Too Little, Too Late, Mr. Reed?
Architecture is a favorite word in the lexicon of John S. Reed, interim chairman of the New York Stock Exchange. And the governance structure that Reed unveiled on Nov. 5 had all the best features of the Bauhaus -- slim, austere, and intimidatingly modern. As expected, he cut the Big Board's 27-member board down to a distinguished roster of eight independent directors, including such luminaries as ex-J.P. Morgan CEO Sir Dennis Weatherstone. Also as expected, he proposed that the exchange's regulators now report to a committee of those independent board members. And he set up a separate executive board of securities industry execs and NYSE members.
But if Reed is expecting applause, he may have a long wait. Institutional investors, who would like regulation to be taken out of the Big Board's hands, swiftly attacked the plan as an inadequate remedy for its flawed market oversight. Securities & Exchange Commission Chairman William H. Donaldson, while praising the plan in general terms, left open the door to more wide-ranging changes in the NYSE's governance down the road. But that may not mollify critics. "The feedback we've gotten thus far on the buy side is extreme disappointment," says Scott DeSano, head of global equity trading at Fidelity Investments.
For now, at least, it seems the NYSE's 1,366 members are the main winners in the Reed plan. While Reed named the first eight nominees who will sit on the new board, future NYSE members will easily be able to propose their own slate of board members -- something unheard of in the era of former CEO Richard A. Grasso. The plan allows just 40 members to nominate a director, and 100 to nominate an entire slate. With the board up for reelection every June, that could mean that "this wonderful board will all be gone next year," notes North Carolina Treasurer Richard H. Moore. Institutional investors are underwhelmed by this dose of shareholder democracy. Jack Ehnes, CEO of the California State Teachers' Retirement System, says that "having members in any way involved in setting up and getting board members nominated is a problem. It's a regulatory body, a public purpose, and in my mind that is a clear conflict."
What went wrong? Reed's careful design was, apparently, overtaken by events -- particularly a report in The Wall Street Journal that the SEC had found the NYSE's regulation of the trading floor to be woefully inadequate, with sparse penalties and widespread trading ahead of customer orders. While reports of such misconduct on the NYSE floor have circulated for years, and even led to criminal charges in the 1990s, the timing of the latest news could not have been worse for the NYSE -- and will boost pressure for Donaldson to do more than just rubber-stamp the NYSE proposals. Indeed, lobbying against the Reed plan began even before the Nov. 5 announcement. The Council of Institutional Investors wrote Donaldson on Nov. 3 to urge that the Big Board get out of the regulation business -- though it did not specify exactly what kind of separate regulatory body it would like to see instead.
There is certainly no lack of alternatives, if critics carry the day. A separate regulatory body, on the model of NASD Regulation, which oversees the NASDAQ market, is one widely discussed possibility. Some securities execs have advocated that the NYSE's oversight of retail brokers should be assumed by the NASD, leaving the NYSE to oversee trading on the exchange floor. Ehnes argues that the SEC should be required to approve the NYSE board members, and favors separating the CEO and chairman positions -- jobs Reed says may be combined, if the new board so desires.
The SEC is inclined to accept the Reed plan, while it continues to work on a broader regulatory scheme for all markets. SEC Commissioner Harvey J. Goldschmid calls the NYSE proposals "a fine first step, but there may well be more to do" as part of the overall review of the exchanges. That's for sure. The SEC needs to seize the momentum and finish the job that Reed has begun.
By Gary Weiss in New York, with Amy Borrus in Washington and Faith Arner in Boston