Editor's note: Got a question you'd like to ask about sectors, companies and issues affecting the markets? Email us at twocents@thestreet.com, and one of our reporters will track down an expert. In today's "Ask the Expert," securities industry reporter Matthew Goldstein explains what regulatory role the NYSE actually plays and examines whether it could lead to conflicts of interest.

Now that Richard Grasso is out at the

New York Stock Exchange

because of the controversy over his eye-popping $139.5 million pay package, the next issue of debate may well be the Big Board's ability to police its members and itself.

The NYSE's role as regulator is fairly simple: watch out for unusual trading activity in the 2,700 listed stocks on the Big Board, make sure NYSE firms play by the rules and, most important, bring disciplinary actions against market wrongdoers.

The biggest category of enforcement action the exchange takes involves allegations of sales-practice violations on the part of member firms. Other areas include insider trading, the conduct of floor brokers and allegations of stock manipulation. (A comprehensive discussion of the enforcement role can be

found here.)

But Grasso's big payday raised serious questions about his ability -- or anyone else's -- to serve in the dual role of stock market cheerleader and regulator. His most vocal critics had contended it's impossible for the NYSE's chairman and CEO to wear a regulator's cap, especially when the people he is supposed to regulate are the ones paying his huge salary.

Buying In

In the eyes of his critics, Grasso's megacompensation package was nothing more than an opportunity for Wall Street's heavy rollers -- many of whom sit on the NYSE's 27-member board -- to curry favor with a top regulator who technically is an employee of the Big Board's 336 member firms.

Jeffery Liddle, a New York securities lawyer who often represents Wall Street employees in regulatory hearings before the NYSE, said the news of Grasso's pay package can't help but leave people wondering "what the people on the NYSE board got" in return.

To be fair, there's no evidence that Grasso's compensation package was a reward for soft-pedaling his duties as regulator. In fact, enforcement actions brought by NYSE prosecutors against Wall Street firms and brokers has steadily risen over the past five years, with 225 cases being filed last year, from 150 in 1998.

But the truth is that the NYSE has never been a trailblazer in prosecuting Wall Street's sins before or since Grasso took the Big Board's top job in 1995. That's true even though the NYSE's enforcement division accounts for roughly a quarter of its 1,500 employees and is one of the Big Board's primary responsibilities.

Good Cop, Bad Cop

It was New York Attorney General Eliot Spitzer who began the sweeping investigation into conflicts of interest between investment bankers and analysts. The

Securities and Exchange Commission

historically has taken the lead in investigating brokerage stock scams. It was federal prosecutors who pursued allegations of illegal trading activity by some of the NYSE's floor brokers -- the middlemen who help match buyers with sellers.

The NYSE's disciplinary actions have tended to be far less sweeping and more limited in nature. The majority of the cases it brings are against individuals rather than its member firms. Last year, for instance, the NYSE brought 236 enforcement cases, of which only 32 were against member firms.

"There are some who say the

NYSE suffers from a degree of industry capture," said Jill Fisch, a securities law professor at Fordham University School of Law. "Its actions tend to be less visible and don't give rise to the same level of market discipline or visible standards."

Indeed, even the NYSE's top prosecutor, David Doherty, is a lot less visible than his peers at the SEC or at the NASD, which serves the self-policing arm for both the

Nasdaq Stock Market

and the broader securities industry. On Wall Street, Stephen Cutler, the SEC's chief of enforcement, and Mary Schapiro, the NASD's president of regulatory affairs, are far better known figures than Doherty.

Of course, it wasn't always that way. At one time, the regulators at the NYSE were the only game in town. In fact, the NYSE has had a self-regulating enforcement division since 1817, roughly 117 years before the SEC came into existence.

Anarchy

One reason Congress created the SEC in 1934 was the poor job the securities industry had done in regulating itself in the years leading up to the stock market crash of 1929. Still, Congress let the NYSE continue operating as a self-regulatory institution.

But now some think it might make sense for the NYSE's regulatory power to be limited to things it does best: keeping tabs on the markets for irregular trading and making sure its member firms are complying with industry standards. A beefed-up SEC, coupled with state securities commissioners and attorneys general, could easily do the job the NYSE does when it comes to enforcement.

Another option would be for the NYSE to follow the lead of the Nasdaq and the NASD, which has taken steps to erect a solid wall separating the market from its regulators. Indeed, part of the idea behind a much-discussed Nasdaq initial public offering is to raise enough money for the NASD to operate as a completely separate entity.

Right now, the NYSE, under pressure from the SEC, is in the process of reforming its corporate governance structures. Some of the ideas under consideration include restructuring the 27-member NYSE board to include more independent directors, reducing Grasso's role in nominating new directors, and possibly splitting the job of chairman and chief executive. Grasso currently holds both posts.

But the NYSE doesn't appear to be giving any serious consideration to getting out of the regulatory business, something critics contend is the only way for Grasso -- or whoever else heads the Big Board -- to avoid the appearance of a conflict of interest.