The NYSE is Now Practicing What it Preaches
from
March/April 2007
by Julie Connelly
A year ago the New York Stock Exchange merged with Archipelago Holdings, a publicly held electronic marketplace, and listed itself on its own exchange under the ticker symbol NYX. Now that it is public, NYSE Group Inc., as it’s called, must meet the same standards for good governance that it laid down for its listed companies in the wake of the Enron and WorldCom scandals and the brouhaha caused by the huge pay packages handed out to former chairman and CEO Richard Grasso. So how does it feel to have to live by your own rules?
Corporate Board Member
’s Julie Connelly put this question and others to Marshall N. Carter, who became chairman of the exchange in 2005 upon the departure of John Reed, the Citigroup veteran who reengineered the NYSE’s ultra-clubby board after taking over from Grasso. Carter, 66, a rangy West Pointer much decorated for his service as a Marine officer in Vietnam, is the former chairman and CEO of Boston’s State Street Bank & Trust Co. Interviewed in his cramped office at the exchange, he talked about the pressures of being a governance exemplar, the board’s role in helping to set strategy, the right way to manage a CEO-succession process, the craft of dealing with investors, and his changing views on sharing the top jobs with Thain. Excerpts:
Do your board members feel they’re under more than the usual scrutiny about how they govern the exchange?
The most significant thing that has happened since Mr. Grasso left is that we now govern ourselves the way we always expected our listed companies to govern themselves. I don’t know why nobody ever called this place to task about that. We weren’t a public company before, but that doesn’t mean you can’t do some of those things, like eliminating conflicts on the board.
I think the only thing we have that is not leading-edge on corporate governance is that when we went public, we went to the Securities and Exchange Commission and said, “We’re concerned to some extent that somebody might try to buy a controlling interest in us. As a public institution with such a big stake in the economy, we believe we should have a 10% restriction on how much stock a shareholder can vote.” So you could own 20% of us, but you cannot vote more than 10%. I know that generally speaking, stockholders don’t like that because it may discourage a merger or a buyout. The funny thing about the exchange is that we’re actually very small—only about 1,500 employees and around $15 billion in market cap—but we have kind of a big footprint. And so we have to be very conscious of our responsibility for running the biggest market in the world, by a factor of three or four.
Shareholder activists complain that as a public company, the NYSE still has a serious conflict of interest in terms of regulating the same member firms it depends on for revenues.
At our board meeting in December 2003, the decision was made to separate the jobs of chief regulatory officer and CEO. So there are now two executives reporting to the board of directors, the CEO [John A. Thain] and the CRO [Richard G. Ketchum]. Their respective duties were very carefully described in the new bylaws, so that you wouldn’t have the situation we had before that, with the CEO also in charge of enforcement and regulation.
When we went public, our regulatory function was spun out from the exchange into a separate nonprofit company. The second step will be combining it with the NASD regulatory function into a new, completely independent company. That will happen probably in six months or so. We’ll keep market surveillance, but the member-firm enforcement will go. The potential for conflict of interest has gone halfway away now, and will go all the way away as soon as this new organization is formed.
The exchange has divided the two top jobs. You’re chairman, and John Thain is CEO. But when you were at State Street, you had both titles. Where do you come down on splitting these responsibilities?
I think that you’ve got to look at the times. In the early 1990s especially, people used to say how well I managed my board. And I would jokingly say, “Well, in the kingdom of the blind, the one-eyed man is king.” Board members are really dependent on the CEO for information about the company. I was on the Honeywell board, and I felt like [then chairman and CEO] Larry Bossidy would tell me what I needed to know. I didn’t have an open airplane ticket to go visit the jet-engine factory unannounced. But if I wanted to go to the jet-engine factory, I’d talk to Larry and say, “Larry, you know I’m on the audit committee. I’d like to get a better feeling for how the factory runs”—and that was fine. At that particular time, in the early to mid-’90s, I think you’d find that 90% of American CEOs would say they wanted the chairman and the CEO as the same person. Now I think 33% of S&P companies have a separate chair. That’s a very significant change.
I think it really depends on the players who are involved. For example, there’s a 15-year difference in age between John Thain and me. I’m 66; he’s 51. It’s a very good relationship, because I don’t want to be CEO—I’ve done that. But I think there’s a different dynamic if the chairman is 61 and the CEO is 58. Especially if the chairman maybe has never been a CEO and wants to “help” manage the company, you’re going to have people stepping on each other’s roles. I believe that it’s a good thing to have the separation of duties, but each company has to look at what makes sense for it.
How do you divide responsibilities with Thain?
Well, I generally focus on managing and coordinating board activities, making sure the agenda addresses all the company’s concerns. I worry a little bit about our strategic direction. I go down to Washington three or four times a year and visit with Congress and the SEC. And I deal with other external parties, like the attorney general here in New York and things like that.
So you’re the outside guy?
No, we’re both sort of the outside guy. I just got back from Tokyo, where I was calling on some of the top-level people there. John was in China doing what I was doing in Tokyo. But the board—managing the board, its four or five committees and agendas—is probably the principal responsibility of the non-executive chair.
Do you spend a lot of time on strategy? Directors complain that they never get to spend enough.
Of the 17 meetings of the board before we went public, 13 or 14 had major strategy pieces in them. The first part of our December budget presentation for 2007 was devoted entirely to strategy: where we are, where we’re going. We have two days of board meetings every other month, plus phone meetings because we’re in a strategic-acquisition mode. So it’s a lot of work. Strategy is discussed at almost every meeting.
How would you define the exchange’s strategy?
When management changed in ’03, we had an 85% share of one product, stocks, which were sold one way with about a 1970 business model. Within six months, the board was starting to have long discussions about what our strategy should be. We established that we wanted to be a multi-asset-class global marketplace. So the first move was a vertical one. We had to add to our product set: We wanted fixed income; we wanted derivatives, options, futures; and we wanted an electronic crossing network. The Archipelago merger was the perfect way to get all that. Also, we were under tremendous pressure from our owners, the seatholders whose seats were worth about $985,000 in the fall of ’03, to go public. Well, you can’t go public with one product and 85% market share, because the only place you’re going is down in stock price. So Archipelago gave us the chance to go public. The second strategic move comes from the fact that we believe a global marketplace for a global industry is appropriate. Launching Euronext [an exchange that enables investors to trade across national boundaries in Europe] is the first step in [creating] that marketplace.
But foreign companies don’t seem eager to list their shares here anymore. What are you doing about that?
There are four reasons why America is losing its competitiveness, and none has a higher priority than any other. No. 1 is our litigation environment and the lack of tort reform. For a non-U.S. company where all its directors can go to jail, this becomes a very serious issue. The second is the strength of the euro and Asian currencies. A Spanish power company that needs to raise $1 billion doesn’t have to come to New York anymore. It can go to the London euro market, or the Chinese can go to Hong Kong. The third is, there is no universal GAAP [generally accepted accounting practices]. And we don’t see much push by the SEC or the PCAOB [Public Company Accounting Oversight Board] to do anything about this in the next couple of years. We just restated our earnings according to the European GAAP, and Euronext restated theirs according to the U.S. GAAP, and it took us about six months. Then finally there’s the implementation of Section 404 of Sarbanes-Oxley. John and I have both testified before Congress on the impact of this extra layer of activities.
There is still the name brand of the NYSE and the prestige of listing here. You do have that. You have the so-called 30% valuation premium accorded to companies that list here [Carter is referring to the increase in market capitalization that he and others say benefits companies trading on the NYSE].
You have the degree to which they have submitted themselves to NYSE regulation. Some of our regulation—our listing standards, the audit committee independence—is actually tougher than Sarbanes-Oxley. But I think people are concerned about us losing our competitive edge as a capital-raising center of the world. And when the Industrial & Commercial Bank of China can raise $22 billion on the Hong Kong Exchange, there’s some validity to that concern.
We do our marketing. We talk about the prestige. The biggest advantage is a much, much larger base of retail and institutional investors in the U.S. So for a Japanese company, say, that has a wide penetration of its products here—I mean, practically every pickup you see is Japanese—if they need to raise capital and want to have their customers as shareholders, this may be the place to be.
John Thain is on the record as saying he’s only going to stick around as CEO for another three years. What are you doing about management succession?
We’re doing the normal management-resources reviews and looking at succession plans. We’ve just completed an assessment of the board, which you do every year, and one of the issues that came up was that board members want more discussion of management succession. Not just at John’s level, but at all levels—his six or seven direct reports, the key executives, executive vice presidents. We’ll be doing that probably in the spring.
The way I like to do succession planning is, first the board spends a good deal of time on the strategy of the company. The second phase is spending a good bit of time on what management-team skills—not just the CEO, but the management
team
—are needed to carry out that strategy. Then the third phase is, let’s start looking at people’s names who can lead that team or who have to be added to that team.
Unfortunately, in the American system they usually do step three first. The CEO and the chairman of the board whip out their favorite persons, and that’s where they start. That’s totally incorrect.
I reject this theory that only certain people can be CEOs. I think if the board is doing the proper reviews, it will over a period of years reinforce the management team. In fact, after we had been doing them for about six years at State Street, I asked the HR executive how many [management] jobs we were filling internally. We had gone from 8,000 employees to 22,000 employees. She told me about 80%. I said, “That’s too many. We’re not bringing fresh people in from the outside.” I wanted to have about 60% to 65% filled internally, so we’d refresh our executive core in the company. Because if you fill every opening from inside, pretty soon you become kind of insular.
At State Street when we did these reviews, we had six or seven screens. The first was high-potential; the second was high-performing. The third was people that were both high-potential and high-performing. The fourth was succession planning. We would force on the organization chart a list of three or four people for each key job—that is, people who can take the job today, those who can take it in 18 months, those who can take it in 36 months, and people who could take it from outside our company. And then we would do a screen of our expatriates—people who are away from their home country. And then we would do a screen of women executives, and then we would do a screen for diversity.
You’d think if you did that over the average tenure of a CEO, which is, you know, seven to 10 years, you should not get caught when the person suddenly gets sick. But look at companies where they have a catastrophic loss of somebody in a plane crash or something and that company completely falls apart.
Do you think the shareholders of the New York Stock Exchange are happy?
The stock is at, what, $96 and something? So the floor member or seatholder who received 80,177 shares for a seat that was worth $985,000 in the fall of ’03 was worth $8.3 million in mid-December. We have some relatively happy shareholders.
The seatholders are the biggest ownership block. General Atlantic is a major shareholder, as is Goldman Sachs, because they were major shareholders of Archipelago when we folded ourselves into Archipelago. After the merger with Euronext, our largest shareholders will be Atticus Capital, an investment-management firm that will own 8.6% of NYSE Euronext. That will be our new name after the transaction closes in the first quarter of 2007.
We’ve got retail investors and the normal hedge funds. We do a lot of communicating with the shareholders, and we have a very open annual meeting. I’m accessible; I take phone calls from stockholders and seatholders. I don’t think we have any big issues here.
Have you been sued yet?
Well, yeah, we did get sued by a couple of floor members, who objected to the amount of stock they were being offered for their seats. It cost us $17 million. That was difficult. But I’m used to getting sued. I was on the Honeywell board for eight years. We got sued around six times. That’s why we have directors’ and officers’ insurance.
