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Commentary: Put The Big Board On The Big Board


Last August, Thomas S. Caldwell paid $2 million for a seat on the New York Stock Exchange. Two weeks later, then-chairman Richard A. Grasso resigned. Ever since, the seat has lost almost half its value as the exchange's market share and profits have come under pressure. No matter. On Aug. 27, Caldwell bought another seat -- for $1.15 million, the cheapest in six years. Caldwell, an investment manager who rents seats to specialists who buy and sell stocks on the trading floor, thinks it was a bargain. How so? Sooner or later, he says, the Big Board will have to sell shares in an initial public offering and he'll make a killing.

It's an idea whose time has come. Caldwell and other NYSE seat holders want to transform the not-for-profit, member-owned exchange into a publicly traded corporation. By swapping seats for shares, they say they can capitalize on the Exchange's growth as it finally moves toward full automation -- and cash out a lot more easily when times are tough. Like Caldwell, many seat holders laud NYSE Chairman John S. Reed for establishing new governance rules, restructuring the board, and paving the way for more electronic trading. But they fear the exchange's woes will persist unless ownership is expanded far beyond the current 1,336 seat holders and the "inordinate influence" of one group -- the specialists, whose jobs are threatened by modernization -- is removed. "Anything other than going public won't work," says Caldwell. "That is the only way we can compete on a world scale."

Going public would force the NYSE to cut costs and improve efficiency, tackle rival exchanges head-on by matching their technology, and, above all, focus on profits. It would also generate the currency to acquire stakes in other exchanges worldwide to funnel trades and listings to the Big Board. And the NYSE would find it easier to raise capital for developing cutting-edge electronic-trading platforms. The more the NYSE trades electronically, the more it can squeeze out costs, reduce prices, increase its trading volumes, and, ultimately, generate more revenues and profits.

The dwindling price of seats has sparked a dissident movement among owners, mostly retired Wall Streeters who rely on rent from seats for income. Some 250 members of the Association of New York Stock Exchange Equity Members are campaigning for an IPO. "In Grasso's time, they were still making lots of money," says Benn Steil, a senior fellow at the Council on Foreign Relations and an expert in financial-markets regulation. "Now they want to capitalize on their seats before there is no value left in them. Going public is the best possible exit strategy." The group's leader, retired floor broker William J. Higgins of Pine Beach, N.J., notes that stock and commodity exchanges all over the country are publicly traded. "We're the last holdout," he says.

Historically, the main opponents of a Big Board IPO have been the specialists and independent floor brokers who operate the centuries-old open outcry system. When Grasso floated the IPO idea in the late 1990s, the specialists shot it down.

Now they're ready to deal. Plagued by downbeat trading volumes and fleet-footed electronic rivals, the collective profits of the NYSE's seven specialist firms plummeted 84%, to just $15 million, in the first half of this year. The largest, LaBranche & Co. (LAB), which is publicly traded, reported second-quarter operating earnings of 2 cents a share, a third of what analysts forecast. Colin Clark, a Merrill Lynch & Co. (MER) analyst, is advising clients to sell the stock. Explains Venky Panchapagesan, assistant professor at the Olin School of Business at Washington University in St. Louis. "More investors are deciding they don't want intermediaries; they want to trade with each other electronically."

A Question of Timing

An IPO wouldn't spell the end of the specialists. "The specialist role must remain," says Caldwell, "as it makes sense to provide liquidity and an orderly market for the NYSE's customers, [but] they have to make a business case, which I think they can." Specialists may even benefit as electronic trading frees them for more hands-on trading of thinly traded stocks, says Merrill's Clark. And the Securities & Exchange Commission is forcing the issue anyway by proposing to modernize the national market system unless the NYSE acts. Says Seth Merrin, president of the Internet-based trading platform, Liquidnet Inc.: "The exchange would be asking [the specialists to give up some] business, and the only way you can hope to do that is by giving them a piece of the action."

None of this ferment has escaped the NYSE board or John A. Thain, the former Goldman Sachs Group Inc. (GS) president who took over as chief executive in January. In June, the board appointed William R. Power, a 30-year veteran of commodity trading who helped the Chicago Mercantile Exchange go public in 2002, to advise it about a Big Board IPO. For now, Thain is concentrating on his August proposal to the SEC to move NYSE trading to a hybrid model that would accommodate both open outcry and electronic markets. Still, Thain has said ownership is next on his agenda. Although he said at an Aug. 2 press conference that he doesn't have "a particular view as to what the correct ownership structure is," an eventual IPO is a strong option. Thain hopes to have a business plan in place within 6 to 12 months -- as a potential launch pad for going public. "Thain was instrumental in taking Goldman public," says 30-year NYSE member James Rutledge. "He has the background."

To get the best price in a public offering, the Big Board needs to beef up its earnings -- a modest $50 million last year on $1 billion of revenues. Other listed exchanges are typically valued at around 18 times their recent earnings. By that measure, the NYSE would be worth just $900 million. "Now is not the time" to go public, says Charlotte A. Chamberlain, an analyst with Jefferies & Co. "Earnings is what matters; the NYSE's net worth is a lot higher than that." In fact, by another measure -- three times book value -- the Big Board would be worth about $2.9 billion. Caldwell, the seat buyer, figures that the exchange should be valued at about $13 billion by calculating that it's worth at least 10 times the Toronto Stock Exchange. Adds Higgins, the dissident leader: "Google (GOOG) has a market cap of $7 billion. Would you rather own Google or the NYSE?"

Toronto and other exchanges have fared well by going public. ArcaEx, which acquired the equity trading business of San Francisco's Pacific Exchange last year, trades at $15 a share, up 30% since its IPO on Aug. 12. Toronto's 133 seats sold for about $137,000 apiece, valuing the exchange at less than $5 million before its November, 2002, offering, according to Washington University's Panchapagesan. Today, the exchange is worth $1.6 billion. And the Chicago Merc's current market cap is about $4.5 billion some 20 months after going public. If action like that comes to the NYSE some day, Caldwell won't regret having another seat at the table.

By Mara Der Hovanesian


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