[Federal Register Volume 69, Number 139 (Wednesday, July 21, 2004)]
[Notices]
[Pages 43644-43646]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-16559]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50028; File No. SR-CBOE-2004-16]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Granting Approval to a Proposed Rule Change and Amendment 
No. 1 Thereto Relating to an Interpretation of Paragraph (b) of Article 
Fifth of Its Certificate of Incorporation and an Amendment to Rule 
3.16(b)

July 15, 2004.

I. Introduction

    On March 4, 2004, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt an interpretation, 
embodied in an agreement dated December 17, 2003 (``2003 Agreement''), 
between the CBOE and the Board of Trade of the City of Chicago, Inc. 
(``CBOT''), of paragraph (b) of Article Fifth of the CBOE Certificate 
of Incorporation (``Article Fifth(b)'') and CBOE Rule 3.16, pertaining 
to the right of the 1,402 Full Members of CBOT to become members of 
CBOE without having to purchase a CBOE membership (``Exercise Right''). 
On April 9, 2004, the CBOE filed Amendment No. 1 to the proposed rule 
change.\3\ The proposed rule change, as amended, was published for 
comment in the Federal Register on May 3, 2004.\4\ The Commission 
received one comment letter on the proposed rule change.\5\ On May 25, 
2004, the CBOE submitted a response to the comment letter,\6\ and the 
commenter replied to CBOE's response in a second comment letter 
submitted on June 16, 2004.\7\ This order approves the proposed rule 
change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Arthur B. Reinstein, Deputy General Counsel, 
CBOE, to Lisa N. Jones, Special Counsel, Division of Market 
Regulation (``Division''), Commission, dated April 8, 2004 
(``Amendment No. 1'').
    \4\ Securities Exchange Act Release No. 49620 (April 26, 2004), 
69 FR 24205.
    \5\ Letter from Thomas A. Bond, Member, CBOE, et al., to 
Jonathan G. Katz, Secretary, Commission, dated April 28, 2004.
    \6\ Letter from Joanne Moffic-Silver, General Counsel and 
Corporate Secretary, CBOE, to Jonathan G. Katz, Secretary, 
Commission, dated May 24, 2003.
    \7\ Letter from Thomas A. Bond, Member, CBOE, et al., to 
Jonathan G. Katz, Secretary, Commission, dated June 8, 2004 (``June 
8th Letter'').
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II. Description of the Proposed Rule Change

    The CBOE is proposing to interpret Article Fifth(b) to explain how 
it will apply, upon the distribution by the CBOT to each of its 1,402 
Full Members upon their individual request, to a separately 
transferable interest representing the Exercise Right component of each 
CBOT Full Membership. According to the CBOE, the CBOT's willingness to 
issue transferable Exercise Right interests is reflected in the 2003 
Agreement. Because CBOE Rule 3.16 currently refers to certain terms 
that were previously interpreted and defined in an agreement between 
CBOE and the CBOT in 1992 (``1992 Agreement''), and the terms are now 
further interpreted and defined in the 2003 Agreement, the proposed 
rule change also amends CBOE Rule 3.16 to add a reference in the 2003 
Agreement.
    The 2003 Agreement contemplates the issuance by the CBOT of a 
separately transferable interest representing the Exercise Right 
component of a CBOT Full Membership in advance of the consummation of 
the CBOT's proposed corporate restructuring, which contemplates a 
similar separately transferable interest structure.\8\ In addition, the 
CBOE represents that the CBOT's membership has approved changes to the 
CBOT Rules and Regulations, pursuant to the terms of the 2003 
Agreement, to give effect to a structure providing for the issuance of 
these interests. Thus, the interpretation, embodied in the 2003 
Agreement, constitutes the substance of the proposed rule change.
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    \8\ The CBOE noted that the CBOT's proposed restructuring has 
not yet been consummated and that it remains uncertain when the 
proposed restructuring will occur. Indeed, the 2003 Agreement 
specifically states that the CBOT is not obligated to consummate the 
contemplated restructuring or any other restructuring. The CBOE also 
noted that the CBOT's proposal to issue a separately transferable 
interest representing the Exercise Right as part of its 
restructuring was the subject of a prior proposed interpretation by 
the CBOE of Article Fifth(b), which was filed with the Commission as 
a proposed rule change in File No. SR-CBOE-2002-01. On April 7, 
2004, the CBOE withdrew this filing. See letter from Arthur B. 
Reinstein, Deputy General Counsel, CBOE, to Lisa N. Jones, Special 
Counsel, Division, Commission, dated April 6, 2004.
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    The interpretation of Article Fifth(b), embodied in the 2003 
Agreement, includes definitions of who will be ``Eligible CBOT Full 
Members'' and ``Eligible CBOT Full Member Delegates'' entitled to 
exercise after the CBOT has issued separately transferable interests 
representing the Exercise Right component of CBOT Full Memberships to 
those CBOT Full Members who request them. The interests are referred to 
in the 2003 Agreement and in this filing as ``Exercise Right 
Privileges.''
    The CBOE represents that, under these definitions, to become a 
member of the CBOE by virtue of the Exercise Right, the holder or 
delegate (i.e., a lessee under CBOT Rules and Regulations) of one of 
the 1,402 outstanding CBOT Full Memberships in which an Exercise Right 
Privilege has been issued must possess one Exercise Right Privilege, 
whether bundled or unbundled \9\ from the related CBOT Full Membership. 
In addition, the CBOE believes that a CBOE exerciser member must also 
possess all of the other rights or privileges appurtenant to a CBOT 
Full Membership; meet the applicable membership and eligibility 
requirements of the CBOT; and be deemed to be a ``CBOT Full Member'' or 
a ``CBOT Full Member Delegate'' under the CBOT Rules and Regulations.
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    \9\ According to the CBOE, under the proposed interpretation of 
Article Fifth(b) embodied in the 2003 Agreement, Exercise Right 
Privileges may be separately bought and sold and bundled and 
rebundled with the other rights and privileges of CBOT Full 
Membership for purposes of making the holder of an Exercise Right 
Privilege eligible to exercise.
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    The 2003 Agreement also provides that the CBOT will adopt and 
maintain rules and procedures acceptable to the CBOE governing the 
issuance and subsequent transfer of Exercise Right Privileges and CBOT 
Full Memberships, to enable the CBOE to administer the operation of the 
Exercise Right in a manner consistent with the interpretation embodied 
in the 2003 Agreement. In addition, the 2003 Agreement states that the 
CBOE intends to make an offer to CBOT Full Members that, subject to the 
terms and conditions of the offer, will allow the CBOE to purchase 
Exercise Right Privileges from those CBOT Full Members that accept the 
offer.\10\ Further, as provided in the

[[Page 43645]]

2003 Agreement, the CBOT and the CBOE have each agreed to provide to 
the other certain current information regarding the status of their 
members, including exercisers and persons who own or lease an Exercise 
Right Privilege.
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    \10\ In addition, the 2003 Agreement states that CBOE's offer 
would have no effect on a CBOT Full Member's right to exercise on 
the CBOE if the CBOT Full Member chooses not to accept CBOE's offer, 
and that holders of the Exercise Right would continue to be entitled 
to become an exerciser member of the CBOE.
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    The CBOE represents that the proposed interpretation of Article 
Fifth(b) is consistent with the language of Article Fifth(b), and that 
the interpretation does not propose to amend Article Fifth(b) in any 
respect; it only interprets how Article Fifth(b) would apply in 
circumstances that were not envisioned when Article Fifth(b) was 
adopted, and therefore were not addressed in the language of Article 
Fifth(b).\11\ The CBOE also believes that the proposed interpretation 
of Article Fifth(b) is consistent with the interpretation of the 
Exercise Right embodied in the 1992 Agreement.\12\
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    \11\ By its terms, Article Fifth(b) may be amended only with the 
approval of 80% of CBOE's members admitted by exercise, and 80% of 
CBOE's members admitted other than by exercise, each voting as a 
separate class.
    \12\ The CBOE noted that the proposed interpretation of the 
Exercise Right that is the subject of this filing does not displace 
the interpretation embodied in the 1992 Agreement, except it 
provides that if there are any inconsistencies between the 
interpretation embodied in the 2003 Agreement and the interpretation 
embodied in the 1992 Agreement, then the interpretation embodied in 
the 2003 Agreement would control.
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    Finally, the CBOE represents that the interpretation of Article 
Fifth(b), embodied in the 2003 Agreement, is intended to apply solely 
in the circumstances involving the issuance of Exercise Right 
Privileges to some or all of its 1,402 Full Members as described in the 
2003 Agreement, so as to make it clear that the interpretation is not 
intended to cover any other circumstances that might arise and also 
have an impact on the Exercise Right.

III. Summary of Comments

    As noted above, the Commission received comments on the proposed 
rule change \13\ from several members of the CBOE.\14\ In general, the 
commenters believe that the Commission should not approve the proposed 
rule change because the interpretation, embodied in the 2003 Agreement, 
constitutes an amendment to Article Fifth(b) and thus should be subject 
to a membership vote.\15\ According to the commenters, Article Fifth(b) 
was established (and approved by the Commission) to provide a mechanism 
for CBOE members and CBOT members who exercise on the CBOE (``CBOE 
exerciser members'') to: (1) Decide on whether changes in the 
definition or structure of a CBOT member would affect the Exercise 
Right, and (2) protect one class of CBOE membership from adversely 
affecting the other.
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    \13\ The Commission notes that the commenters refer to two 
separate proposed rule changes filed by the CBOE--File No. SR-CBOE-
2002-01 and SR-CBOE-2004-16. But see supra note 8 (noting that CBOE 
has withdrawn File No. SR-CBOE-2002-01).
    \14\ See supra notes 5 and 7.
    \15\ See supra note 11.
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    Regarding CBOT's proposed restructuring, the commenters believe 
that the CBOT's proposed restructuring necessitates an amendment to 
Article Fifth(b), and not an interpretation, because once the CBOT 
demutualizes, it will no longer be a membership organization. In 
particular, the commenters state that, changing from a membership 
structure, in which CBOE and its members have information on actions of 
the CBOT that affect the Exercise Right and the number of CBOE 
exerciser members, to a demutualized stock corporation affects the 
governance and operations of the CBOT. The commenters also express 
concern that, along with CBOT's proposed restructuring, committee 
structures, petition processes, and representation on the board of 
directors would also change. Therefore, the commenters believe that the 
CBOT's restructuring warrants an Article Fifth(b) vote. The commenters 
further note that the definition of a ``member of the Board of Trade'' 
is being amended in the CBOT's proposed restructuring, which should be 
subject to an Article Fifth(b) vote. The commenters are also concerned 
that, if the CBOT demutualizes, the Exercise Right could be negated by 
the CBOE; they cite to a provision in the 1992 Agreement that states 
that, if the CBOT, among other things, is acquired by another entity 
(and the surviving entity is not a registered exchange), then Article 
Fifth(b) would not apply.
    In response to the commenters' concerns, the Exchange maintains 
that the CBOT's issuance of the Exercise Right Privileges is separate 
and distinct from the CBOT's pending restructuring.\16\ The Exchange 
believes that the commenters' concerns primarily refer to changes in 
the structure or governance of the CBOT resulting from a 
demutualization--a circumstance not subject to this filing. In 
addition, the Exchange notes that the proposed interpretation provides 
that, although the Exercise Right Privilege would be a transferable 
interest, the holder of the Exercise Right Privilege would not have the 
right to exercise on the CBOE unless the holder also possess a CBOT 
Full Membership.
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    \16\ In its June 8th Letter, the commenters replied that, 
although SR-CBOE-2002-01 was withdrawn, they believe that the CBOT 
restructuring will be occurring soon, and therefore the Commission 
should not separate the issues presented in both filings (citing to 
a letter from Charles P. Carey, Chairman, CBOT, which generally 
provides that, upon final court approval of a settlement agreement 
with plaintiffs in the minority member lawsuit, and the Commission 
declaring CBOT's registration statement effective, it can move 
forward with a membership vote and complete the restructuring). See 
supra note 7.
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    The commenters also express concern that the proposed 
interpretation states that certain disputes concerning the definition 
of a CBOT member as it pertains to the Exercise Right will be subject 
to arbitration as opposed to the membership vote provided in Article 
Fifth(b). Further, the commenters believe that according to the 1992 
Agreement, a CBOE exerciser member does not have the right to transfer 
(whether by sale, lease, gift, bequest, or otherwise) its CBOE regular 
membership or any other trading rights and privileges appurtenant 
thereto. The commenters interpret provisions of the 1992 Agreement to 
require that all equity and trading rights would have to be assembled 
to exercise if the CBOT's demutualization were to occur. Thus, the 
commenters are concerned that the proposed interpretation would allow 
the CBOT to demutualize into three classes of shares (A, B, and C) that 
can be split and sold separately, which constitutes an amendment to 
Article Fifth(b) and not an interpretation.\17\
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    \17\ The commenters also state that, under the CBOT's membership 
organization, the voting rights are joined with the trading rights 
and equity interests and are not separated. However, when CBOT is 
demutualized, the parts will be separated and consequently the 
parties holding the voting rights may be different and have 
different agendas than the parties having the trading rights.
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    In response to the commenter's concerns, the Exchange believes that 
the purpose of the Exercise Right Privilege is to create an interest 
that CBOE, or others, might purchase to reduce the number of 
outstanding Exercise Rights, and to give CBOT members a way to realize 
the value of the Exercise Right without having to sell their entire 
CBOT membership.\18\ The Exchange believes that the proposed 
interpretation embodied in the 2003 Agreement is consistent with the 
language of Article Fifth(b) in that the Exercise Right would remain 
available to a person so long as he or she remains a member of the

[[Page 43646]]

CBOT.\19\ The Exchange notes that the 1992 Agreement provides that if a 
CBOT Full Membership is divided into separate parts, a person must hold 
all of the parts to exercise on the CBOE. The Exchange states that the 
interpretation does not amend Article Fifth(b), rather, as noted above, 
the interpretation describes how the Article would apply under 
circumstances that were not originally contemplated when Article 
Fifth(b) was adopted.
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    \18\ In response, commenters state that the proposed 
interpretation would create two classes of CBOT memberships--one 
with the Exercise Right and one without. Thus, CBOT members would be 
able to receive value for Exercise Right, which was not recognized 
in Article Fifth(b) and the 1992 Agreement. See supra note 7.
    \19\ The CBOE represents that, if and when the CBOT restructures 
and is no longer a membership organization, the CBOE will further 
interpret the Exercise Right to determine its application in light 
of the demutualization. Telephone conversation between Arthur B. 
Reinstein, Deputy General Counsel, CBOE, and Lisa N. Jones, Special 
Counsel, Division, Commission, on June 10, 2004.
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    Further, the Exchange represents that it has been advised by its 
Delaware counsel that, under Delaware state law, it is within the 
general authority of CBOE's Board of Directors to interpret its 
governing documents when questions arise as to their application in 
these types of circumstances, so long as the interpretation adopted by 
the Exchange's Board of Directors is consistent with the terms of the 
governing documents themselves.\20\ The Exchange represents that the 
interpretations do not constitute amendments to the governing 
documents, and thus are not subject to the procedures that would apply 
if they were actually being amended.\21\
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    \20\ See letter from Michael D. Allen, Esq., Richards, Layton & 
Finger, to Joanne Moffic-Silver, General Counsel and Corporate 
Secretary, CBOE, dated June 29, 2004 (providing a legal opinion from 
Delaware counsel in connection with CBOE-2004-16) (``Opinion of 
Counsel'').
    \21\ In its June 8th Letter, the commenters reply that, although 
the CBOE Board of Directors has the right to interpret changes in 
the CBOT membership, Article Fifth(b) requires both the CBOE member 
and the Exercise Right holder to decide if changes or amendments to 
Article Fifth(b) are permissible. Thus, the commenters believe that 
the CBOE Board of Directors is usurping members' rights by 
interpreting Article Fifth(b). See supra note 7.
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IV. Discussion

    After careful review of the proposal, the comments received, and 
CBOE's response to the comments, the Commission finds that the proposed 
rule change is consistent with the requirements of the Act and the 
rules and regulations thereunder applicable to a national securities 
exchange.\22\ In particular, the Commission finds that the proposal is 
consistent with Section 6(b)(5) of the Act,\23\ which requires, among 
other things, that the rules of an exchange be designed to promote just 
and equitable principles of trade, and in general to protect investors 
and the public interest, and Section 6(c)(3)(A) of the Act,\24\ which 
permits, among other things, an exchange to examine and verify the 
qualifications of an applicant to become a member, and the natural 
persons associated with such applicant, in accordance with the 
procedures established by exchange rules.
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    \22\ In approving this rule, the Commission has considered the 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
    \23\ 15 U.S.C. 78f(b)(5).
    \24\ 15 U.S.C. 78f(c)(3)(A).
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    The CBOE believes that the proposed interpretation should clarify a 
circumstance regarding the Exercise Right that was not originally 
envisioned by the CBOE and CBOT when Article Fifth(b) was adopted. The 
CBOE also represents that the CBOT will issue to each of its 1,402 Full 
Members, upon their individual request, a separately transferable 
interest representing the Exercise Right component of the CBOT Full 
Membership. Moreover, the CBOE represents that to be eligible as a CBOE 
exerciser member, one must hold a CBOT Full Membership, which would 
include one Exercise Right Privilege (representing the Exercise Right) 
in addition to all the other rights or privileges appurtenant to a CBOT 
Full Membership.
    The Commission has considered the commenters' concerns about how 
the proposed interpretation could adversely affect the Exercise Right. 
In its decision to approve the proposal, the Commission is relying on 
CBOE's representation that the CBOT will adopt and maintain rules and 
procedures governing the issuance and transfer of the Exercise Right 
Privileges to enable the CBOE to administer the operation of the 
Exercise Right in a manner consistent with Exchange rules. Further, the 
Commission notes that CBOE has represented that both the CBOE and CBOT 
will provide each other with current information regarding the status 
of their members, including exerciser members and persons who own or 
lease an Exercise Right Privilege. The Commission believes that this 
open exchange of information regarding the Exercise Right should 
adequately address any concerns that the proposal will adversely affect 
CBOE regular membership, or any other trading rights and privileges 
thereof.
    The Commission has also considered the commenters' concerns about 
the CBOT's proposed restructuring, and notes that CBOT's proposed 
restructuring has not yet been consummated. The Commission emphasizes 
that this order only approves CBOE's interpretation as it relates to 
the proposed changes to CBOE Rule 3.16. The Commission is not making a 
finding on any facts and circumstances surrounding CBOT's proposed 
restructuring under Delaware law.
    In addition, the Commission is not approving or disapproving the 
terms of the 2003 Agreement; rather, the Commission is approving a 
proposed rule change filed by the CBOE which interprets CBOE's rules. 
Further, in approving this proposal, the Commission is relying on 
CBOE's representation that its interpretation is appropriate under 
Delaware state law,\25\ and CBOE's Opinion of Counsel that it is within 
the general authority of its Board of Directors to interpret Article 
Fifth(b) when questions arise as to its application under certain 
circumstances, so long as the interpretation adopted by the Exchange's 
Board of Directors is made in good faith, consistent with the terms of 
the governing documents themselves, and not for inequitable 
purposes.\26\ The Commission has not independently evaluated the 
propriety of CBOE's interpretation under Delaware state law.
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    \25\ Telephone conversation among Arthur B. Reinstein, Deputy 
General Counsel, CBOE, Katherine A. England, Assistant Director, and 
Lisa N. Jones, Special Counsel, Division, Commission, on July 15, 
2004.
    \26\ See supra note at p. 5.
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-CBOE-2004-16), as amended, 
is approved.
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    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-16559 Filed 7-20-04; 8:45 am]
BILLING CODE 8010-01-P