Boards of Pacific, Chicago Exchanges Agree to Terms of Proposed Consolidation

After more than three months of negotiations, the boards of the Pacific Exchange and the Chicago Board Options Exchange have agreed on terms to consolidate into one market that will trade the bulk of the nation’s stock options business, both sides said Wednesday.

The terms will be drafted into a final agreement to be voted on by members of both exchanges early next year. The deal needs the approval of a two-thirds majority of the Pacific Exchange’s 552 members and a simple majority of the CBOE’s more than 1,300 voting members, but sources said it is expected to be approved.

“The proposed efficiencies and cost savings to our members and customers from this alignment are more than sufficient to pursue consolidation,” said PCX Chairman and Chief Executive Ronald Greber.

Under the agreement, the 116-year-old Pacific Exchange, or PCX, would become a division of the CBOE. The Pacific’s San Francisco floor, which trades options, would stay open as long as there is floor-based trading in Chicago.

Options trading, which allows investors to make significant bets on stocks’ direction with relatively little money down, has boomed in the 1990s.

Under the deal, the San Francisco trading facilities would be expanded and equipment upgraded with CBOE technology. Plans to build a $150-million, 400,000-square-foot headquarters in San Francisco were scuttled as too costly.

“In the big picture of the exchange, this is the right thing to do,” said David Herron, manager of equity trading floor operations for brokerage Charles Schwab & Co. “Still, we haven’t seen all the terms. I don’t think everyone on the equity side is happy--uncertainty doesn’t make anyone comfortable.”

That’s because under the original agreement unveiled July 23, the Pacific’s downtown Los Angeles trading floor--which exclusively trades equities, or individual stocks, and employs a staff of about 100 as well as 50 trading specialists--would be sold or closed as the merged exchange focuses on options alone. The lease on its office space in a building near the Harbor Freeway is up in 2001.

The Pacific has hired investment banker Wasserstein Perella Securities to find a buyer for the equities trading division and discussions have been held with foreign exchanges, private groups and communication firms, said Warren Langley, president and chief operating officer of the PCX.

“We’ve spoken to as rich a group as you can, and several are very interested,” he said. “The one question that keeps coming up is, ‘What’s going to happen to OptiMark?’ ”

Finding a buyer for the Los Angeles equities business is likely to hinge on the success of a new stock trading system devised by OptiMark Technologies, in conjunction with the PCX, to let large institutional investors such as pension funds trade directly and anonymously with one another. The system is expected to be launched in coming months.

One equities trader said it seemed the Pacific gave up more in the bargaining, but he still believes the merger is beneficial.

“I think we came toward them more than they came toward us,” said Dan Turner, founder of Rubicon Securities in Los Angeles. “But if they don’t approve it, where would we be? Clearly we’d be in a weaker competitive position.”

The slower-growing equity business hasn’t produced the revenue that the options business has in recent years.

In negotiating the terms, one sticking point was how best to allocate lucrative options contracts between the two exchanges.

Under the agreement, options now traded on both floors would be assigned to the floor with the greater volume, meaning more duplicated issues would go to Chicago, a PCX spokesman said.

Currently, there are about 200 listed options that overlap between the two, a Pacific spokesman said. The Pacific currently lists 850 stock options. Once the merger is complete, the exchange would trade 1,700 options listings.

In the merged exchange, 70% of any new options listings would go to the Chicago floor and 30% to San Francisco--except for the first three years, when the San Francisco floor would get 40% of new listings to make up for those lost to Chicago in the initial consolidation.

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* ONLINE START-UP: Group to start electronic options exchange. C4