ProfessorBainbridge.com

Harvard Club's got higher standards than Harvard University

David Lat:

In April, we reported that Eliot Spitzer — former governor and attorney general of New York, until he resigned from office in the wake of a prostitution scandal — was applying for admission to the Harvard Club of New York. Spitzer graduated from Harvard Law School in 1984.

Well, the jury has reached a verdict for the ex-prosecutor — and the news for Spitzer is not good. His application was rejected earlier this year, according to an article by Sewell Chan and Nicholas Confessore of the New York Times.

So what did Spitzer, famously known as Client No. 9, have to say about his rejection?

Through a spokesperson, Lisa Linden, Spitzer described the decision as “disappointing.” Linden added: “Last year, Harvard asked Eliot to speak on ethics at the school. He supports the institution financially. It would seem that whoever made this decision at the club is not on the same page as the university itself.”

It's kind of appalling to learn that Harvard University lets Spitzer speak on ethics. It's almost as bad as letting Bill Lerach speak on legal ethics, as some law schools have done. Setting aside Spitzer's penchant for kinky and unsafe sex, his conduct as attorney general was fraught with borderline ethical conduct and, of course, there was Troopergate when he was governor. The guy is a slimeball and it's good to see somebody finally tell him to crawl back under the rock from whence he came.

Bruno on Spitzer

Republican New York Senate Majority Leader Joseph Bruno was the fellow who NY Governor Eliot Spitzer's administration spied. In the W$J, he writes:

New York Gov. Eliot Spitzer is now traveling the state trying to put a scandal behind him that risks enveloping his administration. It's going to be a hard task.

Here's what we know, thanks to some enterprising reporting by the New York Post and an investigation by New York Attorney General Andrew Cuomo: Two close advisers to the governor apparently used the New York State Police to carry out a political smear campaign against me by creating documents designed to generate negative press reports about me. And it nearly worked. ...

Mr. Spitzer is not shy about using threats and verbal abuse against those who oppose him. Wall Street Journal readers will remember that John Whitehead, formerly chairman of the World Trade Center Memorial Foundation, detailed on theses pages a bizarre and threatening phone call from then New York Attorney General Eliot Spitzer in 2005. The call came after Mr. Whitehead wrote an article for this newspaper critical of Mr. Spitzer. There have been profane and abusive phone calls to members of the Senate and Assembly. And, of course, the governor also admitted that he lied to Michael Goodwin of the Daily News about whether his father helped bankroll his campaign for attorney general in 1998.

In light of these incidents, New Yorkers are beginning to raise serious questions about the governor's temperament. And all of this helps place the "Troopergate" scandal in context. This most recent abuse of power represents an intentional effort to damage me politically and--by extension--to destroy the Republican majority in the state Senate.

Bruno's right, of course. Spitzer is a bad actor whose wings desperately need clipping. What's interesting, however, is the quietly bipartisan nature of the attacks on Spitzer. The Washington Examiner recently editorialized:

Deep sea fisherman often cut up smaller fish, throw the "chum" into the water, then catch bigger fish attracted by the free food. The result is often a feeding frenzy among sharks in the vicinity. New York Gov. Elliot Spitzer is now experiencing what it's like to be political chum, a reversal of fortune that his many victims must find fitting. The fisherman is Andrew Cuomo, Spitzer's successor as New York's attorney general. In a state long known for remorseless Machiavellians willing to do whatever is necessary to get to the top, Cuomo may be the only man with more intense ambitions than Spitzer.

The son of a previous New York governor, Cuomo recently made public his evidence that Spitzer used state employees to generate a false charge against state senate majority leader Joe Bruno, a Republican, with whom Spitzer was clashing. Cuomo clearly hopes to incite a feeding frenzy against Spitzer by those other well-known man-eaters, the Empire State's news media. Said frenzy would remove a huge obstacle blocking Cuomo's path to the governor's mansion.

It would also quash Spitzer's presidential ambitions, of course. Which would be a very good thing.

Eliot Spitzer is a Thug

The NYT repo rts:

Gov. Eliot Spitzer vowed on Wednesday to fight any State Senate inquiry into his administration?s internal operations, even as Republican senators were laying the groundwork for an investigation that could lead to subpoenas of top officials. ... The governor has maintained that he was misled by his staff and knew nothing about the effort to discredit Mr. Bruno. But two of his closest aides refused to be interviewed by the attorney general?s investigators, intensifying suspicion, especially among the governor?s critics, that Mr. Spitzer and his staff had not been forthright. ...

?The governor?s people refused, people at the highest level, they refused to sit and answer questions,? [Bruno] said. ?What did they do? They made a little statement. And these are the people who are the closest to the governor, who are governing the state.?

Can you imagine what Attorney General Spitzer would have done to a corporate CEO who told two of his executives to stonewall and who tried to fight off an investigation? Actually, we know exactly what Spitzer would have done:

Former Goldman Sachs Chairman John Whitehead said Thursday that New York Attorney General Eliot Spitzer threatened him during an April phone call for writing an open letter critical of Spitzer's attacks on prominent insurance executive Maurice "Hank" Greenberg. ...

"Mr. Whitehead, it's now a war between us and you've fired the first shot," Whitehead quoted Spitzer as saying. "I will be coming after you. You will pay the price. This is only the beginning and you will pay dearly for what you have done. You will wish you had never written that letter," Whitehead claimed Spitzer said.

Spitzer is a Nixon-like thug.

Spitzer

The W$J reports:

With the disclosure this week that close aides misused state police in an effort to damage a Republican rival, [NY Governor Eliot] Spitzer is facing the same kind of high-profile scrutiny that he was famous for inflicting upon others -- from Wall Street executives to radio conglomerates -- as New York's attorney general. In a role reversal, the aggressive Mr. Spitzer now is on the defensive and vowing to make amends. ...

While the report by [Democratic] Attorney General Andrew Cuomo found that no laws had been broken, it found that a close Spitzer aide schemed to create and give detailed reports to the media showing that Mr. Bruno had been using state aircraft to attend fund-raisers and other political events, rather than for state business as Mr. Bruno had certified. ...

The report found that the governor's communications director, Darren Dopp, and his top liaison to the state police pressured the state police to create, and in some instances re-create, records of Mr. Bruno's use of state aircraft and police escorts.

The report also suggested that the governor's staff gave a false story to investigators to explain why the information was being gathered, saying they were acting on a Freedom of Information Act request from a newspaper.

How can it possibly be the case that lying to investigators and pressuring police to falsify records broke no laws? Does NY have no equivalent of the federal provision in 18 USC 1001 that criminally penalizes, by up to five years in prison, any person who "knowingly and willfully— ... (2) makes any materially false, fictitious, or fraudulent statement or representation; or (3) makes or uses any false writing or document knowing the same to contain any materially false, fictitious, or fraudulent statement or entry." I'm no fan of 18 USC 1001, but it's just the sort of statute Spitzer would have loved back when he was NY Attorney General.

Spitzer's Ethics

Bill Hammond in the NY Daily News on NY AG and gubernatorial candidate Eliot Spitzer:

Eliot Spitzer is running for governor as the best guy to clean up Albany, including its corrupt "pay-to-play" system of shaking down interest groups for campaign donations and other goodies. So what the heck is he doing jetting around on the Gulfstream of a Wyoming businessman who wants to run race tracks and build casinos in New York?

It's one thing for Spitzer to pile up money and endorsements from insiders. Fish gotta swim, pols gotta grub for cash. But accepting deeply discounted air travel from a gambling mogul doing lots of business with state government - as Spitzer and an aide did in May - is too cozy for comfort. The would-be Sheriff of Albany should be keeping a safe distance from favor seekers, not putting himself in a position where he owes them anything.

You'll recall that this is the same guy about whom the W$J reported:

Three civil settlements he struck in an unusual case against wealthy telecom executives and IPOs have allowed him to bestow more than $5 million in largess over the past several months to dozens of community groups across New York state. The recipients are intended as a sort of proxy for individual investors who allegedly suffered from the actions of the defendants, who were accused of profiting from undisclosed awards of sought-after initial public offerings from investment bankers seeking their business. ... But the groups receiving the windfall also represent voter constituencies that could be key to Mr. Spitzer's widely expected Democratic run for governor in 2006.

Assessing Eliot

In November, Eliot Spitzer likely will be elected as New York's next governor. Whether that will be good news for New Yorkers is perhaps debatable, but it's great news for America's economy.

It would be unfair to call Washington Post journalist Brooke Masters' biography of New York's crusading attorney general, Spoiling for a Fight: The Rise of Eliot Spitzer, one-sided. Masters presents the arguments of Spitzer's many critics and does so reasonably fairly. So while Spoiling for a Fight isn't mere hagiography, at the end of the day Masters comes down on Spitzer's side of most controversies. She puts Spitzer into the crusading progressive hall of fame alongside such luminaries as Louis Brandeis, Thomas Dewey, Teddy Roosevelt, and Rudy Giuliani.

What's interesting about the other crusaders to whom masters favorably compares Spitzer, of course, is that they all used their crusades to advance their political careers. Before he was the hero of 9/11, Giuliani rode his mob and white collar prosecutions as a US Attorney in New York City to the Mayor's office. Brandeis' cause lawyering got him to the United States Supreme Court. Teddy Roosevelt's reputation as a reforming police commissioner helped get him to the White House, although San Juan Hill probably helped more (and Leon Czolgosz helped too), a pattern Giuliani apparently hopes to emulate. And, of course, Thomas Dewey got the chance to famously lose the presidency to Truman.

A fair reading of Eliot Spitzer's record as presented by Masters suggests that he is both a genuine cause crusader and a career political hack. Spitzer has consistently used -- and abused -- his authority as New York attorney general to level sweeping accusations against a wide swath of American business. In some cases, like the proverbial stopped clock, he got it right. In a lot of cases, however, the much ballyhooed charges got a lot of press attention but then quietly went away. Indeed, on the few occasions he's taken one of these high profile business cases to trial, he's lost at least as often as he's won. Instead, his record consists mainly of using media pressure to extort settlements from frightened executives.

Spitzer and the Mutual Fund Industry

Let's take just one set of Spitzer cases as our paradigm; namely, the mutual fund late trading "scandal."

Alliance Capital was one of the mutual funds caught up in the late trading/market timing scandal. In order to settle charges brought by NY attorney general Spitzer, Alliance offered to do something that had nothing to do with either late trading or market timing; namely, to cut the fees it charged investors. Alliance knew that was the fastest way to Spitzer's heart. As the Wall Street Journal reported:

"Fees, fees, fees -- that's the big money," Mr. Spitzer crowed to his top lawyers after hearing from Alliance. "When we have a company in this position, we shouldn't give up our leverage to negotiate about the issue that's the 800-pound gorilla."

The trouble was that Spitzer has no legal authority -- none, nada, zilch -- to regulate mutual fund fees. As former SEC Commissioner Ed Fleischman told the Journal:

He's showing an investing and voting public that he can be its champion and make companies shake in their boots ... But a prosecutor making policy can be dangerous if he becomes extortive.

It's as though you got busted for pot possession and the DA said you had to give up snowboarding. What business does the prosecutor have using his leverage that way? What right?

Even if he had regulatory authority over fees, moreover, Spitzer's attack on them would still be misplaced. The industry is highly competitive. Fees are fully disclosed and it's relatively easy for unhappy investors to switch from one fund to another. Put simply, there was no market failure to justify regulation of fees. Instead, Spitzer was engaged in populist paternalism.

Balkanizing the Economy

Masters correctly notes of the mutual fund and other cases that the controversy "over Spitzer and his imitators in many ways reflected the larger fight over competition between state and federal regulators." I would put the point more strongly: The controversy over Spitzer reflects the one of the fundamental reasons the Founders chose to replace the Articles of Confederation with our Constitution.

To be sure, Spitzer got away with a lot of his crusades because the SEC seemed to have fallen asleep at the switch, creating a regulatory vacuum he was only too pleased to fill. The whole point of having federal securities regulation, however, is to avoid balkanizing the capital markets by competing state regulations. Spitzer's litigation crusades reintroduced just such Balkanization, as the rules in New York either differed from those in other states or, worse yet, Spitzer tried to have New York set the rules for the whole country.

As I asked in my earlier TCS column, Spitzer Goes Over the Line, did not the Founding Fathers adopt a Constitution in large part to avoid the economic Balkanization threatened by the Articles of Confederation? And, as I explained in that column, one can be a competitive federalist and still think the SEC should have shut Spitzer down in order to protect the national capital markets.

Losing

Spitzer is a master of trying cases in the media. When forced to take cases to court, however, his record is mixed, at best. In 2005, for example, one of the few mutual fund cases to go to trial ended in a defeat. Former Bank of America broker Theodore Sihpol was acquitted on Thursday of 29 of 33 criminal charges brought by Spitzer alleging that Sihpol helped a hedge fund illegally trade mutual funds. The jury deadlocked on the other 4 charges.

In 2003, Spitzer's much ballyhooed lawsuit against the gun industry, which advanced the novel legal theory that otherwise legal guns are a public nuisance, was shot down by a 3-1 New York state appeals court decision. Master quotes Spitzer as sloughing off the loss with the quip "There are some cases you bring knowing the probability of success is not great." True, but as a matter of legal ethics, the claims made in litigation must be "warranted by existing law or by a nonfrivolous argument for the extension, modification, or reversal of existing law or the establishment of new law." In this case, Spitzer pushed the edge of that envelope, as suggested by the New York court's rebuke:

[T]he Legislative and Executive branches are better suited to address the societal problems concerning the already heavily regulated commercial activity at issue.

Doing It All for Political Gain?

The Economist magazine once called Spitzer "publicity hungry," a point Masters implicitly admits in writing that Spitzer's crusade against stock analysts had the "heady side benefit" of fawning media attention. Yet, there is a dark side to the story to which Masters gives inadequate attention. as the Wall Street Journal reported:

[T]o a host of Empire State charities and well-connected law-school deans, the crusading New York attorney general is acting a lot ... like Santa Claus.

Three civil settlements he struck in an unusual case against wealthy telecom executives and IPOs have allowed him to bestow more than $5 million in largess over the past several months to dozens of community groups across New York state. The recipients are intended as a sort of proxy for individual investors who allegedly suffered from the actions of the defendants, who were accused of profiting from undisclosed awards of sought-after initial public offerings from investment bankers seeking their business. ... But the groups receiving the windfall also represent voter constituencies that could be key to Mr. Spitzer's widely expected Democratic run for governor in 2006.

In sum, Spitzer appears to have used his prosecutorial powers for personal political gain.

We learn just a little of what makes Eliot Spitzer tick from Masters. What does clearly emerge, however, is the boundless nature of Spitzer's ambition. He is unlikely to settle for being governor of New York; instead, he clearly wants to follow the path to the White House blazed by former New York governor Theodore Roosevelt.

It's a fair bet that Spitzer's adversarial personality and penchant for conflict will serve him less well in executive office than it did as attorney general. It's also a fair bet that it will be a very long time before this country again elects a Northeastern liberal to the Presidency (see, e.g., Kerry and Dukakis). For those who have doubts about Spitzer, however, eternal vigilance would seem to be the order of the day.

Mandle on Conason on Spitzer

At CT, Joe Mandle praises Joe Conason's review of Brooke Master's new bio of NY AG Eliot Spitzer:

[Spitzer] exposed widespread corruption, cronyism and immorality at the commanding heights of the American economy, exploding the myth of the self-regulating market.

Piffle. His attack on the mutual fund industry was "a gross abuse of prosecutorial power." "Just a quick overview of Spitzer's tactics over the past couple of years exposes the widespread abuse of authority and the rule of law in pursuing his popular agenda." He has consistently exhibited "egomania and serial disregard for due process." All in all, Spitzer has an impressive record of losing the Wall Street cases he actually takes to trial, conflicts of interest, abusing his prosecutorial powers for personal political gain, pushing his nose into areas that belong to the feds, higher mutual fund fees, using "the criminal law as an in terrorem weapon to force acceptance of industry-wide regulations," using litigation to regulate in ways that neither the state nor federal legislature chose to do, ignoring misconduct by political allies, and abusing the bizzare Martin Act.

More on Spitzer

Dominic Basulto's fine TCS column is a must read; money quote:

Spitzer has attacked business practices that appear to skirt the boundary between black and white and, at the same time, attempted to build cases around rarely prosecuted activities. As the Wall Street Journal pointed out in a recent op-ed piece, though, "the criminalization of widely accepted business practices ex post facto is both unjust and offensive to the rule of law." In the case of Sihpol, it was the prosecution of illegal trading in mutual fund shares after the widely accepted 4pm trading deadline. For some time, it has been a dirty little secret that brokers routinely receive same-day pricing for trades that occur after 4pm, giving them an unfair advantage over rivals who play by the rules. For jurors in the case, this obviously posed a problem -- was Sihpol actually doing anything wrong if the securities laws at that time did not explicitly establish a 4pm trading deadline? Recognizing that jurors would not be able to render a guilty verdict, Spitzer was forced to give key witnesses in the trial immunity from prosecution -- a step that only served to increase doubts about Spitzer's case.

Spitzer Setback

When somebody finally stood up to NY attorney general Eliot Spitzer, refusing to give into his bullying, and forcing Spitzer to take him to trial, Spitzer lost:

Theodore Sihpol, a former Bank of America Corp. broker, was acquitted on Thursday of 29 of 33 criminal charges that he helped a hedge fund trade mutual funds illegally. The jury said it could not reach a verdict on the remaining four counts against Sihpol, leading Manhattan Supreme Court Justice James Yates to declare a mistrial on those charges. The trial marked the first time that New York Attorney General Eliot Spitzer's office has taken a case before a jury in his efforts to reform practices in the $8 trillion U.S. mutual fund industry. (Link)

"This jury of New Yorkers exposes Spitzer as a politician whose ambition has steamrolled too many hardworking men and women of our state," Stephen Minarik, New York State Republican chairman, said in a statement today. "Looks like the so called 'Sheriff of Wall Street' had a gun full of blanks." (Link)

It couldn't happen to a nicer guy. I still think the feds ought to shut Eliot down.

Update Larry Ribstein and Tom Kirkendall both have good posts on this development.

Spitzer. Sigh.

Well, we knew this was coming:

New York Attorney General Eliot Spitzer will announce Tuesday he will run for governor of the state in 2006, a spokeswoman said.

"He's announcing that he has decided to run for governor," Cindy Darrison said of the state's top prosecutor who has taken on Wall Street for fraudulent stock research, and mutual funds for overcharging customers.

Darrison said Spitzer, a Democrat long expected to enter the governor's race, would issue a statement on his Web site, www.spitzer2006.com, sometime after 11 a.m. ET but would not hold a news conference. (Source: CNN Money)

Longtime readers know I'm no fan of Eliot Spitzer. I shan't rehash the arguments here, but if you want more check out my TCS columns Spitzer v. Grasso and Spitzer Goes over the Line. If you really want to be inundated with anti-Spitzer editorializing, check out my archive of blog posts on NY's crusading AG.

Tigerhawk Blasts Spitzer

Tigerhawk dug up a letter to the editor that raises some pretty troubling questions about NY AG Eliot Spitzer:

Mr. Spitzer has turned this industry on its head. There have been no court hearings, no testimony in front of appropriate agencies, yet market values of public brokers have plummeted, and thousands will likely lose their jobs. All due to the "appearance of impropriety."

Speaking of "appearances," how about Mr. Spitzer's tennis pal, campaign contributor and former boss securing a 19% sweeter, all-cash deal for his company from Marsh & McLennan Cos. Inc., after Mr. Spitzer hit Marsh with a tsunami of subpoenas. Then, Mr. Spitzer's tennis buddy ends up as CEO after Mr. Spitzer says he "can't deal" with the current Marsh CEO. Later, Mr. Spitzer says it's OK for his tennis pal, now Marsh's CEO, to pay any potential fines from their contingent commissions, which Mr. Spitzer earlier alleged were ill gotten. Isn't this like the DA indicting someone for burglary and saying they can use the proceeds to cover any fines? Yeah, "appearances" do matter, Eliot, and this does not look good. (Link)

Ponnuru on Spitzer

In the cover article of the latest National Review (apparently unavailable online), Ramesh Ponnuru calls NY Attorney General Eliot Spitzer "the most destructive politician in America." Wow! Regular readers know that Spitzer-bashing is a regular feature of this blog. Yet, Ponnuru takes it to a new level with a careful and thoughtful analysis of Spitzer's impact in a host of areas ranging from finance to guns and beyond. In addition, Ponnuru takes on a very important issue: how can conservatives balance their commitment to federalism and their antipathy towards Spitzer's activism (a topic I took on in Can you be a Competitive Federalist and still want Spitzer to shut the #@!% up?). It's a great analysis - by itself, it justifies going out and buying a copy of National Review.

Spitzer v. Grasso

My latest TCS Daily Column

In light of the filing of New York Attorney General Eliot Spitzer's long-awaited suit against former New York Stock Exchange CEO Richard Grasso, two thoughts come to mind:

(1) The government has no business setting executive compensation. Granted, Spitzer has authority to bring compensation suits against New York not-for-profits like the NYSE. Even so, it is bad policy for the government -- more precisely, an elected official with aspirations to higher office -- to be deciding how much money a corporate executive should be paid.

How much you get paid depends in large part on the thickness of the market for your services. In a thick market, wages tend to be low because there are many potential employees -- all more or less fungible -- competing for jobs. In a thin market, however, wages tend to be high because many employers are competing to hire a small number of eligible workers. The market for burger flippers is very thick. The market for law professors is relatively thick, to my considerable regret. The market for CEOs of Fortune 500 companies (which is what the NYSE essentially is) is thin. I'd guess the number of people who have what it takes to run a Fortune 500 company isn't much larger than the number of people who can run an NBA fast break. So even though much executive pay seems excessive, it's just supply and demand. Eliot Spitzer is unlikely to do a better job than competitive markets.

(2) Yet, Grasso and the NYSE are a special case. According to the WSJ ($), Spitzer alleges that Grasso abused his position as Wall Street's top regulator:

"The 54-page filing paints Mr. Grasso as an iron-fisted ruler, intimidating Wall Street titans that he regulated and manipulating the pay process to enrich himself. It portrays the board and its compensation committee as dysfunctional and its governance structure as conflict-ridden before it was overhauled in the aftermath of Mr. Grasso's ouster last September to strip its chief executive of regulatory authority. ...

"The complaint accuses Mr. Grasso, as the NYSE's chief regulator, of leaving some board members with the impression that if they opposed his pay packages, it would be at their peril. One unnamed board member from Wall Street told investigators that Mr. Grasso 'confronted' him after he expressed concern about his proposed 2000 pay to a staffer, the suit says. The member voted in favor of that year's package and later recalled thinking, 'Thank God I escaped that one. This man was also our regulator [so] you have to be careful,' the suit says.

"It also alleges that Mr. Grasso took actions that benefited firms run by executives determining his compensation, at one point calling the National Association of Securities Dealers on behalf of Mr. Langone [a NYSE board member] as the regulatory organization was investigating his boutique investment bank, Invemed. The NASD eventually sued the bank for improperly sharing profits with favored clients but not Mr. Langone. A NASD spokeswoman said Mr. Grasso's call took place "after the complaint was finalized."

Although Grasso was nominally subject to evaluation by the NYSE board, that board was comprised in large part of ceremonial "public" directors who did not take the job as seriously as they should have and representatives of Wall Street firms who had various conflicts of interest.

The solution, however, is not to make Eliot Spitzer the czar of executive compensation. After all, the problem at the NYSE is a creature of government regulation. The NYSE is a government-created hybrid. On the one hand, it is a private corporation that creates a securities market for the benefit of the specialist brokers who own it; on the other hand, the NYSE is a quasi-public regulator with the primary responsibility for ensuring that its various stakeholders comply with SEC and exchange rules.

This duality has long insulated the NYSE from outside accountability. Its quasi-government status insulates it from discipline by markets and investors. The NYSE is part of a trading market oligopoly with very high barriers to entry, moreover, most of which are attributable to SEC rules. (The SEC, for example, long let the NYSE get away with listing standards making it almost impossible for a firm to de-list.)

Part of the solution is privatization. The NASD and NASDAQ went their separate ways after repeated problems with the SEC over inadequate supervision of its member broker-dealers. It is time for the NYSE to follow their lead.

Privatization, however, is not a complete solution. As the NYSE is organized today, there is an obvious conflict of interest given that the Exchange is owned by the very people who it needs to investigate when there are concerns about trading ahead or front running. In some respects, that conflict of interest would be lessened if the Exchange were owned by public shareholders rather than the specialists. Yet, public ownership might just introduce a different set of conflicts. What if maximizing shareholder returns required the Exchange to overlook misconduct by specialists or others with floor trading privileges, for example?

The answer, it seems to me, is to follow the NASDAQ model. The NYSE's roles as a regulator and a market should be separated. The regulatory functions could be assumed by the SEC, a new SRO, or maybe even the NASD (or some combination thereof). The market then could be spun off through an IPO.

Privatization and reallocation of the exchange's regulatory function have been resisted by virtually all the relevant players. Yet, it is the only solution that addresses both the current governance problems and the longstanding conflicts that are inherent in the Exchange's dual roles.

Spitzer v. Grasso

In light of the filing of New York Attorney General Eliot Spitzer's long-awaited suit against former New York Stock Exchange CEO Richard Grasso, two thoughts come to mind:

(1) The government has no business setting executive compensation. Granted, Spitzer has authority to bring compensation suits against New York not-for-profits like the NYSE. Even so, it is bad policy for the government -- more precisely, an elected official with aspirations to higher office -- to be deciding how much money a corporate executive should be paid.

How much you get paid depends in large part on the thickness of the market for your services. In a thick market, wages tend to be low because there are many potential employees -- all more or less fungible -- competing for jobs. In a thin market, however, wages tend to be high because many employers are competing to hire a small number of eligible workers. The market for burger flippers is very thick. The market for law professors is relatively thick, to my considerable regret. The market for CEOs of Fortune 500 companies (which is what the NYSE essentially is) is thin. I'd guess the number of people who have what it takes to run a Fortune 500 company isn't much larger than the number of people who can run an NBA fast break. So even though much executive pay seems excessive, it's just supply and demand. Eliot Spitzer is unlikely to do a better job than competitive markets.

(2) Yet, Grasso and the NYSE are a special case. According to the WSJ ($), Spitzer alleges that Grasso abused his position as Wall Street's top regulator:

"The 54-page filing paints Mr. Grasso as an iron-fisted ruler, intimidating Wall Street titans that he regulated and manipulating the pay process to enrich himself. It portrays the board and its compensation committee as dysfunctional and its governance structure as conflict-ridden before it was overhauled in the aftermath of Mr. Grasso's ouster last September to strip its chief executive of regulatory authority. ...

"The complaint accuses Mr. Grasso, as the NYSE's chief regulator, of leaving some board members with the impression that if they opposed his pay packages, it would be at their peril. One unnamed board member from Wall Street told investigators that Mr. Grasso 'confronted' him after he expressed concern about his proposed 2000 pay to a staffer, the suit says. The member voted in favor of that year's package and later recalled thinking, 'Thank God I escaped that one. This man was also our regulator [so] you have to be careful,' the suit says.

"It also alleges that Mr. Grasso took actions that benefited firms run by executives determining his compensation, at one point calling the National Association of Securities Dealers on behalf of Mr. Langone [a NYSE board member] as the regulatory organization was investigating his boutique investment bank, Invemed. The NASD eventually sued the bank for improperly sharing profits with favored clients but not Mr. Langone. A NASD spokeswoman said Mr. Grasso's call took place "after the complaint was finalized."

Although Grasso was nominally subject to evaluation by the NYSE board, that board was comprised in large part of ceremonial "public" directors who did not take the job as seriously as they should have and representatives of Wall Street firms who had various conflicts of interest.

The solution, however, is not to make Eliot Spitzer the czar of executive compensation. After all, the problem at the NYSE is a creature of government regulation. The NYSE is a government-created hybrid. On the one hand, it is a private corporation that creates a securities market for the benefit of the specialist brokers who own it; on the other hand, the NYSE is a quasi-public regulator with the primary responsibility for ensuring that its various stakeholders comply with SEC and exchange rules.

This duality has long insulated the NYSE from outside accountability. Its quasi-government status insulates it from discipline by markets and investors. The NYSE is part of a trading market oligopoly with very high barriers to entry, moreover, most of which are attributable to SEC rules. (The SEC, for example, long let the NYSE get away with listing standards making it almost impossible for a firm to de-list.)

Part of the solution is privatization. The NASD and NASDAQ went their separate ways after repeated problems with the SEC over inadequate supervision of its member broker-dealers. It is time for the NYSE to follow their lead.

Privatization, however, is not a complete solution. As the NYSE is organized today, there is an obvious conflict of interest given that the Exchange is owned by the very people who it needs to investigate when there are concerns about trading ahead or front running. In some respects, that conflict of interest would be lessened if the Exchange were owned by public shareholders rather than the specialists. Yet, public ownership might just introduce a different set of conflicts. What if maximizing shareholder returns required the Exchange to overlook misconduct by specialists or others with floor trading privileges, for example?

The answer, it seems to me, is to follow the NASDAQ model. The NYSE's roles as a regulator and a market should be separated. The regulatory functions could be assumed by the SEC, a new SRO, or maybe even the NASD (or some combination thereof). The market then could be spun off through an IPO.

Privatization and reallocation of the exchange's regulatory function have been resisted by virtually all the relevant players. Yet, it is the only solution that addresses both the current governance problems and the longstanding conflicts that are inherent in the Exchange's dual roles.

Spitzer v. Grasso and the Future of the NYSE

In light of the filing of NY AG Eliot Spitzer's long-awaited suit against former NYSE CEO Richard Grasso, it is time to revisit two dominant themes of this blog: (1) The government has no business setting executive compensation. Granted, Spitzer has authority to bring such suits. Even so, it is bad policy for the government - more precisely, an elected official with aspirations to higher office - to be deciding how much money a corporate executive should be paid. How much you get paid depends in large part on the thickness of the market for your services. In a thick market, wages tend to be low because there are many potential employees – all more or less fungible – competing for jobs. In a thin market, however, wages tend to be high because many employers are competing to hire a small number of eligible workers. The market for burger flippers is very thick. The market for law professors is relatively thick, to my considerable regret. The market for CEOs of Fortune 500 companies (which is what the NYSE essentially is) is thin. I’d guess the number of people who have what it takes to run a Fortune 500 company isn’t much larger than the number of people who can run a NBA fast break. So even though much executive pay seems excessive, its just supply and demand.

(2) Yet, Grasso and the NYSE are a special case. According to the WSJ ($), Spitzer alleges that Grasso abused his position as Wall Street's top regulator:

The 54-page filing paints Mr. Grasso as an iron-fisted ruler, intimidating Wall Street titans that he regulated and manipulating the pay process to enrich himself. It portrays the board and its compensation committee as dysfunctional and its governance structure as conflict-ridden before it was overhauled in the aftermath of Mr. Grasso's ouster last September to strip its chief executive of regulatory authority. ...

The complaint accuses Mr. Grasso, as the NYSE's chief regulator, of leaving some board members with the impression that if they opposed his pay packages, it would be at their peril. One unnamed board member from Wall Street told investigators that Mr. Grasso "confronted" him after he expressed concern about his proposed 2000 pay to a staffer, the suit says. The member voted in favor of that year's package and later recalled thinking, "Thank God I escaped that one. This man was also our regulator [so] you have to be careful," the suit says.

It also alleges that Mr. Grasso took actions that benefited firms run by executives determining his compensation, at one point calling the National Association of Securities Dealers on behalf of Mr. Langone [a NYSE board member] as the regulatory organization was investigating his boutique investment bank, Invemed. The NASD eventually sued the bank for improperly sharing profits with favored clients but not Mr. Langone. A NASD spokeswoman said Mr. Grasso's call took place "after the complaint was finalized."

Although Grasso was nominally subject to evaluation by the NYSE board, that board was comprised in large part of ceremonial “public” directors who did not take the job as seriously as they should have and representatives of Wall Street firms who had various conflicts of interest.

The solution, however, is not to make Eliot Spitzer the czar of executive compensation. After all, the problem at the NYSE is a creature of government regulation. The NYSE is a government-created hybrid. On the one hand, it is a private corporation that creates a securities market for the benefit of the specialist brokers who own it; on the other hand, the NYSE is a quasi-public regulator with the primary responsibility for ensuring that its various stakeholders comply with SEC and exchange rules.

This duality has long insulated the NYSE from outside accountability. Its quasi-government status insulates it from discipline by markets and investors. The NYSE is part of a trading market oligopoly with very high barriers to entry, moreover, most of which are attributable to SEC rules. (The SEC, for example, long let the NYSE get away with listing standards making it almost impossible for a firm to de-list.)

Part of the solution is privatization. The NASD and NASDAQ went their separate ways after repeated problems with the SEC over inadequate supervision of its member broker-dealers. It is time for the NYSE to follow their lead.

Privatization, however, is not a complete solution. As the NYSE is organized today, there is an obvious conflict of interest given that the Exchange is owned by the very people who it needs to investigate when there are concerns about trading ahead or front running. In some respects, that conflict of interest would be lessened if the Exchange were owned by public shareholders rather than the specialists. Yet, public ownership might just introduce a different set of conflicts. What if maximizing shareholder returns required the Exchange to overlook misconduct by specialists or others with floor trading privileges, for example?

The answer, it seems to me, is to follow the NASDAQ model. The NYSE’s roles as a regulator and a market should be separated. The regulatory functions could be assumed by the SEC, a new SRO, or maybe even the NASD (or some combination thereof). The market then could be spun off through an IPO.

Privatization and reallocation of the exchange's regulatory function have been resisted by virtually all the relevant players. Yet, it is the only solution that addresses both the current governance problems and the longstanding conflicts that are inherent in the Exchange’s dual roles.