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CBOE-12.31.201410K
Unrestricted Common Stock,
As of June 30, 2014, the aggregate market value of the Registrant's outstanding voting common equity held by non-affiliates was approximately $4.2 billion based on the closing price of $49.21 per share of unrestricted common stock.
The number of outstanding shares of the registrant's common stock as of February 11, 2015 was 84,003,241 shares of unrestricted common stock.
"CBSX" refers to CBOE Stock Exchange, LLC, a facility of CBOE that is 49.96% owned by CBOE. CBSX wholly owned National Stock Exchange, Inc. ("NSX"), a stock exchange and self-regulatory organization, until it sold NSX to a third party on February 18, 2015. CBSX and NSX ceased operations on April 30, 2014 and May 30, 2014, respectively. CBSX is not a consolidated subsidiary of the Company.
"FINRA" refers to the Financial Industry Regulatory Authority.
This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve a number of risks and uncertainties. You can identify these statements by forward-looking words such as "may," "might," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential" or "continue," and the negative of these terms and other comparable terminology. All statements that reflect our expectations, assumptions or projections about the future other than statements of historical fact are forward-looking statements, including statements in the "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." These forward-looking statements, which are subject to known and unknown risks, uncertainties and assumptions about us, may include projections of our future financial performance based on our growth strategies and anticipated trends in our business. These statements are only predictions based on our current expectations and projections about future events. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from that expressed or implied by the forward-looking statements. In particular, you should consider the risks and uncertainties described under "Risk Factors" in this Annual Report.
Over the past five years, our overall volume has increased, especially with respect to our index options and futures contracts. The following chart illustrates annual contract volume across the different categories of products traded at the Company for the periods indicated:
Our operating revenues are primarily driven by transaction fee revenues, which are generated on the contracts traded on our exchanges.
Our primary business of offering exchange-traded options and futures contracts on financial instruments is part of the large and growing global derivatives industry. Derivatives are financial contracts whose value is derived from an underlying asset or reference value. While derivatives exist on a wide range of underlying assets and references, we currently focus on offering derivatives products on individual stocks, stock indexes, exchange-traded funds, exchange-traded notes, interest rates, and various benchmarks related to trading and investment strategies. The global derivatives industry includes both exchanges and a large over-the-counter market. The most common types of derivatives are options, futures and swap contracts. These products allow for various types of risk to be isolated and transferred.
In the listed options market, there are currently options contracts covering approximately 3,600 underlying stocks, indexes and ETPs, among other products. The presence of dedicated liquidity providers, including market-makers, is a key feature of the options market. Market-makers collectively provide continuous bids and offers for all listed options series. Over the past decade, trading in the options market has migrated from being primarily conducted face-to-face, or "open outcry," to being primarily electronic. As a result, many liquidity providers now operate remotely, away from the physical trading floors, and the majority of options trading volume is handled and executed electronically.
Our proprietary products are those in which we have a property right or for which we have an exclusive license, and contribute almost all of our transaction fee revenues for index options and all of our transaction fee revenues for futures. Listed options on equities and ETPs currently may be listed on all options exchanges, while trading in our proprietary products is limited to our exchanges. Thus, our proprietary products are able to support a higher revenue per contract than multiply-listed products.
Over the past five years, average daily volume ("ADV") in our index options has increased from 1.07 million contracts to 1.61 million contracts, and ADV in our futures has increased from 17 thousand contracts to 201 thousand contracts. The increase in index options and futures trading significantly outpaced the growth in the industry and multiply-listed products in this time-frame. These increases are primarily due to increased interest in trading our VIX options and futures and SPX options. See "SPX Options" and "Volatility Trading."
Exchanges set fees to attract multiply-listed options business to their exchanges, which has reduced the revenue per contract that we generate from these options. Fees utilized include both transaction fees assessed to access liquidity and incentive programs to attract order flow. Order flow, particularly customer order flow, is the primary driver of multiply-listed options exchange volumes. In the past several years, the competition for this business has increased significantly, due in part to the limited number of firms, known as consolidators, who make routing decisions based on pricing and their ability to internalize order flow. Some exchanges have structured their options businesses in partnership with established market participants and order flow providers. Others offer specific payments for order flow, in addition to any economic incentives received from market-makers and other participants.
In addition, the number of options exchanges has doubled over the past ten years, from six exchanges to twelve, in large part due to existing exchange holding companies opening new exchanges that offer different markets and pricing models on existing technology. As the business continues to expand, and offer greater margins than the equity trading business, we expect that our competitors, or new entrants into the exchange business, may open additional new options exchanges.
Innovative Products. We have worked closely and collaboratively with market participants to introduce new products and services to meet the evolving needs of the derivatives industry, and plan to continue these efforts. Products we have developed including index options, options and futures on the VIX Index and other volatility indexes, Long-Term Equity AnticiPation Securities ("LEAPS"), short duration options, including Weeklys, FLexible EXchange Options ("FLEX options") and options strategy benchmark indexes.
Leading Brand, Reputation and Market Position. As the operator of the original and largest U.S. options exchange, based on both contract volume and notional value and one of the largest options exchanges in the world, we have a leading brand and reputation.
We believe that the listed options and futures industry, especially with respect to volatility trading, has significant growth potential, including through new participants and products. We expect to further expand our business and increase our revenues and profitability by pursuing the following growth strategies:
Pursue International Opportunities. We intend to continue our efforts to expand the use of our products internationally. At the core of that effort is extending trading hours in our exclusive products. In 2014, we completed the extension of trading hours for VIX futures to nearly 24 hours per day, and plan to extend the trading hours for SPX and VIX options, adding a session each weekday that begins at 2:00 a.m. CT, to align with the opening of the London markets, and ends at 8:15 a.m. CT. We have also expanded, and intend to continue expanding, our educational offerings internationally, including through the European Risk Management Conference, which has been held three times, and the Asian Risk Management Conference, to be held for the first time in 2015. We also offer a CFE communications hub in London where Trading Permit Holders ("TPHs ") can send and receive data and access CFE's trading system.
Develop Innovative Proprietary Products. We intend to license and create proprietary intellectual property to develop proprietary products that meet the needs of the derivatives industry, both through strategic relationships and internally developed products. In 2014, we introduced options and futures on the CBOE Short-Term Volatility Index and futures on the CBOE/CBOT 10-year U.S. Treasury Note Volatility Index. We also announced that we had entered into an agreement with MSCI Inc., under which options on certain MSCI indexes will be solely listed for trading on CBOE in the U.S.
Continue to Enhance Our Trading Systems. We recognize that the opportunity to participate in the growth of the derivatives market will be driven in great part by the trading functionality and systems capabilities that an exchange offers to market participants. We intend to use our strong in-house development capabilities and continued investment to further harden and develop the functionality and capacity of our trading systems.
Increase the Number of Users of Our Products. We seek to increase the number of users who trade our products. Specifically, we have targeted new institutional investors, including pensions and endowments, to inform about how to trade our products, especially our proprietary products. We intend to continue offering education sessions and published materials through the Options Institute. We also educate potential investors through our domestic and European Risk Management Conferences and through participation in industry events. We plan to continue these activities and look for other opportunities to grow the user base for our products.
Attract Over-the-Counter Market Participants. We seek to attract participants from the over-the-counter market, including through our customizable FLEX options products and through offering products similar to those traded over-the-counter, but with listed market protections and benefits, such as transparency, fungibility and centralized clearing.
In addition, through a set of arrangements with S&P OPCO LLC ("S&P"), we permit S&P to license the Company's proprietary indexes and index methodologies for certain purposes to securities firms and other exchanges. The Company and S&P have agreed that S&P may license one or more clearing agencies to clear over-the-counter, or OTC, options based on the S&P 500 Index that meet certain criteria, and that S&P will compensate us for any transaction cleared under such a license based on the notional value of the transaction.
Pursue Select Strategic Opportunities. We evaluate strategic opportunities that we believe will enhance stockholder value. We specifically look for strategic opportunities beyond our current businesses that will capitalize on our core competencies and diversify our sources of revenue.
Equity Options. We offer trading in options on the stocks of approximately 3,100 corporations. The stocks underlying our individual equity options are listed on equity stock exchanges.
Futures. We provide a marketplace for trading ten futures products through CFE. CFE has focused on the trading of futures using the CBOE-created VIX methodology, but also provides trading in S&P 500 Variance futures.
Over the past few years, we have expanded our offerings, and experienced increases in our existing offerings, that allow for customers to trade options on a number of different time horizons, allowing them to pinpoint their preferred timing. In addition to standard option terms, we also offer options with weekly, end of month and end of quarter expirations, and provide LEAPS that allow the user to establish positions that can be maintained for a period of up to fifteen years. Our Weeklys product in particular has seen rapid growth, especially in SPX. We believe that the flexibility provided by these offerings allows us to meet the differing needs of our customers and increase trading volume.
The Company has developed several of its own proprietary indexes and index methodologies. These include volatility indexes based on various broad-based market indexes (such as the S&P 500, the DJIA, the NASDAQ 100 and the Russell 2000), volatility indexes based on ETFs and individual stocks, the CBOE S&P 500 Implied Correlation Index and a series of options strategy benchmarks, including BuyWrite, PutWrite and Collar indexes based on the S&P 500 and BuyWrite indexes based on other broad-based market indexes. In addition to any transaction fee revenue generated on products created based on these indexes, we have licensed others to use some of these indexes to create products and have entered into agreements whereby we have granted to others the rights to sub-license certain indexes. The Company generates revenue from both the calculation and dissemination of index values and from the licensing of our proprietary indexes.
These proprietary products are built both through our in-house research and development staff and our strategic relationships and license agreements with index providers. The following is a discussion of our strategic relationships and additional detail on our most frequently traded products, SPX and VIX options and futures.
S&P 500 and S&P 100 Indexes. We have the exclusive right to offer options contracts on the S&P 500 Index and the S&P 100 Index as a result of a licensing arrangement with S&P OPCO LLC, which was extended in March 2013. Our license with S&P OPCO LLC is through December 31, 2033, with an exclusive license to trade options on the S&P 500 Index through December 31, 2032. We are also authorized to use the S&P 500 Index and S&P 100 for the creation of CBOE volatility indexes, such as the VIX Index, and tradable products on those volatility indexes.
Dow Jones Industrial Average ("DJIA"). We have the exclusive right during standard US trading hours to offer options contracts on the DJIA and certain other Dow Jones indexes through December 31, 2017 as a result of a licensing arrangement with S&P Dow Jones Indices, LLC. We are also authorized to use these indexes to create CBOE volatility indexes and trade options, futures and other products on these indexes.
Russell Indexes. We are able to offer options contracts on the Russell 2000 and certain other Russell indexes through February 28, 2015 as a result of a licensing arrangement with Frank Russell Co. We are also authorized to create RVX, a volatility index based on the Russell 2000, and offer options, futures and other products for trading on this index.
NASDAQ 100. We have a non-exclusive right to offer options contracts on the NASDAQ 100 Index through December 2015 as a result of a licensing arrangement with NASDAQ OMX Group, Inc. Under this license, we are authorized to create VXN, a volatility index on the NASDAQ 100, and offer options, futures or other products on this index.
MSCI. In December 2014, we announced that we had entered into a license agreement with MSCI Inc., under which CBOE has the exclusive right in the U.S. to offer options on six of MSCI's indexes, including the MSCI EAFE Index and the MSCI Emerging Markets Index.
The S&P 500 Index is an index comprised of 500 large-cap U.S. listed companies. It is one of the most commonly followed indexes, and is considered a bellwether for the U. S. economy. The options we offer on the S&P 500 Index are exclusive to CBOE and contribute substantially to our volumes and transaction fees. Because of its status as a bell-weather, SPX is traded in a number of different trading strategies by customers with different goals, including pension funds hedging their equity exposure by buying put options, asset managers seeking enhanced returns by selling covered call options and hedge funds using risk-managed strategies to capture so-called "risk premia" embedded in option prices.
We are also seeing a significant increase in the number of customers who are trading SPX Weeklys, one of our fastest growing products. As a percentage of total SPX contracts traded, SPX Weeklys has increased from 2.2% in 2010 to 30.7% in 2014. We believe that these traders are using this product to fine tune the timing of hedging strategies and maximize the risk premium in strategies that involve the sale of options, such as covered call writing.
CBOE pioneered the volatility trading space, with its introduction of the CBOE Volatility Index (the "VIX Index") in 1993. We introduced futures on the VIX Index in 2004 and options in 2006. The VIX Index is based on real-time prices of options on the S&P 500 Index and is designed to reflect investors' consensus view of future 30-day expected stock market volatility. Since we started offering these products, we have seen trading from a number of different customer segments utilizing a number of different trading strategies, including hedging extreme stock market declines, also known as "tail risk" hedging, and risk-managed strategies that seek to capture the relative price changes of expected volatility at different times in the future.
While the trading volumes in options and futures on the VIX Index have rapidly increased over the past five years, trading volumes in these products are especially sensitive to market volatility, with increases in volume generally occurring along with spikes in volatility. While we believe that there will be continued intrinsic growth in our volatility products, significant changes in the levels of market volatility may significantly impact volumes in these products.
In addition to the VIX Index, we offer other products based on the VIX methodology, including futures on CBOE Russell 2000 Volatility Index and the CBOE/CBOT 10-year U.S. Treasury Note Volatility Index. CFE also lists futures on realized variance using RIVETS® methodology. While volumes in our non-VIX options and futures volatility products are not material to us, we continue to explore opportunities to expand our volatility product offerings, with respect to both new indexes and new asset classes.
A Trading Permit Holder ("TPH") on one of our options exchanges is allowed to enter orders and quotes into the trading system for that exchange. Trading Permit Holder entities can execute trades for their own accounts, for clearing firm accounts, for the accounts of other permit holders or for the accounts of customers.
A trading permit entitles the holder to conduct business on the exchange, including in one of the participant roles described below.
Market-Maker. A market-maker engages in trading our products either for its own account or for the account of his or her firm, but does not act as an agent representing orders for customers. Market-makers have quoting obligations in their appointed product classes. They are granted margin relief and must have a relationship with a clearing firm that will hold and guarantee their positions. The majority of trading permits in use on CBOE and C2 are used for market making. There are additional classes of market-maker, namely Lead Market-Maker ("LMM") permits and Designated Primary Market-Maker ("DPM") permits that also provide incentives for market-makers to provide competitive quotes, and are also called liquidity providers. In addition, TPHs routing orders to CBOE may designate a Preferred Market-Maker ("PMM"). The PMM is afforded a participation right on specific orders provided that it meets certain other requirements with respect to the relevant options class and quoting obligations.
Floor Broker. An individual who represents orders on the CBOE trading floor as an agent is known as a floor broker. Floor brokers generally do not trade for their own account, although they may represent their firms' proprietary account, and do not receive any margin relief.
Electronic Access Permits ("EAP"). An Electronic Access Permit is a trading permit used by TPHs that need a separate access permit for a specific business function and is the most general type of access permit. EAPs may be registered for one of the following: clearing TPHs; TPHs approved to transact business with the public; proprietary TPHs; and order service firms.
The matching algorithms used on our exchanges are the means by which trades are executed and allocated to market participants. Our technology and the rules of our exchanges provide for a variety of different algorithms for matching buyers and sellers. We have the ability to apply different matching algorithms to different products in order to meet the needs of particular market segments. The setting of the matching algorithm affects the share of each trade that a market participant receives and is central to the opportunity and profit potential of market-makers and other liquidity providers.
CBOE utilizes varying matching algorithms across its listed options classes, with different combinations of customer priority, participation rights and pro-rata, modified pro-rata or price-time depending on the product.
C2's matching algorithm is pro-rata for ETP options classes. For equity options classes, the C2 matching algorithm was a price-time matching algorithm with customer priority and DPM participation rights in 2014, but became pro-rata in 2015.
Options orders can be routed to other marketplaces via contracted brokers for execution if a better displayed price exists elsewhere. See "Regulatory Responsibilities - Options Intermarket Linkage Plan." Details on our technological capabilities, as well as key systems offerings available to customers, are described in "Technology."
Each of our exchanges establishes a fee schedule that, among other things, sets the transaction fee for buying or selling options or futures contracts on the exchange and access fees for accessing the exchange. In our proprietary products, we assess these fees on all participants, with the amount of the fee based on the market participant's role and the origin of the underlying order, and subject to discounts based on relative volume or trading strategies. In multiply-listed products, CBOE utilizes a pricing model in which transaction fees are charged to most professionals, including market-makers, but are not charged for most customer orders. Additionally, CBOE offers incentive programs to attract customer order flow, including certain payments for order flow and our volume incentive program, or VIP, which pays credits to permit holders for executing certain types and levels of qualifying customer business at the exchange.
CFE utilizes a pricing model in which transaction fees vary depending on the type of market participant on whose behalf a trade is made and on whether the trade is executed through CFE's trading system, or is a block trade or exchange of contract for a related position transaction. CFE also offers a Day Trade Fee Program that provides rebates on trades that qualify for the program.
Each of the exchanges also currently charges a fee for trading permits that allow access to our exchanges. CBOE has a sliding scale for all Market-Maker Trading Permits held by affiliated Trading Permit Holders and TPH Organizations that are used for appointments in any options classes other than SPX.
In our proprietary products, we compete against futures exchanges and swap execution facilities that offer similar products and other financial institutions that write over-the-counter derivatives. We also compete against certain multiply-listed options products, include SPY, that offer some of the features of our proprietary products.
The multiply-listed options industry is extremely competitive and the competition has intensified. We expect this trend to continue. We compete with a number of entities on several different fronts, including the price, quality and speed of our trade execution, the functionality and ease of use of our trading platform, the range of our products and services, our technological innovation and adaption and our reputation. There are ten other U.S. options exchanges that are our primary direct competitors, including ISE, NASDAQ OMX NOM, NASDAQ OMX PHLX, NYSE Amex and NYSE Arca.
Offering market participants potential participation rights for order flow that they direct or cause to be directed to our exchanges; and
Providing brokers and their customers with a complete source of information on options as well as extensive options education.
CBOE Command, our in-house developed Java application with an infrastructure designed for high performance and low latency, supports trading on all of our exchanges and supports trading nearly 24 hours, 5 days a week on CFE. Our technology supports the trading process from the entering of quotes and orders, to matching trades, to submitting them to OCC for clearing. The technology supports different products, different market models and multiple matching algorithms, as well as a fully integrated complex order book and several auction mechanisms. As mentioned above, CBOE is a hybrid exchange, while C2 and CFE are fully electronic. In the Hybrid format, CBOE Command provides features of screen-based and floor-based trading.
Market data is sent to the Options Price Reporting Authority ("OPRA"), our TPHs, CBOE Financial Network and CBOE Streaming Markets ("CSM"), described below. Our exchanges generate valuable information regarding the prices of our products and the trading activity in our exchanges. For options, market data relating to price and size of market quotations and the price and size of trades is collected and consolidated by OPRA. OPRA disseminates the information for a fee to vendors who redistribute the data to brokers, investors and other persons or entities that use our markets or that monitor general market conditions. After costs are deducted, the fees collected are distributed among OPRA's exchange participants based on their cleared transactions pursuant to the OPRA Plan. As of December 2014, our market data was displayed on approximately 144,000 terminals worldwide. See "Regulatory Environment and Compliance" for further information on OPRA.
Our subsidiary, Market Data Express, LLC ("MDX") sells historical options data and real-time data index values. It also provides market data through CSM, a proprietary streaming data feed. In 2014, we enhanced CSM's offerings to include market depth.
We operate and maintain geographically diverse disaster recovery facilities that essentially replicate the systems available in our primary data center for CBOE and CFE. We expect that the disaster recovery facilities can be up and running in a short period and work with our market participants to ensure that the marketplace can be quickly reopened. We continue to work to improve both the availability of our systems and our disaster recovery facilities, including through simulation testing.
The OCC acts as the issuer, counterparty and guarantor for all options contracts traded on our options exchanges and other U.S. options exchanges. Upon execution of an options trade, we transmit to the OCC a record of all trading activity for clearing and settlement purposes. The OCC fulfills these same functions for futures products traded on CFE.
On December 5, 2014, the SEC adopted a new regulation, Regulation Systems Compliance and Integrity, ("Reg SCI") under the Securities Exchange Act. Reg SCI will require "SCI Entities," which includes self-regulatory organizations like CBOE and C2, to comply with security and capacity requirements with respect to their systems and accompanying compliance procedures. The regulation will replace and codify the current Automation Review Policy. Prior to the November 2015 compliance date, CBOE and C2 will be required to, among other things, establish written policies and procedures reasonably designed to ensure that their systems have adequate integrity to ensure a resilient market in the event of a disruption. This includes, for example, each exchange ensuring that it has adequate disaster recovery facilities that are geographically diverse from the exchange's systems and that facilitate the ability to resume trading within specified timeframes when critical and non-critical SCI systems are rendered inoperable. It also requires timely and substantial notification to be made to the SEC in the event an exchange experiences any system interruption or interference. The SEC has also established various working groups of exchanges to focus on improving market resiliency, including regarding regulatory halts, trade nullification and additional market protections. As adopted, Reg SCI and the other SEC mandated working group initiatives are very complex, and, as such, compliance with rules may require significant resources.
In 2012, the SEC directed the self-regulatory organizations, or SROs, through a new regulation, to submit a plan to create, implement and maintain a consolidated audit trail ("CAT"), which would serve as a comprehensive audit trail of orders that will allow regulators to efficiently and accurately track all activity in Regulation NMS securities in the U.S. market. The regulation requires, among other things, that, upon implementation of a plan, data be reported to a central repository the following day by each exchange and broker dealer. We are working with the other SROs to develop the plan to implement a consolidated audit trail, which is required to detail technological and compliance aspects of the plan and the costs to implement the plan, among other details. The SROs have submitted a plan, but further revisions to the plan are anticipated. Once the plan is finalized and effective, there will be a phased implementation over three years. The exchanges and their participants are likely to incur significant costs related to the implementation of the consolidated audit trail requirements.
Dodd-Frank amended the core principles with which designated contract markets ("DCMs") like CFE must comply under the Commodity Exchange Act. In 2012, the CFTC adopted a number of new regulations applicable to DCMs in order to implement the amended core principles. These regulations related to, among other things, compliance with rules, prevention of market disruption, financial integrity of transactions, disciplinary procedures, system safeguards and financial resources. As a result, CFE implemented a number of new rules, policies and procedures in relation to these new requirements.
One aspect with respect to the amended core principles applicable to DCMs that remains pending relates to amended Core Principle 9. Core Principle 9 requires each DCM to provide a competitive, open and efficient market and mechanism for executing transactions that protects the price discovery process of trading in the DCM's centralized market. CFTC regulations to implement Core Principle 9 remain pending and may address the extent to which a DCM may permit block trades and exchanges of derivatives for related positions in its products to occur through the DCM outside of the DCM's centralized market. CFE cannot predict or estimate the extent to which these regulations may affect CFE or its operations.
In 2013, the CFTC issued a concept release that sought public comment regarding a series of existing and potential pre-trade risk controls; post trade reports and other post-trade measures; system safeguards related to the design, testing, and supervision of automated trading systems; and additional protections designed to promote safe and orderly markets. The concept release was intended to serve as a platform for cataloguing existing industry practices, determining their efficacy and implementation to date and evaluating the need for additional measures, if any. The concept release did not include any proposed new regulations but could lead to the proposal by the CFTC of additional regulations in this regard that could impact CFE or its operations.
Federal securities laws have established a two-tiered system for the regulation of securities exchanges and market participants. The first tier consists of the SEC, which has primary responsibility for enforcing federal securities laws. The second tier consists of self-regulatory organization ("SROs"), which are non-governmental entities that must register with and are regulated by the SEC. CBOE and C2 are SROs, each registered under Section 6 of the Exchange Act as a "national securities exchange" and are subject to oversight by the SEC. CBSX, which ceased offering stocks for trading on April 30, 2014, is not an SRO and was a stock trading facility of CBOE. As the SRO for CBSX, CBOE is responsible for the regulation of the CBSX marketplace and the following discussion of CBOE's responsibilities includes the responsibility to provide regulation for CBSX and CBOE's other facilities. In addition, National Stock Exchange, Inc. ("NSX") is a stock exchange that is a self-regulatory organization and was wholly owned by CBSX until it was sold to a third party on February 18, 2015. NSX
ceased operating its exchange on May 30, 2014. CBOE supported NSX in fulfilling its self-regulatory responsibilities during the time that CBSX owned NSX.
In general, an SRO is responsible for regulating its members, known as TPHs at CBOE and C2, through the adoption and enforcement of rules governing the business conduct of its members. The rules of the exchange must also assure fair representation of its members in the selection of its directors and administration of its affairs and, among other things, provide that one or more directors be representative of issuers or investors and not be associated with a member of the exchange or with a broker or dealer. Additionally, the rules of the exchange must be adequate to ensure fair dealing and to protect investors and may not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Securities Exchange Act.
On June 11, 2013, CBOE and C2 entered into a Consent Order with the SEC, under which CBOE and C2 were censured, ordered to cease and desist from violating certain sections of the Securities Exchange Act, paid a fine of $6 million and agreed to complete certain undertakings. These undertakings included conducting a review of our regulatory programs, enterprise risk management and business influences on regulation, reviewing business practices to ensure compliance with the rules of the exchanges and implementing training programs for employees. We have certified to the completion of these undertakings. The Consent Order also requires on-going certifications by the Company's Chief Executive Officer and Chief Regulatory Officer for five years following the completion of certain of the undertakings.
The operations of CFE are subject to regulation by the CFTC under the Commodity Exchange Act. The Commodity Exchange Act generally requires that futures trading in the United States be conducted on a commodity exchange designated as a contract market by the CFTC under the Act. The Commodity Exchange Act and CFTC regulations establish criteria for an exchange to be designated as a contract market on which futures and futures options contracts may be traded. Designation as a contract market for the trading of a specified futures contract is non-exclusive. This means that the CFTC may designate additional exchanges as contract markets for trading the same or similar contracts.
CFE is a designated contract market that is subject to the oversight of the CFTC and to a variety of ongoing regulatory and reporting responsibilities under the Commodity Exchange Act. As a designated contract market, CFE is required to comply with the applicable core principles and regulations under the Commodity Exchange Act. CFE has surveillance and compliance operations and procedures to monitor and enforce compliance by Trading Privilege Holders with CFE rules. If CFE fails to comply with applicable laws, rules or regulations, CFE may be subject to censure, fines, cease-and-desist orders, suspension of its business, removal of personnel or other sanctions, including revocation of CFE's designation as a contract market.
The National Futures Association ("NFA") performs many regulatory functions for CFE pursuant to a Regulatory Services Agreement with CFE. CFE retains overall responsibility for the regulation of its marketplace. CFE also remains responsible for bringing disciplinary actions against Trading Privilege Holders, including the ability to issue fines in the case of serious rule violations. In the case of financially distressed Trading Privilege Holders, CFE may take various emergency actions to protect customers, other Trading Privilege Holders and CFE. CFE is also a party to cooperative and regulatory information sharing agreements with other SROs and is a member of the Intermarket Surveillance Group, described below.
Our options exchanges are responsible for assessing the compliance of their Trading Permit Holders with the respective exchange's rules and the applicable rules of the SEC. The main activities that the exchanges are required to provide to measure compliance with these rules include:
surveillance designed to detect possible manipulation and violations of other SEC rules;
the examination of CBOE and C2 Trading Permit Holders for compliance with rules such as those related to net capital, books and records, market access and other matters related to the Trading Permit Holders' exchange business function.
As further described below, each options exchange is also responsible for reviewing its Trading Permit Holders' activities related to the conduct of business directly with public customers, or sales practice.
In order to ensure market integrity, we regulate and monitor our Trading Permit Holders' trading activities by using both our employees and third parties under regulatory services agreements. See "Regulatory Agreements" below. Providing effective regulation is important for attracting and retaining the confidence and participation of market-makers, broker-dealers and institutional and retail investors.
We expend considerable time, financial resources and effort to ensure that the exchanges' rules and regulations conform to regulatory best practices within the securities exchange industry and within the regulatory regime overseen by the SEC, our primary regulator. In order to support our efforts and those of our market participants to comply with applicable law and our options exchange rules, we developed a regulatory program to monitor market activity on our options exchanges and across U.S. options market.
We collect certain fees derived from our regulatory function and fines in connection with our disciplinary proceedings. Under the rules of each of our options exchanges, as required by the SEC, any revenue derived from the regulatory fees and fines cannot be used for non-regulatory purposes.
CBOE and C2 have entered into agreements, some pursuant to Section 17(d) of the Exchange Act, under which third parties have agreed to perform regulatory services to our markets. As discussed below, in certain instances, the third party has assumed the regulatory responsibility under Rule 17d-2, while in others, CBOE retains the regulatory responsibility for the activities.
On December 19, 2014, CBOE and C2 entered into an agreement with the Financial Industry Regulatory Authority ("FINRA") under which FINRA agreed to start providing regulatory services to CBOE and C2 on January 1, 2015. Under the agreement, FINRA will perform the majority of the regulatory services for CBOE and C2. CBOE and C2 remain responsible for the regulation of their marketplaces, and retain the authority for bringing disciplinary actions against their Trading Permit Holders.
The SEC approved a national market system plan named the Options Regulatory Surveillance Authority Plan ("ORSA Plan") with the purpose of permitting the U.S. securities options exchanges to act jointly in the administration, operation and maintenance of a regulatory system for the surveillance, investigation and detection of the unlawful use of undisclosed, material information in trading in one or more of their markets. Through the sharing of the costs of these regulatory activities and the sharing of the regulatory information generated under the ORSA Plan, the ORSA Plan is intended to enhance the effectiveness and efficiency with which the exchanges regulate their respective markets and the national market system for options and to avoid duplication of certain regulatory efforts. The ORSA policy committee had delegated the operation of the surveillance and investigative facility contemplated by the ORSA Plan to CBOE. The exchanges also entered into a Regulatory Services Agreement with CBOE, as service provider, pursuant to which CBOE performed certain regulatory and surveillance functions under the ORSA Plan and used its automated insider trading surveillance system to perform these functions on behalf of the exchanges. Effective January 1, 2015, the ORSA policy committee delegated the operation of the ORSA Plan facility to FINRA, and FINRA became the service provider under the Regulatory Services Agreement.
National Market System ("NMS") Plans
OPRA Plan, CTA Plan and NASDAQ Unlisted Trading Privileges Plan
Like all U.S. options exchanges, CBOE and C2 are member exchanges in OPRA, a limited liability company. The OPRA limited liability company agreement sets forth a system for reporting options information that is administered by the member exchanges through OPRA, consisting of representatives of the member exchanges. OPRA is the designated securities information processor for market information that is generated through the trading of exchange-listed securities options in the U.S., and it disseminates certain core trading information, such as last sale reports and quotations. We also participate in the Consolidated Tape Association, or CTA, the Consolidated Quotation Plan, or CQ Plan, and the NASDAQ Unlisted Trading Privileges Plan, which perform analogous services for the U.S. equities market. NYSE Technologies, formerly the Securities Industry Automation Corporation, acts as the "processor" for OPRA, CTA and the CQ Plan. NASDAQ acts as the processor for the NASDAQ Unlisted Trading Plan.
As of December 31, 2014, we employed 520 individuals. Of these employees, 208 were involved in systems development or operations, 124 were involved in direct support of trading operations. The remaining 188 employees provide business development, product development, education, financial, regulation, human resources, legal, planning and research, administrative and managerial support.
We have eight building engineers that are covered by a collective bargaining agreement, which expires on May 31, 2015, with the International Union of Operating Engineers Local 399, AFL-CIO. Management believes that we have strong relationships with our employees and we have never experienced a work stoppage.
Joanne Moffic-Silver. Ms. Moffic-Silver is our Executive Vice President, General Counsel and Corporate Secretary. She has served in that capacity since 1997 and has been employed as an attorney at the Company since 1980. She is currently a member of the executive committee of the board of advisors of Northwestern University School of Law and a member of the Chicago Network. Ms. Moffic-Silver received her B.A. degree from the University of Wisconsin-Madison (Phi Beta Kappa). Ms. Moffic-Silver received her J.D. degree with honors from Northwestern University School of Law.
In addition, we have posted on our website the charters for our (i) Audit Committee, (ii) Compensation Committee, and (iii) Nominating and Governance Committee, as well as our Code of Business Conduct and Ethics and Corporate Governance Guidelines. We will provide a copy of these documents without charge to stockholders upon written request to Investor
Relations, CBOE Holdings Inc., 400 South LaSalle Street, Chicago, Illinois 60605. Our website and information included in or linked to our website are not part of this Form 10-K.
Loss of our right to exclusively list certain index options and futures could have a material adverse effect on our financial performance.
We hold exclusive licenses to list securities index options on the S&P 500 Index, the S&P 100 Index and the DJIA, granted to us by the owners of such indexes and have developed our proprietary VIX methodology. In 2014, approximately 81.8% of our transaction fees were generated by our futures and index options, the overwhelming majority of which were generated by our exclusively-licensed products and products based on the VIX methodology. The bulk of this revenue is attributable to our S&P 500 Index options and VIX Index options and futures. As a result, our operating revenues are dependent in part on the exclusive licenses we hold for these products and our ability to maintain our exclusive VIX methodology.
In addition to the risks related to our exclusive licenses, if we are unable to retain our proprietary rights in the VIX methodology, our volatility products could be subject to multiple listing or loss of the ability to offer these products for trading, which could have a material adverse effect on us.
In addition, the European Parliament has adopted legislation that requires European exchanges to provide non-discriminatory access to benchmarks, like index options, and is considering other legislation that may impact the ability of European banks to trade our products. While similar legislation has not been proposed in the United States, if it were passed, it could cause us to lose our property rights in our internally developed and licensed index products. The adopted and proposed European legislation may limit our ability to expand our activities in Europe while retaining our property rights, and may reduce the volume on our exchanges from international customers.
The value of our exclusive licenses to list securities index options also depends on the continued ability of index owners to require licenses for the trading of options based on their indexes. Although we and the index owners have prevailed in legal actions challenging our rights to exclusively license indexes, we may be subject to legal or other action taken in the future that might impede our ability to exclusively license indexes.
The business of operating options exchanges is characterized by intense price competition, especially with respect to transaction fees. The pricing model for trade execution for options has changed in response to competitive market conditions and our competitors have adjusted transaction fees and fee structures accordingly, including by opening new exchanges, which
allow them to offer multiple pricing models that can appeal to different segments of market participants. These changes have resulted in significant pricing pressures on us, especially on transaction fees for multiply-listed products. As a result of these pricing pressures, our average rate per multiply-listed options contract has decreased from $0.143 in 2012 to $0.092 in 2014. It is likely that this pressure will continue and even intensify as our competitors continue to seek to increase their share of trading by further reducing their transaction fees or by offering other financial incentives to order providers and liquidity providers to induce them to direct orders to their markets.
Like nearly all of the other options exchanges, our options exchanges charge an options regulatory fee or ORF to Trading Permit Holders based on the total number of customer contracts cleared by that Trading Permit Holder, regardless of the exchange on which the trade is executed. Along with fines and other regulatory fees, the ORF revenues may only be used to support our regulatory functions. We may face competitive pressures to further reduce or not increase the ORFs on our exchanges, and if we are unable to maintain or, if necessary, increase the ORFs, our results of operation may be adversely affected.
CBOE and C2 are registered national securities exchanges and SROs, and, as such, are subject to comprehensive regulation by the SEC. CFE is a DCM registered with the CFTC and is subject to comprehensive regulation by the CFTC. See "Business -- Compliance - Securities Industry -- CBOE and C2" for information regarding our ongoing regulatory responsibilities for CBSX.
In addition to the requirements related to operating our markets imposed by the SEC and the CFTC, we also have certain responsibilities for regulating the TPHs that trade on our exchanges. While we have entered into agreements under which FINRA and other SROs with respect to our options exchanges, and NFA with respect to our futures exchange, provide certain regulatory services, we retain responsibility for the regulation of our Trading Permit Holders. See "Business -- Regulatory Responsibilities."
If the SEC were to find one of our programs of enforcement or compliance to be deficient, CBOE or C2 could be the subject of SEC investigations and enforcement proceedings that may result in substantial sanctions, including revocation of an exchange's registration as a national securities exchange. Any such investigations or proceedings, whether successful or unsuccessful, could result in substantial costs, the diversion of resources, including management time, and potential harm to our reputation, which could have a material adverse effect on our business, results of operations or financial condition. In addition, CBOE or C2 may be required to modify or restructure their regulatory functions in response to any changes in the regulatory environment, or they may be required to rely on third parties to perform regulatory and oversight functions, each of which may require us to incur substantial expenses and may harm our reputation if our regulatory services are deemed inadequate.
Although CBOE Holdings itself is not an SRO, CBOE Holdings is subject to regulation by the SEC of activities that involve the exchanges. Specifically, the SEC will exercise oversight over the governance of CBOE Holdings and its relationship with CBOE and C2. See "Regulatory Environment and Compliance—Regulatory Responsibilities."
If we are unable to execute the undertakings in the Consent Order, it may have a significant adverse impact on our business.
On June 11, 2013, CBOE and C2 entered into the Consent Order with the SEC under which CBOE and C2 were censured, ordered to cease and desist from violating certain sections of the Securities Exchange Act, paid a fine of $6 million and agreed to complete certain undertakings. These undertakings included conducting a review of our regulatory programs,
enterprise risk management and business influences on regulation; reviewing business practices to ensure compliance with the rules of the exchanges; and implementing training programs for employees. The Consent Order also requires on-going certifications by CBOE and C2's Chief Executive Officer and Chief Regulatory Officer for five years.
We may be subject to additional investigations or proceedings by the SEC if the SEC were to find that we did not fulfill our obligations under the Consent Order. Any investigations or proceedings, whether successful or unsuccessful, could result in substantial costs, the diversion of resources, including management time, and potential harm to our reputation, which could have a material adverse effect on our business results of operations or financial condition.
a reduction in trading by customers,
heightened capital requirements,
regulatory or legislative actions,
reduced access to capital required to fund trading activities, or
Over the past few years, a number of legislative actions have been taken, both domestically and internationally, that may cause our customers, including market makers, to be subject to increased capital requirements and additional compliance burdens. These actions, including Basel III, Dodd-Frank and the Collins Amendment to Dodd-Frank, may cause customers to reduce the number of trades they make on our exchanges.
In addition, the transaction fees generated are different based on type of product and other factors, including the type of customer and certain volume discounts. See "Management's Discussion and Analysis -- Operating Revenues -- Average revenue per contract." If the amount of our trading volume decreases, or the mix traded shifts to our lower revenue per contract products, our revenues from transaction fees will decrease. We can offer no assurance that we would be able to reduce our costs to match the amount of any such decrease.
Legislative or regulatory changes affecting the listed options market could have a material adverse effect on our business.
Changes in regulation by the SEC, CFTC or other government action, including SEC approval of rule filings by other SROs or entities, including OCC, could materially affect our markets. In recent years, the securities and futures industries have been subject to significant regulatory changes as a result of increasing government and public scrutiny in response to the global economic crisis.
Under the Collins Amendment to the Dodd-Frank Act, starting in 2015, U.S. banks are required to use a new approach in order to compute their risk weighted assets, which include exchange-traded options and futures. This is expected to increase the capital requirements for U.S. bank holding companies, and bank subsidiaries involved in the trading and clearing of derivatives. These increased capital requirements may reduce trading in options and futures due to bank-affiliated broker-dealers reducing their own trading, charge their customers more to trade or reducing the type or number of customers.
In 2012, the SEC directed the self-regulatory organizations to submit a plan to create, implement and maintain a consolidated audit trail, which would serve as a comprehensive audit trail of orders that will allow regulators to efficiently and accurately track all activity in Regulation NMS securities in the U.S. market. In addition to increased regulatory obligations, implementation of a consolidated audit trail could result in significant additional expenditures, including to implement any new technology to meet any plan's requirements. The SEC has also adopted Regulation Systems Compliance and Integrity ("Reg SCI") and established working groups of exchanges to focus on improving market resiliency. Meeting the requirements of Reg
SCI or other regulations or mandates generated by these working groups could result in significant additional expenses, including for technology and compliance.
In addition, Congress, the SEC and other regulatory authorities could impose legislative or regulatory changes that could adversely impact the ability of our market participants to use our markets, or participate in the options or futures industry at all. Any such changes could result in the loss of a significant number of market participants or a reduction in trading activity on our markets, any of which could have a material adverse effect on our business. Changes or proposed changes in regulation may also result in additional costs of compliance and modification of market participants' trading activity on our exchanges.
We compete with a number of entities on several different fronts, including the cost, quality and speed of our trade execution, functionality and ease of use of our trading platform, range of our products and services, our technological innovation and adaptation and our reputation. We compete with futures exchanges and swap execution facilities that offer comparable products and with the over-the-counter market with respect to our proprietary products. With respect to our multiply-listed products, our principal competitors are the ten other U.S. options exchanges. See the risk factor "Our business may be adversely affected by price competition."
Most of the equity options and options on ETPs listed and traded on our exchanges are also listed and traded on other U.S. options exchanges. Changes we have implemented in response to competitive pressures may not be successful in maintaining or expanding our market share in those products in the future. Likewise, our future responses to these or other competitive developments may not be successful in maintaining or expanding our market share.
market, promote and sell their products and services more effectively;
We depend on a number of service providers, including clearing organizations such as the OCC and its member clearing firms; securities information processors such as the Consolidated Tape Association and OPRA; regulatory service providers such as FINRA and NFA; the host of our data center; and various vendors of communications and networking products and services. More specifically:
OPRA, UTP Securities Information Processor and the Consolidated Tape Association consolidate market information to provide market and regulatory information. If one or both of them were unable to provide this information for a sustained period of time, we may be unable to offer trading on our options markets.
FINRA and NFA provide regulatory services for our options and futures exchanges, respectively, while, in most cases, we retain regulatory responsibilities for such services. If FINRA or NFA stopped providing services, or provided inadequate services, we may be subject to action by the SEC or CFTC, or may have limitations placed upon our markets.
Our competitors, as well as others, have obtained, or may obtain, patents that are related to our technology or the types of products and services we offer or plan to offer. We may not be aware of all patents containing claims that may pose a risk of infringement by our products, services or technologies. In addition, some patent applications in the United States are confidential until a patent is issued, and therefore we cannot evaluate the extent to which our products and services may be covered or asserted to be covered in pending patent applications. Thus, we cannot be sure that our products and services do not infringe on the rights of others or that others will not make claims of infringement against us. Claims of infringement are not uncommon in our industry. If one or more of our products, services or technologies were determined to infringe a patent held by another party, we may be required to pay damages, stop using, developing or marketing those products, services or technologies, obtain a license from the holders of the patents or redesign those products, services or technologies to avoid infringing the patent. If we were required to stop using, developing or marketing certain products, our business, results of operations and financial condition could be materially harmed. Moreover, if we were unable to obtain required licenses, we may not be able to redesign our products, services or technologies to avoid infringement, which could materially adversely affect our business, results of operations or financial condition.
We operate, monitor and maintain our computer systems and networks, including the systems that comprise CBOE Command, the platform for trading on our exchanges. If we are unable to operate, monitor or maintain these systems and networks, or program them so that they operate correctly and maintain the integrity of their data, it could have a material
adverse effect on our ability to conduct our business. Although we have a complete back-up of CBOE and CFE, the back-up systems or disaster recovery plans may prove to be inadequate in the event of a systems failure or cyber-security breach. Despite the enhancements made to our disaster recovery facilities, there can be no guarantees that we will be able to open an efficient, transparent and liquid marketplace, if we can open at all.
In addition, we have extended the trading hours on CFE for VIX futures, and expect to extend the trading hours in 2015 for certain products on CBOE. With extended trading hours, we have to operate our systems longer and have fewer non-trading hours to address any potential concerns with the systems on which we rely.
unanticipated disruption in service to our participants,
failures or delays during peak trading times or times of unusual market volatility,
slower response times and delays in trade execution and processing,
incomplete or inaccurate accounting, recording or processing of trades, and
a loss in transaction or other fees due to the inability to provide services for a time,
requests by market participants or others that we reimburse them for financial loss, either within the constraints of the limited liability provisions of our exchanges' rules or in excess of those amounts,
trading to diminish on our exchanges due to dissatisfaction with the platform, and
The secure and reliable operation of our computer systems, our communications networks and the systems of our service providers and market participants, is a critical element of our operations. These systems and communications networks may be vulnerable to unauthorized access, including the improper access of personally identifiable information, malware and other security problems, as well as to acts of terrorism, natural disasters and other events that are beyond our control. If our security measures are inadequate or if there are interruptions or malfunctions in our systems or communications networks, our business, financial condition and operating results could be materially impacted. We may be required to expend significant resources in the event of any real or threatened breaches in security or system failures, including to protect against threatened breaches and to alleviate harm caused by an actual breach, and may suffer harm to our reputation and litigation. Measures we implement for security and otherwise to provide for the confidentiality, integrity and reliability of our systems may prove to be inadequate in preventing system failures or delays in our systems or communications networks, which could lower trading volume and have an adverse effect on our business, financial condition and operating results.
The volume of options and futures transactions and the demand for our products and services are directly affected by economic, political and market conditions in the United States and elsewhere in the world that are beyond our control, including:
The right to trade on our exchanges is made available through trading permits for which the user pays a fee. These fees account for a significant portion of our operating revenues -- 9.6% in 2014. CBOE charges the highest relative trading permit rates in the options industry. We may face pressure from our customers to lower these rates or may see larger firms electing to use fewer permits to access our exchanges. If the demand for trading permits to our exchanges is less than historic levels or if we are unable to maintain permit rates, our ability to generate operating revenues through the granting of permits for trading access would be negatively impacted, which could adversely affect our profitability.
As the parent company for SROs, we are responsible for maintaining exchanges that comply with securities and futures laws, and SEC and CFTC regulations and the rules of the respective exchanges. Our ability to comply with applicable laws and rules is largely dependent on our policies and procedures designed to meet those compliance responsibilities, as well as our ability to attract and retain qualified personnel throughout the company. Our policies and procedures to identify, monitor and manage compliance risks may not be fully effective. Management of legal and regulatory risk requires policies and procedures to properly monitor, record and verify a large number of transactions and events. We cannot provide assurance that our policies and procedures will always be effective or that we will always be successful in monitoring or evaluating the compliance risks to which we are or may be exposed, or that our compliance and internal audit functions would be able to identify any such ineffectiveness. If these policies and procedures are not effective, we may be subject to monetary or other penalties by our regulators.
Our future success depends in large part on our management team, which possesses extensive knowledge and managerial skill with respect to the critical aspects of our business. The failure to retain members of our management team could adversely affect our ability to manage our business effectively and execute our business strategy.
Our business is also dependent on highly skilled employees, especially those who provide specialized services to our clients and oversee our technology functions. Many of these employees have extensive knowledge and experience in highly
technical and complex areas of the options trading industry. Because of the complexity and risks associated with our business and the specialized knowledge required to conduct this business effectively, and because the growth in our industry has increased demand for qualified personnel, many of our employees could find employment at other firms if they chose to do so, particularly if we fail to continue to provide competitive levels of compensation. If we fail to retain our current employees, it would be difficult and costly to identify, recruit and train replacements needed to continue to conduct and expand our business. In particular, failure to retain and attract qualified systems personnel could result in systems errors. Consequently, our reputation may be harmed, we may incur additional costs and our profitability could decline.
Over the past five years, we have demutualized, launched a second options exchange, experienced significantly increased volume on our futures exchange and extended trading hours on our futures exchange, and plan to extend trading hours in SPX and VIX options. We expect that our business will continue to grow, which may place a significant strain on our management, personnel, systems and resources. We must continually improve our operational, financial and regulatory systems and managerial controls and procedures, and may need to continue to expand, train and manage our workforce. We must also maintain close coordination among our technology, accounting, finance, marketing, sales, regulatory and compliance functions. We cannot assure you that we will manage our growth effectively. If we fail to do so, our business could be materially harmed.
The frequency of cyber attacks is increasing in general, and various groups have specifically targeted the financial services industry due to its perceived role in the economic and political climate. At the date of this filing, we have no evidence of any cases of data theft, corruption or destruction of data or compromised customer data. Security breaches may have significant costs in terms of cash outlays, business disruption, revenue losses, internal labor, overhead and other expenses. Measures we implement to monitor the environment and protect our infrastructure against security breaches and misappropriation of our intellectual property assets may prove insufficient, which could result in system failures and delays that could cause us to lose market participants, experience lower trading volume, incur significant liabilities or have a negative impact on our competitive advantage.
We run the risk that our Trading Permit Holders, other persons who use our markets or our employees may engage in fraud or other misconduct, which could result in regulatory sanctions and serious harm to our reputation, especially because we are the parent company of SROs. It is not always possible to deter misconduct, and the precautions we take to prevent and
detect this activity may not be effective in all cases. In addition, misconduct by, or failures of, participants on our exchanges may discourage trading on our exchanges, which could reduce revenues.
Legislation has been proposed, both domestically and internationally, that could change the way that our market participants are taxed on the products they trade on our markets. The proposals include modifications to the taxation of financial products, including repealing the "60/40 Rule," which allows market-makers to pay a blend of capital gains and ordinary tax rates on their income, requiring all derivatives to be marked-to-market, eliminating the exemption for "qualified covered calls," and the implementation of a transaction tax. If the proposed tax law changes, a transaction tax or other tax change that detrimentally impacts options or futures trading were to become law, they could have a negative impact on the options and futures industry and us by making transactions more costly to market participants, which may reduce trading.
The IRS has proposed new regulations under Section 871(m) that may require dividend tax withholding for a significant number of transactions completed by foreign persons. If the proposed regulations are adopted, or unless significant changes are made to the regulations, there may be a significant reduction in trading by foreign persons, either by their choice or due to brokers refusing to trade options for such persons.
In addition to proposed tax changes that would affect our market participants, states are currently modifying the apportionment factors on which the taxes are based, and are becoming more aggressive at asserting nexus over corporations that are not domiciled in the state. If these state tax laws change, or if states are successful at asserting nexus against us, we may be subject to taxes in additional states or at a higher amount in the states in which we operate. If this occurs, we may experience a higher marginal state tax rate.
We may selectively explore acquisition opportunities or strategic alliances relating to other businesses, products or technologies. We may not be successful in integrating other businesses, products or technologies with our business. Any such transaction also may not produce the results we anticipate, which could adversely affect us.
We may selectively explore and pursue acquisition and other opportunities to strengthen our business and grow our company. We may enter into business combination transactions, make acquisitions or enter into strategic partnerships, joint ventures or alliances, any of which may be material. The market for acquisition targets and strategic alliances is highly competitive, which could make it more difficult to find appropriate merger or acquisition opportunities. If we are required to raise capital by incurring debt or issuing additional equity for any reason in connection with a strategic acquisition or investment, financing may not be available or the terms of such financing may not be favorable to us and our stockholders, whose interests may be diluted by the issuance of additional stock.
The process of integration may produce unforeseen regulatory and operating difficulties and expenditures and may divert the attention of management from the ongoing operation of our business and harm the reputation of the companies. We may not successfully achieve the integration objectives, and we may not realize the anticipated cost savings, revenue growth and synergies in full or at all, or it may take longer to realize them than expected, any of which could negatively impact our results of operations, financial condition or the market price of our common stock.
Our organizational documents contain provisions that could block actions that shareholders might find favorable, including discouraging, delaying or preventing a change of control or and unsolicited acquisition proposals for us. These include provisions:
Our principal offices are located at 400 South LaSalle Street, Chicago, Illinois 60605. Through our wholly-owned subsidiary, Chicago Options Exchange Building Corporation, we own the building in which our principal offices are located and occupy approximately 300,000 square feet of this building. In addition to our principal offices, we also lease additional office space, approximately 10,000 square feet, which includes our data center and remote network operations.
We believe the space we occupy is sufficient to meet our current and future needs.
On November 12, 2012, CBOE brought suit against International Securities Exchange, LLC ("ISE") in the United States District Court for the Northern District of Illinois alleging that ISE infringes three of its patents (United States Patent Nos. 7,356,498; 7,980,457; and 8,266,044 (the "QRM patents")) related to quote risk monitor ("QRM") technology. CBOE has requested injunctive relief and monetary damages. On February 20, 2013, the court ruled that the case be transferred to the United States District Court for the Southern District of New York. On October 31, 2013, the court stayed the litigation pending resolution of Covered Business Method ("CBM") Patent Reviews at the United States Patent and Trademark Office ("USPTO") that ISE had petitioned for. On March 4, 2014, the USPTO instituted CBM Patent Reviews on CBOE's three QRM patents. In the CBM Patent Reviews, ISE has alleged that CBOE's three QRM patents are invalid because they are directed to subject matter that is not eligible for patent protection. On May 22, 2014, the USPTO instituted Inter Parties Review ("IPR") Proceedings, which ISE had petitioned for, on some but not all claims of two of CBOE's QRM patents (United States Patent Nos. 7,356,498 and 7,980,457). In the IPR Proceedings, ISE has alleged that claims of two of CBOE's QRM patents are invalid because they are directed to subject matter that is either anticipated or obvious in view of the prior art. Both the CBM Patent Reviews and IPR Proceedings are adjudicated by the Patent Trial and Appeal Board of the USPTO.
On May 23, 2014, Harold R. Lanier sued 14 securities exchanges, including CBOE, in the United States District Court for the Southern District of New York on behalf of himself and a putative class consisting of all persons in the United States who entered into contracts to receive market data through certain data plans at any time since May 19, 2008 to the present. The complaint alleges that the market data provided under the CQ Plan and CTA Plans was inferior to the data that the exchanges provided to those that directly receive other data from the exchanges, which the plaintiffs allege is a breach of their "subscriber contracts" and a violation of the exchanges' obligations under the CQ and CTA Plans. The plaintiffs seek monetary and injunctive relief. On May 30, 2014, Mr. Lanier filed two additional suits in the same Court, alleging substantially the same claims and requesting for the same types of relief against the exchanges who participate in the UTP and the OPRA data plans. CBOE is a defendant in each of these suits, while C2 is only a defendant in the suit regarding the OPRA Plan.
Unrestricted Common Stock
The Company's unrestricted common stock is listed on the NASDAQ Global Select Market under the trading symbol CBOE. As of January 30, 2015, there were approximately 172 holders of record of our unrestricted common stock.
The following table sets forth the high and low sales prices by quarter for shares of our unrestricted common stock as reported on NASDAQ and cash dividends declared per quarter:
(1) On December 10, 2013, the Company's board of directors declared a special cash dividend of $0.50 per share. The dividend was paid on January 17, 2014 to stockholders of record at the close of business on January 3, 2014.
(2) On February 4, 2015, the Company's board of directors declared a quarterly cash dividend of $0.21 per share. The dividend is payable on March 20, 2015 to stockholders of record at the close of business on February 27, 2015.
Each share of unrestricted common stock, including restricted stock awards, and restricted stock units is entitled to receive dividend and dividend equivalents, respectively, if, as and when declared by the board of directors of the Company.
The table below shows the purchases of equity securities by the Company in the three months ended December 31, 2014, reflecting the purchase of unrestricted common stock under the Company's share repurchase program:
The Company purchased 248 shares of unrestricted common stock at an average price of $54.42 in the three months ended December 31, 2014 to satisfy employees' tax obligations upon the vesting of restricted stock. These purchases were not part of the publicly announced repurchase program.
The following graph compares the cumulative total return provided to stockholders on our unrestricted common stock since our initial public offering against the return of the S&P Midcap 400 Index and a customized peer group that includes CME Group Inc., Intercontinental Exchange Inc., The NASDAQ OMX Group Inc. and CBOE Holdings.
An investment of $100, with reinvestment of all dividends, is assumed to have been made in our unrestricted common stock, the index and the peer groups on June 15, 2010, and its performance is tracked on a annual basis through December 31, 2014.
COMPARISON OF 54 MONTH CUMULATIVE TOTAL RETURN*
* $100 invested on 6/15/10 in stock or 5/31/10 in index, including reinvestment of dividends.
(1)Reflects the date of the Company's initial public offering.
Net income per share allocated to common stockholders (1)
Cash dividends per share paid on Class A and B Common Stock
Total stockholders'/members' equity
Net income per share allocated to common stockholders is calculated by dividing net income for each of the periods as if the restructuring transaction had occurred at the beginning of the year ended December 31, 2010.
Transaction fees accounted for 70.9%, 69.4% and 69.7% of total operating revenues for the year ended December 31, 2014, 2013 and 2012, respectively.
Index options and futures contracts accounted for 81.8%, 78.8% and 67.7% of our transaction fees for the year ended December 31, 2014, 2013 and 2012, respectively.
Our share of total exchange-traded options contracts for the year ended December 31, 2014 was 29.9% up from 27.9% and 27.8% in 2013 and 2012, respectively.
Employee costs, representing our largest expense category, were 19.7%, 20.6% and 20.3%, of total operating revenues for the years ended December 31, 2014, 2013 and 2012, respectively.
In December 2014, we entered into an agreement with the Financial Industry Regulatory Authority ("FINRA") to provide a majority of regulatory services to the CBOE and C2 options markets. We do not expect revenue generated from regulatory fees to be materially impacted by the agreement with FINRA. As a result of this agreement, we will experience a shift in expenses from employee costs to outside services.
We intend to continue developing innovative proprietary products that meet the needs of the derivatives industry, both through strategic relationships and internal development.
We intend to continue our efforts to expand the use of our products internationally. At the core of that effort is extending trading hours in our exclusive options and futures products.
We intend to continue to enhance our trading platform by continuing to invest in hardening and augmenting the functionality and capacity of our trading systems.
We seek to attract participants from the over-the-counter market, through customizing options products and through offering products similar to those traded over-the-counter.
We evaluate strategic opportunities that we believe will enhance stockholder value.
The Company believes that the number of investors that use options represents a growing proportion of the total investing public and that the increasing use of options represents a long-term trend that will continue in the future. Furthermore, we believe significant opportunities exist to expand the use of options by both institutional and professional investors and for the migration of activity from the over-the-counter market to exchanges.
While there is no certainty, we expect that the industry-wide and Company-specific factors that contributed to past volume changes will continue to contribute to future volume changes. However, additional factors may arise that could also impact trading volume which may result in increases or decreases in our trading volume, such as new or existing competition, or other events. Considering these factors, we do not expect past trading volumes to be an indicator of future trading volume.
Access fees represent fees assessed to Trading Permit Holders for the opportunity to trade, including fees for trading-related functionality, on CBOE, C2 and CFE. The CBOE program contains a tier-based market-maker appointment system with different trading permits based on trading function and, in the case of market-makers, the assessment of a surcharge for certain CBOE proprietary products. Beginning in mid-2013, CBOE implemented sliding scales for all Market-Maker and Floor Broker Trading Permits held by affiliated Trading Permit Holders and TPH Organizations that are used in any options classes other than certain proprietary indexes. The number of trading permits made available is limited.
To facilitate trading, the Company offers technology services, terminal and other equipment rentals, maintenance services, trading floor space and telecommunications services. Trading floor and equipment rentals are generally on a month-to-month basis. Facilities, systems services and other fees are generally monthly fee-based, although certain services are influenced by trading volume or other defined metrics, while others are based solely on demand.
The SEC requires that the revenues derived from certain of the fees from our regulatory functions, some of which are included in this revenue category, and regulatory fines must be used for regulatory purposes. Expenses related to our regulatory functions are included in our operating expenses, mainly in employee costs and outside services.
In December 2014, we entered into an agreement with the Financial Industry Regulatory Authority ("FINRA") to provide certain regulatory services to the CBOE and C2 options markets. Additionally, CBOE entered into a separate agreement with FINRA, under which it assigned to FINRA the responsibility to perform regulatory services for the Options Regulatory Surveillance Authority ("ORSA"). FINRA began performing the services on January 1, 2015.
Revenue generated through regulatory service agreements with other options exchanges (in 2015, we will no longer generate revenue from these regulatory service agreements);
Revenue generated through our order routing cancel fee and position transfer fee;
Most of our expenses do not vary directly with changes in our trading volume except royalty fees and trading volume incentives.
Employee costs are our most significant expense and include salaries and benefits, stock-based compensation, incentive compensation, severance and employer taxes. Salaries and benefits represent our largest expense category and tend to be driven by both our staffing requirements and the general dynamics of the employment market. Stock-based compensation is a non-cash expense related to equity awards. Stock-based compensation can vary depending on the quantity and fair value of the award on the date of grant and the related service period.
Data processing expense consists primarily of costs related to the maintenance of computer equipment supporting our system architecture, circuits supporting our wide area network, support for production software, fees paid to information vendors for displaying data and off-site system hosting fees.
Outside services consist primarily of consulting services, which include: the supplementation of staff for activities primarily related to systems development and maintenance and legal, regulatory and audit and tax advisory services.
Royalty fees primarily consist of license fees paid for the use of underlying indexes in our proprietary products usually based on contracts traded. The Company has licenses with the owners of the S&P 500 Index, S&P 100 Index and certain other S&P Indexes, the DJIA, the NASDAQ 100 and the Russell indexes. This category also includes fees paid to market participants for order flow that they direct or cause to be directed to our exchanges and fees related to the dissemination of market data related to S&P indexes.
Trading volume incentives consist of market linkage expenses incurred to send certain orders to other exchanges. If a competing exchange quotes a better price, we route the customer's order to that exchange and pay certain of the associated costs. Regardless of whether the transaction is traded at our options exchanges, the order flow potential enhances our overall market position and participation and provides cost savings to customers.
Income and expenses incurred through activities outside of our core operations are considered non-operating and are classified as other income/(expense). These activities primarily include interest earned on the investing of excess cash and investments in other business ventures.
We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact of, and any associated risks related to, these policies on our business operations is discussed throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations." For a detailed discussion on the application of these and other accounting policies, see Note 1 to our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, an amendment to FASB ASC Topic 205, Presentation of Financial Statements and FASB ASC Topic 360, Property, Plant and Equipment. The update revises the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity's operations and financial results, removing the lack of continuing involvement criteria and requiring discontinued operations reporting for the disposal of an equity method investment that meets the definition of discontinued operations. The update also requires expanded disclosures for discontinued operations, including disclosure of pretax profit or loss of an individually significant component of an entity that does not qualify for discontinued operations reporting. This ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2014. The Company has elected early adoption of the guidance and does not believe it will impact our consolidated balance sheets, statements of income, comprehensive income or cash flows.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. In addition, it provides guidance on accounting for certain revenue-related costs including when to capitalize costs associated with obtaining and fulfilling a contract. The guidance provides companies with two implementation methods. Companies can choose to apply the standard retrospectively to each prior reporting period presented (full retrospective application) or retrospectively with the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings of the annual reporting period that includes the date of initial application (modified retrospective application). This guidance is effective for annual reporting periods
beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The Company is in the process of evaluating this guidance, though we do not expect it will materially impact our consolidated balance sheets, statements of income, comprehensive income or cash flows.
The increase in total operating revenues was primarily driven by higher transaction fees and market data fees. The increase in transaction fees was primarily driven by an 11.6% increase in total volume in 2014. We experienced volume growth across all product categories. As reported by the OCC, total industry cleared options contract volume was 4.3 billion contracts in 2014, a 4% increase from 2013.
The increase in total operating expenses was primarily driven by higher employee costs, depreciation and amortization, data processing and royalty fees, partially offset by lower outside services. Employee costs reflect accelerated stock-based compensation expense and severance expense related to the transition of regulatory services to FINRA. The increase in royalty fees primarily resulted from higher volume in licensed and proprietary products.
The increase in total other expense was primarily driven by an impairment charge of $3.0 million related to our investment in IPXI Holdings, LLC ("IPXI"), partially offset by a reduction in equity losses in other investments.
Transaction fees increased 10.2% to $437.8 million for the year ended December 31, 2014, representing 70.9% of total operating revenues, compared with $397.2 million for the prior year period, or 69.4% of total operating revenues. This increase was largely driven by an 11.6% increase in trading volume, partially offset by a 1.2% decrease in the average revenue per contract. The increase in trading volume was across all product categories and the decrease in average revenue per contract primarily resulted from a shift in volume mix and an increase in volume based incentives. We believe volume across our product segments increased year over year due to market volatility, increased use of our proprietary products most directly tied to volatility and success in capturing market share. Trading volume is impacted by many factors, including: macroeconomic events, market volatility, regulatory actions or considerations, availability of capital, competition, pricing and number of trading days in the period.
Average revenue per contract, discussed in more detail below, is impacted by our fee structure, which includes volume based incentive programs, mix of products traded, the account type (customer, firm, market-maker, etc.) and the manner in which a trade is executed (electronic, open-outcry, etc.). The implementation of fee changes, which may increase or decrease our average revenue per contract, is primarily to ensure that we are competitive in the options marketplace and to ultimately improve and continue to drive order flow to our exchanges. We cannot predict the trading patterns of market participants, which may be based on factors outside our control, but we can attempt to price our products at levels that are competitive in our market.
The Company's average daily trading volume ("ADV") was 5.26 million contracts in 2014, up 11.6% compared with 4.71 million for 2013. The Company experienced ADV increases across all product categories. We continued to experience growth in the trading of our proprietary products, primarily SPX options, VIX options and VIX futures. For the year ended December 31, 2014 as compared to the prior year period, we experienced increases in total volume in SPX options, VIX options and VIX futures of 7.9%, 11.5% and 26.7%, respectively. Total trading days in 2014 and 2013 were two hundred fifty-two.
The following summarizes changes in total trading volume and ADV by product for 2014 compared to 2013.
The following summarizes average revenue per contract by product for 2014 compared to 2013.
Rate structure— Our rate structure includes sliding scales, volume discounts, volume incentive programs and caps on fees as part of our effort to increase liquidity and market share in multiply-listed options. Average revenue per contract on multiply-listed options (equities and exchange-traded products) decreased 19.1% and 12.5%, respectively. These decreases resulted primarily from increases in volume-based incentives for these products. Average revenue per contract on futures increased 3.4%. The increase was primarily due to fee changes implemented in 2014.
The demand for trading permits could be impacted by market fluctuations that affect trading volume.
Market data fees increased 22.2% to $30.4 million for the year ended December 31, 2014 from $24.9 million in the prior year. Market data fees represent income derived from OPRA as well as the Company's market data services, which for the year ended December 31, 2014 were $15.0 million and $15.4 million, respectively, and for the same period in 2013, were $12.9 million and $12.0 million, respectively. Income derived from OPRA is allocated based on each exchange's share of total cleared options transactions. The Company's share of OPRA income for the period ended December 31, 2014 increased to 24.9% from 21.7% for the same period in 2013 as a result of an increase in the Company's share of total cleared options transactions. Revenue generated from the Company's market data services, which provide current and historical options and futures data, increased $3.4 million, resulting primarily from an increase in subscribers and rates for certain market data services.
Regulatory fees increased 1.2% for the year ended 2014 to $37.1 million from $36.7 million in the same period in the prior year. Regulatory fees are primarily generated by the options regulatory fee that we charge on all Trading Permit Holder customer volume industry-wide which increased compared to the prior period. The higher revenue attributed to volume was partially offset by CBOE and C2 lowering their respective options regulatory fee rates as of August 1, 2014, and a decrease in regulatory fees received for other regulatory services, primarily related to CBOE Stock Exchange, LLC ("CBSX"), which ceased trading operations on April 30, 2014.
In December 2014, we entered into an agreement with the Financial Industry Regulatory Authority ("FINRA") to provide a majority of the regulatory services to the CBOE and C2 options markets. The Company does not expect revenue generated from regulatory fees to be materially impacted by the agreement with FINRA.
All contracts traded on our exchanges must be cleared through clearing members of the OCC. At December 31, 2014, there were one hundred seven Trading Permit Holders that are clearing members of the OCC. Two clearing members accounted for 46% of transaction and other fees collected through the OCC in 2014. The next largest clearing member accounted for approximately 11% of transaction and other fees collected through the OCC. No one Trading Permit Holder using the clearing services of the top two clearing member firms represented more than 42% of transaction and other fees collected through the OCC, for the respective clearing member, in 2014. Should a clearing member withdraw from CBOE, we believe the Trading Permit Holder portion of that clearing member's trading activity would likely transfer to another clearing member.
Total operating expenses increased $17.2 million, or 6.0%, to $303.4 million for the year ended 2014 from $286.2 million in the year ago period, resulting from higher employee costs, depreciation and amortization, data processing and royalty fees, partially offset by lower outside services. Expenses decreased to 49.2% of total operating revenues in the year ended 2014 compared with 50.0% in the same period in 2013.
For the year ended December 31, 2014, employee costs were $121.7 million, or 19.7% of total operating revenues, compared with $118.1 million, or 20.6% of total operating revenues, in the same period in 2013. This represented an increase of $3.6 million, or 3.1%, resulting from higher salaries of $3.6 million, driven primarily by annual pay adjustments, higher payroll taxes of $0.5 million and higher health insurance costs of $0.4 million, higher severance expense of $2.4 million, primarily due to transition of a majority of regulatory services to FINRA, and higher annual incentive compensation of $2.0 million, which is aligned with performance targets, partially offset by lower stock-based compensation expense of $5.2 million.
In December 2014, we entered into an agreement with FINRA to provide certain regulatory services to the CBOE and C2 options markets. As part of the agreement, a significant number of our regulatory staff, as well as certain systems staff supporting our regulatory functions, transitioned to FINRA resulting in a headcount reduction of over 100 employees. As a result of the reduction in headcount, we expect employees costs to be lower in 2015.
Data processing expenses increased $1.3 million to $19.2 million for the year ended December 31, 2014 compared with $17.9 million in the prior-year period. The increase in data processing expenses is primarily due to higher costs for hardware and software maintenance.
Expenses related to outside services decreased to $32.0 million for the year ended December 31, 2014 from $34.5 million in the prior-year period. The $2.5 million decrease is primarily due to lower costs related to litigation, partially offset by higher costs for contract programmers. The Company received an insurance reimbursement for legal expenses of $1.5 million in 2013.
In December 2014, we entered into an agreement with FINRA to provide certain regulatory services to the CBOE and C2 options markets. As noted above, certain staff transitioned from CBOE to FINRA. As a result of the transition, costs for former employees in regulatory and systems staff supporting our regulatory functions, will be included in outside services in 2015. As a result, we expect outside services to be in higher in 2015. We do not expect this change to result in a material increase in total operating expenses in 2015.
Royalty fees for the year ended December 31, 2014 were $66.1 million compared with $56.6 million for the prior year period, an increase of $9.5 million. The increase is primarily due to higher trading volume in licensed and proprietary products and an increase in royalty rates as a result of the amendment the Company executed with S&P OPCO LLC ("S&P"), effective as of March 2013, relating to the Company's license to trade options and futures and create products based on certain S&P indexes and higher fees associated with dissemination of certain market data.
Net loss from investment in affiliates was $4.2 million for the year ended December 31, 2014 compared with $2.2 million for the same period in the prior year. The loss in 2014 and 2013 primarily included the Company's share of the operating loss of Signal Trading Systems, LLC and, in 2014, the impairment of our investment in IPXI which totaled $3.0 million. See Note 3 to the consolidated financial statements for additional information on the Company's investment in Signal Trading Systems, LLC and IPXI.
For the year ended December 31, 2014, the income tax provision was $120.0 million compared with $107.7 million for the same period in 2013. This increase is primarily a result of higher taxable income and a higher effective tax rate. The effective tax rate was 38.7% and 38.0% for the year ended December 31, 2014 and 2013, respectively.
The Company's market share of total options contracts traded on U.S. exchanges was 27.9% for the year ended December 31, 2013 compared to 27.8% for the year ended December 31, 2012.
Total operating revenues increased due to higher transaction fees, regulatory fees and exchange services and other fees, partially offset by lower access fees.
Total operating expenses increased due to higher employee costs, depreciation and amortization and royalty fees, partially offset by lower data processing, outside services, trading volume incentives and other expense.
Significant Events in 2013
Total industry cleared contract volume in 2013 totaled 4.1 billion contracts, a 3% increase from the 2012 volume of 4.0 billion contracts as reported by the OCC. In addition, 2013 marked the second highest year for options industry cleared contract volume to date and the third consecutive year in which volume surpassed 4 billion contracts.
In 2013, we experienced growth in the trading of our proprietary products, primarily SPX options, VIX options and VIX futures. For the year ended December 31, 2013 as compared to the prior year period, we experienced increases in total volume in SPX options, VIX options and VIX futures of 18.9%, 29.1% and 67.9%, respectively.
On March 9, 2013, CBOE entered into Amendment No. 12 (the " S&P Amendment") to the License Agreement (as amended, the "S&P Agreement") by and between CBOE and S&P, as successor-in-interest to Standard & Poor's Financial Services LLC, pursuant to which CBOE and C2 may list for trading securities options on the S&P 500 Index, the S&P 100 Index and certain other S&P Indexes. The S&P Amendment extended the term of the S&P Agreement until December 31, 2033 and provides exclusivity to the Company until December 31, 2032 with respect to the S&P 500 Index.
The S&P Amendment also provides new pricing terms, effective March 9, 2013, and additional changes in pricing terms in subsequent years. The revised pricing terms include the terms that describe the fees that CBOE agrees to pay S&P with reference to the trading on the markets of CBOE and its affiliates of securities options and futures on the CBOE Volatility Index. The S&P Amendment also provides each party with an option to terminate the S&P Agreement in the event that trading in options on the S&P 500 Index fails to meet certain volume thresholds for three consecutive calendar quarters, with CBOE's option to terminate upon a change in control.
On June 11, 2013, CBOE and C2 entered into a Consent Order under which the Company was censured and ordered to cease and desist from violating certain sections of the Securities Exchange Act, paid a fine of $6.0 million and agreed to complete certain undertakings. Other expense for the twelve months ended December 31, 2014 included $1.0 million related to the penalty. In the fourth quarter of 2012, the Company recorded an expense of $5.0 million related to this matter.
Transactions Impacting our Financial Performance for the Twelve Months Ended December 31, 2013
Effective January 1, 2013, the Company increased its options regulatory fee rates for CBOE and C2. Effective September 1, 2013, CBOE decreased its options regulatory fee rate and C2 suspended its options regulatory fee rate.
In February 2013 and March 2013, the Company enhanced the Volume Incentive Plan ("VIP") to incent firms to execute qualifying electronic, public customer, multiply-listed volume at CBOE in excess of certain thresholds, with a graduated schedule for higher tiers.
The Company granted restricted shares of stock to certain officers and employees on February 6, 2013. In addition to the amounts recognized in connection with these grants, the Company recorded accelerated stock-based compensation expense totaling of $3.2 million for certain executives due to provisions contained in employment arrangements.
On May 23, 2013, the Company granted shares of restricted stock to the incoming Chief Executive Officer and President and Chief Operating Officer, in connection with their new positions. The grants to the Chief Executive Officer and President and Chief Operating Officer totaled $2.5 million, of which 50% vested upon grant.
The Company recorded accelerated stock-based compensation of $0.8 million to recognize the remaining value of stock grants awarded to employees in its regulatory division who will no longer receive stock-based compensation.
Total operating revenues for the year ended December 31, 2013 increased $59.8 million, or 11.7%, to $572.1 million from $512.3 million in the prior year. The following summarizes changes in total operating revenues for the year ended December 31, 2013 compared to 2012.
Transaction fees increased 11.2% to $397.2 million for the year ended December 31, 2013, representing 69.4% of total operating revenues, compared with $357.1 million for the prior year period, or 69.7% of total operating revenues. This increase was largely driven by a 6.0% increase in the average revenue per contract and a 4.7% increase in trading volume. The increase in average revenue per contract resulted from a shift in volume mix to our highest average revenue per contract products, index options and futures contracts, partially offset by higher volume-based incentives, which lowered our average revenue per contract for multiply-listed options.
The following summarizes transaction fees by product for 2013 compared to 2012.
The Company's ADV was 4.71 million contracts in 2013, an increase of 3.7% compared with 4.54 million for 2012. Total trading days in 2013 and 2012 were two hundred fifty-two and two hundred fifty, respectively. Due to the impact of Hurricane Sandy, all exchanges were closed two days in October 2012 resulting in no trading activity on those days.
The Company experienced growth in index options and futures contracts, including SPX options, VIX options and VIX futures, while volume decreased in equity options. The following summarizes changes in total trading volume and ADV by product for 2013 compared to 2012.
The average revenue per contract was $0.334 in 2013, an increase of 6.0% compared with $0.315 in 2012. Average revenue per contract represents transaction fees divided by total contracts.
There were a number of factors that contributed to the increase in our average revenue per contract in 2013 compared to 2012. These include:
Product mix—The increase in the average revenue per contract reflected a shift in the volume mix by product. Index options and futures contracts accounted for 31.4% and 3.4% of total trading volume in 2013, up from 26.8% and 2.1% in 2012, respectively. Index options generated total average revenue per contract of $0.670 representing the highest options average revenue per contract, while futures contracts generated our highest total average revenue per contract of $1.570.
SPX options, VIX options and VIX futures— For the year ended December 31, 2013 as compared to the prior year period, the total trading volume in SPX options, VIX options and VIX futures increased by 18.9%, 29.1% and 67.9%, respectively.
Access fees for the year ended December 31, 2013 decreased to $61.0 million from $64.1 million in the comparable prior year period. The decrease in access fees was primarily due to the implementation of an incentive programs for market-maker trading permits and floor brokers implemented in May 2013, which lowered monthly access fees.
Exchange services and other fees for the year ended December 31, 2013 increased 18.8% to $37.3 million from $31.4 million in the comparable period in the prior year, resulting from the introduction of a network access option offered in connection with the Company's data center move to New Jersey in December 2012.
Market data fees increased 2.3% to $24.9 million for the year ended December 31, 2013 from $24.3 million in the same period in the prior year. OPRA and Company market data fees for 2013 and 2012 were $12.9 million and $12.0 million and $15.0 million and $9.3 million, respectively. The Company's share of OPRA income for the period ended December 31, 2013 decreased to 21.7% from 24.4% for the same period in 2012 as a result of a decrease in the Company's share of total cleared options transactions. Revenue generated from the Company's market data services increased $2.7 million, resulting primarily from an increase in subscribers to CBOE Streaming Markets and other market data services and an increase in subscriber rates.
Regulatory fees increased 74.5% for the year ended 2013 to $36.7 million from $21.0 million in the same period in the prior year, resulting from CBOE and C2 increasing their options regulatory fee rates and higher Trading Permit Holder customer volume industry-wide as compared to the same period in 2012. In September 2013, CBOE decreased its options regulatory fee rate and C2 suspended its options regulatory fee rate.
Total operating expenses increased $18.0 million, or 6.7%, to $286.2 million for the year ended 2013 from $268.2 million in the year ago period, resulting from higher employee costs, depreciation and amortization and royalty fees, partially offset by lower data processing, outside services, trading volume incentives and other expense. Expenses decreased to 50.0% of total operating revenues in the year ended 2013 compared with 52.3% in the same period in 2012.
For the year ended December 31, 2013, employee costs were $118.1 million, or 20.6% of total operating revenues, compared with $104.2 million, or 20.3% of total operating revenues, in the same period in 2012. This represents an increase of $13.9 million, or 13.3%, resulting from increases in stock-based compensation of $8.5 million, annual incentive compensation of $3.7 million and salaries of $4.4 million resulting from increases in staffing, primarily for regulatory functions. These increases were partially offset by lower severance expense of $2.5 million.
The increase in stock-based compensation of $8.5 million resulted from the amortization of stock-compensation expense relating to the February 2013 and May 2013 grants and the recognition of $4.0 million of accelerated stock-based compensation related to the February 2013 grant to certain executives due to provisions contained in their employment arrangements and the recognition of the remaining value of stock grants awarded, in June 2010, to employees in the Company's regulatory division who were no longer eligible to receive equity-based compensation.
Depreciation and amortization increased by $3.0 million to $34.5 million for the year ended December 31, 2013 compared with $31.5 million for the same period in 2012.
Data processing expenses decreased $1.7 million to $17.9 million for the year ended December 31, 2013 compared with $19.6 million in the prior-year period. The decrease in data processing expenses is primarily due to decreases in hardware and software maintenance relating to the migration of the trading platform completed in December 2012.
Expenses related to outside services decreased to $34.5 million for the year ended December 31, 2013 from $36.3 million in the prior-year period. The $1.8 million decrease is primarily due to lower costs related to litigation. The Company received insurance reimbursement for legal expenses of $1.5 million during the year ended December 31, 2013.
Royalty fees expense for the year ended December 31, 2013 were $56.6 million compared with $46.1 million for the prior year period, an increase of $10.5 million. The increase is primarily due to higher trading volume in licensed index products and an increase in royalty rates as a result of the amendment the Company executed with S&P to the existing S&P Agreement.
Trading volume incentives decreased $2.0 million to $4.3 million for the year ended December 31, 2013 compared to $6.3 million for the prior year period. The decrease was primarily due to lower volume in multiply-listed options products, modifications in the criteria for contracts qualifying for certain quantity-based fee waivers and adjustments to the fees paid by the Company for transactions linked to away exchanges.
Other expenses decreased $3.7 million to $5.5 million for the year ended December 31, 2013 compared to $9.2 million for the same period a year ago. In 2012, the Company accrued an estimated expense of $5.0 million related to the SEC investigation of CBOE's compliance with its obligations as a self-regulatory organization under the federal securities laws. In 2013, the Company recorded an additional $1.0 million related to the final agreement with the SEC resulting in a net decrease of $4.0 million year over year.
Net loss from investment in affiliates was $2.2 million for the year ended December 31, 2013 compared with $1.7 million for the same period in the prior year. The loss in 2013 and 2012 primarily reflected the Company's share of the operating loss of Signal Trading Systems, LLC.
For the year ended December 31, 2013, the income tax provision was $107.7 million compared with $85.2 million for the same period in 2012, a direct result of an increase in the effective tax rate and higher taxable income. The effective tax rate was 38.0% and 35.1% for the years ended December 31, 2013 and 2012, respectively. The increase in effective tax rate for the year ended December 31, 2013 compared to 2012 is the result of 2012 including the recognition of discrete items related to prior periods. During the twelve months ended December 31, 2012, the Company filed amended returns for 2008, 2009 and 2010 and completed its return for 2011 and recognized, as a discrete item, in the aggregate, a $12.9 million net benefit for a Section 199 deduction for U.S. production activities. No comparable prior period adjustments were recorded in the year ended December 31, 2013.
Historically, we have financed our operations, capital expenditures and other cash needs through cash generated from operations. Cash requirements principally consist of funding operating expenses, capital expenditures, actual and anticipated quarterly and special dividend payments and common stock repurchases under the announced program. We expect to use cash on hand at December 31, 2014 and funds generated from operations to continue to meet our 2015 cash requirements. From time to time, we consider the possibility of acquisitions, dispositions and strategic alliances that we believe would strengthen our business in the long-term; however, if consummated these transactions may negatively impact our liquidity in the short-term.
Net cash flows used in investing activities totaled $52.1 million and $31.2 million for the years ended December 31, 2014 and 2013, respectively. Expenditures for capital and other assets totaled $50.2 million and $28.7 million for the years ended December 31, 2014 and 2013, respectively, primarily representing purchases of systems hardware and development of software to harden and enhance our trading platform and operations. The Company made an investment in Signal Trading Systems, LLC of $2.0 million in 2014.
Our future expenditures for capital and other assets are expected to be primarily driven by spending to harden the company's systems, as well as ongoing investments in systems hardware and software that enhance trading technology.
Net cash flows used in financing activities totaled $283.9 million and $107.4 million for the years ended December 31, 2014 and 2013, respectively. The $176.5 million increase in net cash flows used in financing activities resulted primarily from higher quarterly dividends, the payment of a special dividend in 2014 and repurchases of unrestricted common stock.
For the year ended December 31, 2014, net cash flows used in financing activities consisted of $168.3 million in unrestricted common stock purchases under the Company's share repurchase program, $67.0 million for the payment of quarterly dividends, $43.8 million for the payment of a special dividend and $8.3 million for other share repurchases, which consisted of unrestricted common stock surrendered to satisfy employees' tax obligations upon the vesting of restricted stock.
Net cash provided by operating activities was $224.4 million and $200.5 million for the years ended 2013 and 2012, respectively. The increase in net cash flows provided by operating activities was primarily due to an increase in working capital generated by strong operating results.
Net cash provided by operating activities was $48.4 million higher than net income for the fiscal year ended December 31, 2013. The net increase was mainly a result of $34.5 million in depreciation and amortization, the recognition of stock-based compensation totaling $20.8 million and increase in income taxes payable of $9.0 million partially offset by an increase in accounts receivable of $4.2 million and an increase in income tax receivable of $10.3 million.
Net cash flows used in investing activities totaled $31.2 million and $33.0 million for the years ended December 31, 2013 and 2012, respectively. Expenditures for capital and other assets totaled $28.7 million and $30.1 million for the years ended December 31, 2013 and 2012, respectively, primarily representing purchases of systems hardware and software. In 2013, the Company made investments in IPXI Holdings, LLC for $0.6 million and Signal Trading Systems, LLC for $1.9 million.
Net cash flows used in financing activities totaled $107.4 million and $166.9 million for the years ended December 31, 2013 and 2012, respectively. The decrease in net cash flows used in financing activities resulted primarily from the payment of a special dividend in the prior year totaling $66.2 million.
For the year ended December 31, 2013, net cash flows used in financing activities consisted of $45.3 million in unrestricted common stock purchases under the Company's share repurchase program, $58.4 million for the payment of quarterly dividends and $6.1 million for other shares purchased, which consisted of unrestricted common stock surrendered to satisfy employees' tax obligations upon the vesting of restricted stock.
For the twelve months ended December 31, 2014, the Company purchased 3,215,246 shares of unrestricted common stock at an average cost per share of $52.35, totaling $168.3 million in purchases under the program.
Since inception of the program, the Company purchased 7,855,070 shares of unrestricted common stock at an average cost per share of $39.51, totaling $310.4 million in purchases under the program.
In December 2014, OCC announced a newly formed capital plan designed to comply with proposed new SEC standards for covered clearing agencies. Under the plan, OCC's existing exchange stockholders, which include CBOE, would contribute a pro-rata share of $150 million in equity capital which would increase OCC's shareholders' equity. CBOE's capital contribution under the plan would be $30 million. In addition, OCC's stockholders would commit to provide replenishment capital on a pro-rata basis, if certain capital thresholds are breached. CBOE's obligation to provide replenishment capital under the plan would be subject to a cap of $40 million. In exchange for the equity capital from its stockholders, OCC would, subject to determination by its board of directors and compliance with legal requirements, commit to pay an annual dividend to its stockholders equal to the after-tax income of OCC, in excess of the amount required to maintain its target capital requirement and satisfy other capital requirements, and after refunds to its clearing members equal to 50% of distributable earnings before tax. The plan is subject to approval by all of OCC's stockholders and the SEC.
The Company currently leases office space including, a remote network operations center and data center, with lease terms remaining from 8 months to