Caldwell Asset Management Inc.
Independent Investment Managers
September 8, 2004
Board of Directors
Board of Executives
The New York Stock Exchange, Inc.
11 Wall Street
New York, NY
Dear Ladies and Gentlemen:
The management of the New York Stock Exchange (“NYSE”) is to be commended for their handling of the challenges we have all faced this year. Dealing with pressing regulatory and competitive issues, while traveling a learning curve, is not an easy task. Clearly, priorities had to be established as we moved from damage control to business stabilization and now strategic planning and implementation. I believe most of our Members recognize this sequence despite their current angst regarding Seat prices and leases. The purpose of this note is to follow up on my previous correspondence dated January 21, 2004. In that letter, I noted our two-fold role as a business and as a selfregulated organization (“SRO”). Given the challenges we faced, heavy emphasis had to be placed initially on the SRO function. Our Board of Directors and governance structure reflect that emphasis.
As we move forward we must begin to think of the business and wider corporate functioning of the NYSE. Part of a broadened focus may well include examining the current governance structure, which is currently more suited to a simple regulated entity with a monopoly or near-monopoly market position. To illustrate, the primary requirement for being a Director of the NYSE is that one has no financial interest in the organization. Little or no direct securities trading experience appears also to be a nomination preference. I suggest that the NYSE would have some trouble listing the shares of a company with similar constraints.
It is important for the NYSE to have a strong SRO function, either in tandem with or separated from our organization. If we are able to maintain this function under our broad corporate umbrella, that would be a positive. The current Board of Directors and our present governance model would be ideal for this critical adjunct of the NYSE. Mr. Richard Ketchum is also clearly a positive force in this regard.
My basic point is that the demands of our business may well require a business Board of Directors in the traditional sense. We are in a very competitive business. We have no defacto monopoly and our market position is not unassailable. We must compete for listings and trading volume. An international market beckons us and our capital must be built up for expansion and upgrades. We must also attract and retain highly skilled staff and management. In addition to the above we will continually be faced with brutal price and function competition.
To face the future we must also position ourselves to acquire other trading properties, either domestic or international. Either the NYSE has to recognize that it is now in a wider business or the SRO function will not have much to regulate. The growth and merging of large exchanges in Asia, Europe and here in North America can, in the future, have an impact on our relative position. Given America’s current dominance in financial services worldwide, a narrow focus at the NYSE can have a broad negative impact on both the financial sector and our economy at large.
America has lost its dominance in other economic sectors and the NYSE is a central feature in this broad economic contest. We must build on its recognized expertise in order to remain a world financial player. Our position is far more fragile than many regulators and legislators may recognize. In summary, a smart, tough, efficient and yes, profitable NYSE is what is required. Our first step in this quest must be a change from a Not For Profit Corporation (“NFPC”) to a For Profit Corporation. Our NFPC status has been detrimental to the NYSE on several fronts. Organizations of all types suffer from entropy or run-down over time. They lose their “edge”. That happened at the NYSE. Without the discipline of strong growth and results on the bottom line many NFPCs do not prepare for the challenges of the future. A clear example is shown in other exchanges that shifted their status to “For Profit” and then did an IPO. Dramatic efficiencies emerged.
We need to attract bright people, build capital and protect, then build market share. These are real goals requiring real assets. We are no longer simply a utility for the financial industry. Since we as an organization already pay taxes, our current status does not seem rational. Lacking a profit discipline in the past, good financial results were not as productively used as they could have been. It appears that, within our proposed hybrid trading model, a greater proportion of trading will be processed electronically. This is an expensive proposition to put in place, yet it can be very profitable to the NYSE, when fully functioning. This new initiative is simply the beginning of our on-going future capital needs. The above part also brings us to our current ownership structure. Members, whether they be floor traders, specialist, retirees or investors are constrained, in their sharing in the overall rewards of this business, to Seat leases and/or floor trading profits. This may be a declining proportion of our business in the future. Logically and legally it is not reasonable for business owners to be limited to benefiting from only one aspect of an enterprise. As we progress with broader products and trading alternatives, the revenue generators of the NYSE and hopefully their profitability must also benefit the owners of our business.
That fact speaks directly to the greater appropriateness of a share ownership structure over that of a Seat or Membership. True, this means lease payments may accrue to the NYSE, yet this could be offset in whole or in part through dividends from a broader revenue base. Initially, however, it may require a split share solution with one class allowing for floor access and leases such as at the Chicago Mercantile Exchange. I personally believe this should be a transitory situation if adopted. Specialists and floor brokers would be able to offset floor access or lease payments with dividends if a one class of share structure were adopted. This structuring would allow participation in the broader revenue base (floor plus electronic) of the NYSE. Shareholders would have the ability to diversify their investments through partial sales and specialists or floor brokers could redeploy capital to more productive uses within their businesses.
Many of our owners are retirees who in effect are dependent on one share (a Membership) and its sole income stream (a lease). They would be able to participate in a wider income base or diversify in a more prudent manner. Another advantage of a share structure versus Membership is that the anachronistic constraint of personal ownership could be removed and corporations would then be able to hold shares directly. At some point a limit of say 10% might be advisable, in order to assure the NYSE’s independence. The above comments and broad suggestions lead directly toward an IPO. As Mr. Thain has noted, there needs to be an understanding of and improvement in our business model and revenue generators. This has not been a particular priority in the past. Changing our NFPC status can reap significant benefits, as many public exchanges have clearly illustrated.
What is really required, however, is the will to move the NYSE into the current millennium. The benefits of a publicly traded NYSE are myriad. Without belaboring the point, it is important that all of our customers are able to own part of this great organization. A broader ownership base, solid governance, best price, greatest liquidity and outstanding management should be our goals. As we become a widely owned business in our own right the NYSE will be seen as less of a club and more as what it really is – America’s leading financial institution. I personally am of the opinion that our management is fast approaching the point where we must move on these matters. As stated in one of the great self-help programs: “Half measures will avail us nothing”. I would like to thank the management for their commitment and efforts over this difficult year and hope we can now proceed with the new “building phase” of the NYSE.
Thomas S. Caldwell