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Scaling down the Big Board
( 2003-11-07 09:23) (Economist.com)

Governance of the New York Stock Exchange is to change dramatically under plans unveiled by its interim boss, John Reed. But his proposal that the exchange keep its regulatory role will disappoint many.

John Reed, the interim chairman and chief executive of the New York Stock Exchange (NYSE), published his proposals for a revamp of the exchange¡¯s governance on Wednesday November 5th. He hopes that the changes will rebuild confidence in the Big Board, which took a battering when his predecessor, Dick Grasso, was ousted after an outcry over his $187.5m pay package. Mr Reed is proposing to ensure that the exchange¡¯s controversial regulatory functions are independent of the securities firms that trade on the exchange and the companies that list on it, while remaining under the exchange¡¯s roof. But critics feel that the exchange has done such a poor job of regulating itself that the Securities and Exchange Commission (SEC), the main markets regulator, should get someone else to do the job.

Mr Reed is proposing that the day-to-day operations of the exchange be separated from its governance and from the regulation of trading. For starters, the exchange¡¯s 27-member board¡ªstuffed, to date, with top officials from the securities firms and companies regulated by the NYSE¡ªis to be slimmed down to one with no more than 12 directors, none of whom would be from the securities industry or a company listed on the exchange. Securities-industry executives would instead serve on various advisory committees. All regulation would be the responsibility of the board¡¯s independent directors.

The NYSE's troubles burst into the open late this summer, when details of Mr Grasso¡¯s remarkable compensation deal were first disclosed. Since then, critics, including William Donaldson, the SEC¡¯s chairman, have asked whether Mr Grasso¡¯s pay may have diverted resources from the exchange¡¯s all-important regulatory function. Such suspicions appear to have been given substance by an as-yet-unpublished SEC report into trading violations by the specialist firms that trade on the exchange. (The NYSE is the last big exchange to trade by ¡°open outcry¡± rather than electronically.) According to the Wall Street Journal, the SEC probe found that improper trading in around 2.2 billion shares cost investors more than $150m. Even more worryingly, the report said, ¡°the NYSE's disciplinary programme¡­does not adequately discipline or deter violative conduct.¡±

These findings are so damning that they may be enough to sway Mr Donaldson. He told Congress in September that self-regulation had ¡°worked pretty well¡± at the exchange, but he may have to revisit that opinion. The SEC has already been made to look flat-footed in its regulation of Wall Street investment banks and fund managers by the zealous campaigns of Eliot Sptizer, the New York attorney-general. When it comes to the NYSE, it may choose to be more proactive.

Already, the SEC's response to Mr Reed's proposals suggests that it may have something more dramatic in mind. The commission described them as a step in the right direction, but added that it would continue to look at ¡°further market-wide reforms¡±. In addition to the SEC's approval, Mr Reed must secure the backing of the exchange's 1,300-plus members in a vote on November 18th. The signs are that they will recognise that Mr Reed's changes are the least they can expect.

After all, if the SEC report into regulatory failings at the exchange is published, or more details are leaked, it may cause other users of the exchange to demand radical reform of the exchange's operation, as well as governance. Mr Reed wants representatives from big investing institutions, such as mutual-fund managers and pension funds, to get more involved in the governance of the exchange. But they may decide that the exchange is still too close to the interests of Wall Street, rather than the Main Street investors they are supposed to represent. Fidelity, a giant fund manager, has already called for an end to the specialist system of trading. The specialists might soon find that their cosy, centuries-old trading system is an idea whose time has gone.

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