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L'affaire de Grasso -- It was About Money, Not Compensation

An editorial by Wall Street & Technology Columnist Larry Tabb.

Now that virtually everyone has weighed in on the Grasso affair I figure it's my turn.

First let me say that while I have tremendous respect for Mr. Grasso, I have always been fearful of the man, and while having poked and prodded the NYSE a few times I have pretty much remained criticism-free. While I have never met him, Grasso has just seemed like a larger-than-life character and not the kind of a person that you wanted to cross. And while he has managed the NYSE, with not so much of an iron hand but let's say a fearsome reputation, he has kept most of his critics and detractors at bay, at least up to the past year.

That said, he had done an amazing job at running the exchange. During a time of increased market fragmentation, the development of a cadre of competitors (ECNs) and a host of new fangled ideas on ways to "better" match buyers and sellers the NYSE has not only held his ground but has developed new products, services and technologies to actually gain market share instead of losing it like many other national exchanges.

While I don't want to say that Mr. Grasso's compensation was excessive or egregious, for what price to you pay a man for leading an organization through tremendous change, overcoming adversity and increasing market share in a very competitive world? But I do believe that SEC Chairman Donaldson said it best when he said something like "I guess I left the job a little early."

In looking at this issue I don't want to dredge up the past, rehash the media, or look at the very serious conflict of interest issues that SEC Chairman Donaldson is championing and that plague the NYSE. What I would like to do is put a different spin on this story that has not been played. I would like to talk about another reason why this affair had gotten this wide degree of attention, why it wouldn't die, why traditional allies, members, as well as his historic detractors lined up against him, and while the conflict brought the unseating of Grasso, his departure will not be the end of this conflagration. In fact, Grasso's resignation will be the beginning of the decline of the NYSE as a centralized market.

Why didn't this affair go away? In short, it's self-interest, and not Grasso's but the market participant's. Look at the people and firms that will profit by Grasso's demise and you most likely saw the folks who threw the largest knives. While the numbers are hard to ignore, compensation is not at the bottom of this, fragmentation is.

Fragmentation, or the splitting up of a centralized market into smaller sub-markets or competing markets benefits liquidity providers: the dealers, hedge funds, and investors that can spot and take advantage of abnormalities, dislocations, and arbitrage opportunities in a decentralized / fragmented market. If there is a single place where all buyers and sellers meet, then there is no opportunity to buy below and sell above the market.

The NYSE is this centralized market where most U.S.- listed equities trade. In this market a "specialist" is the liquidity provider and dealers, while close to the action, have few arbitrage opportunities.

Over the past few years there has been tremendous pressure to open the centralized NYSE trading model to competition from ECNs. Challenges to the centralized model, phrased as ITS redesign/elimination (Intermarket Trading System -- which has inherent time lags that make it difficult for ECNs to trade listed stocks), or the repeal of the "pass-through" rule (making it difficult to trade listed stocks outside of NYSE) have been posed by outside entities, however they had stalled or routinely rebuffed by the exchange, of which Grasso was the leading factor.

With Grasso gone, the exchange will come under increasing pressure to transcend either into a regulatory body or a for-profit entity (or split into one of each) and it will be increasingly difficult to stave off attacks on both ITS and the trade-through rule. If ITS and / or the trade-through rule are decommissioned, I believe it will be more difficult to fight the push toward a fragmented market structure and ECN execution, making it more challenging for the NYSE to maintain a centralized market structure with its near monopoly on listed US equity trading.

Dealers call this competition, saying that the fragmented market with multiple market centers, high speed connectivity, and market participants slugging it out to obtain the best price is the way that markets work best. While this may be true, we should have made best execution and investor protection front and center in this debate, instead of using one man's, albeit tremendous, compensation package as a wedge to break open the liquidity of the largest and most prestigious exchange in the globe. Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio

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