The Board of Directors
The Board of Executives
The New York Stock Exchange
11 Wall Street
New York, NY
Dear Ladies and Gentlemen:
The challenges of 2003 are, in part, a harsh reminder that the New York Stock Exchange (“NYSE”) is caught in a unique and ongoing quandary. It is both a non-profit, quasi-regulatory “utility” and a corporation that must compete in order to survive and grow. Within these pressures, the NYSE must serve a variety of constituencies, all with legitimate claims on its functioning. This discussion paper attempts to provide a basis for considering why and how the NYSE can address all of its stakeholders through becoming a publicly traded, for-profit organization. The following points outline a reasonably compelling case for this course of action.
1. Legislators, regulators, issuers, institutional investors and the general public have a sense of unease with the narrow ownership base of the NYSE. Of the 1366 seats, the vast majority are held by Specialists or Specialist-related persons. I, for example, am an investment manager who owns a seat and leases it to a Specialist trading firm. The optics and possible influence of one ownership constituency on an institution with world economic influence will be a continuing source of vulnerability to the NYSE. Mr. Reid’s heroic efforts in 2003, establishing governance guidelines, restructuring the Board(s) and selling the package to regulators, legislators and investors turned a potentially fatal blow to the NYSE into a “near miss.” Without his presence, stature and efforts, events could have been quite different. The point to keep in mind, however, is the underlying basis of the problem (real or perceived) was the inordinate influence of one group on the utility aspect of the NYSE. The NYSE needs to have a wide ownership base, reflecting its broad role in our society.
2. Pressure to separate the Self-Regulatory Organization (“SRO”) function from the listing, trade processing, data sales and overall corporate growth aspects of the NYSE will be ongoing. It has often been stated that the SRO function is central to the NYSE’s stature. It is not. Some years ago, I argued the opposite point as a Board Member of the Toronto Stock Exchange. I was wrong. The value of a securities exchange is based upon the liquidity it provides and the fair dealing it offers. It is irrelevant who actually enforces this latter requirement, as long as it is done and seen to be done. The independence of the SRO function is therefore paramount and if anything, this separation will add to the stature of the NYSE. The current governance structure is a step in the right direction, but if one more violation occurs, all the statesmanship and salesmanship in the world will not preserve the current NYSE structure. Future growth and thus world positioning would be significantly undermined for the foreseeable future.
3. The case for our Specialist system can and must be made on a business basis. Our dual functioning has jeopardized this important NYSE feature as a result of regulatory overlap. With a separate regulatory body policing this function, infractions will be dealt with as necessary, yet the overall Specialist role would remain, as it makes sense to the NYSE’s customers, through providing liquidity and an orderly market mechanism which underpins our central market status. The argument is that separation of the two roles (SRO and business) may insulate the Specialist system from behavioral concerns with individual traders. For the record, I personally view the role of the Specialist and the floor-trading environment as necessary and valid for the NYSE in the future.
4. In the not too distant future, the NYSE will be compelled to invest in system upgrades and expansion. Our physical facilities will also require significant investment. The NYSE lives in a competitive world where other exchanges have now unlocked significant sources of capital with which to grow. Over time, large European or Asian exchanges may well challenge the NYSE’s current position. Added to this possibility is the fact that public exchanges have a currency in their shares with which to take over or merge with other exchanges. This means of transacting business could have us facing substantial, consolidated exchange groupings and thereby becoming marginalized on a worldwide basis. This can have a major overall economic impact on America’s relative economic position. The NYSE is in the business of attracting listings of world scale companies. We are in competition and to be successful in the future we must anticipate what will be, rather than look at what is and was. If last year’s Wall Street Journal article regarding NASDAQ overtures was correct, then any acquisition (if desirable) could be more easily facilitated with publicly traded shares. The dual-listing issue, which has recently surfaced, could possibly be dealt with through a public share offer to Nasdaq, if it were thought advisable.
Unlocking Value and Liquidity
5. The spreads between bid and ask prices for NYSE seats are typically in hundreds of thousands of dollars. If one has to sell at a given point, for estate or personal reasons, the impact can be significant for our owners. In essence, it is akin to holding one share, where the quote is $1,450,000 bid to $1,900,000 asked (at the time of this writing). By exchanging their seats for stock, current seat owners would be switching their lease income stream for a combination of dividends and capital gains from their share holdings. A clear case that this swap would be extremely advantageous to the owners is not hard to make, particularly when viewing the experiences of other exchanges which have entered the public markets. Our Members would be realizing the substantial underlying value of the NYSE and the fact that it would truly be the world standard in publicly traded exchanges. A stock split prior to an IPO would not only provide our owners with a tighter market, but also liquidity for a portion of this investment, with which to diversify into possibly less volatile holdings. To illustrate unlocking value, the Toronto Stock Exchange (“TSE”), having “gone public” in 2002, now has a market capitalization of $1.3 billion (U.S.) compared with a $2 billion valuation for the NYSE (1366 seats x $1.5 million). The comparison of these two numbers speaks volumes. On a simplistic basis, comparable Canadian/U.S. valuations are roughly ten times, representing trading volumes and economic output etc. On that basis, an NYSE seat, or the comparable number of shares, would be valued at approximately $9.5 million each ($13 billion divided by 1366 seats). This “off the cuff” number does, however, illustrate that there would be significant upward value potential for seat holders. The current 20 times multiple of earnings for most public exchanges also supports a significantly higher valuation. At a minimum, the share valuations would be some multiple of current seat values. TSE seats, although held artificially low and with approximately 120 members, moved from $39,000 U.S. to in excess of $9,750,000 U.S. as a result of its IPO.
6. The above conversion of seats into shares would also generate approximately $200 million in additional revenues for the NYSE from existing Specialists’ fees. NYSE income could also be augmented through listing, trading, market data and other business service revenues. Other sources of revenue can be developed once a true NYSE business model is addressed. One advantage to both the NYSE and Specialists is that the approval and lease processes would then be united, bringing greater flexibility, simplicity and control to the process. This may also result in more realistic fee calculations. This general revenue stream would then be part of the NYSE framework, where it can be allocated more appropriately to current and future NYSE needs.
7. This is still a sensitive topic, yet looking to the future, it will have to be addressed. We have been very fortunate in attracting leaders recently with a sense of public purpose who have either donated retirement time or made significant financial sacrifices to help the NYSE. That will not always be the case at the CEO and other management levels. A compensation regime will eventually have to be in place to compete with other public companies for talent and skill. At present, the dual role (utility and business) of the NYSE can place constraints on our attracting management depth in the future. Clarity of purpose and goals are mandatory for professionals working for the NYSE. Having dual responsibilities is serving two masters. One will suffer.
As noted above, the SRO function is not the keystone of the NYSE. If anything, it is our Achilles heel. Separating our regulatory burden into a different entity and building our business foundation to deal with future challenges would enable the NYSE to address clearly the best practices in each area. This dichotomy, coupled with becoming a forprofit, publicly owned corporation, would simply and visibly address all the constituencies having a stake or interest in the NYSE. The current governance structure, although a vast improvement over what was, is still a hybrid with some of the same vulnerabilities which will surface over time. Within the breathing space we have now been granted, it is incumbent upon us to build a significantly better structure which will withstand future regulatory and competitive challenges. The purpose of this letter is simply to put this issue on the table. If agreement is secured for this course of action, the path is relatively straightforward with numerous precedents to lead the way.
Thank you for your consideration in this matter. I would gladly offer any assistance to further this course of action.
Thomas S. Caldwell