Piemonte v. Chicago Bd. Options Exchange, Inc., 75 Civ. 441-CLB.

• Decision Date: 18 December 1975
• Docket Number: No. 75 Civ. 441-CLB.,75 Civ. 441-CLB.
• Parties: Sabino PIEMONTE, on behalf of himself and all others similarly situated, Plaintiffs, v. CHICAGO BOARD OPTIONS EXCHANGE, INC., et al., Defendants.
• Court: U.S. District Court — Southern District of New York

405 F. Supp. 711

Sabino PIEMONTE, on behalf of himself and all others similarly situated, Plaintiffs, v. CHICAGO BOARD OPTIONS EXCHANGE, INC., et al., Defendants.

No. 75 Civ. 441-CLB.

United States District Court, S. D. New York.

December 18, 1975.

Berman & Zivyak by Jeffrey Zivyak, New York City, for plaintiffs.

Lord, Day & Lord by John J. Loflin, George R. Reid, II, New York City, for defendants Chicago Bd. Options Exchange and Chicago Bd. Options Exchange Clearing Corp.

Townley, Updike Carter & Rodgers by James K. Leader, New York City, for defendant Chicago Bd. of Trade.

MEMORANDUM DECISION

BRIEANT, District Judge.

By his second amended complaint, plaintiff sues on behalf of himself and all other individuals who were holders of option contracts issued by the defendant Chicago Board Options Exchange Clearing Corporation¹ ("Clearing Corporation") for the purchase of the underlying stock of International Business Machines Corporation ("IBM") at a price of $180.00 a share which options were exercisable before 10:30 A.M. on January 27, 1975.

Jurisdiction is premised on § 22 of the Securities Act of 1933, 15 U.S.C. § 77v, § 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa, and principles of pendent jurisdiction.

While plaintiff's motion to declare a class action remained undetermined, defendants Chicago Board of Options Exchange, Inc. ("CBOE") and the Clearing Corporation, moved to dismiss the second amended complaint for failure to state a claim under Rule 12(b)(6), F.R.Civ.P., or in the alternative for summary judgment pursuant to Rule 56, F.R.Civ.P.

Undisputed Facts

CBOE is a non-stock, or membership, corporation organized in Delaware for the purpose of maintaining an auction market for transactions in securities options. It is registered with the Securities and Exchange Commission ("SEC"), pursuant to Section 6 of the Securities Exchange Act of 1934, 15 U.S.C. § 78f, as a national securities exchange.

The Clearing Corporation is a Delaware corporation organized for the purposes of settling options transactions effected on the floor of the CBOE, as well as on all other national securities exchanges which may be approved by the SEC for options trading, and of assuming the obligations as issuer of all such options.

The CBOE operates as a securities exchange, generally in the same fashion as the New York Stock Exchange and other stock exchanges. It provides an auction market for the purchase and sale of securities by investors — the basic difference being that the only securities traded on the CBOE are call option contracts for certain listed stocks traded publicly and actively on other national securities exchanges.

The call options traded on the CBOE are issued by the Clearing Corporation. These options are securities, each of which gives the holder the right, commencing at the time it is issued and expiring at a fixed expiration date (no longer than nine months after issuance), to purchase 100 shares of a particular underlying stock from the Clearing Corporation at a specified option or exercise price. The expiration date, the exercise price, and the number of shares of the underlying stock for each series of traded options are standardized by CBOE and the Clearing Corporation prior to the issuance of any options of that series. For example, the options involved in this case — IBM Jan 180's — were securities which gave the holder of a single contract the right at any time commencing upon the issuance of the option and expiring at 10:30 A.M., Chicago time, on January 27, 1975, to purchase 100 shares of common stock of IBM from the Clearing Corporation at a purchase price of $180.00 per share.

A CBOE option is issued by the Clearing Corporation only after a buyer and a seller, acting through or for a member firm, have agreed on the floor of the CBOE as to the price (known as the premium) at which the option is to be purchased. The transaction is reported by the parties' brokers to the Clearing Corporation, and the option is issued at 10:00 A.M. on the following business day if the full premium has been paid to the Clearing Corporation by the buyer's broker. The premium is in turn paid by the Clearing Corporation to the seller, who is known as the writer of the option. From the time of issuance until the expiration of the option, the buyer, i. e. the holder of the option, has the right to exercise it in accordance with the Clearing Corporation's rules, and the writer has the obligation, upon the assignment of an exercise notice to him, to perform the Clearing Corporation's obligations with respect to that option. Thus, for every outstanding option issued by the Clearing Corporation, there will be a writer who has agreed (by selling the option through his broker on the floor of the CBOE) to perform the Clearing Corporation's obligation to deliver the underlying stock upon payment of the specified exercise price, in the event that the option is exercised and the exercise notice is assigned to him.

Of course holders of options need not actually exercise them in order to turn a profit. They may instead sell their options in a closing sale transaction. The CBOE maintains an active secondary market in the options issued by the Clearing Corporation up until 2:00 P.M. on the business day preceding the expiration date. Whether a particular option has any value on the secondary market at any time depends upon the then current price of the underlying stock and the perceived likelihood that the stock will sell above the exercise price on or before the expiration date. Obviously no one would pay a premium for the right to buy a certain stock at a stated price which is higher than the quoted price for the same stock on another exchange, unless one thought that before expiration, the price of the underlying stock would rise above the exercise price. So the quoted price of an option represents the concensus of the market participants as to the future price — value of the underlying stock.

While option holders can either exercise their options or sell them on the CBOE, they must take one of these two courses of action before the expiration date in order to realize a profit on the transaction.

While it might be assumed that all holders whose options have increased in value will either sell or exercise, it is entirely possible that some people may forget that they will lose their entire investment unless they actually do sell before 2:00 P.M. on the business day preceding expiration or exercise in accordance with the Clearing Corporation's rules.

Under the Clearing Corporation's rules, a holder of an option may exercise it only by causing his broker to file a written exercise notice with the Clearing Corporation on the prescribed form on or before the fixed expiration date. When an exercise notice is timely and properly filed, the Clearing Corporation assigns the exercise in accordance with its random selection procedures to any one of the writers of options, having the same standardized terms as the one which was exercised, and that writer is then obligated to perform the Clearing Corporation's obligation to deliver the stock against payment of the exercise price.²

Plaintiff's Claim

Plaintiff purchased five IBM Jan 180 call options on or about December 24, 1974, through a New York Stock Exchange member firm. These options were issued by the Clearing Corporation and were traded on the CBOE. Each of the five options gave plaintiff the right to purchase, on or before the fixed expiration date, 100 shares of IBM stock at a purchase price of $180.00 per share. The fixed expiration date was January 27, 1975 at 10:30 A.M. Thus to exercise his options plaintiff was required to arrange through his stockbroker for the submission of an exercise notice to the Clearing Corporation prior to that time.³

On January 24, 1975, after the close of trading in the securities markets, the SEC announced a suspension of trading in IBM stock until 10:00 A.M. (Eastern Standard Time), Tuesday, January 28, 1975, or earlier if it appeared in the public interest, because of an impending decision by the United States Court of Appeals for the Tenth Circuit in Telex Corp. v. International Business Machines Corp., 510 F.2d 894 (10th Cir. 1975).

Trading in all January IBM options had ceased earlier the same day pursuant to the CBOE rule which stops trading in a series of options at 2:00 P.M. on the business day prior to the expiration date of the series.

The Clearing Corporation announced that IBM January options would be exercisable on January 27, 1975, that is, that the SEC suspension order would affect neither an option holder's right to exercise his IBM January option, nor the fixed expiration of his option.

On Friday, January 24, 1975, IBM stock closed at 162 7/8 on the New York Stock Exchange. On Monday, January 27, 1975 the stock traded in foreign markets at 177 and lower. IBM was not traded on the NYSE on January 27th, but it did open on the Midwest Stock Exchange at 2:31 P.M., after the SEC lifted its suspension of trading. IBM traded on the Midwest Exchange between 181¾ and 186, closing at 182 7/8 . On Tuesday, January 28th, IBM stock opened on the NYSE at 188, which was the high for the day, and it closed at 179¾.

At the start of business on Monday, January 27, 1975, the expiration date, there were 2,372 IBM Jan 180 option contracts outstanding, each for 100 shares of IBM stock. Eighty-six of these option contracts were exercised that day prior to their expiration. Among those not exercised were the five option contracts owned by plaintiff.

Counts I and V of the Second Amended Complaint

In Count I the plaintiff alleges a violation of Rule 10b-5, 17 C.F.R. § 240.10b-5, which was promulgated by the SEC under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b). He claims that the Prospectus issued by the Clearing Corporation was "materially misleading and failed to state material facts...