Lessons from the Grasso Affair

Richard A. Grasso's resignation as chairman of the New York Stock Exchange came with stunning swiftness. It is appropriate. The spectacular size of his compensation package was unseemly at best. But more important, it was unacceptable for someone who was also regulating members of the exchange. Some elements of Grasso's compensation were just plain wrong. The most egregious example was the $5 million bonus that Grasso received for his job performance after September 11. While the ability of the exchange to start functioning again after the terrorist attacks was remarkable, so was the performance of the firefighters, police, and thousands of other New Yorkers.

But even beyond Grasso's poor judgment and missteps, it's clear that the exchange needs to significantly change the way it is run. The first order of business is to ensure that the NYSE, at a minimum, meets the same standards of corporate governance as the companies that list on the exchange. That means publicly disclosing the full compensation of top executives. If such a rule had been in effect, it would have been much harder for Grasso's pay package to sneak by under the radar until its announcement.

And just as public companies have been forced to reinforce the independence of their boards of directors, the NYSE needs to do the same. The number of so-called public or outside directors on the board has to be increased, and they have to come genuinely from areas outside of financial services and related industries.

The NYSE also needs to resolve issues that go beyond those of the typical public company. One of Grasso's biggest problems was that he wore two hats -- in one he looked out for the members of the NYSE, who own the exchange, and in the other he was their regulator, determining listing requirements and monitoring violations of trading rules, including insider trading. The two roles necessarily conflict, since actions that are in the public's interest may not be what the members of the exchange want -- and it certainly seems that Grasso had an incentive to lean toward the views of the members, who paid him that enormous sum.

For that reason, the whole question of whether the NYSE -- and the securities industry in general -- can regulate itself needs to be reexamined. That won't happen overnight. There's a long history of self-regulation in the securities industry, which has always argued that it knows best how to catch bad behavior. But as the Grasso case shows, self-regulation practically guarantees conflicts of interest. In the end, it may turn out that the NYSE needs a separate regulatory organization, distinct from the exchange itself, much like the NASDAQ. That is a better way to go.

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