Governance Issues at the New York Stock Exchange

<< Previous

Composition of the Board Contd...

The CII reported that the directors on the board were too busy to devote the required time to regulatory matters. Most of the directors were top executives of companies and they had their own businesses to look after. The CII report stated, "Board members have too many connections among themselves to be effective."²³ For instance, Grasso was inducted into the board of Home Depot, while Home Depot's co-founder Ken Langone was a director at the NYSE.

Analysts felt that conflict of interests in the roles played by the members of the BoD was one of the main reasons for misgovernance at the NYSE. The role of the directors was to maintain a free and fair market environment and to ensure high standards of working to safeguard the interests of the public. But, this did not happen. There was a primary conflict of interest between the role played by members of the BoD in their capacity as members of the board and their role as CEOs or important officials in their primary businesses. Half of the directors who represented the board did business on the exchange, and the other half had companies listed on the exchange or had a close relationship with listed companies. Commenting on the role of non-industry directors, Fortune wrote, "But these people don't wake up each morning wondering how they can protect investors - they wake up thinking about how to make money for their companies, a noble goal to be sure, but not exactly the watchdog role the securities market might like."24

Of the role conflict, Robert Mittelstaedt, vice dean and director - executive education, Wharton School of Business, said, "They are fundamentally different activities. You can't be both a regulator and an organization that is trying to draw companies [as members] and make it attractive for them to function on the exchange."²⁵

The Role of Specialists

The specialist system at the NYSE also attracted considerable criticism. In April 2003, the SEC initiated an investigation against trading violations committed by specialists. The specialists were alleged to be involved in front running²⁶. However, the NYSE refuted the charges and announced that SEC was inquiring into violation of the negative-obligation rule²⁷. But analysts pointed out that the objective of the inquiry remained the same, though the rules violated differed.

The primary question which the NYSE needed to answer was whether its specialists purchased shares at lower price with an intention to sell them afterwards for profit. The firms which faced investigation included - Spear, Leeds & Kellogg (a subsidiary of Goldman Sachs), Fleet Boston Financial, Bear Wagner (partly owned by Bear Stearns), LaBranche and Van der Moolen.

This was not the first time the specialist system had come under scrutiny. In 1999, NYSE entered into a settlement with the SEC to make the specialist system more transparent.²⁸ However, with fresh allegations against specialists surfacing again in 2003, analysts felt that not much had been done to bring transparency into the system.

Next >>

---

23] English, Simon, Wall Street report slams 'cosy' NYSE, www.telegraphic.co.uk, August 8, 2003.
24] Lashinsky, Adam, NYSE: Who's Minding the Store? Fortune, March 24, 2003.
25] How to Restore Credibility at the NYSE, www.knowledge.wharton.upenn.edu, September 24, 2003
26] An illegal activity in which a trader takes a position in an equity in advance of an action which he/she knows his/her brokerage will take that will move the equity's price in a predictable fashion.
27] The negative obligation ensures that specialists do not get involved in the market on their own behalf when the market is able to "make itself" and sufficiently match buyers with sellers. This obligation on the specialists provides the public an opportunity to transact with one another without the intervention of the specialists.
28] The SEC was investigating the charges of violations by specialists' way back in early 1990s. As a result of SEC investigation, one floor broker was banned from the securities industry.