The Big Board: Crying Out for Regulation
By Robert Kuttner
The New York Stock Exchange, disgraced by the latest scandal, is desperately trying to salvage its regulatory authority. Its much-anticipated report on its own corporate governance has been deferred, pending deeper reforms. This whole sorry affair, like the Enron (ENRNQ )/Arthur Andersen mess and the Wall Street stock-analyst scandal, cries out for government regulation.
I once debated a conservative who had mostly contempt for regulation. Was there any agency he liked? "The SEC," he finally replied. Why? Because financial markets offer so many opportunities for insiders to gain at the expense of investors, he admitted, that ordinary forms of market discipline are not adequate. Amen.
But as recent scandals have revealed, the Securities & Exchange Commission has mistakenly delegated too many regulatory duties to industry bodies. The accountants' professional association and lobbying group, the American Institute of Certified Public Accountants (AICPA), was given de facto control of accounting standards. The National Association of Securities Dealers was allowed to be both self-regulator and self-serving lobby. The stock exchanges were given authority for establishing and enforcing their own rules.
As it turned out, these self-regulatory organizations (SROs) were competent to police small-time larceny but not the systematic conflicts of interest that enrich Wall Street's biggest players. Former New York Stock Exchange Chairman Richard A. Grasso's enormous, unwarranted compensation shows that the collapse of self-regulation is complete. It's time for the SEC to resume direct authority over stock exchanges.
The implosion of Wall Street's self-regulation was the result of other forms of deregulation. In the 1960s and '70s, there were few big scandals because most conflicts of interest were precluded by government rules. There could be no Enron scandal before the 1990s, since electricity was closely regulated. There was no savings and loan meltdown before the 1980s: S&Ls were tightly regulated. Lucrative self-dealing was less possible because the law wisely segregated commercial banks, investment banks, and insurers into separate industries.
These structural regulatory barriers also reinforced norms of professionalism. Bankers viewed their role as conscientious scrutinizers of corporate loans, not as seekers of what amounted to kickbacks. Accountants saw themselves as agents of rectitude, not of dubious bookkeeping schemes.
But with deregulation came so many opportunities for profiteering through conflicts of interest that self-regulation didn't stand a chance. Stock analysts, now part of investment banking, received CEO-approved money for promoting stocks of favored corporations. The AICPA didn't resist accounting manipulation because its own blue-chip members were engineering it. The NYSE couldn't heal itself.
After the Enron and WorldCom scandals, Congress passed the Sarbanes-Oxley bill to put accounting under an agency overseen by the SEC. Sarbanes-Oxley addressed board responsibility for financial reports but not other issues of governance. That fell to the stock exchanges and ultimately to the SEC.
Now the NYSE has been disgraced not just as a weak regulator but also as another bundle of conflicts of interest. Grasso's grotesque compensation is no anomaly, but a telling reflection that the NYSE is an insider club operated by and for broker- dealers, specialist traders, investment bankers, and its own executives -- at the public's expense.
The NYSE, after all, is a private entity owned by its members. It is no accident that the recent scandals were remedied by outsiders such as New York State Attorney General Eliot Spitzer and Senator Paul Sarbanes (D-Md.) rather than the NYSE, or that pressure for deeper reform is coming from state treasurers, large pension funds, and the SEC, not from Wall Street.
There is talk of more resignations at the NYSE, more disclosure, tougher standards for corporate boards, and of splitting the Big Board into a stock exchange and an independent regulatory arm. But the clubbiness that produced the Grasso debacle is entrenched in the history and culture of the institution. Even a reformed NYSE should not be writing rules for how corporations should be governed, how exchanges should be run, and how to limit specialist enrichment at investor expense. These urgent questions about the best way to govern a capitalism prone to conflicts of interest should be addressed by Congress and enforced directly by the SEC.
Robert Kuttner is co-editor of The American Prospect and author of Everything for Sale.