(b). The rule change suggested that CBOE proposed new
paragraph (c) in response to the Board of Trade's decision on May 1, 1990, to
permit its members to delegate their floor access rights to the Board of Trade's
evening trading sessions. In its notice regarding the new rule, CBOE declared
that the new provision was effective immediately and did not require either
public comment or SEC consideration because the new paragraph was merely an
"interpretation" of an existing CBOE rule.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 36
The new Rule 3.16(c) precluded CBOT lessors and their delegates from
trading at CBOE because the Rule limited the Exercise Right to "full" Board of
Trade members, which CBOE defined as members holding "all the trading rights and
privileges afforded to Board memberships as in existence in February 4, 1972
(the date [CBOE's] Certificate of Incorporation was adopted) except for such
rights and privileges which [CBOE] may exclude." SEC Release No. 34-28756, 56
Fed. Reg. 1658 (January 16, 1991). Pursuant to CBOE's new interpretation of the
Rule, if a "full" member "leased, licensed, delegated or in any other fashion
transferred" any of its Board of Trade rights or privileges, neither the
transferor nor the transferee could exercise at CBOE.
Following its adoption of revised Rule 3.16(c), CBOE issued several
circulars advising that Board of Trade exercisers who leased their Board of
Trade evening trading privileges were at risk of losing their CBOE memberships.
Consistent with the new rule, on May 16, 1990, CBOE revoked Board of Trade
member Patrick Arbor's CBOE membership. Partly in response to CBOE's revocation
of Mr. Arbor's membership, the Board of Trade petitioned the SEC to abrogate the
new Rule 3.16(c) on the basis that it could not be enforced without public
comment and regulatory approval because it constituted a new substantive
limitation on, rather than a mere interpretation of, the Exercise Right
guaranteed in Article Fifth(b).
On June 18, 1990, the Board of Trade filed a detailed comment letter
with the SEC regarding Rule 3.16(c). The Board of Trade again implored the
Commission summarily to abrogate the rule, and ultimately to disapprove it, on
the basis that the Rule violated federal securities laws and
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 37
was inconsistent with Article Fifth(b) of CBOE's Certificate of Incorporation.
As the Board of Trade explained in its comment, Rule 3.16(c) unduly restricted
Board of Trade members' right to participate in CBOE by terminating the Exercise
Right for all members who leased any of their Board of Trade privileges pursuant
to Board of Trade rules. In addition, the Board of Trade argued that the Rule
impaired the Exercise Right in violation of the procedural provisions of Article
Fifth(b), which expressly require CBOE to obtain the approval of 80% of Board of
Trade exercisers in addition to 80% of other CBOE members before amending the
Exercise Right.
Approximately one week after the Board of Trade filed its objections
with the SEC, CBOE withdrew the Rule, which CBOE had initially claimed was
immediately effective as an "interpretation" of existing exchange rules, and
refiled it as a proposal for prior SEC review and approval./15/ Although CBOE
maintained that the amended filing was still an interpretation of existing CBOE
rules, CBOE stated that it would not enforce the rule until the earlier of
October 26, 1990, or the date the Commission acted on the proposal. CBOE then
notified Mr. Arbor that it would not terminate his CBOE membership during this
"moratorium" period even though the delegation of his evening trading privileges
constituted grounds for revoking his seat.
On August 10, 1990, the Board of Trade commented on CBOE's amended
proposal. In early November 1990, the SEC advised the Board of Trade that,
despite the passing of the October
--------
/15/ CBOE submitted File No. SR-CBOE-90-11 to the Commission on May 2,
1990, but withdrew the proposal after the Board of Trade objected to CBOE's
summary adoption of the Rule as an interpretation not subject to prior SEC
approval. See 58 Fed. Reg. 32969-01.
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Jonathan G. Katz
December 11, 2000
Page 38
26 deadline, CBOE would not enforce Rule 3.16(c) until the Commission approved
it. On January 2, 1991, CBOE effectively withdrew the rule by amending its
proposal to add an "interpretation" that restored the ability of Board of Trade
members to exercise their right to CBOE membership even if they delegated their
evening trading privileges at the Board of Trade. Under CBOE's "revised"
interpretation of proposed Rule 3.16(c), unless CBOE began evening trading hours
or the SEC otherwise approved a change to the rule, Board of Trade members who
delegated their evening trading privileges would remain "full" Board of Trade
members entitled to exercise their right to trade at CBOE. Although the new rule
remained the subject of a Board of Trade challenge, the SEC never ruled on the
revised proposal because CBOE withdrew it in its entirety when the Commission
approved the 1992 Agreement between CBOE and CBOT. See SEC Release No. 34-32430;
58 Fed. Reg. 32969.01, (June 14, 1993), at 32969 n.3 and 32970 (approving the
1992 Agreement and noting that CBOE agreed to "withdraw File No. SR-CBOE-90-21
upon Commission approval of the current rule proposal"). CBOE's treatment of its
leasing rule is thus yet another example of how CBOE periodically attempts to
amend the Exercise Right in violation of Article Fifth(b) only to retreat in the
face of a legal challenge by the Board of Trade.
D. The 1992 Agreement.
The Board of Trade's objections to CBOE's proposed Rule 3.16(c)
triggered the negotiations that led to the Agreement executed by the parties on
September 1, 1992. The Agreement,
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Jonathan G. Katz
December 11, 2000
Page 39
which constitutes a joint interpretation of Article Fifth(b) that is legally
binding on both CBOE and the Board of Trade, summarizes the dispute that led to
its adoption as follows:
WHEREAS, the parties, in their own capacity and on behalf of their
respective members, dispute the meaning of certain terms as used in
Article Fifth(b) and the nature and scope of the entitlement referred
to therein of a CBOT member to be a CBOE member (the "Exercise
Right"); and
WHEREAS, the parties, in their own capacity and on behalf of their
respective members, wish to resolve this dispute to their mutual
benefit, including to avoid the costs, delays, and uncertainties of
legal proceedings;
NOW, THEREFORE, in consideration of the foregoing and the mutual
promises and agreements contained herein . . . the parties, in their
own capacity and on behalf of their respective members, agree as
follows . . . .
Preamble, 1992 Agreement. (Exh. C)
As is evident from the Preamble and from the contract itself, both
CBOE and the Board of Trade made concessions in the Agreement. The Board of
Trade agreed to withdraw its challenge to CBOE's position that the Exercise
Right passes to a Board of Trade full member's delegate when the member leases
his or her trading privileges. See (Exh. C P. 2(a)) (noting that only Eligible
CBOT Full Members or their delegates are entitled to the Exercise Right). In
addition, the Board of Trade agreed that, in order to preserve the Exercise
Right, Board of Trade full members or their delegates would have to retain
possession of all rights and privileges appurtenant to CBOT full membership as
defined in the Agreement. See id. P. 2(b). (This provision meant that while
Article
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Jonathan G. Katz
December 11, 2000
Page 40
Fifth(b) referred to "every member" of the Board of Trade, and the Board of
Trade had created over the years four additional membership categories for
thousands of new members--Associate, GIM, IDEM and COM--to trade some, but not
all, Board of Trade contracts, the Exerciser Right would not extend to those new
membership classes.) The Board of Trade also agreed that exerciser members would
not have the right to transfer to third parties, whether by lease, sale, or
gift, their CBOE regular memberships or any of the attendant trading rights. See
id. (P)3(a). Finally, the Board of Trade agreed that only the 1402 Board of
Trade full memberships in existence at the time the Agreement was executed would
be considered "CBOT Full Memberships" entitled to the Exercise Right under
Article Fifth(b); no new memberships created by the Board of Trade would qualify
for the Exercise Right. See id. (P)2(c). In keeping with these obligations, the
Board of Trade promised to amend its rules and regulations in the form
prescribed in Paragraph 4(a) of the Agreement and to maintain effective records
of both delegations and new trading rights and privileges granted to CBOT Full
Memberships. See id. (P)2(c).
CBOE made several concessions in return for the Board of Trade's promises.
First, CBOE expressly agreed not to discriminate against Board of Trade
exercisers and affirmed that "all Exerciser Members, including Exerciser Members
who are Eligible CBOT Full Member Delegates, have the same rights and privileges
of CBOE regular membership as other CBOE Regular Members" except the right to
sell or otherwise transfer their CBOE regular memberships to third parties. Id.
(P)3(a). As CBOE noted in Paragraph 3(e), a "significant purpose of the
Agreement is to ensure that
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Jonathan G. Katz
December 11, 2000
Page 41
CBOE will not make any offer, distribution, or redemption to CBOE Regular
Members as a class which would have the effect of diluting the rights under
Article Fifth(b) of Eligible CBOT Full Members and Eligible CBOT Full Member
Delegates." Id. (P)3(e). To this end, CBOE promised to establish a "reasonable
record date for any offer, distribution or redemption subject to Paragraph 3(a)"
so that eligible Board of Trade members would have the opportunity to exercise
their right to CBOE membership in time to participate in such offers. Id.
(P)3(b).
In addition to guaranteeing the equal rights of Board of Trade exercisers,
CBOE specifically agreed that, "in the event the CBOT merges or consolidates
with or is acquired by or acquires another entity," the "Exercise Right of
Article Fifth(b) shall continue to apply and this Agreement shall continue in
force and effect" if:
(i) the survivor of such merger, consolidation or acquisition ("survivor")
is an exchange which provides or maintains a market in commodity futures
contracts or options, securities, or other financial instruments[;]
(ii) the 1,402 holders of CBOT Full Memberships are granted in such merger,
consolidation or acquisition membership in the survivor ("Survivor
Membership")[;] and
(iii) such Survivor Membership entitles the holder thereof to have full
trading rights and privileges in all products then or thereafter traded on
the survivor (except that such trading rights and privileges need not
include products that, at the time of such merger, consolidation or
acquisition, are traded or listed, designated or otherwise authorized for
trading on the other entity but not on the CBOT).
(Exh. C,(S)3(d)).
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Jonathan G. Katz
December 11, 2000
Page 42
In recognition of the foregoing promises, CBOE agreed to incorporate
certain provisions of the Agreement into a new version of Rule 3.16(c) and to
"rescind[] and withdraw[]" its previous proposal, which the Board of Trade had
challenged as contrary to both Article Fifth(b) and federal securities laws. Id.
(P)3(f). To that end, CBOE submitted for approval a new version of proposed Rule
3.16(c) incorporating the following provisions of the 1992 Agreement: (1) the
definition of "Eligible CBOT Full Member" as "an individual who is a holder of
one of the 1,402 existing CBOT full memberships (and only those memberships) who
is in possession of all trading rights and privileges appurtenant
[thereto];"/16/ (2) the definition of "Eligible CBOT Full Member Delegate" as
"the individual to whom a CBOT Full Membership is delegated (leased) and who is
in possession of all trading rights and privileges appurtenant [thereto];" (3)
the provision stating that the term "member of the Board of Trade of the City of
Chicago" refers only to Eligible CBOT Full Members and Eligible Full Member
Delegates; and (4) the provision stating that potential Board of Trade
exercisers are entitled to exercise their rights to CBOE membership in a manner
that will permit them to participate in CBOE offers, distributions or
redemptions on the same terms as other CBOE regular members. See SEC Release No.
34-31977, 58 Fed. Reg. 14453-02 (March 17, 1993) (incorporating by reference
selected portions of the 1992 Agreement).
--------
/16/ In defining the term "trading rights and privileges appurtenant to
CBOT Full Membership" the Agreement makes clear that CBOE must preserve the
Exercise Right so long as either Board of Trade Full Members or their Delegates
possess the right and privilege "to trade as principal and broker for others in
all contracts traded on the CBOT, whether by open outcry, by electronic means,
or otherwise, during any segment of a trading day." Exh. C, (P)1(c).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 43
Finally, and perhaps most importantly, CBOE agreed to interpret both
Article Fifth(b) and the Exercise Right "in accordance with the provisions of"
the 1992 Agreement. See Exh. C, (P)4(d) ("The parties mutually agree that it is
appropriate, and within the meaning and spirit of Article Fifth(b), for the CBOE
to interpret Article Fifth(b) in accordance with the provisions of this
Agreement"). In so doing, CBOE specifically agreed to limit its interpretive
authority over revised Rule 3.16(c) and Article Fifth(b). The import of CBOE's
contractual obligation is clear: even though Article Fifth(b) and revised Rule
3.16(c) are exchange rules subject to interpretation by CBOE, see 15 U.S.C. (P)
78a(27), CBOE may not construe these provisions in a manner that conflicts with
the 1992 Agreement. Any such interpretation would constitute a breach of the
Agreement, rather than a proper exercise of CBOE's interpretive authority,
because the 1992 Agreement is not an exchange rule, but an independent contract
enforceable by its own terms in a court of law. See Exh. C, (P)6(c) ("The
parties mutually agree that either party to this Agreement may bring suit . . .
to enforce the terms of this Agreement and to recover damages for any breach").
The contractual and legally enforceable nature of CBOE's promise to limit its
interpretive authority is further evidenced by the Agreement's remedy and choice
of law provisions, which establish that the parties contemplated enforcement of
the terms of the Agreement in the courts.
Recognizing that the proposed Board of Trade and CBOE rule changes
specified in the Agreement would be governed by federal law (the Commodity
Exchange Act and the Securities Exchange Act of 1934), the Agreement stated that
Illinois law would govern the remainder of the
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Jonathan G. Katz
December 11, 2000
Page 44
contract. Exh. C, (P)6(b). Thus, Illinois contract law governs enforcement of
all the terms of the Agreement not expressly incorporated in what is currently
CBOE Rule 3.16(b). See ibid. (stating that "[e]xcept to the extent that this
Agreement or any rule adopted pursuant [thereto] is governed by any law of the
United States . . ., this Agreement shall be governed by and construed in
accordance with the laws of the State of Illinois").
The SEC approved the 1992 Agreement and CBOE's implementing Rule 3.16(c) on
June 14, 1993, whereupon CBOE withdrew all previous submissions regarding the
proposed rule. See SEC Release No. 34-32430, 58 Fed. Reg. 32969-01 (June 14,
1993) (approving the 1992 Agreement and a revised version of CBOE's proposed
Rule 3.16(c) giving "effect to the Agreement" and "implement[ing] the
antidilution provisions, the notice requirements, and the fee and qualification
waivers of the Agreement"). Although CBOE recently amended and reorganized its
membership rules, see Order Approving Amended Proposal, SEC Release No. 34-
43056, 65 Fed. Reg. 46524 (July 28, 2000), the 1992 Agreement continues to
govern CBOE's interpretation of Article Fifth(b) and the Exercise Right. See
Rule 3.16(b) (November 18, 1999).
IV. RESTRUCTURING AND ELECTRONIC TRADING AT THE BOARD OF TRADE.
In recent years, the Board of Trade has enhanced its electronic trading
capabilities and developed plans to reorganize its business operations in order
to improve its ability to compete. Many futures exchanges today rely heavily, if
not exclusively, on electronic trading. Many futures
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 45
exchanges have also taken steps to demutualize and reorganize their business
operations as for profit corporations. The Board of Trade's efforts to modernize
its operations in these areas were undertaken to address these competitive
challenges. CBOE claims these same competitive developments are the catalysts
for terminating the Exercise Right in the manner described in the Proposed Rule
Change. A synopsis of the Board of Trade's restructuring plan and electronic
trading activities is therefore necessary for the Commission properly to
evaluate the proposed rule.
A. Restructuring.
For many years, the Board of Trade was a specially chartered not-for-profit
Illinois Corporation. In August 2000, as the first step of the restructuring
plan, the Board of Trade reincorporated in Delaware as the Board of Trade of the
City of Chicago, Inc., a nonstock, not-for-profit Delaware corporation. On
August 23, 2000, the Board of Trade also formed a wholly owned subsidiary called
Electronic Chicago Board of Trade, Inc. (eCBOT) in order to reorganize and
consolidate its electronic trading business, which is now operated in part by
Ceres Trading Limited Partnership.
The Board of Trade is currently preparing a Form S-4 registration statement
describing the balance of its restructuring transactions. When that filing is
made, we will ask the Commission to include the Form S-4 in the record of this
proceeding as a complete, authoritative description of the restructuring plan.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 46
The Board of Trade's restructuring plan calls for the demutualization of
the Board of Trade and its conversion into a stock, for profit Delaware
corporation. In that connection, the Board of Trade will distribute shares of
stock to its current members. As a for profit company, the Board of Trade will
have the ability to issue capital stock and to implement a number of value
enhancing strategies in the future, including, but not limited to, (1) a public
offering of stock in the for profit Board of Trade and/or its eCBOT subsidiary;
or (2) a complete separation of the for profit Board of Trade and eCBOT.
Under the restructuring plan, the for profit Board of Trade will have a
dual class capital structure. Each Board of Trade member will receive a number
of shares of Class A stock based upon an allocation methodology recommended by
an Independent Allocation Committee comprised of public directors and adopted by
the Board of Trade's Board of Directors. The shares of Class A common stock will
be subject to restrictions on transfer for the first 180 days following the
completion of the restructuring transactions, except that shareholders may
transfer their shares of Class A common stock during that period if such shares
are transferred together with the associated shares of Class B common stock.
After expiration of this 180 day period, the Class A common stock will be freely
transferable. The Board of Directors will be authorized to remove this transfer
restriction if it believes that removal would be appropriate.
In addition to Class A shares, each Board of Trade member will receive a
share of Class B stock representing an equity interest and a membership. Class B
stock will be issued in five
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 47
series. Each series of Class B stock will carry with it the trading rights and
privileges that correspond to the trading rights and privileges of one of the
five current classes of membership at the Board of Trade. The 1402 Full Members
of the Board of Trade will receive Series B-1 Common Stock. Like today, only
Full Members will be able to trade all futures and options listed on the Board
of Trade both electronically and by open-outcry during any segment of the
trading day. The Associate Members will receive Series B-2 Common Stock. Like
today, Associate Members will be able to trade as members only those futures and
options contracts listed on the Board of Trade in government instruments,
indexes, energy, debt and commodity options. The GIM Members will receive Series
B-3 Common Stock. Like today, GIM Members will be able to trade as members only
futures and options contracts listed on the Board of Trade in, generally,
government instruments and other debt instruments. The IDEM Members will receive
Series B-4 Common Stock. Like today, IDEM members will be able to trade as
members only in futures and options contracts listed on the Board of Trade in
securities-based indices, money market instruments and energy products. The COM
Members will receive Series B-5 Common Stock. Like today, COM Members will be
able to trade as members only those options contracts that are listed for
trading on the Board of Trade. No shares of Series B Common Stock will be
subject to transfer restrictions.
After the restructuring transactions are effectuated, just as today, only
the 1402 Full Members/Class B-1 Shareholders will be entitled to trade as
principal and broker for others in all contracts traded on the CBOT whether by
open outcry, electronic means, or otherwise, during any
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Jonathan G. Katz
December 11, 2000
Page 48
segment of a trading day. Thus, like today, only the 1402 Full Members of the
for profit Board of Trade (or their delegates) will have the Exercise Right.
B. Electronic Trading at the Board of Trade.
-----------------------------------------
Since 1992, the Board of Trade has operated two types of execution
facilities -- open outcry and electronic. Only Board of Trade members in the
appropriate membership category may execute trades in the open outcry trading
pits or on the electronic trading system. Nonmembers may trade in these markets,
but must give their orders to a member for execution.
The Board of Trade has made its futures contracts and related options
available for trading electronically since 1992, initially as part of the GLOBEX
system. In 1992, the Board of Trade also inaugurated electronic futures trading
on some contracts through a local area network system known as Project A.
Project A was operated through the electronic trading division of Ceres, a
Delaware Limited Partnership of which the Board of Trade is the General Partner.
Ceres limited partnership interests are held by Board of Trade members and
member firms of the Board of Trade Clearing Corporation.
In 1994, the Board of Trade transferred all electronic trading in its
products to the Project A System. Over the years, the products offered on
Project A expanded as did its time of operation. In October 1994, Project A was
available for trading Treasury Security futures and related options in an
afternoon session from 2:30 pm to 4:30 pm. In November 1995, Project A was
expanded to allow trading in Treasury Security futures in an overnight trading
session. In February 1996, agricultural futures contracts were added to the
evening trading session on Project A. In
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Jonathan G. Katz
December 11, 2000
Page 49
January 1998, the evening open outcry session at the Board of Trade was
eliminated and the hours of operation on Project A were expanded yet again.
Trading in Dow Jones Industrial Average futures contracts was then added to the
Project A trading session in April 1998.
In September, 1998, the Board of Trade began to offer side-by-side, or
simultaneous, electronic and open outcry trading in many of its contracts. At
that time, Project A's side-by-side trading was limited to Treasury Security
Futures. For well over two years, any Board of Trade full
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Jonathan G. Katz
December 11, 2000
Page 50
member that exercised the right to become a CBOE member could have traded on
CBOE's floor, on the Board of Trade's floor and on Project A during the course
of a single trading day.
In August 2000, Project A was discontinued. In its place, the a/c/e
system was launched. Under the a/c/e system all Board of Trade contracts,
including agricultural futures, are available for trading before and after the
daily open outcry session. The contracts traded in the a/c/e system and the
times when electronic trading may occur are reflected in the following chart
from the Board of Trade's web-site:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
A/C/E CBOT Hours London Frankfurt Tokyo Tokyo (During Non-
Platform (Chicago Time) (During Daylight Daylight Savings)/1/
(Sunday - Savings)/1/
Friday)
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- Financial 8:00 p.m. - 4:00 p.m. 2:00 a.m. - 10:00 p.m. 3:00 a.m. - 11:00 p.m. 10:00 a.m. - 6:00 a.m. 11:00 a.m. - 7:00 a.m.
-----------------------------------------------------------------------------------------------------------------------------------
- Equity 8:15 p.m. - 4:00 p.m. 2:15 a.m. - 10:00 p.m. 3:15 a.m. - 11:00 p.m. 10:15 a.m. - 6:00 a.m. 11:15 a.m. - 7:00 a.m.
-----------------------------------------------------------------------------------------------------------------------------------
- Metals 8:15 p.m. - 4:00 p.m. 2:15 a.m. - 10:00 p.m. 3:15 a.m. - 11:00 p.m. 10:15 a.m. - 6:00 a.m. 11:15 a.m. - 7:00 a.m.
-----------------------------------------------------------------------------------------------------------------------------------
- Ags 8:30 p.m. - 6:00 a.m. 2:30 a.m. - 12:00 p.m. 3:30 a.m. - 1:00 p.m. 10:30 a.m. - 8:00 p.m. 11:30 a.m. - 9:00 p.m.
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- Effective as of October 15, 2000
/1/ Chicago Daylight Savings starts on the first Sunday in April and ends on
the last Sunday in October. London and Frankfurt Dalight Savings starts on
the last Sunday in March and ends on the last Sunday in October. Tokyo does
not observe Daylight Savings.
24-Hour Time:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
A/C/E CBOT Hours London Frankfurt Tokyo Tokyo (During Non-
Platform (Chicago Time) (During Daylight Daylight Savings)/1/
(Sunday - Savings)/1/
Friday)
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- Financial 20:00 - 16:00 2:00 - 22:00 3:00 - 23:00 10:00 - 6:00 11:00 - 7:00
------------------------------------------------------------------------------------------------------------------------------------
- Equity 20:15 - 16:00 2:15 - 22:00 3:15 - 23:00 10:15 - 6:00 11:15 - 7:00
------------------------------------------------------------------------------------------------------------------------------------
- Metals 20:15 - 16:00 2:15 - 22:00 3:15 - 23:00 10:15 - 6:00 11:15 - 7:00
------------------------------------------------------------------------------------------------------------------------------------
- Ags 20:30 - 6:00 2:30 - 12:00 3:30 - 13:00 10:30 - 20:00 11:30 - 21:00
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- Effective as of October 15, 2000
/1/ Chicago Daylight Savings starts on the first Sunday in April and ends on
the last Sunday in October. London and Frankfurt Daylight Savings starts on
the last Sunday in March and ends on the last Sunday in October. Tokyo does
not observe Daylight Savings.
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Jonathan G. Katz
December 11, 2000
Page 51
As the chart shows, the Board of Trade's financial futures contracts still are
available through a/c/e during the trading day on a side-by-side basis with open
outcry trading in those contracts. The Board of Trade has actively considered
extending this side-by-side trading to the Board of Trade's agricultural futures
contracts as well, but has deferred now taking that action until the validity of
CBOE's recent Agricultural Product Amendment to the Exerciser Right has been
determined.
Since the launch of the a/c/e system, nonmembers that want to trade
Board of Trade products have enjoyed virtual direct access to Board of Trade
products electronically by connecting to a customer order routing system. These
orders are routed through a server located with a clearing member firm and, once
they pass that credit check, are entered into the a/c/e system. (Project A did
not permit this kind of customer order routing.)
Based on this system, Futures and Options Week recently described
Fimat, a brokerage firm, as having in place a mechanism that offers its clients
"direct access" to a/c/e as well as Globex, the Chicago Mercantile Exchange's
electronic trading system. (Exh. S) Indeed, Fimat itself claims that it has the
technology "to offer our customers instant access to the world's premier
exchange-traded derivatives." Thus, Fimat offers its customers direct access to
the Board of Trade's markets without any action by the Board of Trade to expand
access to the a/c/e system beyond its current members and member firms.
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Jonathan G. Katz
December 11, 2000
Page 52
C. Ceres Trading Limited Partnership.
----------------------------------
In 1992, the Board of Trade formed the Ceres Trading Limited
Partnership to initiate development of the Board of Trade's electronic trading
system. Ceres owns the electronic trading software, which it licenses to the
Board of Trade for the purpose of electronic trading and receives a licensing
fee from the Board of Trade for the electronic trading of the Board of Trade's
products, including those traded on the a/c/e system. When formed, the General
Partner of Ceres was the Board of Trade. Now the General Partner of Ceres is
eCBOT, the Board of Trade's electronic trading subsidiary. There are two classes
of Ceres limited partners. Class A limited partnership interests are held by
individual members of the Board of Trade. Class B limited partnership interests
are held by Board of Trade clearing member firms. From time to time since 1992,
these Ceres limited partners have received cash distributions from the
partnership.
In connection with restructuring, Ceres will be consolidated into For
Profit Board of Trade, with For Profit Board of Trade issuing shares of its
Series A preferred stock to the current limited partners of Ceres in exchange
for their limited partnership interests. The Series A preferred stock will not
be subject to any transfer restrictions.
V. THE HISTORY AND PRACTICE OF DUAL ACCESS.
----------------------------------------
In different fashions throughout the Preamble to its Proposed Rule
Change, CBOE insists that "CBOT members must choose at any given time to use
their CBOT membership to trade
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Jonathan G. Katz
December 11, 2000
Page 53
either on the CBOT or (by exercise) on the CBOE but not on both exchanges at the
same time." 65 Fed. Reg. at 69587. CBOE calls this limitation a "practical cost"
that has always been imposed on the use of the Exercise Right, and that has
operated to limit the number of exerciser members from 450 to 700 over the
years. Ibid. CBOE claims that preserving this "practical cost" was a principal
purpose of the 1992 Agreement.
A review of the operative documents and the practice of many CBOE
exerciser members reveals that the "practical cost" does not exist. Nothing in
Article Fifth(b) says that an exerciser member must forgo trading at the Board
of Trade. Nor does the 1992 Agreement impose such a restriction. To the
contrary, the 1992 Agreement requires every exerciser member at CBOE to have
right and privilege "to trade as principal and broker for others in all
contracts traded on the CBOT, whether by open outcry, by electronic means, or
otherwise, during any segment of the trading day. . . ." (Exh. C, P. 1(c)).
Even prior to 1992, both the Seventh Circuit and the Commission
concluded that exerciser members could trade at both CBOE and the Board of
Trade. See, e.g., Clement v. SEC, 674 F.2d 641, 643 (7th Cir. 1982) (noting that
the right to CBOE membership conferred upon Board of Trade members under Article
Fifth would be of "little value" to a Board of Trade member if "he were expected
to be on the floor of the CBOE on a full-time, or nearly full-time, basis"). As
the court observed in Clement, CBOE's pre-1980 market maker rules expressly
permitted trading on the CBOE and another exchange in the same day. See ibid.
(noting that the old rules enabled Board of
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 54
Trade members to "fulfill [their] obligations to the public on [the CBOT] as
well as "engage in a volume of trading on the CBOE"). Indeed, the court vacated
and remanded the Commission's order approving proposed Rule 8.7 on the basis
that the Commission failed to consider that the rule change could "result in
Clement and other [Board of Trade] members ceasing to trade as market makers on
the CBOE." Id. at 646-47.
The Commission also understood that exercisers could trade on both
exchanges. See SEC Release No. 21008, 49 Fed. Reg. 23721 (June 7, 1984)
(emphasizing in approving CBOE's 25% in-person trading requirement that the
requirement would not preclude Board of Trade exercisers from trading as market
makers on the CBOE because they could fulfill their obligations to other markets
on the same days they traded at CBOE either by routing off-floor orders to floor
brokers or by dividing their time between the two exchanges). In approving the
twenty-five percent rule, the Commission emphasized that CBOT and CBOE market
maker memberships were not mutually exclusive and even the seventy-five percent
in-person requirement was not anticompetitive because it did not prevent
exercisers from trading on both markets in the same day or trading period.
If all CBOE is saying in its Proposed Rule Change is that no one can
physically be in two places at the same time, CBOE is correct. But that really
isn't the issue. Today, any Board of Trade full member or any full member
delegate may become a CBOE member, trade at CBOE as a market-maker or broker
and, while at CBOE, use the telephone to trade on the Board of Trade's markets
at member rates. All the exerciser member needs to do is call another member of
the Board
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Jonathan G. Katz
December 11, 2000
Page 55
of Trade to execute the order. Or, any exerciser member at CBOE could just walk
across an internal bridge that links the buildings housing the two exchanges and
trade on the floors of both CBOE and the Board of Trade during the same day.
That goes on every day and has for many years.
Electronic trading has similarly allowed exerciser members to trade on
both exchanges since it was introduced in 1992. For example, an exerciser member
could trade on CBOE all day and at night trade electronically in Board of Trade
futures contracts on Project A or, now, the a/c/e system. That right or trading
privilege is available to full members of the Board of Trade in any contract
traded electronically and has been for years. Any exerciser member also could
trade at CBOE during the day and at the same time enter orders on the a/c/e
system in any of the financial futures contracts now traded electronically on a
side-by-side basis with open outcry markets. Indeed, some exerciser members are
CBOE members but trade only or predominantly at the Board of Trade. Board of
Trade Chairman David Brennan is one such member. No practical cost has precluded
Chairman Brennan from exercising his right to become a CBOE member, meeting all
applicable qualifications, and trading at the Board of Trade.
In sum, no practical bar or cost exists for exerciser members that
want to trade at both CBOE and the Board of Trade. In addition, no operative
legal document imposes such a restriction. The linchpin of CBOE's Proposed Rule
Change is therefore an apparition. The notion that CBOE may impose a cap on
Board of Trade exerciser memberships because in practice such a cap has always
existed has no basis in fact. Any of the 1402 Board of Trade full members today
could
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Jonathan G. Katz
December 11, 2000
Page 56
exercise their right to become a CBOE member, trade on CBOE's floor in
compliance with its rules, and at the same time trade as a member on the Board
of Trade either by open outcry or electronically.
VI. THE COMMISSION SHOULD DISAPPROVE PROPOSED RULE 3.16(c).01.
Section 19(b)(2) of the 1934 Act provides that the "Commission shall
approve a Proposed Rule Change of a self-regulatory organization if it finds
that such Proposed Rule Change is consistent with the requirements of this title
and the rules and regulations thereunder applicable to such organization. The
Commission shall disapprove a Proposed Rule Change of a self-regulatory
organization if it does not make such finding." Securities Exchange Act of 1934,
(S) 19(b)(2). Under this standard, the Commission should disapprove CBOE's
Proposed Rule Change.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 57
CBOE's proposal contains four substantive amendments to the Exercise
Right./24/ In its notice to the SEC, CBOE characterizes these amendments as
"interpretations" of existing exchange rules necessitated by the Board of
Trade's actions. Whether styled as "interpretations" or "amendments," CBOE's
substantial modifications to the Exercise Right cannot be approved consistent
with federal securities law.
CBOE does not have the authority unilaterally to amend Article
Fifth(b). That charter provision requires a class vote to amend the Exercise
Right. In an attempt to circumvent that exchange rule requirement, CBOE offers
its Proposed Rule Change as an interpretation of the Exercise Right, Article
Fifth(b) and Rule 3.16(b). Far from a legitimate interpretation, the Proposed
---------------------
/24/SEC Release No. 34-43521, 65 Fed. Reg. 69585. As discussed in greater
detail supra at 12-15, the four amendments to the Exercise Right effected by
CBOE's Proposed Rule Change are:
(1) The Stock Retention Amendment, which states that if, after
restructuring, any Board of Trade full member sells even one share of
Class A stock in the for profit Board of Trade that member would
forfeit the Exercise Right;
(2) The Customer Access Amendment, which states that the Exercise Right
will terminate immediately if the Board of Trade extends the right to
trade all CBOT products (whether electronically or otherwise) to
persons who are not CBOT full members or full member delegates;
(3) The Dual Access Amendment, which states that the Exercise Right will
terminate immediately if CBOE exerciser members have the ability to
trade at the Board of Trade at the same time they trade at CBOE; and
(4) The Agricultural Trading Amendment, which states that the Exercise
Right will terminate if agricultural futures contracts are traded
electronically during the day at the Board of Trade.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 58
Rule Change would invalidate the Exercise Right by rewriting Article Fifth(b)
and Rule 3.16(b). CBOE's proposal is predicated upon a fundamental misconception
both of existing practices at the Board of Trade and of the Board of Trade's
restructuring plan, violates existing exchange rules, unnecessarily burdens
competition, and unfairly discriminates against certain members of the CBOE in a
manner prohibited by federal law. See Securities Exchange Act of 1934
(S)(S) 6(b)(1) (a national securities exchange must comply with its own rules);
6(b)(5) (the rules of an exchange must, among other things, be designed "[to]
facilitat[e] transactions in securities, to remove impediments to and perfect
the mechanism of a free and open market system, and, in general, to protect
investors and the public interest"); and 6(b)(8) (the rules of an exchange may
not "impose any burden on competition not necessary or appropriate in
furtherance of the purposes of this Act"). The Commission should therefore
disapprove Rule 3.16(c).01 in accordance with Sections 6(b), 19(b)(2), and
19(g)(1) of the Exchange Act.
A. None of the Four Amendments in CBOE's Proposed Rule
Change May Be Approved Under the Exchange Act.
1. By Failing to Provide a Class Vote and by Attempting
to Impose a 700 Member Ceiling on Exercisers, CBOE's
Proposed Rule Change Conflicts With Existing Exchange
Rules in Violation of Section 6(b)(1) of the Exchange
Act.
Sections 6(b)(1) and 19(g)(1) of the Exchange Act require an exchange
to comply with its own rules. See Section 6(b)(1) (stating that a national
securities exchange will not be registered by the Commission unless it can
"comply . . . with the provisions of this Act, the rules and
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 59
regulations thereunder, and the rules of the exchange"); (S) 19(g)(1) ("Every
self-regulatory organization shall comply with the provisions of this Act, the
rules and regulations thereunder, and its own rules"). Thus, a rule change that
conflicts with an existing exchange rule cannot be approved under Section
19(b)(2) of the Exchange Act.
Proposed Rule 3.16(c).01 conflicts with existing CBOE rules in
violation of these provisions of the Act. CBOE's proposal would (1)
substantively amend the Exercise Right in Article Fifth(b) without securing the
class vote approvals required in that exchange charter provision and (2) deny
the Exercise Right to each of the 1402 Board of Trade members guaranteed that
right under Article Fifth(b) and CBOE Rule 3.16(b). Article Fifth(b) is a
special exchange rule that, by its explicit terms, may be amended only with 80%
approval of all exerciser and regular CBOE members voting as separate classes.
See Article Fifth(b) ("No amendment may be made with respect to this paragraph
(b) of Article FIFTH without the prior approval of not less than 80% of
[exerciser and regular members], each such category of members voting as a
separate class"). Unilateral modification of the Exercise Right through
interpretation of either Article Fifth(b) itself or a related exchange rule is
thus prohibited by Article Fifth(b)'s class voting requirements. CBOE itself has
conceded that the Article Fifth(b) class vote requirement applies to "any
change" or "modification" to the Exercise Right. (Exh. L at 2) (responding to a
question about the procedure for "detaching, retiring, or otherwise modifying"
the Exercise Right by stating that "any change in the right's terms must be
approved by an 80 percent vote of [exercise members]" (emphasis added)).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 60
Certainly, the CBOE's cap on the Exerciser Right and the four
accompanying amendments CBOE would make to that Right constitute changes or
modifications that must be adopted pursuant to the class vote requirements of
Article Fifth(b). Because CBOE never received the required class vote approvals,
its Proposed Rule Change violates exchange rules and must be disapproved.
The cap or ceiling that CBOE would impose on the Exercise Right
clearly contravenes existing exchange rules. Article Fifth(b) expressly states
that "every" Board of Trade member is entitled to the Exercise Right
"notwithstanding any limitation on the number of [CBOE] members." CBOE's
response that it is interpreting Article Fifth(b) "as interpreted in" existing
Rule 3.16(b) is unavailing, because the current rule expressly guarantees the
right of 1402 Board of Trade members to trade at CBOE. See, e.g., SEC Release
No. 34-32430, 58 Fed. Reg. 32969 (June 14, 1993) (approving the version of what
is currently Rule 3.16(b), which expressly recognizes the Exercise Right as
belonging to each holder of "one of the 1,402 existing CBOT full memberships").
There is thus no factual or legal basis for CBOE's assertion that permitting all
1402 members to exercise their right to CBOE membership "has never been
contemplated or allowed since the Exercise Right was first established." SEC
Release No. 34-43521, 65 Fed. Reg. at 69589.
If CBOE wishes to amend Article Fifth(b) to impose a cap on the number
of Board of Trade exercisers, it may do so by securing the requisite class vote
approvals. Its attempt to do so unilaterally in the guise of "interpreting"
existing rules must be rejected.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 61
2. CBOE's Proposed Rule Change is Anti-Competitive
in Violation of Section 6(b)(8) of the Exchange Act.
----------------------------------------------------
In addition to conflicting with existing exchange rules, Proposed Rule
3.16(c).01 imposes an unnecessary burden on competition in violation of Section
6(b)(8). The protections on the Exercise Right contained in Article Fifth(b)
further the goal, recognized by both Congress and the SEC in creating and
interpreting the Exchange Act, of eliminating unnecessary barriers to
participation in national securities markets. See S. Rep. No. 94-75, at 1;
42 Fed. Reg. 63974 (December 21, 1977). This policy is codified in Section
6(b)(8) of the Act, which requires that "[t]he rules of the exchange do not
impose any burden on competition not necessary or appropriate in furtherance of
the purpose of this Act." See also Clement v. Securities and Exchange Comm'n,
674 F.2d 641(7th Cir. 1982) (vacating and remanding the Commission's approval of
a CBOE rule because the Commission failed adequately to consider the rule's
anti-competitive effect on participation in the exchange).
CBOE's Proposed Rule Change unnecessarily burdens competition in
violation of Section 6(b)(8) because it unnecessarily limits the number of
exercisers who would otherwise compete with other CBOE market makers and
brokers. CBOE advanced the same anti-competitive argument when it attempted to
adopt the original Rule 3.16(c), which purported to extinguish the Exercise
Right when any Board of Trade full member leased his day or evening trading
privileges. See May 21, 1990, letter from Nancy R. Crossman, at 4 (Exh. T)
(stating that the leasing rule was necessary to guard against the "very serious
adverse consequences" that would result from an
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 62
"uncontrollable influx of hundreds of new members at the CBOE[] severely taxing
the capacity of the trading floor and seriously affecting the value of CBOE
memberships"). Then, as now, CBOE attempted unilaterally to amend the Exercise
Right to ensure that most "members of CBOT would continue to actively trade
mainly on the CBOT," ostensibly because doing so was necessary to maintain what
CBOE claimed was a critical "self-limitation on the number of CBOT members
actually using the facilities of the CBOE." Ibid. As previously discussed,
however, CBOE retreated from this anti-competitive, protectionist approach in
the face of legal challenges from the Board of Trade and instead adopted what is
currently Rule 3.16(b), which preserves the Exercise Right in a Board of Trade
member's delegate.
CBOE's proposal is also anticompetitive as a general matter because it
is designed to inhibit the Board of Trade's ability to modernize its business
operations and extend the benefits and market efficiencies of its electronic
trading to market participants throughout the world. While it is hard to imagine
a more anti-competitive target for a rule proposal, CBOE incredibly tells the
Commission that "CBOE does not believe that the Proposed Rule Change will impose
any burden on competition." 65 Fed. Reg. at 69590. Its blind eye causes CBOE to
identify no procompetitive benefits that would outweigh the decrease in the
volume and liquidity of CBOE trading effected by the proposed rule or its
actions to restrain competition at the Board of Trade. The requirements of
Section 6(b)(8) of the Exchange Act compel disapproval of CBOE's Proposed Rule
Change.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 63
3. CBOE's Proposed Rule Change is Discriminatory in
Violation of Section 6(b)(5) of the Exchange Act.
-------------------------------------------------
CBOE's Proposed Rule Change also unfairly discriminates against
exerciser members in violation of Section 6(b)(5) of the Exchange Act. Section
6(b)(5) provides that rules of a national securities exchange shall not be
"designed to permit unfair discrimination between customers, issuers, brokers,
or dealers." 15 U.S.C. (S) 78f(b)(5) (1976). The Commission has long recognized
that Article Fifth(b) vests Board of Trade exercisers with "all rights and
privileges" of CBOE membership. SEC Release No. 34-21008, 50 Fed. Reg. 20310
(June 1, 1984). Indeed, in its initial registration application to the SEC, CBOE
stated that, except for transferability, "[i]n all other respects, the rights of
all members of the Exchange are identical." SEC Form 1 at 3 (Exh. K); see also
SEC Release No. 34-28246, 55 Fed. Reg. 30772 n.2 (July 27, 1990) (stating that
"Article Fifth of the CBOE Certificate of Incorporation grants individual CBT
members the right to become a full CBOE member, with all the rights and
privileges afforded all other individual CBOE members. . . .").
CBOE's Proposed Rule Change is discriminatory in violation of Section
6(b)(5) because it penalizes exerciser members for participating in other
markets when such participation is not precluded by Article Fifth(b) or existing
Rule 3.16(b). If adopted, CBOE's proposed interpretation would unfairly
discriminate against Board of Trade exerciser members by forcing them to choose
between trading on the CBOE and trading on the Board of Trade while allowing all
other CBOE members, if they are members of other exchanges, to trade on those
exchanges as they see
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 64
fit. CBOE's Proposed Rule Change would thus unfairly discriminate against Board
of Trade exercisers in violation of Section 6(b)(5) of the Exchange Act. Compare
49 Fed. Reg. 23721 (June 7, 1984) (approving CBOE's rule requiring that twenty-
five percent of a market maker's total options transactions be executed in
person precisely because it did not discriminate among CBOE members, but "[o]n
its face, the proposed in-person rule applies to all members equally" and would
have a positive "net effect" on the options market).
Unlike the in-person market maker rule that the Commission approved in
1984, Proposed Rule 3.16(c).01 does not "on its face . . . appl[y] to all
members equally," but imposes heretofore nonexistent restrictions on exerciser
members that it does not impose on other CBOE members. Id. at 23724. For
example, the proposal's Stock Retention and Dual Access Amendments impose
restrictions unique to Board of Trade exerciser members because CBOE does not
restrict the right of any other member to sell equity interests that are
unrelated to CBOE membership, nor does it attempt to limit other members' right
to participate in other markets. Because these restrictions are not only
unnecessary to protect CBOE's resources, but are contrary to existing exchange
rules (and even the 1992 contract, see, infra at 88-96), Rule 3.16(c).01 cannot
be approved consistent with Section 6(b)(5) of the Exchange Act.
B. CBOE's Stock Retention Amendment May Not Be
Approved Under the Exchange Act.
-------------------------------------------
Selling stock in an exchange is not a "trading right or privilege."
Nevertheless, the Stock Retention Amendment in CBOE's Proposed Rule Change would
condition preservation of the
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 65
Exercise Right on a member's retention of all shares of its Class A stock in the
restructured Board of Trade. At a minimum, this Amendment to the Exercise Right
(1) violates exchange rules (notably Article Fifth(b)) because it was adopted
without a class vote, (2) imposes an undue burden on competition, and (3) harms
the public interest by unduly restricting potential markets in securities
(specifically Class A shares). In addition, the terms and stated basis for
CBOE's amendment run contrary to existing CBOE Rule 3.16(b), which was approved
in connection with the 1992 Agreement. For these reasons, the Proposed Rule
Change should be disapproved.
CBOE Rule 3.16(b) states that for purposes of the Exercise Right in
Article Fifth(b), "the term 'member of the Board of Trade of the City of
Chicago' ... as used in Article Fifth(b), is interpreted to mean an individual
who is either an 'Eligible CBOT Full Member' or an 'Eligible CBOT Full Member
Delegate,' as those terms are defined in the [1992 Agreement]." The 1992
Agreement defines an "Eligible CBOT Full Member" as "an individual who at the
time is the holder of one of the One Thousand Four Hundred Two (1,402) existing
CBOT full memberships ("CBOT Full Memberships") and who is in possession of all
trading rights and privileges appurtenant to such CBOT Full Membership." (Exh.
C). The 1992 Agreement then defines an "Eligible CBOT Full Member Delegate" as
"the individual to whom a CBOT Full Membership is delegated (leased) and who is
in possession of all trading rights and privileges
--------------------
/25/For completeness, the Commission should note that these same
definitional provisions were
(continued...)
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Jonathan G. Katz
December 11, 2000
Page 66
appurtenant to such CBOT Full Membership" to mean "(1) the rights and privileges
of a CBOT Full Membership which entitle a holder or delegate to trade as
principal and broker for others in all contracts traded on the CBOT, whether by
open outcry, by electronic means, or otherwise, during any segment of a trading
day when trading is authorized; and (2) every trading right or privilege
granted, assigned or issued by CBOT after the effective date of this Agreement
to holders of CBOT Full Memberships, as a class, but excluding any right or
privilege which is the subject of an option granted, assigned or issued by CBOT
to a CBOT Full Member and which is not exercised by such CBOT Full Member."
(Exh. C).
None of these terms suggests that if a Board of Trade full member
sells stock in the for profit Board of Trade he will no longer have "all trading
rights and privileges appurtenant to such CBOT membership." Thus, CBOE's Stock
Retention Amendment is not consistent with these terms at all, but is a
substantive revision that imposes a new requirement on the Exercise Right in
violation of an existing CBOE rule.
Rather than conform to the terms of its rules, CBOE's Proposed Rule
Change purports to interpret provisions of the 1992 Agreement other than those
incorporated into Rule 3.16(b). CBOE believes that contract authorizes it to
recast the terms of Article Fifth(b) and Rule 3.16(b). In fact, the contract
does just the opposite. In Paragraph 4(b) of the 1992 Agreement,
------------------
/25/(...continued)
embodied in Board of Trade Regulation 210.00 which was adopted, submitted to the
CFTC and made effective in 1992.
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Jonathan G. Katz
December 11, 2000
Page 67
CBOE agreed not to amend or modify Rule 3.16(b) "in any way" "without the
written consent of the CBOT." Thus, the contractual provision CBOE relies upon
to justify its unilateral revisions to Article Fifth(b) and Rule 3.16(b)
actually precludes CBOE from that action, in much the same manner that the class
vote procedure in Article Fifth(b) operates to limit CBOE's power to amend the
Exercise Right.
Even if CBOE may, contrary to the 1992 Agreement, unilaterally "amend
or modify" Rule 3.16(b), the contract can not be read as CBOE suggests./26/
Nothing in the contract allows CBOE to modify the Exerciser Right so that if,
following the Board of Trade's restructuring, any full member sells even one
share of the Class A stock it receives in the restructuring transactions, the
Exercise Right terminates. CBOE cites Paragraph 2(b) of the 1992 Agreement,
which specifies that:
[I]n the event the CBOT splits or otherwise divides CBOT Full
Memberships into two or more parts, all such parts and the trading
rights and privileges appurtenant thereto shall be deemed to be part
of the trading rights and privileges appurtenant to such CBOT Full
Memberships and must be in the possession of an individual as either
an Eligible CBOT Full Member or an Eligible CBOT Full Member Delegate
to be eligible to be an Exercise Member.
(Exh. C, (P) 2(b)) (emphasis added).
CBOE's attempt to "interpret" the term "CBOT Full Membership" to
encompass equity rights that did not exist at the time the definition was
adopted stretches the meaning of the
------------------
/26/ To be clear again, the Board of Trade believes that the contract
issues should be resolved by the courts. We are responding here to CBOE's use of
the contract. We believe CBOE's Proposed Rule Change violates the Exchange Act,
independent of its constituting a breach of the 1992 Agreement.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 68
term beyond all plausible bounds. CBOE's interpretation, which fails as a matter
of both logic and law, is contrary to Section 6(b) of the Exchange Act and
should not be approved./27/
1. Paragraph 2(b) of the 1992 Agreement Does Not Prevent the
Transfer of Purely Equitable Interests Such As Class A Shares.
--------------------------------------------------------------
The Commission has recognized that the definition of the term "Full
Membership" in existing Rule 3.16(b) concerns the ability to "trade as a
principal and broker in all contracts by open outcry or electronically during
any segment of the trading day." SEC Release No. 34-32430, 58 Fed. Reg. 32969
(June 14, 1993) (approving the current version of Rule 3.16(c)) (Exh. D). This
definition cannot legitimately be read to involve in any way holding or selling
equity shares in CBOT as a "trading right or privilege" that must be retained by
a CBOT full member in order to preserve the Exercise Right in the event of
restructuring. The fact that the restrictions in Paragraph 2(b) do not pertain
to ownership rights such as Class A shares is also evidenced by CBOE's
insistence, as
--------------------
/27/ CBOE's interpretation of the 1992 Agreement is internally
inconsistent. In its proposal, CBOE asserts that, "after the CBOT restructures
as a for profit stock corporation, the CBOT no longer will have members, because
the CBOT will no longer be a membership corporation." Proposed Rule, 65 Fed.
Reg. At 69589. CBOE then asserts that, by "destroying its membership structure,
the CBOT will have made it impossible for its former members to hold 'all
trading rights and privileges appurtenant to such CBOT Full Membership,' a
requirement that Paragraphs 1(a) and 2(b) [of the 1992 Agreement] established as
a fundamental prerequisite to the continued existence of the Exercise Right."
Ibid. CBOE goes on to note, however, that "notwithstanding" all this, it "does
not interpret the Exercise Right as having been extinguished if the CBOT only
takes th[e] single reorganization step" of converting "from a membership to a
stock corporation." Ibid. Perhaps CBOE realizes that the for profit Board of
Trade will have members after restructuring. The holders of each series of Class
B common stock will have trading rights and privileges that correspond to their
trading rights and privileges today. They will be members of the Board of Trade
subject to its self-regulatory authority just as they are today.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 69
codified in CBOE Rule 3.16(b), that Board of Trade delegates are entitled to the
Exercise Right because they hold all trading privileges "appurtenant to" Board
of Trade membership even though they do not possess any of a full member's
ownership or voting interests. See Rule 3.16(b). If the bundling precondition to
preserving the Exercise Right meant that an individual had to possess all the
trading rights and privileges of membership as well as all equitable interests,
delegates would not be entitled to exercise.
That the "holding all rights" requirement for exercise is restricted
to rights that involve true trading privileges is further evidenced by CBOE's
concession that the restrictions in Paragraph 2(b) of the 1992 Agreement do not
apply to Board of Trade members' limited partnership interests in Ceres, which
were also created in 1992. See Exh. C, (P) 3(d) (making no mention of equity or
other ownership interests in setting forth the requirements for preserving the
Exercise Right in the event of CBOT's restructuring). Before the 1992 Agreement
was adopted, both CBOE and the Board of Trade submitted it to their members for
approval. In a question and answer document circulated to members of both
exchanges,/28/ the question was asked whether the provisions of the 1992
Agreement governing the Exercise Right applied to Board of Trade members'
limited partnership interests in Ceres. As CBOE is well aware, the answer was
unequivocally "no" because Ceres interests "are not trading rights or privileges
and are therefore not subject to the Agreement." Q&A p.3 (Exh. C) (emphasis
added).
------------------
/28/ See June 1, 1992, letter from Scott Early to Burton R. Rissman, Esq.,
counsel for CBOE (providing the Q&A to counsel for use with CBOE) (Exh. U).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 70
The parties' understanding that the 1992 Agreement was inapplicable to
Ceres limited partnership interests seriously undermines CBOE's assertion that
the sale of Class A shares would terminate the Exercise Right. The Board of
Trade's planned restructuring offers another convincing illustration. Ceres
Limited Partnership interests in the Board of Trade's electronic trading
business, which all agree were not implicated by the 1992 Agreement, will be
exchanged for Series A preferred stock, under the current formulation. Under
CBOE's position, any sale of that stock by a Full Member would terminate the
Exercise Right, a strange twist given the accepted fact that Ceres limited
partnership interests were not subject to the 1992 Agreement since they did not
involve trading rights and privileges.
CBOE's assertion in its Proposed Rule Change that it is "interpreting"
existing Rule 3.16(b) in stating that a member must possess all equitable
interests associated with Board of Trade membership in order to preserve the
Exercise Right is simply implausible in light of the plain text of the Agreement
and Article Fifth(b). If CBOE wishes to amend the term "every member" in Article
Fifth(b) and the term every "Eligible CBOT Full Member" in existing Rule 3.16(b)
to mean "any member who retains all trading and equitable interests attending
Board of Trade membership," it may do so only by obtaining the requisite class
vote approvals under Article Fifth(b) and obtaining the requisite written Board
of Trade consent under Paragraph 4(b) of the 1992 Agreement. It may not do so
through a unilateral "interpretation" of the Agreement that amends Article
Fifth(b) and Rule 3.16(b) in violation of federal securities law.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 71
2. Restructuring Will Not Split or Divide Full
Memberships Under the 1992 Agreement.
-------------------------------------------
As is apparent from the text of Paragraph 2(b) of the 1992 Agreement,
the phrase "split or divide" implies taking something that already exists and
breaking it up into pieces or portions. That "something" for purposes of
Paragraph 2(b) of the 1992 Agreement is the then "existing CBOT full
membership." See Exh. C (P) (a) (defining "CBOT Full Membership" to mean one of
the One Thousand Four-Hundred Two (1402) existing CBOT full memberships"). A
"split or divide" of the then existing membership is simply not accomplished
when a Board of Trade member sells a share of Class A stock. Class A shares are
equitable interests (distributed to members in the form of dividends) that did
not exist when Paragraph 2(b) was written. In addition, neither the distribution
nor the sale of such interests in any way implicates trading rights or
privileges with which the 1992 Agreement was concerned, much less effects a
division of trading rights and privileges appurtenant to membership that would
extinguish the Exercise Right under the Paragraph 2(b).
After restructuring, trading rights and privileges will be implicated
only by Class B stock. Specifically, only 1402 shares of Class B Series B-1
stock will be issued, one for each current full membership. As a comparison of
full members' trading rights and privileges before and after restructuring
reveals, restructuring will not split or divide a full member's trading rights
and privileges:
CBOT Full Member's Exclusive Trading Rights and Privileges
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 72
<TABLE>
<CAPTION>
Following Execution of the 1992 Agreement Following CBOT's Restructuring
----------------------------------------- ------------------------------
<S> <C>
. 1402 Full Members . 1402 Full Members holding Series
B-1 stock
. Broker and trade any CBOT contract . Broker and trade any CBOT contract.
. Lease CBOT trading rights . Lease CBOT trading rights
. Exercise Rights . Exercise Rights
. Voting rights . Voting rights
. Liquidation rights . Liquidation rights
. Ability to sell trading rights for profit . Ability to sell trading rights for profit
</TABLE>
As is evident from the foregoing comparison, the 1402 CBOT full
members who currently have the right to trade by open outcry and electronically
in all CBOT contracts as principals and brokers, whose trading rights may be
leased or sold, and who possess the right to CBOE membership under Article
Fifth(b) will retain all of these privileges following the creation of the for
profit Board of Trade. CBOE's Proposed Rule Change thus depends on an
interpretation of Paragraph 2(b)'s reference to "trading rights and privileges"
that is broader than the text will bear. See SEC Release No. 34-43521, 65 Fed.
Reg. at 69589. CBOE's attempt unilaterally to impose a condition on the Exercise
Right in response to the potential distribution of Class A shares has nothing to
do with Paragraph 2(b) of the 1992 Agreement or with CBOT members' trading
rights and privileges and thus cannot be approved as an "interpretation" of
Article Fifth(b) consistent with Section 6(b) of the 1934 Act.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 73
3. Even if Class A Shares Could Be Considered Trading Rights,
CBOE's Proposed Rule Change Could Not Be Approved
Consistent with Section 6(b) of the Exchange Act.
----------------------------------------------------------
Even if Class A shares were to be considered "trading rights and
privileges" appurtenant to Board of Trade full membership (as CBOE argues), a
member's decision to sell these shares would not terminate the Exercise Right
under Paragraph 2(b) of the 1992 Agreement. This is because, under the Board of
Trade's restructuring proposal, the distribution of Class A shares would not be
limited to full members. Although Associate members, as well as membership
classes known as GIMs, IDEMs and COMs, will receive fewer shares than full
members, all Board of Trade members will receive the same Class A stock, which
will be distributed to all members as a dividend regardless of the full or
limited nature of each member's trading privileges.
The fact that full members are not the only stockholders that will
receive Class A shares defeats CBOE's reliance on Paragraph 2(b) of the 1992
Agreement. As is clear from the answer to Question 11 in the Q&A regarding the
1992 Agreement that was approved by CBOE and distributed to CBOE's membership,
if a new trading privilege is made available to a "significant number of non-
Full Members on the same terms on which it is offered to Full Members," then the
full members do not have to retain possession of this privilege to preserve the
Exercise Right under Paragraph 2(b) of the Agreement. (Exh. C, Q&A at 3)./29/
Thus, even if Class A shares could
------------------
/29/ The precise text of question and answer 11 is as follows:
Q- What if the CBOT offers new trading privileges available to more than
just Full
(continued . . . )
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 74
properly be considered "trading rights and privileges appurtenant to full
membership," a member's decision to sell his or her shares would not terminate
the Exercise Right under Paragraph 2(b) of the 1992 Agreement because Class A
shares are distributed not just to a "significant number of non-Full Members,"
but to all non-Full Members of the Board of Trade in the same manner as they are
distributed to Full Members. Ibid.
CBOE's attempt to restrict the Exercise Right under the guise of
"interpreting" existing rules and definitions is not only disingenuous -- it is
prohibited under the class voting requirements in Article Fifth(b) and is
incompatible with the terms of Rule 3.16(b), especially in light of CBOE's
contractual obligation not to amend or modify that rule "in any way" without the
Board of Trade's written consent. Because CBOE's proposed prohibition on the
sale of Class A shares contravenes both Article Fifth(b) and the definition of
"Eligible CBOT Full Member" in existing Rule 3.16(b), the Proposed Rule Change
cannot be approved consistent with Sections 6(b)(1) and 19(g)(1) of the Exchange
Act.
--------------------
/29/ (...continued)
Members as a class; would a Full Member be required to have the new
trading privilege to exercise at the CBOE?
A- No, if the option is offered to a significant number of non-Full
Members on the same terms on which it is offered to Full Members. Only
when the new trading privilege is part of a benefit given to Full
Members as a class must it be possessed in order to exercise at CBOE.
(Exh. C, Q&A at 3).
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 75
C. The Dual Access Amendment Should Not Be Approved.
-------------------------------------------------
CBOE's Dual Access Amendment provides that the Board of Trade's
business decision to upgrade its electronic trading capability will terminate
the Exercise Right because the "reformulated electronic trading facility . . .
would afford CBOT members (or their delegates) the ability to trade CBOT
products at the same time as they are trading on CBOE pursuant to the Exercise
Right." SEC Release No. 34-43521, 65 Fed. Reg. 69585, 69588. This aspect of
CBOE's Proposed Rule Change should not be approved for two reasons. First,
CBOE's proposed "interpretation" would effect a substantive amendment to the
Exercise Right in violation of the "every present and future" member of the
Board of Trade requirement of Article Fifth(b), as well as its class vote
requirement, because exerciser members have always been permitted to continue
trading at the Board of Trade after becoming CBOE members. Second, the rule
change violates multiple provisions of the 1934 Act because CBOE's admittedly
anti-competitive justification for proposing it is to prevent 1402 Board of
Trade members expressly granted the right to become CBOE members from exercising
that right. See 65 Fed. Reg. at 69589./30/ One is hard-pressed to imagine any
justification that could be in greater conflict with Section 6(b) of the
Exchange Act.
------------------
/30/Specifically, CBOE asserts that, as a result of the Board of Trade's
restructuring, "CBOT members (or stockholders) would no longer have to choose at
any given time between trading CBOT products as members or stockholders of that
exchange or trading CBOE products as exerciser members of the CBOE" and that "if
the exercise right were not extinguished in the face of these changes, it is
probable that all 1402 of the present full members of CBOT, or their lessees,
would chose to exercise to trade on the CBOE, since they could do so while
retaining trading access to all CBOT products by means of the electronic trading
facility." 65 Fed. Reg. at 69589.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 76
CBOE's decision to destroy a legal right out of fear that it might be properly
exercised is not only anti-competitive and contrary to the public interest, it
is a violation of CBOE's own rules that cannot be upheld consistent with Section
6(b)(1) of the Exchange Act.
Contrary to CBOE's assertion, Article Fifth(b) and CBOE Rule 3.16(b)
do not even suggest, much less mandate, that Board of Trade members who exercise
their right to trade on CBOE may not continue to trade at the Board of Trade.
Board of Trade exercisers have always traded on both exchanges, and do today,
consistent with Article Fifth(b) and without objection from CBOE:
. Since 1972, Board of Trade exerciser members have been able to trade
at CBOE during the day while at the same time executing orders at the
Board of Trade by telephone or messenger or spending part of the day
at either exchange (exerciser members also could serve as brokers on
both markets);
. Since 1987, when the Board of Trade instituted its evening session,
exerciser members have been able to trade on both exchanges by trading
on CBOE during the day and at the Board of Trade at night;
. Since 1992, exerciser members have been able to trade on CBOE during
the day and trade electronically in Board of Trade products through
the GLOBEX (until 1994) and Project A electronic trading platforms;
and
. Since 1998, exerciser members have been able during normal trading
hours at CBOE to use the Project A system and, more recently, the
a/c/e platform to trade financial
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 77
products at the Board of Trade side-by-side with the pit trading of
those products at the Board of Trade./31/
CBOE is thus incorrect in asserting that the Board of Trade's restructuring or
enhanced electronic trading capability will confer upon exerciser members the
unprecedented ability to trade on both
------------------
/31/ As evidenced by the following chart, various Board of Trade contracts
are currently available for trading on the a/c/e system during regular trading
hours at CBOE and the Board of Trade.
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
A/C/E CBOT Hours London Frankfurt Tokyo Tokyo (During Non-
Platform (Chicago Time) (During Daylight Daylight Savings)/1/
(Sunday - Savings)/1/
Friday)
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- Financial 8:00 p.m. - 4:00 p.m. 2:00 a.m. - 10:00 p.m. 3:00 a.m. - 11:00 p.m. 10:00 a.m. - 6:00 a.m. 11:00 a.m. - 7:00 a.m.
-----------------------------------------------------------------------------------------------------------------------------------
- Equity 8:15 p.m. - 4:00 p.m. 2:15 a.m. - 10:00 p.m. 3:15 a.m. - 11:00 p.m. 10:15 a.m. - 6:00 a.m. 11:15 a.m. - 7:00 a.m.
-----------------------------------------------------------------------------------------------------------------------------------
- Metals 8:15 p.m. - 4:00 p.m. 2:15 a.m. - 10:00 p.m. 3:15 a.m. - 11:00 p.m. 10:15 a.m. - 6:00 a.m. 11:15 a.m. - 7:00 a.m.
-----------------------------------------------------------------------------------------------------------------------------------
- Ags 8:30 p.m. - 6:00 a.m. 2:30 a.m. - 12:00 p.m. 3:30 a.m. - 1:00 p.m. 10:30 a.m. - 8:00 p.m. 11:30 a.m. - 9:00 p.m.
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- Effective as of October 15, 2000
/1/Chicago Daylight Savings starts on the first Sunday in April and ends on
the last Sunday in October. London and Frankfurt Daylight Savings starts
on the last Sunday in March and ends on the last Sunday in October.
Tokyo does not observe Daylight Savings.
24-Hour Time:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
A/C/E CBOT Hours London Frankfurt Tokyo Tokyo (During Non-
Platform (Chicago Time) (During Daylight Daylight Savings)/1/
(Sunday - Savings)/1/
Friday)
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- Financial 20:00 - 16:00 2:00 - 22:00 3:00 - 23:00 10:00 - 6:00 11:00 - 7:00
-----------------------------------------------------------------------------------------------------------------------------------
- Equity 20:15 - 16:00 2:15 - 22:00 3:15 - 23:00 10:15 - 6:00 11:15 - 7:00
-----------------------------------------------------------------------------------------------------------------------------------
- Metals 20:15 - 16:00 2:15 - 22:00 3:15 - 23:00 10:15 - 6:00 11:15 - 7:00
-----------------------------------------------------------------------------------------------------------------------------------
- Ags 20:30 - 6:00 2:30 - 12:00 3:30 - 13:00 10:30 - 20:00 11:30 - 21:00
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- Effective as of October 15, 2000 /1/Chicago Daylight Savings starts on
the first Sunday in April and ends on the last Sunday in October. London and
Frankfurt Daylight Savings starts on the last Sunday in March and ends on the
last Sunday in October. Tokyo does not observe Daylight Savings.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 78
exchanges and will thereby extinguish the Exercise Right. In fact, if CBOE's
Dual Access Amendment were to be applied now, and not considered to be a new
requirement, the Exercise Right would already be terminated and would have been
for many decades. Moreover, the Dual Access Amendment is incompatible with
market conditions that existed even when CBOE was founded, as the Commission
itself has recognized.
CBOE's position regarding simultaneous trading is not only factually
incorrect, but utterly inconsistent with the fact that the Exercise Right has
value for Board of Trade members precisely because it permits them to trade at
CBOE as well as maintain their obligations to other exchanges and markets,
notably the Board of Trade. As the Seventh Circuit observed in Clement v.
Securities and Exchange Comm'n, 674 F.2d 641 (7th Cir. 1982), the right to CBOE
membership conferred upon Board of Trade members under Article Fifth would be of
"little value" to a Board of Trade member if "he were expected to be on the
floor of the CBOE on a full-time, or nearly full-time, basis." Id. at 643. CBOE
initially addressed this problem by creating two classes of market maker
appointments. See former Rules 8.7(b); 8.3.02. Although CBOE's dual market maker
structure has since been eliminated, see 49 Fed. Reg. 23721, 23723 (June 7,
1984), the Commission approved the two classes of appointments in 1973 knowing
that they permitted Board of Trade members to reap the benefit of the Exercise
Right while participating in other markets. See Securities Exchange Release No.
9985, 1 S.E.C. Doc. 11 (Feb. 1, 1973). The Commission further recognized
exerciser members' right to trade on both exchanges in 1984 when it noted in
approving CBOE's amended in-person market maker rule that the rule was not
anticompetitive even though it
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 79
burdened exerciser members whose obligations at the Board of Trade often kept
them away from the CBOE floor because it placed the burden on exerciser and
regular CBOE members equally. See 49 Fed. Reg. 23721, 23723 (June 7, 1984). As
the Seventh Circuit observed in Clement, CBOE's market marker rules enabled
Board of Trade members to "fulfill [their] obligations to the public" by trading
on the CBOT as well as to "engage in a volume of trading on the CBOE that made
[their] market making economically viable." Clement, 674 F.2d at 643.
As is clear from both the Commission's longstanding recognition of an
exerciser member's ability to continue trading at the CBOT and the parties'
failure to restrict the dual access privilege in existing Rule 3.16(b), the
Board of Trade's current restructuring proposal simply maintains the historical
right of exerciser members to trade both at the Board of Trade and at CBOE. The
Commission should disapprove CBOE's Dual Access Amendment because it is not an
interpretation of Article Fifth(b) or existing Rule 3.16(b), but a substantive
amendment that conflicts with, and requires class votes under, Article Fifth(b).
Just as CBOE cannot unilaterally interpret the term "every member" in Article
Fifth(b) or the term "Full Member" in existing Rule 3.16(b) to mean "every
member who retains all equitable interests in its Board of Trade membership," it
cannot unilaterally interpret those terms to mean "every member who will
discontinue trading at the Board of Trade after exercising."
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 80
D. The Customer Access Amendment Should Not Be Approved.
-----------------------------------------------------
CBOE states the Board of Trade's creation of an electronic trading
subsidiary would extinguish the Exercise Right because "[t]hrough this
reformulated electronic trading platform, nonmembers would have equivalent
access to trade CBOT products that previously could be traded only by and
through members." See SEC Release No. 34-43521, 65 Fed. Reg. 69585, 69588
(stating that, as a result, "CBOT members no longer would enjoy exclusive access
to trade CBOT products"); see also ibid. (asserting that, under the Board of
Trade's restructuring proposal, nonmembers "will not be required to own seats or
any other type of membership interests in order to utilize directly the
electronic trading platform"). CBOE's Proposed Rule Change is fraught with
inconsistencies and is based on a fundamental misunderstanding both of existing
practices at the Board of Trade and the Board of Trade's restructuring proposal.
According to CBOE, "once the CBOT's electronic trading facility may be
accessed directly by nonmembers of the CBOT for the trading of CBOT products
that previously could be traded only by CBOT members," Board of Trade members
(or their delegates) will have lost a key trading "privilege" of membership as
defined in Rule 3.16(c) -- the "privilege of being able to trade CBOT products
to the exclusion of nonmembers." Id. at 69689. Putting aside whether CBOE's
construction of "privilege" makes sense, it skips over certain basic facts.
First, nonmembers today may access Board of Trade markets through
exchange members. Indeed, the markets exist to facilitate trading by members and
nonmembers alike. Second, although it is true that only members may execute
trades on the Board of Trade, no
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 81
restructuring plan at the Board of Trade contemplates changing that statutory
requirement. See Section 4(a) of the Commodity Exchange Act. Nor could it. Today
only Board of Trade members have access to execute orders by or through the
a/c/e system. Third, electronic trading and technology generally have provided
nonmembers with more market information and market power, in effect, than ever
before. Any successful electronic trading platform must adapt to those
competitive realities. That is why Board of Trade member firms today have used
available technology to link their customer's computer terminals with the member
firm servers to provide virtually instant market access, allowing customers to
place orders on exchange electronic trading systems with fractional timing
differentials from member orders. These developments are not the result of the
Board of Trade's restructuring plan; they are facts of life in the highly
competitive, technologically-sophisticated world in which our markets now
operate. Nothing the Board of Trade or CBOE will do will stop those forces from
evolving.
1. CBOE's Position With Respect to Direct Access is
Contrary to Existing Rule 3.16(b), the Terms of the
Restructuring Proposal, and CBOE's Historical
Treatment of the Exercise Right.
---------------------------------------------------
CBOE misreads the definition of "Eligible CBOT Full Member" in
Paragraph 1(a) of the 1992 Agreement. All that definition requires is that a
full member be "in possession of all trading rights and privileges appurtenant
to" CBOT Full Membership. Maintaining rights and privileges is a far cry from
having those rights and privileges exclusively. Even if it were permissible for
CBOE to import the adjective "exclusive" from Black's Law Dictionary into the
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 82
1992 Agreement and thereby amend the definition of "Eligible CBOT Full Member"
contained in Rule 3.16(b) without securing the class vote approvals required by
Article Fifth(b) or the consent required in Paragraph 4(b) of the contract, CBOE
would still be wrong in asserting that the Board of Trade's restructuring plan
gives customers trading rights "equivalent" to those of full members. 65 Fed.
Reg. at 69589. According to CBOE, if Board of Trade customers have the right to
trade directly on the CBOT, Board of Trade members will no longer enjoy
exclusive trading rights and privileges and thus will no longer be eligible to
exercise their right to CBOE membership. See ibid.
But Rule 3.16(b) expressly defines "trading rights and privileges
appurtenant to" Board of Trade full membership as the "right to trade as
principal and broker in all contracts traded on the CBOT." Because the Board of
Trade's proposed restructuring would not permit customers to act as brokers at
all, much less with respect to all contracts traded at the Board of Trade, the
"trading rights and privileges" of full membership, as those terms are defined
in Rule 3.16(b), would remain exclusively with the Class B-1 shareholders under
the Board of Trade's restructuring proposal.
The untenable nature of CBOE's proposed interpretation of "trading
rights and privileges" is further evidenced by CBOE's failure in the past to
threaten termination of the Exercise Right in response to extensions of trading
privileges similar to those at issue here. For example, although associate
members have long enjoyed the ability to trade as principals and brokers at the
Board of Trade, CBOE never asserted that their ability to share in this
"privilege" of full membership terminated the Exercise Right because full
members no longer enjoyed "exclusive" trading rights
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 83
and privileges. CBOE's reaction (or, perhaps more appropriately, lack thereof)
to the Board of Trade's decision years ago to permit associate members to trade
as principals and brokers reflects a proper understanding of the term "trading
rights and privileges" as it is currently defined in Rule 3.16(b). Because
associate members cannot trade all contracts as required by Rule 3.16(b)'s
definition of full members' rights, their ability to trade as principals and
brokers did not in any way threaten the Exercise Right. Similarly, granting
Board of Trade customers direct access to the a/c/e system will not destroy the
Exercise Right because customers will not be permitted to act "as principals and
brokers with respect to all contracts traded on the CBOT." Contrary to CBOE's
assertion in its Proposed Rule Change, customers who have direct access to the
a/c/e platform, like associate members who have the right to trade as principals
and brokers, will not have trading rights and privileges "equivalent" to those
of full members, and thus will not affect full members' retention of the
Exercise Right in the wake of the Board of Trade's restructuring.
Finally, the restructuring proposal itself highlights the impropriety
of CBOE's reliance on the definition of "trading rights and privileges" in Rule
3.16(b) as a basis for threatening the Exercise Right. It is planned that the
Board of Trade's new charter will contain a provision guaranteeing that members
holding Class B stock would be charged transaction fees on their trading lower
than any nonmembers, whether trading by open outcry or electronically. Full
members, the holders of Class B-1 stock, will be the only parties who will
receive that "most favored nation" treatment for trading in all Board of Trade
contracts. Thus, granting customers direct access will not confer upon them this
or any other trading privilege "exclusive" to full membership -- it will simply
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 84
enhance competition and increase market participation in a manner consistent
with, and indeed encouraged by, the Exchange Act.
As is evident from: (1) the contours of the restructuring proposal,
(2) the definition of "Eligible CBOT Full Member" in Rule 3.16(b), and (3) the
fact that the Exercise Right survived the creation years ago of associate and
other fractional Board of Trade memberships, CBOE's proposal is predicated on
the erroneous assertion that granting customers direct access to the Board of
Trade's electronic trading system would elide the distinction between Board of
Trade full members and nonmembers that is necessary to preserve the Exercise
Right. The manner in which CBOE's proposed interpretation exalts form over
substance by conditioning the Exercise Right on mutual exclusivity between the
trading rights and privileges of full members (Class B-1 shareholders) and other
nonmembers of the Board of Trade exposes Rule 3.16(c).01 as nothing more than an
attempt to circumscribe the Exercise Right in violation of Article Fifth(b). The
Proposed Rule Change should not be approved./32/
------------------
/32/ Even if CBOE were correct in asserting that the restructuring
proposal gives customers trading rights "equivalent" to those of full members
and thus violates a condition for preservation of the Exercise Right, the Board
of Trade could simply prevent the application of the proposed interpretation by
restricting nonmember direct access through a/c/e to some, but not all, Board of
Trade contracts. Under CBOE's theory, the Exercise Right would then remain in
place since nonmembers would not have access to all contracts, as the experience
with associate members and other non-full Board of Trade memberships confirms.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 84
2. CBOE's Position with Respect to Direct Access
Violates Section 6(b) of the Exchange Act.
---------------------------------------------
CBOE's Customer Access Amendment is inconsistent with Section 6(b) of
the Exchange Act for multiple reasons. CBOE's proposal violates Section 6(b)(1)
because it: (1) effects a substantive amendment to the Exercise Right without
securing the class vote approvals required by Article Fifth(b); and (2)
construes certain terms defining the scope of the Exercise Right in a manner
that directly conflicts with the definitions set forth in Rule 3.16(b). CBOE's
position with respect to direct access also violates Section 6(b)(8) of the
Exchange Act because CBOE's flawed assertion that restricting the Exercise Right
is necessary to protect the exchange's resources does not justify the restraint
on competition effected by limiting access to CBOE's markets as well as the
Board of Trade's ability to compete in the electronic trading market. CBOE's
Proposed Rule Change, which forces the Board of Trade to sacrifice either the
Exercise Right or its ability to compete, simply cannot be approved consistent
with Section 6(b)(8) of the Act.
E. Side by Side Electronic Trading in Agricultural Futures Has No
Bearing on the Exercise Right.
--------------------------------------------------------------
CBOE maintains that the Exercise Right will terminate immediately if
the Board of Trade permits agricultural contracts to be traded on the electronic
trading system during the day because this restructuring step alone would
eliminate full members' "exclusive" right to trade these contracts. See 65 Fed.
Reg. at 69588 (stating that permitting agricultural contracts to be
electronically traded during the day "would result in all of CBOT's agricultural
contracts, which heretofore have been traded only by CBOT full members by open-
outcry on the CBOT trading floor,
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 86
being traded during all of the CBOT's hours of operation on the electronic
trading system, side-by-side with trading in the CBOT's open-outcry market").
CBOE's premise is factually wrong. The Board of Trade's agricultural
futures contracts have, since 1996, been traded electronically. Now those
contracts trade on the a/c/e system from 8:30 pm to 6:00 am Chicago time. In
addition, since 1998, Board of Trade financial products have been traded
electronically side-by-side with open outcry trading during the regular daily
trading session. All the Board of Trade is proposing to do is to put its
agricultural products on a par with the financial product sector. That
competitive business decision has nothing whatsoever to do with the Exercise
Right.
In any event, CBOE's Agricultural Trading Amendment should be
disapproved because it is inconsistent with CBOE's acceptance of existing side-
by-side electronic trading practices, unnecessarily burdens competition in
violation of Section 6(b)(8), and conflicts with existing exchange rules by
disregarding the class vote requirements in Article Fifth(b) and the provisions
of Rule 3.16(b). In its proposed interpretation, CBOE asserts that the Exercise
Right will terminate "[e]ven if the CBOT implements only the modification to the
way in which agricultural contracts are traded, without restructuring as a for
profit stock corporation, [because] the right to trade these contracts, which
formerly was limited to CBOT full members on the CBOT trading floor, will then
be shared with all persons who have access to the new electronic trading
facility." 65 Fed. Reg. at 69588.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 87
As is apparent from the foregoing statement, CBOE's position with
respect to agricultural contracts is rooted in the same imaginative, but
untenable, interpretation of "trading rights and privileges appurtenant to full
membership" as CBOE's objection to direct access generally. CBOE's assertion
that the Exercise Right will terminate if the Board of Trade permits daytime
electronic trading of agricultural contracts therefore fails for the same reason
as CBOE's proposal regarding direct access: existing Rule 3.16(b) does not
require Board of Trade full members to possess trading privileges that are
mutually exclusive of trading rights possessed by other members or nonmembers in
order to preserve the Exercise Right. As a result, allowing nonmembers to trade
agricultural futures contracts electronically during the day will not divest
full members of any of the trading privileges they must retain in order to
preserve the Exercise Right.
Moreover, allowing nonmembers to trade agricultural contracts on the
a/c/e platform during the day does not violate full members' exclusive trading
rights any more than did the Board of Trade's decision to allow associate
members to trade as principals and brokers in certain contracts formerly
reserved to full members. In issuing an "interpretation" that uses the Board of
Trade's pro-competitive proposal regarding agricultural contracts as a basis
for threatening the Exercise Right, CBOE amends that Right in violation of
Article Fifth(b), perverts the provisions of existing Rule 3.16(b), and
unnecessarily burdens competition in violation of Section 6(b)(8) of the
Exchange Act. The Commission should therefore disapprove CBOE's Proposed Rule
Change.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 88
F. CBOE's Proposed Rule Change Violates the 1992 Agreement.
--------------------------------------------------------
To this point, the Board of Trade has not argued that the Commission
should disapprove CBOE's Proposed Rule Change because it constitutes a breach of
the 1992 contract. The breach of contract action is properly before the Illinois
state courts under Paragraph 6(c) of the contract./33/ In its motion to dismiss
the Board of Trade's suit, however, CBOE asserts that the 1992 Agreement is not
a contract governed by Illinois law, but an exchange rule subject to
interpretation by CBOE and reviewable only by the Commission. See CBOE's
Memorandum in Support of Motion to Dismiss (Memorandum), Civ. A. No. 00 CH
15000, Dec. 1, 2000, at 4. Although the 1992 Agreement is quite plainly a
contract, not an exchange rule, assuming for purposes of argument that CBOE is
correct and the Agreement is an exchange rule, the direct conflict between
CBOE's Proposed Rule Change and the 1992 Agreement would simply provide a
separate ground for disapproving proposed Rule 3.16(c).01 under Section 6(b) of
the Exchange Act.
1. The 1992 Agreement Is Not an Exchange Rule.
-------------------------------------------
In support of its contention that the 1992 Agreement is an exchange
rule, CBOE states in its memorandum supporting its motion to dismiss that the
"1992 Agreement acknowledged and
------------------
/33/Paragraph 6(c) provides:
The parties mutually agree that either party to this Agreement may
bring suit (on its own behalf or on behalf of its members, or both) to
enforce the terms of this Agreement and to recover damages for any
breach of this Agreement.
<PAGE>
Jonathan G. Katz
December 11, 2000
Page 89
required that its material terms would be subject to the SEC's approval as a
rule change pursuant to the requirements of [S]ection 19(b) of the Exchange
Act." Memorandum at 4. Noting that the SEC "approved the terms of the 1992
Agreement" as set forth in CBOE's proposed Rule 3.16(c), see SEC Release No.
34-32430, 58 Fed. Reg. 32969 (June 14, 1993), CBOE concludes that the Agreement
"thereby became effective as a CBOE rule change in accordance with federal law."
Memorandum at 4.
What CBOE knows, but deliberately ignores, is that Rule 3.16(b), which
incorporates only two definitions from the Agreement, but not the Agreement
itself, was the only proposed rule change published for comment and approved by
the SEC in connection with the 1992 contract. See SEC Release No. 34-31977, 58
Fed. Reg. 14453 (March 17, 1993) (publishing for comment the current version of
Rule 3.16(b) incorporating only certain provisions of the 1992 Agreement); (Exh.
D) (approving the proposed rule); Memorandum at 4 (noting that the Agreement
itself required only that certain "material terms" would be "subject to SEC
approval as a rule change"). While both the Agreement and the proposed rule
[then] 3.16(c) were submitted to the Commission in 1992, only the proposed rule
was approved as an exchange rule. Because the text of the Agreement was not
incorporated into Rule 3.16(c), and because the Agreement itself was never
published or approved as a rule change as required by Section 19 of the Exchange
Act, CBOE is simply incorrect in asserting that the entire Agreement is an
exchange rule. See Securities Exchange Act of 1934, ss. 19(b)(1) (stating that
"[e]ach self-regulatory organization shall file with the Commission . . . copies
of any proposed rule or any proposed change in, addition to, or deletion from
the rules of such self-
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regulatory organization" and that the "Commission shall, upon the filing of any
[such] rule change, publish notice thereof" and, prior to decision, "give
interested persons an opportunity to submit written data, views, and arguments
concerning [the proposed rule]").
That the 1992 Agreement is not an exchange rule is further evidenced
by the terms of the contract itself, many of which would be rendered meaningless
if the Agreement were in fact nothing more than an exchange rule subject to
unilateral interpretation by CBOE. Paragraph 4(a) of the Agreement provides:
From and after the Effective Date and so long as this Agreement
remains in force and effect, the CBOT Rule Change shall not be amended
or modified in any way by the CBOT without the written consent of the
CBOE, and the CBOE Rule Change shall not be amended or modified in any
way by the CBOE without the written consent of the CBOT, which consent
in either case shall not be unreasonably withheld.
Exh. C, P. 4(a). This paragraph, which governs the manner in which the parties
may amend their respective rules to implement certain provisions of the 1992
contract, contemplates the existence of the Agreement separate and apart from
the implementing rule changes and would be meaningless if construed merely as
part of the CBOE rule change to which it refers. More importantly, the Paragraph
makes clear that CBOE "shall not" modify or amend "in any way" the terms of the
Agreement governing who is an Eligible CBOT Full Member "without the written
consent of the CBOT." Ibid. CBOE never obtained such consent from the Board of
Trade before filing its Proposed Rule Change. Accordingly, if the 1992 Agreement
is an exchange rule, CBOE's attempt to change by interpretation the 1992
Agreement constitutes a plain violation of that exchange rule
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Jonathan G. Katz
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and thus Sections 6(b) and 19(g) of the Exchange Act. Moreover, if the
Commission now approves CBOE's Proposed Rule Change, CBOE still will be
immediately in breach of the 1992 Agreement for that reason as well.
Paragraph 6(b) similarly speaks to the Agreement as a contract
enforceable under Illinois law, only parts of which are subject to federal
regulation by virtue of their incorporation into exchange rules:
Except to the extent that this Agreement or any rule adopted pursuant
to this Agreement is governed by any law of the United States or of a
rule or regulation adopted by a regulatory agency pursuant to any such
law, this Agreement shall be governed by and construed in accordance
with the laws of the State of Illinois.
Exh. C, P. 6(b). If the parties intended the Agreement to be an exchange rule,
the latter provision of this paragraph would be superfluous, a construction that
is prohibited under general principles of contract and statutory interpretation.
See, e.g., In re Hill, 981 F.2d 1474, 1487 (5th Cir. 1993) ("the law abhors an
interpretation that results in the language of a contract having no meaning at
all"); In re Kazmierczak, 24 F.3d 1020, 1022 (7th Cir. 1994) (stating that a
"proposed contractual interpretation that would read out of a contract language
obviously important to one of the parties . . . is plain implausible"); cf. also
United States v. Nordic Village, Inc., 503 U.S. 30, 36 (1992) (noting the
"settled rule that a statute must, if possible, be construed in such fashion
that every word has some operative effect"). As is plain from its text and its
history, the 1992 Agreement is not an exchange rule, but an independent contract
enforceable by its own terms under Illinois law.
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2. Even If the 1992 Agreement Is an Exchange Rule,
the Commission Could Not Approve CBOE's Proposed
Rule Change Consistent with Sections 6(b) and 19(g)
of the Exchange Act.
---------------------------------------------------
Sections 6(b)(1) and 19(g)(1) of the Exchange Act unambiguously
require self-regulatory exchanges to abide by their own rules. Section 19(b)(2)
of the Exchange Act ensures compliance with this mandate by prohibiting the
Commission from approving any Proposed Rule Change that violates these
subsections. Because CBOE's Proposed Rule Change violates the 1992 Agreement,
CBOE's assertion that the Agreement constitutes an exchange rule would, if true,
compel disapproval of the proposed rule under the Act.
In its Proposed Rule Change, CBOE attempts to disguise four
substantive amendments to the Exercise Right as an "interpretation" of the 1992
Agreement necessitated by the Board of Trade's proposed restructuring and other
business plans. As we have seen, in much the same way that CBOE has failed to
insulate its amendments from the class voting requirements in Article Fifth(b),
CBOE's camouflage does not prevent the self-described "rule change" from
violating Paragraph 4(b) of the 1992 Agreement, which requires CBOE to obtain
the Board of Trade's "written consent" if the Exercise Right of the 1402 Board
of Trade full members is to be "amended or modified in any way." Because CBOE
did not even seek, much less obtain, that consent, CBOE's Proposed Rule Change
violates the 1992 Agreement.
The four amendments to the Exercise Right in proposed Rule 3.16(c).01
also violate the substantive provisions of the 1992 Agreement and thus CBOE's
obligation to interpret all aspects
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of the Exercise Right "in accordance with" the contract. As an initial matter,
CBOE's attempt to place a cap or ceiling on the number of Board of Trade members
who may exercise their right to CBOE membership clearly violates the Agreement,
which guarantees precisely 1402 Board of Trade members the right to membership
in CBOE. CBOE's interpretation of the Agreement's reference to "1402" members to
mean "700 or less," like its interpretation of the Agreement's use of word
"entitled" to mean "might be allowed," simply cannot be squared with the
contract and therefore violates the Exchange Act. See Securities Exchange Act of
1934, (S)(S) (6)(b)(1); 19(g)(1).
CBOE's position with respect to the sale of Class A shares similarly
violates the 1992 Agreement and thus cannot be approved consistent with the Act.
In support of its contention that the Exercise Right terminates once a Board of
Trade full member sells even one share of Class A stock, CBOE relies on
Paragraph 2(b) of the Agreement, which states that "in the event the CBOT splits
or otherwise divides CBOT Full Memberships into two or more parts," a Board of
Trade full member "must be in the possession of all such parts" in order to
preserve the Exercise Right. (Exh. C, (P) 2(b)). As previously discussed in
relation to CBOE's reliance on Rule 3.16(b), CBOE's attempt to construe the
phrases "existing membership" and "trading rights and privileges" in Paragraph
2(b) of the Agreement to encompass equity rights that did not exist at the time
the Agreement was adopted conflicts with the express definitions in the
contract. Even if CBOE had the authority unilaterally to interpret the terms of
the Agreement, which it does not, it is clear from Paragraph 1(c) of the
Agreement that "trading rights and privileges" does not refer to equitable
interests such as Class A shares. See Exh. C, (P) 1(c) (defining "trading rights
and privileges" of full membership as
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the ability to "trade as principal and broker in all contracts by open outcry or
electronically during any segment of the trading day"). In attempting to amend
the term "Eligible CBOT Full Member" as used in 1992 Agreement to mean "any
member who retains all trading and equitable rights attending Board of Trade
membership," CBOE's Proposed Rule Change violates the express provisions of the
contract and thus cannot be approved under the Exchange Act.
Like CBOE's proposed amendment regarding the sale of Class A shares,
CBOE's proposed amendment regarding the impact on the Exercise Right of direct
customer access to the a/c/e platform violates both the definition of "trading
rights and privileges" set forth in Paragraph 1(c) of the 1992 Agreement and
CBOE's obligation to interpret the Exercise Right in accordance with the
contract. In its proposed rule, CBOE asserts that "once the CBOT's electronic
trading facility may be accessed directly by nonmembers of the CBOT for the
trading of CBOT products that previously could be traded only by CBOT members,"
the Exercise Right will terminate because Board of Trade members "will have lost
a key 'privilege' of membership within the meaning of the 1992 Agreement -
namely, the "[ability] to trade CBOT products to the exclusion of nonmembers."
65 Fed. Reg. at 69588. CBOE's reliance on the 1992 Agreement's definition of
"trading rights and privileges" to support its position on direct access is
clearly misplaced. Again, Paragraph 1(c) of the Agreement expressly defines
"trading rights and privileges" as the ability to "trade as principal and broker
for others in all contracts traded on the CBOT, whether by open outcry, by
electronic means, or otherwise during any segment of a trading day." Because
granting customers direct access to the a/c/e platform would not permit
nonmembers to act as principals or brokers at all, it is not the Board
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Jonathan G. Katz
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of Trade's restructuring plan, but CBOE's proposals regarding direct access to
agricultural and other contracts, that must be rejected as inconsistent with the
1992 Agreement./34/
Finally, CBOE's proposal that the Exercise Right terminates if an
exerciser member trades on both CBOE and the Board of Trade violates the 1992
Agreement. Because the contract imposes no such restriction on exerciser
members, CBOE's proposed amendment regarding dual access cannot be approved
consistent with Sections (6)(b) and 19(g) of the Exchange Act.
3. Summary.
--------
As is apparent from the foregoing discussion, even if the 1992
Agreement were an exchange rule, proposed Rule 3.16(c).01 could not be approved
consistent with the Exchange Act.
--------------------
/34/ The Board of Trade's restructuring proposal clearly satisfies the
three requirements necessary under Paragraph 3(d) of the 1992 Agreement for both
the Exercise Right and the 1992 Agreement to "continue in full force and effect"
after the Board of Trade restructures its business operations:
. First, the Agreement requires that the restructured entity operate as
"an exchange which provides or maintains a market in commodity futures
contracts or options, securities, or other financial instruments." The
Delaware for profit corporation created by the Board of Trade's
restructuring plan satisfies this condition by providing a market in
commodity futures or options, securities, and other financial
instruments.
. Second, the Agreement requires that the current "1,402 holders of CBOT
Full Memberships" be granted memberships in the restructured entity.
All 1402 Board of Trade full members retained the rights and privileges
of membership when the Board of Trade reestablished itself in Delaware,
and all 1402 full members will continue to retain all the rights and
privileges of membership as Class B Series B-1 shareholders in the
fully restructured, for profit Board of Trade.
. Finally, the Agreement requires that membership in the restructured
entity "entitle[] the holder thereof to have full trading rights and
privileges in all products then or thereafter traded on the survivor
[corporation]." All 1402 full members have full trading rights and
privileges in all contracts traded on the surviving for profit Board of
Trade, and will continue to possess such rights in the fully
restructured, for profit entity.
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Jonathan G. Katz
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CBOE's contention that the 1992 Agreement is an exchange rule thus precludes,
rather than supports, approval of its Proposed Rule Change.
VII. CONCLUSION
----------
Article Fifth(b) of CBOE's Certificate of Incorporation guarantees
Board of Trade members two basic rights: the right to CBOE membership and the
right not to have that membership right altered in any way without the approval
of 80% of Board of Trade member CBOE exercisers. CBOE's Proposed Rule Change
violates both rights in order to accomplish admittedly anti-competitive goals
through a pseudo "interpretation" of existing rules that conflicts not only with
Article Fifth(b), but with other exchange rules and federal securities law.
Recognizing that its Proposed Rule Change would not be approved if put
to a vote of the requisite class members, CBOE has yet again attempted to
interpret its way out of the requirements of Article Fifth(b) and Section 6(b)
of the Exchange Act. Even if CBOE were correct in asserting that the 1992
Agreement is itself an exchange rule that CBOE has the authority to interpret,
the Proposed Rule Change would violate Section 6(b)(1) of the Exchange Act
because it relies on an "interpretation" of existing rules that conflicts with
the 1992 Agreement. The logic behind the contract's restriction of CBOE's
interpretive power over the Exercise Right is clear: if CBOE had complete
discretion to set the terms of Board of Trade membership in CBOE for purposes of
Article Fifth(b), the supermajority voting requirement in Article Fifth and the
"no unilateral change" to the Exercise Right clause in the 1992 Agreement would
be meaningless.
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CBOE's poorly disguised effort to cast a substantive amendment of the Exercise
Right as an "interpretation" of existing rules simply cannot be permitted under
the 1934 Act. The Commission should therefore disapprove the Proposed Rule
Change in accordance with the standards set forth in Section 19(b)(2).
Respectfully submitted,
/s/ Dennis A. Dutterer
Dennis A. Dutterer
Interim President and CEO
The CBOT urges its members and membership interest holders to read the
Registration Statement on Form S-4, including the proxy statement/prospectus
contained within the Registration Statement, regarding the CBOT restructuring
referred to herein or in connection herewith, when it becomes available, as well
as the other documents that the CBOT has filed or will file with the Securities
and Exchange Commission, because they contain or will contain important
information. CBOT members and membership interest holders may obtain a free copy
of the proxy statement/prospectus, when it becomes available, and other
documents filed by the CBOT at the Commission's web site at www.sec.gov, or from
the CBOT by directing such request in writing or by telephone to: Board of Trade
of the City of Chicago, Inc., 141 W. Jackson Blvd., Chicago, Illinois 60604-
2994, Attention: Office of the Secretary, Telephone: (312) 435-3605, Facsimile:
(312) 347-3827. This communication shall not constitute an offer to sell or the
solicitation of an offer to buy, nor shall there be any sale of securities in
any state in which offer, solicitation or sale would be unlawful prior to
registration or qualification under the securities laws of any such state. No
offering of securities shall be made except by means of a prospectus meeting the
requirements of Section 10 of the Securities Act of 1933, as amended.
