Grasso, Spitzer and the NYSE

Eliot Spitzer's suit to recover Grasso's overcompensation by the NYSE is discussed by the WSJ's Holman Jenkins, Professor Bainbridge (with a link to the complaint and a WSJ summary) and Houston's Clear Thinkers (summarizing the Jenkins article).

There are a number of plausible, and in my view incomplete, ways to view this mess, prominently including a governance failure at the NYSE (where was the board, which approved Grasso's compensation?) and unbridled ambition by Spitzer.

The essence of the problem as I see, though, is government regulation of business, in this case of the securities industry. Given the incentives this regulation creates, everybody's behaving reasonably and expectedly:

--The NYSE has been protected from full-fledged competition by other exchanges and true self-regulatory organizations by the SEC's power to regulate exchanges and SRO's. Grasso's political skills enabled him to protect this fiefdom and the profits of the now-outmoded specialists who, in turn, kept him in power and rolling in dough.

--But NYSE governance has been reformed in the wake of l'affaire Grasso, in particular by addition of a "Board of Executives." Why is it now necessary for Spitzer to use his power to supervise non-profits? Answer, per Jenkins: Reed and the NYSE power structure want this sticky problem off their backs so they don't have to muck around with the powerful securities professionals and get into questions that could jeopardize the future of the NYSE.

--But if Spitzer is so ambitious and is being left a clear field, why doesn't he sue the managers who approved Grasso's compensation? Because, again per Jenkins, he gets securities industry political support if he handles this so only Grasso gets hurt. So Spitzer gets what he wants (publicity), the industry gets what it wants, and "everybody's" happy.

--Why doesn't the SEC, which has the power to supervise NYSE governance, get on the case? Indeed, is there a supremacy clause problem here? Well, if there is, chances are the SEC won't raise it, because the SEC also lives off industry support, much as it would like to appear to be the champion of the "ordinary investor."

The solution? Not, as Professor Bainbridge suggests, a simple NASDAQ-style restructuring, with a split of the trading and regulatory arms. The answer is, to put it bluntly, deregulation of the securities industry.