Big Changes for the Big Board

With Grasso gone, the New York Stock Exchange looks set for an overhaul

For a man as thin-skinned, vain, and publicity-conscious as Richard A. Grasso, it must have been hell. Day after day, from almost the moment the full details emerged of his $188 million pay package on Sept. 9, the 57-year-old chairman of the New York Stock Exchange has been the subject of an almost unprecedented tide of private maneuvering -- with even his old allies on the trading floor turning against him -- and public revulsion. Grasso remained defiant, but in the end, the pressure was too intense. With opposition mounting from his board and the trading floor, heat from the Securities & Exchange Commission, and increasing calls for his ouster, Grasso resigned on Sept. 17.

Grasso's downfall was stunning in its swiftness. And beneath the mounting criticism was a sobering reality for the 211-year-old Big Board as it struggles to salvage its tarnished reputation as the gold standard of the financial markets. Now that Grasso is gone, the NYSE is likely to undergo far-reaching structural and regulatory changes. The controversy over Grasso has come at a crucial time for the NYSE, and the furor over his pay has shone a spotlight on an already simmering debate over its weak governance. Since March, the SEC had been prodding the NYSE to review how the exchange runs itself -- a process that was supposed to culminate on Oct. 2, when an NYSE committee, chaired by former New York Comptroller H. Carl McCall and President Clinton's former Chief of Staff, Leon Panetta, planned to announce its slate of governance changes. Grasso had called a special meeting for Sept. 24 to discuss the proposals. Grasso felt "he is a persuasive fellow, and he wants to talk [his opponents] out of it," says a source close to one board member.

But as calls for his departure mounted, with Presidential candidates Senators John Edwards (D-N.C.) and Joseph I. Lieberman (D-Conn.) joining the chorus, the board called a special meeting. Grasso realized he could not survive. The board initially picked as interim chairman a Grasso loyalist on the board, prominent Silicon Valley lawyer Lawrence W. Sonsini. However, late on Sept. 17 Sonsini turned down the offer.

The NYSE's new governance proposals will now have to contrast dramatically with the anemic initial ones announced in June. Otherwise, the SEC will likely force real change on the exchange. "I think they're going to have to start from scratch," says Muriel Siebert, the first female NYSE member, who now heads discount brokerage Muriel Siebert & Co.

Although the SEC is publicly waiting to see what the NYSE says, back-channel communications between the Big Board and its overseer have been intense. Some NYSE members had flown to Washington in recent days to meet with high SEC officials to press the case against Grasso. The mood at the SEC is impatient. In the end, an independent panel -- or a small group of directors who played no role in setting Grasso's pay -- may wind up supervising the delicate task of overhauling the exchange. "The NYSE board, as it currently exists, cannot credibly review its own actions," says a top SEC official.

Some areas where change is likely:

-- FULL DISCLOSURE. The NYSE and other stock markets are subject to few disclosure requirements unless they are public companies themselves. In its June proposals, the NYSE agreed to publish the salaries of its top officials. But pension funds and other institutions, led by the trade group Council of Institutional Investors, want the NYSE to follow the same rules as NYSE-listed companies. This goal is also being pursued by an interest group with a far different agenda -- exchange members, whose fealty to Grasso abruptly eroded after the revelation of his enormous pay package. Dissident members say they were particularly stunned by the $5 million bonus to Grasso after the September 11 attacks.

-- BOARD COMPOSITION. An overhaul is likely for the NYSE board, from its nominating process to its makeup. It consists of 27 members, of whom 12 are supposed to represent the interests of the public, though they are often corporate moguls. Some critics favor revamping the definition of "public" so that independent directors dominate -- a process that may lead to the removal of top Wall Street executives, such as Goldman, Sachs & Co. Chairman Henry M. Paulson Jr., a leading advocate of Grasso's ouster. That would shift the balance of power to directors from outside the securities industry, such as former Secretary of State Madeleine K. Albright, a recent addition to the board who publicly backed Grasso while quietly pushing for his ouster, according to an aide to one board member. Albright did not return calls. According to an agency official, SEC Chairman William H. Donaldson believes some members of the current board have no credibility and should go but is leaving that decision to the board.

NYSE members have their own agenda. They are pushing for directors who represent the hundreds of members, estimated at 70% of the total, who lease out their seats. That is not likely to have much appeal to institutional investors. But all critics unite in wanting to end the NYSE chairman's input into board nominations, which has been tantamount to control of the selection process. The nominating committee would no longer have annual "audiences" in which the chairman puts forth a list from which the committee selects board members. The practice has drawn widespread criticism since it was revealed by Grasso in an interview with BusinessWeek (BW -- Sept. 15).

-- THE TOP JOB. Grasso wore two hats -- chairman and CEO. But those roles are likely to be split, with the chairmanship becoming a nonexecutive position. That would enhance the independence of the board. But not all governance critics are enthusiastic. Sarah A. Teslik, executive director of the Council of Institutional Investors and an outspoken critic of Grasso, says she has received "unofficial feelers" that the NYSE is moving in that direction. But "I don't know how much difference it would make," she says.

-- REGULATION. A hot potato that was avoided by the NYSE governance committee's initial report, the issue can no longer be avoided: Many investors and others were outraged by Grasso's huge pay precisely because he regulated the companies that rewarded him so generously. One possibility under discussion is to move some or all regulatory functions to a separate organization, much as the regulation of the NASDAQ stock market was assigned to a separate institution in 1996. Representative Richard H. Baker (R-La.), chairman of the house subcommittee on capital markets, observed on Sept. 17 that "the chairman of an exchange shouldn't be paid for overseeing both the regulatory side and the business side."

Such proposals are unlikely to see final form until Grasso's ultimate successor is named. He had favored either of his two co-presidents, Catherine R. Kinney or Robert G. Britz. But their lavish pay packages and close association with Grasso made them nonstarters. Should Sonsini not be appointed, others whose names have been floated as possible replacements include former SEC Chairman Arthur Levitt and John H. Biggs, former TIAA-CREF chairman.

Grasso loyalists insisted until the end that talk of succession was premature. "He's had the support of the board in the past, he has the support of the board in the present, and he'll have the support of the board in the future," was the Sept. 16 verdict of board member William B. Summers Jr., chairman of McDonald Investments Inc. in Cleveland. But that clearly wasn't the view of Goldman Sachs (GS ) Paulson, Morgan Stanley (MWD )'s Chairman & CEO Philip J. Purcell, and Albright, described by sources close to the board as the leading dissidents.

Until the final moments, Grasso's opponents on the board were playing a waiting game. They hoped -- ultimately correctly -- that the onslaught of public pressure would force Grasso to quit. Anonymity was the order of the day, and fear of retribution was high. "With one phone call, [Grasso] can tell us we are under an investigation that will require 300 lawyers for 25 years," says a person close to one Wall street board member.

Another sobering factor was that, until the final moments, Grasso still had a significant -- if rapidly dwindling -- cadre of admirers. Even a leading dissident exchange member -- William Higgins, who is pressing for board membership for people who lease out their seats -- wanted his colleagues to forgive and forget. Says Higgins: "When people make mistakes on the floor, we call that a QT -- questionable trade. I tell people who call that Grasso had a QT, he should clean it up, clear the losses, and go on." But Grasso did much more than make a bad trade -- and he paid the price for his unrelenting greed.

By Gary Weiss in New York and Paula Dwyer in Washington, with Mara Der Hovanesian in New York, and bureau reports

— With assistance by Mara Der Hovanesian

    Before it's here, it's on the Bloomberg Terminal.