From: Peter M. Todebush
Securities and Exchange Commission
Attn: Nancy M. Morris, Secretary
Re: File No. SR-CBOE-2006-106
Dear Ladies and Gentlemen,
Some say the original documents separating the Chicago Board of Options Exchange (CBOE) from the Chicago Board of Trade (CBOT) did not include any wording regarding “equity rights”. This omission does not preclude addressing this issue at a later date, which was done in the bilateral agreement of 1992, signed by Billy O’Connor of the CBOT (also a co-founding member of the CBOE), and Duke Chapman and Bill Floersch of the CBOE. This document enumerated the rights of CBOE ERP (Exercise Right Privilege) Members to participate in any distribution made by the CBOE, even to the extent that ‘potential’ CBOE ERP Members would be given a 90-day window to exercise in order to participate without incurring any CBOE Member dues or fees. These enumerated rights, agreed to by both the CBOE and the CBOT, did not incur any rule or by-law changes, and therefore did not require a membership vote. They also are reaffirmed in the 2001 agreement, paragraph 10 (the 1992 Agreement shall remain in full force and effect, and the CBOT and CBOE hereby reaffirm all of their respective rights and obligations thereunder).
Some say, if the CBOE Regular Members give up their own access rights, then access rights no longer exist for anyone, including CBOE ERP Members. The glaring omission here is Regular Members are exchanging their access rights for compensation (equity in the demutualized CBOE). The ERP Members are being eliminated without compensation.
The request by the CBOE for a unilateral rule change of the bilateral agreement has some interesting ramifications. Bill Floersch, Jack Callahan, Bob Sheehan, John Stafford (and others) are individual CBOE ERP Members who run ‘market making/trading’ operations that account for 30% plus of the daily volume of the CBOE. Add to this the large Wall Street firms that use CBOE ERP Memberships for their ‘market making/trading’ functions (UBS, Merrill, Morgan Stanley, etc) and the daily volume participation reaches 45%. The unilateral rule change, by eliminating an entire class of membership (CBOE ERP), emasculates the daily volume and liquidity of the Exchange. The CBOE acknowledges this by allowing ERP Members to continue trading for an unidentified “interim period of time”.
Additionally, there are large institutional holdings of ERP interests (UBS says they have more than 50, Merrill has over 30, etc.). The unilateral rule change of the bilateral agreement, by eliminating the CBOE ERP Membership, will result in a large transfer of wealth, engineered by a Board of Directors composed entirely of CBOE Regular Members, that would not allow the 11 Independent Directors to vote (‘fait accompli’, done in private session). Where is the fiduciary responsibility of the Board of Directors?
There are two membership categories: CBOE Regular Member and CBOE ERP Member (actual and potential). By eliminating the ERP Member, the CBOE Board shrinks its membership by more than 50%. Section 6(c)(4) of the Securities and Exchange Act expressly provides that an Exchange “shall not have the authority to decrease the number of memberships in such exchange. . . below such number in effect on May 1, 1975.. . .” On May 1, 1975 the number of CBOE Members included all the CBOE ERP Members (actual and potential). Where did the CBOE Board of Directors receive the authority to eliminate all the CBOE ERP Members, thereby reducing its total membership below the May 1, 1975 level?
The SEC has to deny the CBOE request for a rule change.
Peter M. Todebush
CBOT Full Member 1976