The Booming Big Board
The luncheon room of the New York Stock Exchange is packed with the players and friends of the John F. Kennedy Knights high school football team. At a podium, Richard A. Grasso, chairman of the NYSE, is recounting a story. "Someone once asked me where my family's wealth came from," he tells the crowd of inner-city students, who had no place to hold their awards dinner before the NYSE donated its space. "I said: `Oil, gas, and rubber.' I grew up in Queens. My relatives ran an Exxon station near LaGuardia Airport."
Thirty years ago, Grasso walked through the doors of one of the most insular and tradition-bound organizations in all of finance. The 22-year-old Grasso, who left New York City's Pace University a year before graduating, had no family connections or pedigree to help launch his career. That Grasso, 50, the first chairman to rise from the NYSE staff, was able to gain the top spot at the citadel of capitalism in June, 1995, is a remarkable accomplishment. More than just a personal victory, however, it signifies a new era at the exchange, an era in which the NYSE's efforts to recreate itself are paying off as it moves aggressively into new markets and counters a host of competitive challenges.
It's 11 Wall Street, not NASDAQ, London, or Tokyo, where many of the world's leading companies want their stocks listed. Of course, the NYSE's fortunes and those of other U.S. exchanges are being buoyed by the long bull market. But under Grasso, not only is the NYSE turning the tide and regaining precious market share in the trading of NYSE-listed stocks, it is rapidly increasing its roster of foreign companies and is attracting a record number of NASDAQ transfers, including high-profile technology companies such as Gateway 2000, America Online, Bay Networks, and Iomega--and is reserving the ticker symbol "M" in the hopes of one day snagging Microsoft. Grasso's ambitions don't stop there: The NYSE is also in hot pursuit of initial public offerings, where NASDAQ has long reigned supreme.
TROUBLED RIVAL. Scandals and regulatory problems in the NASDAQ stock market in recent years have thrown the NYSE's reputation for integrity and strong regulation into stark relief. "The NYSE has been under constant competitive attack for the last 20 years, and there was certainly the threat that NASDAQ would completely subsume their own role as the trading market of choice," says Samuel L. Hayes III, a professor of investment banking at Harvard business school. "But I personally think NASDAQ has blown it." Events at NASDAQ have "brought into question the integrity of that marketplace, and I don't think there's been anything comparable to that in the NYSE." And while Tokyo and London have enjoyed periods in the last 15 years when their stature as financial centers was rising at the expense of New York, the NYSE is now benefiting from "the swing in the balance of power toward New York as the most important financial center," says Hayes. "The NYSE is still seen by foreign companies as the prestigious market in the world to be listed on."
Clearly, the NYSE is enjoying newfound momentum. The technology programs stressed by former NYSE chairman John J. Phelan, Jr. in the 1980s set a foundation that has enabled the NYSE to become more highly automated and cost-efficient than ever before. But whether NASDAQ has really blown it is debatable. In a way, a fresh battle is only beginning. NASDAQ remains a smart, aggressive, well-funded competitor. Its parent, the National Association of Securities Dealers, or NASD, has strong new leadership in Frank G. Zarb, a well-connected businessman with a solid history of turning around troubled organizations. "It would be a great mistake to sell short the competitiveness of NASDAQ in the future," says William C. Freund of Pace University's Graduate School of Business and a former economist at the NYSE. "They're going to be reorganized and aggressive. In some ways they'll move more toward an auction-market setting, toward the NYSE model." As with the NYSE, NASDAQ's volume has mushroomed, and NASDAQ is also attracting record numbers of companies, though most are much smaller.
In the war between the exchanges, the winner will be the trading system that offers the greatest efficiency, the best service, and the most liquidity--at the lowest price. But there are other winners: The companies that will get fairer and more open markets for the trading of their stocks and the investors, both big and small, who will get the most for their investment dollars.
While the main battle is between the NYSE and NASDAQ, the two markets must also contend with a new breed of competitors massing on the sidelines. Such alternative trading systems, which include established electronic communication networks (ECNs) such as Instinet Corp., as well as the newer Bloomberg Tradebook, allow institutions to trade among themselves and avoid any middleman. The computerized systems are becoming more popular with powerful institutional traders, who view them as a low-cost alternative. The Securities & Exchange Commission recently asked for comments on how regulation needs to evolve along with these new ventures. It noted that "alternative trading systems handle almost 20% of the orders in over-the-counter stocks and almost 4% of orders in securities listed on the NYSE." That's up from 13% in OTC stocks and 1.4% in NYSE-listed stocks in 1991. ECN volume is getting a boost from new SEC rules. Among other things, the rules require some customer orders to be displayed to a broader audience. NASDAQ and some regional exchanges are exploring links with the ECNs, which could pump up their market share.
Meanwhile, business is booming on the NYSE. Membership prices are rocketing. Memberships, called seats, allow firms to trade on the floor of the NYSE. Seat prices hit an all-time high in 1996, when one sold for $1.45 million, up 38% from the high price in 1995. The latest public sale was for $1.35 million. No wonder: The bull market has sent volume to a daily average topping 500 million shares, handled without a glitch by the NYSE's trading system, up from an average of 202 million in 1992. In 1996, the NYSE had net income of $74.4 million on revenues of $561.5 million, with more than 40% of revenues coming from listing fees, and the rest from fees including those for trading, market data, and use of facilities and equipment. That compares with net income of $56.7 million on revenues of $500.8 million in 1995.
Grasso's NYSE is also regaining market share. In 1996, it wrested back some of the share it lost in the late 1980s and early 1990s when its portion of the volume of transactions of NYSE-listed stocks slid from 86.2% in 1988 to 81.7% in 1992. Now, the NYSE's market share is back up to 83% and has inched up in three of the past four years. More significant is its gain in the distribution of trades. In 1996, the NYSE got 73.2% of the total number of trades in NYSE-listed stocks made on U.S. exchanges, up from 70.2% the year before and up from a low of 65.2% in 1992.
Crucial to the NYSE's future growth is its progress internationally. In 1997, one out of every four new listings is a foreign company, and such listings have almost tripled in the past five years, to 320. Grasso hopes to list between 500 and 600 non-U.S. companies by 2000. The NYSE calculates that the total market cap for international companies eligible to list on the NYSE is $8.4 trillion. The NYSE has joined other U.S. exchanges in moving to allow price quotes in sixteenths, rather than eighths, and Grasso recently announced that the NYSE will be able to quote prices in decimals, rather than fractions, perhaps as soon as April 1998. That brings it in line with world stock markets and fits nicely with the NYSE's overarching goal to be the first "truly global" stock exchange. "We have the opportunity to redefine this franchise for a very long period of time," says Grasso. "That drives everything we do."
To lead the international charge, Grasso recruited European investment banking hotshot Georges L. Ugeux in 1996. He also expanded the NYSE's network of International Advisory Committees, adding a Latin America Committee headed by Carlos Slim, the head of Telefonos de Mexico, and broadened the Japanese Committee into the Asia-Pacific Advisory Committee to include the entrepreneur-rich Pacific Basin. Grasso himself travels extensively abroad.
OUT OF AFRICA. The NYSE's international roster is led by companies from Britain, Canada, Chile, and Mexico. Privatizations such as the IPO of Germany's Deutsche Telekom in 1996 have been a great boon for the NYSE. But the Big Board is looking to all corners of the globe for new listings. "If I were just taking India, Brazil, and China, those three probably represent over the next five years a huge reservoir," says Ugeux. Last year, the NYSE listed its first Russian company, Vimpel-Communications, and its first Ghanian company, Ashanti Goldfields Co.
NASDAQ is also looking abroad for growth. "International will be a key battleground for us," notes Zarb. "They're formidable, and we are, too. We have to be a little better because we don't have the years of history and tradition and image." Both the NYSE and NASDAQ's global ambitions are hampered by the slow progress in developing international accounting standards acceptable to both the SEC and other countries.
To be a truly global exchange, the NYSE will need to offer more global products and trade so-called ordinary shares--foreign shares listed directly on the NYSE--in addition to the usual American Depositary Receipts. The NYSE is building capabilities to trade non-U.S. shares in ordinary form, in dollars and possibly also in one or more other currencies, says Robert G. Britz, the NYSE's head of operations and technology.
STEPPING IN. In their forays overseas, NASDAQ and the NYSE are talking up the virtues of their particular brand of trading. Long at the heart of the NYSE-NASDAQ clash has been the issue of which market has the better trading system. In the NYSE's highly-automated, but floor-based system, NYSE memebers called specialists must maintain an orderly market in the trading of their assigned stocks, with one specialist for each stock. If a significant imbalance between supply and demand develops, the specialist must step in with his firm's capital to buy or sell stock and provide a "fair and orderly market." In the vast majority of cases, retail orders meet and are executed without the specialist stepping in.
To speed up the process, the NYSE has invested $1.2 billion in technology during the past decade. "Technology is the saving grace," says the NYSE's president, William R. Johnston. "We're running this exchange with fewer people than ever before." Now, the NYSE features the world's largest commercial installation of flat-screen, high-definition display panels and is working on a wireless communication system to make floor brokers more efficient. About 85% of all trades in NYSE-listed stocks, or 40% of the dollar volume of its trading, flow through the NYSE's automated order-handling system. The NYSE can process 2.3 billion shares a day, more than 4 times its average daily volume, and plans to be able to process 3 billion by the end of the summer. NASDAQ has sped up an overhaul and expansion of its network, which can process 1 billion shares a day. It plans to be able to process 2 billion by early 1998.
In the screen-based NASDAQ market, competing dealers, called market makers, have traditionally interacted electronically with just about every trade. A customer's broker sends her order to the market maker offering the best price. Market makers profit from the gap, or spread, between the price they pay to buy shares and the price they offer to sell those shares to another investor. To be sure, NYSE specialists, who get commissions, also profit from trading for their account, but with customer orders taking precedence over specialist trades, spreads have tended to be narrower on the NYSE.
NASDAQ's growth since its inception in 1971 has been phenomenal, but its fundamental system of trading has come under attack in recent years. It was the subject of a Justice Dept. review of whether NASDAQ dealers colluded to set stock prices. In August, 1996, the SEC censured the NASD for failing to halt widespread price-fixing on NASDAQ. The NASD agreed to pay at least $100 million over five years to upgrade regulatory operations, and the regulatory effort is now separate from the operations of the NASDAQ stock market.
Now, the new order-handling rules instituted by the SEC are changing the trading landscape. The rules, which create a more level playing field for small investors, are being phased in on NASDAQ stocks and also apply to the NYSE. For the first 500 stocks phased in, a NASDAQ analysis found the average quoted spread shrinking by more than 30%. If spreads continue to narrow as more of NASDAQ's stocks come under the rules, companies that added wide spreads to their list of reasons to move to the NYSE may be less inclined to leave NASDAQ. But if market makers are loath to take the same level of risk for a now diminished reward, there may be less liquidity and the new rules could lead to greater swings in NASDAQ stock prices.
One competitor the NYSE doesn't worry about: the American Stock Exchange. After 22 AMEX companies transferred to the NYSE in 1996, "there aren't that many companies left on AMEX that fit our listing standards," says L. Paige Thompson, the NYSE's vice-president for domestic listings. While the NYSE and NASDAQ are focused on many of the same companies, AMEX is adopting a new niche strategy as its equity business shrinks to an average of just 22 million shares a day. While continuing to focus on its successful options business, it is pursuing a novel strategy to build investment banking relationships to help draw a tier of smaller companies that could become less attractive to NASDAQ dealers under the new order handling rules. Amex is offering aggressive investor relations support programs to increase the companies visibility.
Although Grasso won't say it, NASDAQ's travails with the regulators have given the NYSE an edge in persuading companies to hop over. In the U.S., the tech sector is the main battleground, and Grasso isn't shy about coveting what he calls NASDAQ's "fearsome foursome": Microsoft, Intel, Cisco Systems, and Amgen. In explaining why the NYSE moved to cap the maximum listing fee at $500,000 last year, Grasso notes that since listing fees are structured on shares outstanding, a company such as Intel Corp. might have had a listing fee of $2 million or more.
To be where the action is, the NYSE opened a small office in Menlo Park, Calif., in the heart of Silicon Valley. The Big Board's attempt to woo companies from NASDAQ has "escalated dramatically," says Sanford R. Robertson, chairman of Robertson, Stephens & Co. "I'm surprised they haven't done it sooner." Says Daniel H. Case III, president and chief executive officer of Hambrecht & Quist, the high-tech investment-banking firm, which listed on the NYSE last year: "They spent more money and are working aggressively for it." NASDAQ is also beefing up its Menlo Park office and now has 18 people there.
NYSE PERKS. Both NASDAQ and the NYSE provide some form of advertising support to attract and retain companies. "We'll promote a new listing so a company can say to themselves that if the NYSE includes us in their advertising or seminar program, that will, in essence, bring down the cost of listing," says Grasso. "It's an investment we're making in the merchandising of an important listing event." The NYSE throws in perks such as the use of its boardroom for company functions and analyst meetings.
NASDAQ's president, Alfred R. Berkeley III, doesn't shy away from saying how much the NYSE's wooing of its premier companies irks him: "We'd like to be let alone," he says. "But if not, we're going to be their worst enemy, their worst nightmare." Berkeley says that except when listing issues come up, he doesn't spend much time thinking about the NYSE. Instead, "we think about a new pricing curve where we have very significant competitors that are emerging on the Internet," he says.
Tech companies that left NASDAQ for the NYSE cite a wide range of reasons for switching. "We thought it would become more appropriate as we became more established," says Scott Murray, Learning Co.'s CFO. Murray, along with Iomega Corp.'s treasurer Robert J. Simmons, also cite high levels of customer service from their specialist. "You end up with one market maker more familiar with your stock because they are the only trader," says Murray. "You have better visibility on who the buyers and sellers are."
The NYSE's prestige internationally is also a selling point. For America Online CEO Stephen M. Case, moving to the NYSE was about "improving our global profile. The NYSE has the prestige and the global reach" AOL wanted as it pushes into new markets in Europe and Asia. Also, "we felt an auction market with a specialist would mean lower spreads. And that has happened," says Case. According to AOL's investor relations staff, on NASDAQ only 38% of trades had a spread of one-eighth or less, compared to 60% on the NYSE.
Despite these high-profile defections, NASDAQ still boasts many of the leading technology companies. Among them are companies that have a strong sense of loyalty to a market that took them on when, say, the NYSE would not. NASDAQ's system of multiple market makers for each stock helps provide liquidity to smaller companies that don't yet have a large following among analysts and need multiple dealers to generate more interest in their stock. And when it comes to listing fees, the price is right on NASDAQ, where listing fees are far lower than on the NYSE. NASDAQ is also the master of an art that the NYSE is just now getting better at: self-promotion and marketing. The NYSE doubled its entire advertising budget from $7 million to $14 million for 1997, but that pales next to the $20 million that NASDAQ has to spend on TV advertising alone.
Meanwhile, NASDAQ disputes the notion of a nascent exodus of companies to the NYSE. A record 96 U.S. and non-U.S. NASDAQ companies defected to the NYSE in 1996, up from 62 in 1995 and 45 in 1994, but "there wasn't a break in the dam at all," says John Wall, NASDAQ's executive vice-president for market services. "We lost some good-size companies, such as Bay Networks, America Online, and St. Jude Medical, but we lost them all for specific reasons," says Wall. The NYSE, he notes, was Bay Network's largest customer.
As for the leading member of the "fearsome foursome," Microsoft's chief financial officer, Michael W. Brown, has just been appointed chairman of NASDAQ's board of directors. Intel's Treasurer, Arvind Sodhani, also on NASDAQ's board, states: "We're very well served by NASDAQ." Yes, he says, the NYSE has made a "fairly determined effort" to attract Intel, but "there's no reason to move." As for tech firms such as Bay Networks and Iomega that made the move, Sodhani says that "a lot of those are younger firms, and they may have had their own reasons to want to do it."
Wall complains that the competition is skewed because of the NYSE's Rule 500. That requires that NYSE companies get a supermajority of shareholders voting approval if a company wants to delist. The NYSE says the issue is a red herring, since companies don't want to leave. Wall says the issue is not a red herring and that he has the letters from NYSE companies to prove it.
The rule helped the exchange land Concert PLC, the proposed entity that would come out of the planned merger of MCI Communications, NASDAQ's fifth-largest company, and British Telecommunications, an NYSE company. Both NASDAQ and the NYSE wanted Concert, and on Apr. 14 MCI announced that Concert would join the NYSE. Since BT's shares are on the NYSE and will be renamed Concert, moving BT's shares to NASDAQ would run up against Rule 500. In a press release, MCI chief executive Bert C. Roberts Jr. said that "securing the approval would have been inappropriate at a time when shareholder focus should be on the merits and opportunities presented by the merger." Roberts griped to SEC chairman Arthur Levitt Jr., who asked the NYSE to review the rule. The NYSE is reevaluating the rule and expects to have a decision by year's end.
Not only does the NYSE want NASDAQ's stars of today, it doesn't want to miss another Intel-in-the-making. Until 1983, only three IPOs had been launched on the NYSE. Since then, over 700 companies, excluding closed-end funds, have gone public on the NYSE. According to Securities Data Co., the NYSE had 117 IPOs in 1996, with proceeds of $23.7 billion, up from 74 IPOs with proceeds of $13.7 billion in 1995. NASDAQ had 730 IPOs in 1996 with proceeds of $25.4 billion. The NYSE will soon launch an ad campaign focusing on its IPOs.
Quality control will be a key issue for the exchange when pursuing more entrepreneurial companies. "Grasso's problem is to get more listings while, at the same time, maintaining the listing requirements for those companies coming on board," notes Perrin Long, an independent analyst of the securities industry. The NYSE has modified its listing standards in recent years to allow companies to qualify based on cash flow. That attracted a number of cable and broadcasting companies. Previously, companies had to meet minimum earnings levels and have three consecutive years of profitability. And in mid-1996, the exchange altered what it calls the "North American standard" so that companies could aggregate holdings in Mexico and Canada with their U.S. operations in order to qualify for a listing.
Increasingly, the competition between the NYSE and NASDAQ is evolving into a battle of the brands. "Every day, we wage what we call a cornflakes war of brand preference," says Grasso. The NYSE has greatly increased its visibility by expanding its broadcast-center operations and allowing more TV stations to set up booths above the exchange floor or to broadcast from the floor itself. The NYSE also made real-time stock prices available to TV stations such as CNBC, CNNFN, and Grupo Televisa in late 1996. About 100 live broadcasts go out from the NYSE every day, compared with fewer than 30 in 1995. One of the fastest growing items in the NYSE revenue stream is from the sale of market data. That produced $82.3 million in revenue in 1996, a 14% increase from 1995.
NASDAQ is countering with its own broadcast site in Manhattan--a room dominated by 100 video monitors. Much as the NYSE's trading floor provides photo opportunities for newly listed companies, NASDAQ's site is a slick showplace to impress prospective or new NASDAQ companies, serve as a backdrop for broadcasts, or be used for analyst meetings.
SCATTERED BATTLES. As the NYSE dukes it out with NASDAQ for new listings, it is also waging a fierce fight to have more of the trades in those stocks executed on the NYSE, rather than on one of the regional exchanges. It remains to be seen how quoting prices in sixteenths of a dollar, instead of eighths, as a step toward decimalization, will affect the war for market share. "We think our volume will go up, and that our market share will increase dramatically," says Grasso. "It will impose significant competitive pressures on alternative markets." It will make it tougher to pay for order flow, he says, referring to the sale of orders to firms that pay a few cents per share for orders routed their way. If the gap between the bid and offer on a stock shrinks from the minimum 12.5 cents gap that has been standard, that practice will become less lucrative--and, Grasso hopes, fewer orders will be drawn away from the NYSE.
As technology breaks down the barriers to entry in securities trading, the pace of change at the Big Board will have to increase. The competitive forces gathering to chip away at its franchise are huge. Yet the NYSE has been combating such pressures for decades and has managed to flourish. Richard Grasso is quite aware of the challenges facing his NYSE--and will fight like hell to maintain its momentum. As the battles continue, the real victors will be investors who get lower trading costs and better service.