Editorial: NYSE Goes Chapter 11! Public Companies Jump Ship; SEC Files For Public Offering!

Ya, right—the Securities and Exchange Commission is going public. And the New York Stock Exchange is going to declare bankruptcy. That’s ridiculous.

Or is it? Stranger things have happened.

Consider this editor’s flight of fancy …

The story starts in December 2004, when the Nasdaq Stock Market files its registration statement to go public. Actually, it starts before that, with the Nasdaq’s 2001 acquisition of a stock exchange based in Brussels, which triggers additional acquisitions of alternative trading systems and platforms. Either way, it starts with the Nasdaq, and Chairman Frank Zarb’s desire to be global and public.

Once accomplished, capitalization breeds acquisition, so the Nasdaq decides to purchase Instinet Group and its electronic trading system in April 2005.

The moves aren’t only strategic; they’re a declaration of war against the New York Stock Exchange, weighed down at the time by accusations of excessive compensation and trading abuses by specialists.

But once the NYSE unburdens itself of its former chief executive and other distractions, it has no choice but to go public as well; the Nasdaq’s relatively tame “dual listing” strategy is infuriating enough, but now it is a well-capitalized, fully electronic rival and on the prowl. The NYSE must put on the boxing gloves.

Pressures to compete and build profit drive the NYSE to acquire properties in a race for market domination. Hence the acquisition of Archipelago (completed only last month), and the likely acquisition of additional global, mercantile, options and futures exchanges, from Philadelphia and Toronto to London and Switzerland and beyond.

Whether the acquisitions are market or technology driven is irrelevant—they’re critical to an exchange with archaic trading practices and aggressive competitors. Winning the game also hinges on volume: stock-trading commissions are shrinking, so volume is critical to success. And with the Nasdaq stock market’s electronic trading platform slowly chipping away at NYSE, market share is critical. This becomes more of an issue as exchanges in Chicago and elsewhere mull mergers and IPOs, adding competitive and pricing pressures.

But commoditization demands differentiation, so the consolidation trend forces both the NYSE and Nasdaq to create products and services that entice companies to “get listed.” The Nasdaq moves first, acquiring Maynard, Mass.-based Shareholder.com to “maximize the value companies receive from NASDAQ,” according to Executive Vice President Bruce Aust. Both exchanges create premium listing tiers to distinguish themselves and their offerings; the Nasdaq announces “Global Select,” and the NYSE mulls a new classification with lighter requirements.

All the while, organizational changes, appointments and resignations accompany the acquisition integrations. Changes come fast, perhaps too fast; the NYSE, after all, is a 214-year-old institution that spent its entire history as a nonprofit and a regulator. Now it must regulate itself—that’s right, it’s a listed company on its own exchange. And while a NYSE spokesman told this editor via email that “extra safeguards and disclosures are built into the listing of NYX,” the SEC order approving the NYSE transformation acknowledged the potential for conflict, noting that the proposed safeguard procedures “will not apply to the initial listing of the common stock of NYSE Group” due to timing issues. A backup plan was approved by the Commission, but the SEC is also going to get a quarterly report summarizing the self-regulation of the NYSE and affiliated stocks. While there may be other examples of self-listing stocks, we haven’t seen how they operate in an aggressively consolidating global market.

In any event, changes are afoot. And the turmoil is exacerbated by a listings boom. (Yes, this column is just a “what if” discourse, but according to a recent report, 881 small-business registrations were filed in 2005 alone, making it a record year. Growth is not theoretical; it’s happening.) The growth generates increased fees for NYSE Regulation, which provides the nonprofit regulatory arm more capital for hiring. And where does the NYSE pull talent from? The SEC, of course. (According to SEC Commissioner Paul Atkins, 350 people left the SEC last year.) Instead of jumping to law firms, ex-SEC staffers now have another profitable option: the newly cash rich NYSE.

But don’t forget, the NYSE Group has more than oversight and referee responsibilities; it has profit pressures. That means it must regulate itself and its members, while simultaneously meeting Wall Street’s expectations. That is, it must meet the expectations of the members it regulates. (Talk about a conflict of interest.)

So the NYSE must grow, acquiring additional services to compete with Nasdaq and boost profits.

The NYSE decides it needs a “compliance and governance services” offering to compete with Nasdaq’s Shareholder.com, but Thomson Financial has already acquired CCBN. So the exchange looks to wire services. Following Warren Buffet’s lead in acquiring Business Wire, the NYSE acquires PR Newswire, with its growing array of disclosure and investor-relations services.

Now the exchange finds itself going head-to-head with Thomson Financial, whose parent company is, you guessed it, listed on the NYSE. It also finds itself in a complex entanglement with Dow Jones—the NYSE simultaneously feeds data to, partners with, and regulates, the company.

Thomson Corp. and Dow Jones call foul. The SEC steps in.

The Commission’s staffers—already annoyed with the NYSE’s arrogance and jealous of its market capitalization—now find themselves bargaining with former co-workers (who are, of course, now higher paid and option-rich).

Accounting irregularities are found.

Conflicts of interest are uncovered.

Listed companies begin to jump ship, swimming to the Nasdaq and other exchanges without dual regulatory conflicts.

NYSE Group’s revenues plummet.

The stock tanks.

Funds for the regulatory arm—funded by fees assessed to members—begin to dry up, and NYSE Group is wary of over-funding NYSE Regulation due to the negative earnings impact. Layoffs ensue at the regulatory arm, examinations decrease, and more problems follow.

Wells Notices are delivered.

Acquisitions are delayed.

Debt reduction is required.

Chapter 11 restructuring is considered.

The NYSE Group finally proposes to divest itself of its regulatory arm.

And to whom?

The Commission, of course.

But how does a federal regulatory agency acquire a non-profit and compete for talent and resources against global bodies and well-capitalized SROs?

Through the same mechanism employed by the NYSE: a public offering.

Sound crazy?

You bet. But the potential for conflicts of interest here are massive. And stranger things have happened.

This column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

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