From Dinosaur To Dynamo?

Thanks to CEO John Thain's reforms, the NYSE's future suddenly looks promising

No wonder John A. Thain turned them down flat when leaders of the New York Stock Exchange first broached the idea of his taking over as chief executive officer in late 2003. Back then, the NYSE was reeling from scandal over the gargantuan pay package for ousted Chairman and CEO Richard A. Grasso. The feds were closing in on middlemen on the trading floor who they believed were ripping off customers. And amid it all, the hidebound old exchange was losing business as technologically superior rivals won over traders and companies alike. Thain, then president of Goldman, Sachs & Co. (GS ), said no thanks. "Why would I ever want to do that?" he says.

But then the leaders sounded exactly the right notes. The NYSE is crucial to the U.S. and global market systems. It's in big trouble. And, dangling the perfect inducement to a guy who styles himself as a problem-solver, they told him how it would be a great challenge. Reform-minded director and now Chairman Marshall N. Carter even cooked breakfast for Thain one fall morning in his upper East Side apartment. A lecturer at Thain's two alma maters, Massachusetts Institute of Technology and Harvard University, he pleaded that the NYSE badly needed someone who could blaze a "path to the future" and "restore confidence and trust." Thain couldn't resist. He quit his $20 million-a-year post at Goldman to take the $4 million NYSE job.

Now, as the NYSE stands on the brink of going public through a merger with all-electronic rival Archipelago Holdings Inc. (AX ), known as Arca, it looks as if Thain's move was smart for both parties. Arca's stock price has soared about 260%, while the NYSE's seat prices have jumped threefold. The 50-year-old Thain, an electrical engineer by training, may prove to be the savior of the hoary old trading floor even as he pushes its technology to the exchange world's cutting edge. Traders may still start their days in a cozy member's club where stuffed animal heads gaze down at them, but they'll increasingly make deals on wireless devices that will make BlackBerrys seem outdated.

The 213-year-old exchange's future, very much in doubt a few years ago, is suddenly promising. Thain's NYSE could become a global powerhouse that dominates markets far beyond U.S.-based blue chips. In his vision, the new NYSE could be a one-stop shop where investors can buy global stocks, futures, options, exchange-traded funds, and bonds. It could challenge the powerhouse Chicago futures markets and, with a new place for hot young companies to list, could steal much of the thunder of U.S. rival NASDAQ. It could even own a European exchange.

Of course, that rosy future isn't a sure thing. NASDAQ and others are waiting for a slipup. "Competitors are licking their lips at what they see as a once-in-a-lifetime opportunity to steal volume," says market expert Benn Steil, director of international economics at the Council on Foreign Relations in New York. Already, smaller outfits, such as big block-trading broker Liquidnet Inc., are carving out growing chunks of trading business. The NYSE's market share continues to slip, as it has since about 1999. And national borders, along with Washington regulatory fiefdoms, still matter.

Thain has plenty of minefields to cross. Will the Securities & Exchange Commission impose tough conditions on the Archipelago merger? Could technical glitches unsettle his modernization efforts? Might rivals make trading so cheap that investors flock to them? Even unforeseeable scandals or a backlash from within the NYSE ranks could derail his plans. "To some extent, he's fighting the legacy culture at the NYSE, a culture that still feels the NYSE is really the go-to exchange and there's no reason to fix it because it wasn't broken," says Richard A. Herr, an analyst at the investment firm of Keefe, Bruyette & Woods Inc.

But odds are good that the reserved, slightly shy Thain will pull off most of his game plan in the three more years he's giving himself in the post. Even critics give the straitlaced CEO, who hails from tiny Antioch, Ill., high marks for rebuilding the NYSE's credibility with regulators who were furious at predecessor Grasso's $140 million payday. By agreeing last April to pay $20 million for regular audits of its regulatory program and to install video cameras to police the trading floor, the NYSE also has moved past the nasty scandal involving at least 20 former middlemen -- so-called specialists -- who the SEC said enriched themselves at a cost to investors of $158 million between 1999 and 2002. Thain doesn't expect such blots on the NYSE's record to endanger the outfit's self-regulatory plans, even as the SEC debates calls from the likes of the Securities Industry Assn. to mesh NASDAQ's regulator, the NASD, with the NYSE's self-regulatory unit.


More important, Thain, who took his post in January, 2004, has rushed to modernize the trading floor -- even if some people joke that he's dragging it into the 20th century. The key is his plan to take NYSE public by merging with the technologically superior Archipelago, a deal that won overwhelming backing from NYSE members in December. The bourse is now on a growth path -- which is why optimists bid up the price of seats on the NYSE from less than $1 million early last year to $4 million now. The believers also hiked Archipelago's stock from under 17 a share last April to more than 60 now. Thain is "bridging the worlds of technology, market structure and policy in a way that is very compelling," says Timothy F. Geithner, chief executive officer of the Federal Reserve Bank of New York.

By persuading NYSE members to accept the Archipelago deal, Thain will close the door on the exchange's private-club structure. Soon after the merger is O.K.'d by the SEC -- and that could happen any day -- Archipelago's stock will be rechristened NYSE Group Inc. (ticker symbol NYX), and holders of the NYSE's 1,366 seats will become shareholders. Soon after, outsiders will be able to buy the NYSE Group stock by way of a secondary public offering.

Getting this far is in many ways a testament to Thain's persuasive talents. He convinced specialists that they needed to accept a new trading system that will shrink their roles sharply if not render them obsolete. Thain, who once oversaw tech operations at Goldman, has pushed a computer-human "hybrid" system that will give investors choices. Those who want their trades handled by specialists, figuring they'll get better prices that way, can ask for them. Those who value speed can route their orders to the NYSE's computers for instant matching -- the same kind done on NASDAQ or Archipelago. Investors will still be able to send their trades to ArcaEx, Archipelago's superfast system, which for now will operate separately from NYSE's.

Outside pressures helped Thain sell exchange members on the changes. Before he joined the NYSE, rivals such as Archipelago -- whose leaders once mocked the NYSE as a dinosaur -- were nibbling at the Big Board's trading volume. The SEC was also threatening to foster the growth of alternative markets by pushing a rule, now slated to go into effect in June, that would require that each stock trade be routed electronically to the market that offers the best price. With all that, specialists could see extinction if they didn't find ways to keep business in New York. "Specialists have always been very adaptable," says Robert B. Fagenson, vice- chairman and CEO of Van der Moolen Specialists USA LLC (VDM ), one of seven remaining specialist firms on the floor.

While the middlemen are hoping they'll do better as volume surges, plenty of observers expect them to fade away as investors insist on fast electronic trades. Thain's hybrid, they argue, will prove little more than a short-lived sop to the specialists. "The hybrid will die a swift and merciless death," argues Harold S. Bradley, chief investment officer for the mutual fund firm American Century Investments in Kansas City, Mo. "It's basically a quaint last bit of respect for a dying and anachronistic way of doing business."

But Thain echoes a timeless refrain: that the floor folks give the NYSE a big edge over fully automated exchanges. By standing ready to buy volatile stocks, they can stop erratic plunges and keep markets moving when sellers can't find buyers. They will also keep markets lively in less-traded stocks, which Thain expects will be their forte.

Whether he actually believes that or not, Thain's changes don't depend on the specialists' survival. Armed with Archipelago's superfast computers and the NYSE's enhanced ones, the exchange could do fine without human intervention. So long as the cost of trading remains low, Thain is betting, buyers and sellers will keep flocking to the NYSE.

The approach mirrors the one the hugely successful Chicago Mercantile Exchange (CME ) took a couple years ago, when it moved to a trading system that's now mostly electronic, along with converting from a member-owned operation into a public company. Thain was so impressed by the CME, in fact, that he welcomed former CME Chief Executive Officer James J. McNulty as an NYSE director.

The CME's popularity with investors has impressed Thain, too. After going public at 35 a share in December, 2002, the CME's stock now fetches around 422. Will investors ride a similar rocket with the NYSE? Unlikely. The CME, unlike the NYSE, has a monopoly on trading in its futures contracts, whereas investors can buy or sell NYSE-listed stocks on lots of exchanges. What's more, the CME creates products at the drop of a hat -- recently launching snowfall futures, for instance -- while the NYSE for now is largely stuck with equities. That's partly why Thain plans to pump up the NYSE's arsenal of products with futures, options, and fixed-income securities.

Archipelago, too, has been a role model for the NYSE chief. Coming from nowhere in the late 1990s, it now controls about 20% of the volume in NASDAQ-listed stocks and a smidgen of NYSE-listed trading. Since Goldman was one of Arca's main financial backers, Thain watched the company's rise from a ringside seat. He tapped several Arca executives for top spots at the NYSE. Integrating them into the NYSE team will be challenging. But in the end, they'll likely give it some sorely needed verve.

Thain chose Archipelago as the vehicle to go public. Now he's planning to wield it against NASDAQ. Arca gives him control of a big chunk of trading volume in NASDAQ-listed stocks. Thain also can use the exchange to woo young companies that don't yet meet the NYSE's high listing standards. His hope is that Arca will serve as a farm team for the Microsofts of tomorrow. Finally, Arca gives him an instant inroad into options by adding the Pacific Exchange, which Archipelago owns.


Thain's biggest challenge will be to pull off his management integration, his technological innovations, and the transformation into a publicly traded company all at the same time. "It's like changing a Ford (F ) into a Honda (HM ) while driving down the road at 55 miles an hour," says Georgetown University associate professor James J. Angel.

Thain shrugs off worries about his U.S. rivals. He is stalking bigger game, eyeing European exchanges such as the London Stock Exchange, Euronext, and Eurex. "There will be consolidations between the U.S. and Europe, and we want to make sure we're well positioned to be a leader in that consolidation," he says. Such a move could ease the problem of foreign companies forgoing U.S. exchanges because of regulations such as the Sarbanes-Oxley Act. Of course, getting clearances from U.S. and foreign regulators to snap up a European bourse won't happen overnight or possibly at all.

For investors eyeing NYSE shares, Thain's plan is surely ambitious. Yet he has already moved fast toward creating his vision of a global marketplace whose many products will trade at lightning speed. Even if he gets only halfway there, investors should find the trip rewarding.

By Joseph Weber

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