NASD and NYSE merger: Multiplying Failures.

November 15, 2006

Oh, puhlease!

Here we go again.

Nearly 70 years ago, following the collapse of the US financial markets and the onset of the Depression, Congress scrambled to come up with a two-pronged response to Wall Street's predicament.

One, to implement a regulatory scheme that would restore investor confidence in the tarnished securities markets.

Two, to initiate a regulatory system that would promote public oversight (the Securities and Exchange Commission and state regulation) with industry-savvy expertise (self-regulatory organizations such as the NYSE and NASD).

For a time, the two-pronged approach worked.

Unfortunately, the regulators of the US markets just didn't quite seem to notice the advent of the nuclear age, the space age, and the Internet. Life at the regulators failed to adjust. The alarm clocks went off, but those in charge pressed "snooze" and simply stayed asleep. Which is where they remain.

Worse, in the case of the NASD/NASDAQ and NYSE, the regulators formed an unholy alliance with their respective markets, and it took the SEC and the Department of Justice to force the SROs to recognize their inherent conflicts and to separate from their former market centers. It's just not a pretty sight to see regulators dragged kicking and screaming into the realization that they weren't doing the jobs and needed to reform. And now the NYSE and NASD want to join forces.

Bad, old habits die hard. Frankly, too many of the reforms forced upon the NYSE and the NASD by the SEC and the Deparment of Justice have proven to be cosmetic. When the SEC censured the NASD about a decade ago, then SEC Chairman Levitt admonished the wayward regulator by asking:

Where was the NASD, the cop on the Nasdaq beat?

The NASD was not blind to these practices in the marketplace. It simply looked the other way.

Nor has the NYSE escaped censure for its own failures, as we have witnessed in more recent times. Not only did that venerable institution fall asleep amidst widespread misconduct on its own floor (right under its nose), but it is still enmeshed in the Grasso affair.

I think we expect too much out of laws written on paper. The US securites laws -- largely creatures of the 1930s -- are breaking down under the strains of an evolving market (both domestic and foreign). In a sense, they are remarkable for their longevity and flexibility. However, they are also showing signs of age and hardening of the arteries. I mean, gee, when was the last time I used that typewriter now gathering dust on the floor of my closet? The fact is that things and ideas can become obsolete. It's just tough to admit it -- perhaps because it's a sign that we're getting old and an indication that we need to get off our butts and do something new.

Sadly, the folks at the SEC, the NYSE, and the NASD just don't seem willing to wrestle with the complicated and pressing issues of the day. No, they seem more intent on firing staff lawyers who want to investigate major broker-dealers (and, omigod!! -- ask questions of CEOs of firms that advertise on television). They seem more intent on finding ways to bloat their salaries and expand their staffing, while at the same time refusing to admit that they just don't prevent fraud and the bad guys keep infesting our markets in an exponentially growing degree. Ultimately, it all stinks of too many bureaucrats trying to preserve their turf and justify their jobs and salaries. It is protectionism at its worst.

Bottom line. Present-day self-regulation is an abject failure. That's not a profound or even timely conclusion -- Eliot Spitzer issued that condemnation in September 2002. Look it up.

All of which explains why I read the various NASD, NYSE, and SEC speeches and missives about merging NYSE and NASD with more than a touch of cynicism. The folks who have perpetuated a failing system of regulation are now asking our indulgence -- give them a chance to join forces. What nonsense!

From what I'm reading about the proposed merger, the NYSE will apparently continue to regulate its "members" within the construct of the new self regulator. Great! Those of us who have complained for years about the inequities between the NYSE's gentler approach to regulating NYSE firms and the NASD's heavier hand on smaller firms, simply see this separate-but-equal merger as perpetuating an anticompetitive disparity.

Further, since NASD and NYSE haven't developed a credible anti-fraud agenda within the past decade --- we still see the same tired, old responses to the same historic scams --- why would putting together more of these folks promote better regulation? At some point, you simply throw in the towel and the baby goes out with the bathwater!

The solution to the problems of regulating Wall Street demands fresh, new minds and ideas. The old guard has been discredited but stubbornly retains power.

One solution is to simply enhance existing regulation at the state and federal level. Candidly, I'm not a big fan of that. Government bureaucrats are less flexible and creative than their SRO counterparts.

Still, you just don't pour new wine into old wineskins -- and that's all we're doing by merging the NASD with the NYSE and expecting something marvelous to ensue. No, the time for such passivity has passed. Our securities markets face growing competition from abroad --- both in terms of IPOs eschewing listings on US markets because of regulatory burdens, and in terms of the growing market share of foreign exchanges (and the concomittant decline in the dominance of ours). Indeed, it is a new world. And heavy-handed, overly expensive, multi-layered regulation will only stifle the ability of our markets and financial institutions to compete.

Alas, that is the nettlesome challenge. If we lower our standards, then our credibility suffers and we incubate more fraud. If we impose standards that hamstring our ability to compete on a level playing field with international competitiors, then we strangle ourselves with unrealistic good intentions and lose the battle to lesser lights.

Always, that is the dynamic that must be addressed. You have to find a balance between your aspirations and reality.

Hopefully, the industry and investing public will protest the apparent path that the SEC and the SROs seem prepared to embark upon. We need to create an entirely new system of private-sector regulation --- one that involves investors, public issuers, financial institutions, and registered persons. Wall Street cannot simply regulate itself. Wall Street's regulators cannot meet privately atop a mountain and then impose their new Ten Commandments of self-regulation.

The challenges of the 21st Century will not be met by merging two failed regulators.