Corporate Governance

The Merger of the NYSE and Deutsche Borse: The Appropriate Regulatory Model for Stock Exchanges

By J Robert Brown Jr.

The NYSE is about to be acquired by Deutsche Borse AG.  NYSE is the junior partner and will end up with only a minority of the directors on the holding company.  The acquisition is a good time to once again reconsider the regulatory role for the NYSE. 

The NYSE was at one time an association of members (brokers and dealers) and a non-profit.  In 2006, the NYSE converted to a for profit company.  The Stock Exchange has skillfully used its public status to engage in some acquisitions, including Euronext, a collection of European stock exchanges.  As a for profit company, the NYSE has a duty to shareholders to profit maximize.  This is the case with all for profit companies.  But unlike other companies, the NYSE has regulatory obligations.  Traditionally, the regulatory responsibility has involved oversight of its members, the development of listing standards, and market surveillance.  For profit operations created tension with these duties.  Enforcing regulatory requirements was not always the most profit maximizing behavior.

When the NYSE went public, it had two broad choices with respect to regulation.  First, it could give up its regulatory role completely, allowing the government (or other self regulatory organizations) to perform the regulatory functions.  Alternatively, it could retain the regulatory functions but attempt to insulate them from the "for profit" influence. 

The NYSE opted for the latter.  It retained all of the traditional regulatory functions but gave oversight to a wholly owned subsidiary, NYSE Regulation, which was a New York non-profit.  A series of requirements were put in place designed to ensure that NYSE Regulation remained independent of the for profit holding company, most noticeably the requirement of an independent board.  They are discussed here.

As a matter of theory, the idea that a subsidiary could remain independent of the parent was never certain.  For one thing, while NYSE Regulation had considerable operational independence, its funding still came from the holding company (there was a non-public agreement about funding between the two entities).  For another, members of the holding company could sit on the board of NYSE Regulation (although they could not be a majority of the directors), providing a potential avenue for influence. 

Since becoming a for profit company, however, the NYSE has clearly reconsidered the benefits of the regulatory function.  The creation of FINRA, a the product of a merger between the NASD and the NYSE broker-dealer supervisory function, largely got the NYSE out of the broker-dealer oversight business.  Next to be jettisoned was the surveillance function.  Last year, the NYSE announced that it was contracting with FINRA to perform the function.  For more detail on all of this, go to the post here.  

The only significant regulatory function left is the development and enforcement of listing standards.  As the NYSE (and the SEC) move forward on the merger with the Deutsche Borse, it is time to consider whether this last regulatory vestige should be eliminated.  The holding company will apparently be incorporated in the Netherlands and the board will have a majority of non-NYSE directors, with Europeans dominant.  In the long term, the structure will provide some ability for European directors to influence US listing standards (perhaps by sitting on the board of NYSE Regulation). 

The NYSE should be freed from the remaining constraints of its regulatory responsibilities.  Authority to write and enforce listing standards should be transferred to the SEC.  The Agency is already deeply enmeshed in the corporate governance process and deeply enmeshed in the determination of listing standards (something confirmed by SOX and Dodd-Frank). 

Full post as published by The Race to the Bottom on February 15, 2011 (boomark / email).