Thomas Caldwell – Framework for the NYSE and Functioning of the NYSE
Board of Directors
Board of Executives
The New York Stock Exchange, Inc.
11 Wall Street New York, NY
Dear Ladies and Gentlemen:
The current debate among New York Stock Exchange (“NYSE”) Members (“Owners”) regarding for-profit or not, appears to have descended into two immovable camps. The following framework may assist in discussions among all of us. First, there are essentially two groups involved, owner/lessors who receive an income stream from leases and owner/customers (practitioners and order flow providers) who use the facilities, products or offerings of the NYSE at a cost. Each group perceives their investment in a somewhat different light. Let me say, initially, that it is clear both groups have a strong affinity for the NYSE and each has a desire to see the NYSE grow and prosper.
Owner/lessors see their investment as an asset which provides an income stream, often for retirement, and an asset for estate purposes. Owner/customers tend to view their investment more as a means to generate trading or execution revenues and profits. Recognizing these legitimate groups and their interests, the next step involves breaking the discussion into two basic components:
1) Framework for the NYSE and
2) Functioning of the NYSE.
Here is where our challenge as Owners becomes apparent. When discussing a Framework we have to take off our customer’s hat and think solely as Owners. Conversely, when discussing Functioning we must take off our Owner’s hat and think exclusively as customers. This may be difficult, but all of us should have enough objectivity to make the attempt. I should also mention that the following points are not all-inclusive and are merely put forward as reference points for our own ideas and discussions. Further elaboration could be reserved for another time.
The question is: “If we were to design a stock exchange to compete and grow in the 21st Century, how would we construct it?”
a) Ownership – Seats or shares? Shares have the clear advantage of being a currency with which to expand the business. They are an accepted method of ownership which can be pledged and which can represent smaller, fractional ownership of the overall asset and its profits. Generally speaking, the wider the ownership base, the stronger the corporation. That, however, is part of a different discussion.
b) Management – You want to be able to attract and keep the best managers available in order to remain competitive. Being constrained in terms of compensation will lead to revolving senior management, as individuals continually move from a high profile NYSE position into either public office or a better paying post in for profit corporations. The danger is we could become a career stepping-stone without the continuity to achieve long-term strategies.
c) To have access to capital for future expansion and efficiencies, the NYSE will need to restructure itself, certainly as a share based corporation and most probably as a for-profit entity. If we are in a “slow growth” domestic environment, then we are being led to look internationally. Shares will be needed.
d) Accountability – There must not only be a basis for evaluating senior management but that basis must also have substance. For example, current profits or losses at the NYSE have no meaning to Owners and are only of academic or passing interest. When earnings truly have a bearing on the well-being of Owners, then accountability and clarity are demanded. For example, it is unlikely the Grasso fiasco would have occurred in a for profit environment. This can be expanded upon if needed. e) Efficiency – Clearly, there has been a striving for efficiency at the NYSE under the new regime. It was needed and results will no doubt be forthcoming. The point is, this burst of efficiency was necessitated by a deterioration which occurs over time in all not-for-profit entities. After these current efforts are successful there is a strong argument for enshrining them in a for-profit framework.
f) Owners should have the right to share in the overall profits of the entity. For example, the inter-relationship of floor-based and electronic trading will be decided not by discussion, but rather by the functioning realities of the proposed hybrid. Should greater volumes, relative or absolute, flow toward electronic trading, then all Owners (lessor and customer) should participate in that profit stream. If not, it could simply become a discretionary management fund. Further, profits from data, information, proprietary or new products should also accrue to the whole body of Owners.
g) One should note that the vast majority of mutually owned, not for profit entities in the savings and insurance industries have converted to share based, for-profit corporations. The reasons go well beyond the few points noted.
h) By way of comparison, for-profit, public exchanges with a small fraction of our listings and volumes are now valued significantly above our current market capitalization. This means they will be the consolidators, not us. To ignore other institutions is dangerous. The world in which we live is far more integrated than even five or ten years ago. That fact can provide challenges, opportunities and information.
i) Openness – The governance of any entity should allow for the direct participation, at the board level, for its varying constituencies, as well as the public interest. This too can be discussed at a later date.
j) To the extent we must regulate ourselves, the function should be “one step removed” with separate governance, accountability and reporting. Clearly it is a subject for negotiations with regulators as to the degree of acceptable separation. We currently meet or exceed SEC standards in this regard, even according to their concept release on this subject regarding demutualized exchanges.
k) We would want to be able to reward innovation and nurture it within. Having lost options and derivatives, we should correct the framework which prompted these growth drivers to leave or develop elsewhere (e.g. ISE, CBOE, AMEX). New products will be developed and we must be in a position to reward and attract innovation.
l) In regard to customer responsiveness, it is generally perceived that for profit entities are more responsive to their customers than not for profit. The NYSE has numerous customer constituencies and a for profit model may well be better structured to address all of them more efficiently. At present, we are often viewed as a one constituency environment and that suspicion continually surfaces in the investment and regulatory worlds. The above points are general and certainly not all-inclusive but to discuss the above, we again must think as Owners. To turn to Functioning, we must only have a customer’s hat on and remember that successful entities must provide a real benefit to its customers at a competitive price. Functioning appears to be the major focus of practitioners and order flow providers, and understandably so. Part of the concern rests upon a view of for profit corporations which implies charging what the market will bear (or not) in the interests of short-term gain. For example, in our January town hall meeting it was indicated that the floor was being “subsidized” to the extent of $75 million and the point made that this might be discontinued in a “for profit” model. If that amount is what is required to keep a healthy, prosperous floor environment which many of us believe is part of our “edge” then it is, in reality, a cost of doing business, which any for profit organization would gladly undertake. Clearly, no rational manager would wish to damage the economics of access or order flow or any critical business aspect through inflated charges. Safeguards, guarantees and some consultative process or mechanism should be discussed for both the comfort and protection of our owner/customers.
Long-term business Functioning requires fairness to customers, employees, Owners and suppliers alike. By the same token, any group of lessors or customers demanding unique rights at the expense of others will lead to corporate downfall. I have purposely not expanded on Functioning to the same degree as Framework, since those participating in the NYSE as owner/customers have strong views and can articulate their concerns better than I can. The point of all of this is to listen, discuss and strive to be open. The goal is to be fair to all of our constituencies. One further topic worth elaborating upon is the current decoupling of seat prices and leases. Clearly, there is now a speculative premium on seats based upon the notion that management will “do something” regarding the economic functioning of the NYSE. I believe the current higher prices have the potential to mask our true situation and may, in effect undercut the need for substantive changes in our Framework. Exchanges are no longer monopolies or industry utilities. They are in the business of providing easy access to cost effective liquidity, price discovery, information and proprietary products. The past is gone and we must now choose between fear-based nostalgia and the courage to change. One will lead to inevitable decline while the other holds the potential of an exciting, rejuvenated, financial powerhouse on the world stage. We can achieve this goal.
Thomas S. Caldwell
The Exchange Members’ Association, Inc.