Has the NYSE been sufficiently fixed after the "Grasso Affair"?

Dwight M. Owsen
Long Island University
 
Jerry G. Kreuze
Western Michigan University

Now that the controversy has cooled and some changes have occurred at the New York Stock Exchange (NYSE), it is time to reflect on those memorable events. That reflection, unfortunately, reveals that the current internal structural changes within the NYSE will be insufficient. Notable financial disasters like Enron and WorldCom have pointed to problems with trading specialists in North American financial markets. Therefore, those still under public suspicion in the "Grasso Affair" must have their activities thoroughly and publicly aired for their personal benefit and for the benefit of the financial markets. Moreover, self-regulation within the NYSE may need to be revoked and that regulation moved to outside agencies for the benefit of the NYSE and the financial markets. The approval of Grasso's pay package, according to SEC Chairman, William Donaldson, "raises serious questions regarding the effectiveness of the NYSE's current governance structure."

Let's accept for the moment the Mr. Grasso, the former president of the NYSE, behaved honorably and legally both as a leader of the NYSE and in accepting $140 million or more in compensation from a non-profit organization. It appears that this will be decided in the courts after all. Let's also put aside that Mr. Grasso was working for a non-profit rather than a for-profit organization; that his organization receives a tax break subsidy from the federal government, unlike for-profit organizations; and that none of his board had their own money invested as stock in that organization. That way we can forget about the reality that for-profit executives face a full force of competition and struggle through a more competitive managerial environment on the way to the top of their organizations. Let us also forget that non-profit CEOs rarely face the sort of irate stockholder suits or stockholder voting revolts that happen when people have their own money at stake. Stakeholder lawsuits against management and board members claiming economic loss frequently can be substantiated for for-profit organizations. Moreover, these organizations often pay substantial amounts of corporate income taxes, providing necessary funds for the infrastructure needed for businesses to operate profitably.

Let us only consider the perception of the NYSE as a regulator. It would seem that the NYSE prefers this arrangement better than having the SEC, or an independent private agency like the Financial Accounting Standards Board, acting as the regulator for the NYSE. By not being subject to an outside agency, the NYSE arguably retains the initiative to control its own regulation by those most informed about its problems. A perceptional problem occurs, of course, in that those whose activities are regulated, such as the "specialists" regulated are also on the compensation board determining the pay of the chief regulator. This situation allows skeptics to contend that NYSE board members can "buy" the leadership of the NYSE. New York Comptroller, Alex Hevesi, believes "when an official is paid an extraordinary amount of money by those he is suppose to regulate, there is an obvious conflict of interest." Nevertheless, as dangerous as this overcompensation scheme was as a precedent for similar future incidents, the related perception of association insiders controlling the NYSE and being involved in operations requiring such protection from prosecution may well place a drag on the prices of all NYSE stocks. Certainly, non-normative compensation (for a non-profit organization) can only feed this skepticism.

It is the normal reaction of for-profit business leaders to allow the alleged malefactor to quietly leave and then develop structural firewalls and safeguards to prevent the problem, even if only perceptional, from reoccurring. These "pro-active' measures provide an all important visible precedent that leaders are not to be prosecuted for "mistakes". This idea maintains the culture supporting corporate leadership. Mr. Hevesi further maintains "it would not be enough to change the leadership of the NYSE without implementing reforms that will ensure the exchange is an effective regulator and leader in corporate America." The problem with such precedents and policies is that other leaders, seeking to maximize opportunity against these cultural norms, see little control or "teeth" in such precedents. With these social behaviors exempt from penalty except of course a loss of position, it seems hardly a deterrent for retirement seeking CEOs not to seek a last minute windfall. Those potential malefactors may be only too willing to provide unspecified services that the public perceives as selectively non-prosecutable by those being regulated for significant career exiting gains.

To rectify these perceptions and to repair the reputation of the NYSE, government subpoena power by legislative committees and related testimony and other legal processes must be initiated to fully uncover the relevant details in the hopes of minimizing future incidents. This investigative process will send a message likely to be unambiguously interpreted by potential malefactors in all areas of the securities market. Social psychologists warn that such potential malefactors assess only what punishments actually occur and not the rhetoric that surrounds the potential incidents. Only when the former NYSE president and the board members who provided that extraordinary compensation are thoroughly investigated, for their own and the public's interest, can the NYSE begin to repair its reputation. After all, procedures established after a leadership problem occurs can be systematically dismantled as soon as memories fade, as the Savings and Loan debacle attests. It then becomes once again business as usual.

So how can we fix this situation? Certainly, we can hope the honorable people involved have their actions thoroughly disclosed and their reputations restored. We can also ask that wrongdoers be punished to deter future "mistakes" by financial leadership. Moreover, the rot and smell usually permeates to middle and lower levels once it seems that the leadership has gotten "away with it." Firewalls or not, there should be an intense auditing of non-profits and financial institutions after this incident; otherwise those organizations will also get tarred with the same brush in the public's mind. Now may well be the time that regulation concerning the internal operations of the financial markets separate from the NYSE. The SEC, the Treasury Department, or the Justice Department should instead set up shop on the floor of the exchange.

Before our colleagues who free regulatory nihilists object, recall what has happened in auditing standard setting with the AICPA and the Public Corporations Accounting Standards Board. Also, let us consider why we have such regulation in the first place. In the 1970s, before the Moss and Metcalf Committees, Dr. Abraham Briloff argued that as long as the leaders in the financial markets were going to manipulate financial regulation, the investor might do better by simply dispensing with such regulation. Gabriel Kolko, on the other hand, argues that it was the financial industry itself that asked for financial regulation. This self-serving regulation was designed to comfort wealthy investors with the belief that the masses would not take their money out of the stock market and place it in real estate and other investment options. This regulatory process has been in place since the 1929 stock market crash because of the then current public revelation of corruption in the financial markets. The financial industry has a history of only giving in to outside regulators when needed to placate worried investors. It is a reactionary regulatory process. Today, more than ever, it would be in the best interests of these financial institutions to concede more of the regulatory remaining with the NYSE (for trading specialists especially) to an outside agency or to the government to lower the business risk premium of investors revealed by the Grasso Affair. Otherwise, the financial markets will be swimming upstream against a steady current, until memories of these events fade sufficiently.

Please send any suggestions or comments to owsend@yahoo.com.

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