John Reed, the interim head of the
New York Stock Exchange
, will talk with members of a special committee today about how to improve the governance of the institution. Reed and the committee might want to look no further than the exchange's own rule book.
The NYSE imposes few rules on how listed companies govern themselves. But despite all of the furor over former exchange chairman Dick Grasso's outsized pay package, the exchange still doesn't meet even these basic guidelines, much less the more stringent rules it has proposed for listed companies.
"Forget about listing on NYSE,
the NYSE couldn't list on the Singapore exchange," said Patrick McGurn, senior vice president and special counsel at proxy adviser Institutional Shareholder Services. "They are that backwards in terms of compliance and transparency issues."
Among the problems cited by governance experts or uncovered by
A lack of independent directors on the exchange's audit committee;
The presence of non-independent directors on the institution's nominating committee;
The presence of listed company executives on the exchange's compensation committee.
A minority of independent directors on the exchange's board.
"It's pretty clear they weren't following what they were preaching," said Harvard Business School professor Jay Lorsch.
The NYSE is currently reviewing its governance guidelines and has made some changes to address particular complaints, says exchange spokesman Ray Pellecchia. He declined to comment on why the NYSE does not meet the standards it sets for its listed companies, but pointed to a report the exchange issued in May.
In the report, the exchange argued that its board has a different purpose than those of public companies. The boards of public companies are charged with looking out for the interests of the companies' shareholders. In contrast, the report argued, the NYSE's board has to look out not only for the broker dealers who own the exchange but for the companies who are listed on it and the investors who buy stocks traded on it.
"The exchange's governance must reconcile the sometimes conflicting roles that the exchange plays, give voice to its order-providing and listing customers, afford representation to its constituent 'taxpayers,' and assure that market professionals and issuers steer the exchange clear of suboptimal regulation and listing standards without putting the 'fox in charge of the chicken coop,' " the NYSE said in the report.
The exchange can de-list companies that don't meet its governance guidelines. To date, though, the Big Board has faced no similar consequences for not meeting its own listing standards. That may be changing.
For many investors, Grasso's pay package indicated that the exchange wasn't doing a very good job reconciling its "conflicting roles," or of protecting the investing public, which it called its "ultimate constituency." In fact, how the world's largest financial market is governed has been the key topic of concern for many investors in the wake of revelations about its former chairman's $187.5 million pay package.
The subsequent outrage led to Grasso's resignation last month.
But scrutiny has turned from Grasso to the board of the NYSE, which approved his compensation. Noting that many directors appear to have conflicts of interest in serving on the board, some critics have called for individual directors or even the entire board to resign. Others have proposed a number of reforms, including increasing the representation of investors on the NYSE board and separating the NYSE's regulatory and exchange functions.
Despite the clamor for change, Reed has said that the NYSE will review its governance and the circumstances behind Grasso's compensation before it revises its board composition or governance guidelines. The results of that review, which is being conducted by the special committee, were originally supposed to be released on Thursday, but has been delayed.
Governance experts say the exchange might want to take a look at the governance standards it requires of its listed companies in looking for ways to improve its own operations.
The primary requirement the NYSE makes is that the boards of listed companies include an audit committee composed solely of "independent" directors. The NYSE considers directors of a listed company to be independent if they are not employees of the company, do not have a material business relationship with the company, do not have interlocking business relationships with the company's executives and are not family members of the company's executives.
Additionally, the Big Board also requires companies boards to have no more than three "classes" of directors. With one class up for election each year, the NYSE requires every board member to stand for election at least every three years.
The NYSE also has other guidelines on when company executives and directors can sell their stock and what kinds of shares can be traded on the exchange. But since the stock of the Big Board isn't publicly traded, these are not particularly applicable to the exchange itself.
But the NYSE has proposed additional guidelines for listed companies that are relevant to the Big Board. The reforms, which have yet to be approved by the Securities and Exchange Commission, would require the following of listed companies:
A compensation committee composed solely of independent directors;
A nominating or corporate governance committee comprised solely of independent directors;
A board of directors in which independent board members comprise a majority;
Regular meetings of non-management directors;
Written determinations of the board of directors that independent directors have no "material" relationships with the listed companies.
Additionally, the proposals would tighten up the exchange's definition of independence. For instance, former employees couldn't qualify as independent directors until they had been away from the company for five years. The NYSE only demands that they be away from the company for three years now. Likewise, a former auditor of the company would have to wait five years before being considered "independent" under the new rules.
Out of Compliance
Governance experts say even the NYSE's proposed rules aren't particularly strict. Still, the Big Board's compliance with both its current and proposed rules is either questionable or non-existent.
One particular area of concern is the Big Board's audit committee. The NYSE requires each listed company to have an audit committee composed entirely of independent members.
The NYSE board members who sit on the exchange's audit committee are Carol Bartz, who is the CEO of
, and Andrea Jung, the CEO of
. Additionally, the exchange has nominated Peter Larson, the former CEO of
, to serve as chairman of the committee.
Avon, as an NYSE-listed company, pays fees to the exchange, creating a business relationship. That relationship would seem to taint Jung's "independence" under the exchange's standards.
While Larson is no longer an employee of a listed company, he was until 2000, a recent enough time to call into question his nominal independence as well.
Rules proposed by the NYSE last year set more-stringent standards for listed companies. Among the new rules: independent directors must comprise a majority of their boards, and nominating and compensation committees must be composed solely of independent board members.
While those rules have not yet gone into effect, many listed companies have already begun to move toward compliance with them. The NYSE has not joined them.
In June, the exchange shook up the makeup of its compensation committee as details of Grasso's pay package began to emerge. Although the Big Board removed directors from the committee who represent the securities industry, the current committee members can't be described as "independent."
Of the four current members, two are executives of listed companies and one, Gerald Levin, was the CEO of a listed company until last year.
Meanwhile, NYSE guidelines reserve half of the spaces on its nominating committee for broker-dealers, who provide the exchange with the bulk of its revenue. Directors from the securities industry also are guaranteed 12 of the 27 current board positions, with three more reserved for executives at the exchange.
But even the non-industry dealers aren't truly independent, as many of them are executives of listed companies.
"The board isn't even close to being independent," said McGurn. "You'd be hard-pressed to find an independent member of the
Some governance experts think that the NYSE's non-compliance with its own guidelines is fairly damning of the exchange.
The guidelines are "pretty skimpy," said Beth Young, a senior researcher at The Corporate Library, which serves as a watchdog of public companies. "They're not at all what you would call best practices."
Instead of failing to comply with its own standards, the exchange should hold itself to a higher standard, some say.
But other governance experts say that additional rules may not necessarily solve the Big Board's problems.
Even if the NYSE complied with its own rules, that "doesn't mean investors can be reassured as to the quality of the board," said James Westphal, a professor of management at the University of Texas at Austin's McCombs School of Business.