When interim New York Stock Exchange Chairman John S. Reed unveiled a new governance plan for the exchange on Nov. 5, the heads of state pension funds immediately cried foul. Reed had not only failed to select a public pension fund representative for the new board but had also declined to separate the market's regulatory and commercial functions, a feature the funds had sought. Within minutes, powerful state controllers and treasurers overseeing some $600 billion in assets began lobbying the Securities & Exchange Commission to alter Reed's plan.
That's not likely. Those now calling for the SEC to step up and put its mark on Reed's plan overlook a crucial point: The agency has already done so. Chairman William H. Donaldson and aides who oversee market regulation reviewed numerous versions of the plan, and they insisted on key alterations along the way, say sources close to the matter. By the time Reed announced the details, the new design was as much the SEC's as it was his. The new structure also passes muster with prominent corporate governance experts. Even mutual funds, which also wanted a seat of their own, are begrudgingly accepting the new system. By insisting on separating regulation from the marketplace, "critics are putting form over substance," says Patrick McGurn, senior vice-president at Institutional Shareholder Services Inc., which advises pension and mutual funds on governance issues.
To ensure backing for his plan, Reed was careful to lay the groundwork with the two constituencies that matter most: the 1,366 voting members of the exchange and the five members of the SEC. Reed has met with hundreds of exchange members, scheduling an eight-city blitz to speak to some 950 members who lease out their seats. And he consulted almost daily with the SEC's senior staff, who briefed Donaldson along the way. The result is that Reed's new constitution is likely to win overwhelming approval from members on Nov. 18. If all goes according to plan, a new board will meet on Dec. 4 to choose a chairman and chief executive officer -- or it may vote to separate the two jobs. And while Donaldson and other SEC commissioners are leaving the door open to more changes next year, especially in the way the floor functions, they are likely to give Reed's blueprint their blessing in mid-December.
NO SEPARATION NEEDED
Despite calls from critics that Reed spin off regulation, Donaldson believed it was unnecessary. An SEC source says Donaldson thought Reed's toughest job would be figuring out how to give the regulatory unit a long enough leash to make unpopular decisions without interference, but not so independent that it would be isolated from the markets or immune to the consequences of its rulings.
Reed's solution: an independent supervisory board holding all the voting power, with input from a separate advisory board representing listed companies, Wall Street firms, and other interested parties. It was also Reed's idea to create a Chief Regulatory Officer who reports to the independent board, not NYSE management. But the SEC insisted on more. It said the NYSE chief exec could not participate in board meetings at which regulatory matters were discussed. Nor could the CEO set the CRO's compensation.
To further satisfy the SEC, Reed came up with a Regulatory Oversight Committee, composed only of independent board members, to hire, review, and, if necessary, fire the CRO. That board will also determine the division's staffing levels and annual budget. "The CRO is so independent it's almost scary," says a top SEC official. The SEC also asked Reed to clarify that the CEO would not be able to take part in three other board committees dealing with compensation, audits, and governance matters.
Will the reforms mollify critics? State pension fund trustees are dubious. "The composition of the board really doesn't provide for the kind of independence we'd like to see," says Sean Harrigan, president of the board of the California Public Employees' Retirement System (CalPERS), the nation's largest pension fund, with $147 billion in assets.
But the SEC thinks the public pension funds are in the minority. While mutual- fund companies are disappointed they didn't get a designated board seat, they aren't battling the Reed plan. "Our big fight will come later," says John J. Wheeler, head of equity trading at mutual-fund company American Century Investment Management, "when the new board gets down to the nuts and bolts of how to make the auction market more electronic." McGurn says the true test of independence will depend on whether the CRO's budget and staff truly are beyond management's reach.
Some governance gurus think Reed may have chosen a board that is too independent. "They have no stake in the institution," says Charles M. Elson, director of the University of Delaware's John L. Weinberg Center for Corporate Governance. He says the board, which has eight director-nominees but could expand to 12, should include representatives of the investing public.
Reed isn't budging. He's convinced that his new design is the best way forward. Of course, if he's wrong, he'll be long gone from the exchange by the time that becomes evident.
By Paula Dwyer, with Amy Borrus, in Washington and with Christopher Palmeri in Los Angeles