NEW YORK STOCK EXCHANGE
 

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REGULATING THE REGULATOR

GOVERNANCE STRUCTURE AT NYSE

The CII reported that the directors on the board were too busy to devote required time to regulatory matters. It was pointed out that most of the directors were top executives of the companies and they had their own businesses to look after. The CII report stated, "Board members have too many connections among themselves to be effective."[1] For instance, Grasso was inducted into the board of Home Depot Inc, while Home Depot's co-founder Ken Langone was a director at NYSE.

Analysts felt that conflict of interests in the roles played by the members of the BoD was one of the main reasons for misgovernance at NYSE. The role of the directors was to maintain free and fair market environment and ensure high standards of working to safeguard interest of public. But, analysts were doubtful about the performance of the board.

THE ROLE OF SPECIALISTS

The specialist system at NYSE attracted considerable criticism. In April 2003, the SEC initiated an investigation against trading violations committed by the specialists. The specialists were alleged to be involved in front running[4] . However, NYSE refuted the charges and said that SEC was inquiring over violation of negative-obligation rule[5] . But analysts pointed out that the objective of the inquiry remained the same though the rules violated differed. The primary question which NYSE needed to answer was whether, its specialists purchased shares at lower price with an intention to sell them afterwards for profit. The firms which faced the investigation included - Spear, Leeds & Kellogg (subsidiary of Goldman Sachs), Fleet Boston Financial, Bear Wagner (partly owned by Bear Stearns), LaBranche and Van der Moolen.

This was not the first time the specialist system had come under scrutiny. In 1999, NYSE entered into a settlement with the SEC to make the specialist system more transparent.[6] However, with fresh allegations against specialists surfacing again in 2003, analysts felt that not much was done to bring in transparency in the system. It was reported that in the early 2000s, when businesses were reeling under pressure due to slowdown, specialist firms at NYSE posted pre-tax profit margin of 35-37% against the 9.7% margin of the corporate America. This raised questions about the working methods of specialists. Many felt that specialists took unfair advantage of the exclusive knowledge of investor orders.

Further, analysts were also critical about execution of orders at NYSE. Investors could not execute their buy/sell orders immediately as they were required to go through specialists or floor brokers paying high commissions.

THE FINAL ASSAULT-CEO COMPENSATION

NYSE also faced increased criticism because it did not reveal its executive compensation figures. With increasing pressure from media and SEC, NYSE announced the executive compensation figures in August 2003. It announced that Grasso was paid lump sum amount of $140 million for his services and his employment contract was extended up to the year 2007. Further the exchange also revealed that Grasso would be receiving around $1.4 million as salary per year and a bonus of $1 million per year. In addition, NYSE also announced that Grasso was entitled to receive around $48 million in future as benefits. Grasso's pay package attracted criticism from all quarters. Due to increasing criticism, Grasso announced that he would not take $48 million. Grasso's pay package was publicly criticized by Donaldson. Donaldson issued a statement saying that Grasso's pay package raised doubts about the NYSE administration and asked NYSE to submit the minutes of the meetings in which Grasso's compensation was finalized. Meanwhile, Washington Post[7] reported that members of the executive compensation committee were appointed by Grasso himself. The composition of the compensation committee also received serious criticism. Many were critical that the compensation committee comprised of executives from the companies which were regulated by the NYSE. Further Fortune reported that one of the NYSE directors through an email claimed that board members who were not in compensation committee never knew the breakdown of the Grasso's pay deal[8].

Refuting the allegations about the executive compensation, NYSE said that it acted on the advice of HR consultants. It was reported that NYSE took advice from Hewitt Associates[9] regarding Grasso's compensation and the exchange had hired an independent consultant - Vedder Price[10] to assess the compensation of Grasso. Analysts felt that Grasso's pay package should be in lines with the salary drawn by the chief of SEC and cited that SEC chief earned around $142,500 per annum. But some felt that there was nothing wrong in NYSE chief earning on par with the top financial services industry executives. However, analysts considered Grasso's pay package high even when compared to the salary earned by the top executives in the financial services industry.

Grasso's pay package even attracted criticism from the NYSE insiders. The members of the exchange were furious that while the operating income and volume of trade on the exchange were declining; Grasso was rewarding himself with such hefty amount. It was reported that the cost of operating on NYSE had increased by over 30% during 2000-2003. The public resentment against Grasso further increased with two large pension funds in the US criticizing his pay package and demanding his resignation. With mounting pressure, Grasso resigned in September 2003.

[1]English, Simon, Wall Street report slams 'cosy' NYSE, www.telegraphic.co.uk, August 8, 2003.

[2]Lashinsky, Adam, NYSE: Who's Minding the Store? Fortune, March 24, 2003.

[3]How to Restore Credibility at the NYSE, www.knowledge.wharton.upenn.edu, September 24, 2003

[4]An illegal activity in which a trader takes a position in an equity in advance of an action which he/she knows his/her brokerage will take that will move the equity's price in a predictable fashion.

[5]The negative obligation ensures that specialists do not get involved in the market on their own behalf when the market is able to "make itself" and sufficiently match buyers with sellers. This obligation on the specialists provides the public an opportunity to transact with one another without the intervention of the specialists.

[6]The SEC was investigating the charges of violations by specialists' way back in early 1990s As a result of SEC investigation, one floor broker was banned from the securities industry.

[7]Leading US newspaper.

[8]Tully, Shawn, See Dick Squirm, Fortune, September 15, 2003.

[9]Established in 1940, Hewitt Associates is a global outsourcing and consulting firm delivering a complete range of human capital management services.

[10]Founded in 1952, Vedder, Price, Kaufman & Kammholz, P.C is a law firm. The firm advices organizations on the corporate responsibility and other relating matters.