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Grasso's Pay: The Side Show to Real Issues

The New York Stock Exchange (NYSE) is like a truck with four flat tires. Driven until recently by longtime chairman Richard Grasso, it remains inoperable. The board can replace him with Lawrence Sonsini, Madeline Albright, or Leon Panneta, or a triumvirate of those three, but that won't solve the NYSE's numerous structural problems. Until that structure is overhauled, rather than tweaked, investors will continue to be inadequately protected.

Let's begin with the specialist system of trading stocks. Specialists-individuals granted a monopoly on information and control of order flow-are permitted, even encouraged, to take positions in the shares they trade. Day after day, in up, down, and sideways markets, they make money positioning themselves ahead of and in-between public orders. The original rationale for the specialist system was that it was necessary to have someone ready to make a market in a given stock when one did not exist (that is, to provide investor liquidity when none exists). With billion and two billion share days and trillions of dollars moving in and out of equity shares daily, the specialists' function of buyer or seller of last resort is a ridiculous fiction. That they never fail to make money is prima facie evidence that they are anything but a sacrificial provider of liquidity. As ex-SEC Chairman Arthur Levitt said, "It's like being in a card game in which only one of the players gets to see everyone else's hand. Specialists exploit that advantage, too."

In addition to its monopolistic position, the NYSE is self-regulating. "Self regulation," according to NY State Attorney General Eliot Spitzer, "has been an abject, utter failure.and anyone not seeing that must have been on the dark side of the moon." Mr. Grasso, until the wheels fell off-or flattened out-did a marvelous job of obfuscating this issue. Specialists who front-run (or "fail to observe negative obligation") have historically received a slap on the wrist (or is it a slap on the back?). Quarrels (with the recent exception of LaBranche and Co.) were rare and almost always kept private, for reasons of "image." The NYSE's public "image" was seldom tarnished, and its protectionist practices rarely called into question. Chairman Grasso managed to keep the public, regulators, and politicians contentedly munching on blue cheese while searching for a wayward cow to jump overhead. In many ways, it is this cosmic transportation capability that made Mr. Grasso so invaluable and worth the hundred plus million dollars he was paid by those who populated the Big Board.

Another NYSE failure has been little discussed. The Exchange has quasi-judicial powers over its members. Essentially this means that NYSE officers may bring action against members that can result in censure, fine, and/or removal from the securities industry. Yet specialists-who explouit their informational monopoly for huge monetary gain-can choose to withhold market information from traders who do not cooperate with them. Traders without information cannot do their job. A trader not doing his job is in danger of becoming an ex-trader.

Recently, several floor brokers have admitted to the press that they fear NYSE retribution for whistle-blowing. As a former block trader who dealt with listed stocks daily, I too can testify to the punitive behavior of the specialists when confronted by trader criticism. The Exchange's judicial powers have been used to discourage criticism. And it has worked to perfection for 211 years. Until now.

Richard Grasso's pay, in many ways, is a side-show to many of these structural issues. Yes, Mr. Grasso failed to understand the monumental conflict of interests in his relationship with those he was charged with regulating (that he and Kenneth Langone of Home Depot sat on each other's compensation committees, for example). Yes, Mr. Grasso fought NYSE transparency tooth and nail while supposedly championing a new era of transparency for companies listed on his exchange (he battled long and hard to retain his board seat on Home Depot and hide his compensation). Yes, he seemingly defined his job as, first and foremost, to protect the interests of his NYSE cronies at the expense of the investing public. Still, these failures weren't unique to him. The exchange itself is a seriously flawed system in need of a four-tire change. That the center of a capitalist economy is a self-regulating monopoly with judicial powers over those who must transact with them is not only ironic, but intuitively insane.

As Sarah Telik, executive director of the Council of Individual Investors, has said, "The nicest thing you can say about the NYSE and their performance is that they are set up in such a way that you can't expect them to do a good job. And they haven't disappointed."