Market Mover

by Robert Greifeld

  In retrospect, the proposed changes in Reg NMS seem obvious, essential, and even inevitable. But at the time, getting it passed by the Commissioners at the SEC was a nerve-racking process. NYSE had significant influence in Washington and a powerful brand. For many, the floor of NYSE represented the center of American capitalism. It’s an international tourist attraction; it looks great on TV. I remember the first time I visited—the crowded floor, the commotion, the colorful jackets of the traders, the incredible energy of the place, the sense that you had entered the living heart of financial markets. We were proposing changes that would potentially undo or alter it significantly. That gave people pause, and, understandably, it sometimes overshadowed the merits of our arguments. NYSE was able to translate its rich history into significant mind share as well as market share. Its name commanded immediate attention in Washington. We certainly developed a healthy respect for our rival’s political clout, if not its business acumen.

  Over time, I came to better understand the incentives that dominate the mind-sets of policy makers. With help from my team, we put in the time and effort to persuade them of our point of view, and in the process we developed good relationships with key political leaders. And yes, we hosted our share of campaign fund-raisers. It’s an unavoidable truth that political contributions are part of what gets you access in Washington. But it’s naïve to think the biggest check was some kind of skeleton key to unlock political favor. The merits of the argument still dominate the decision—at least that was my experience in the decade and a half I spent wrangling with the various Commissioners, Congress members, Cabinet members, and other curious creatures that constitute our nation’s political class. There is a certain rough pragmatism that operates in Washington, and that’s a good thing.

  Imperfect Progress

  In the end, Reg NMS struck down the trade through rule in nonelectronic markets. It basically said that if a posted quote for a security was not electronically accessible, you could trade through it. That changed everything. The father no longer had to cross the busy highway to buy his daughter a slightly less expensive but relatively inaccessible drink. NYSE was betting that even with the change of regulations, their exchange had so much liquidity that people would still trade on the floor. That proved to be wrong.

  In 2005, after Reg NMS was passed (but not yet implemented), I testified again before the Senate Banking Committee and commended them for the rule changes. I told them that I believed that Reg NMS would remove a substantial obstacle to competition among our nation’s equity markets and establish incentives for floor-based markets to move toward electronic trading. What I also believed but did not say was that those incentives were about to hit the NYSE floor like a ton of bricks. Following the adoption of the rule, their market share of trading volume in their own listed stocks fell precipitously—from 80 percent to 20 percent. Quickly, they were forced to get up to speed on electronic trading. They’d already made moves in that direction, buying an ECN in 2005, but their ambivalence was costly. In a post–Reg NMS world, they have never recovered their former dominance.

  Nasdaq was a beneficiary of this regulatory shift. In 2007, we became the largest exchange by trading volume in the country. Our competitive advantage had increased significantly. Stop being satisfied with No. 2. We had finally succeeded in tilting the rules back toward parity. We could now compete with NYSE and other exchanges on a more even playing field—and we were good competitors. For the first time since the rise of ECNs, manual markets were no longer the weak link in the national market system, slowing down trading, while specialists on the floor, with their distinct time-and-place advantage, attempted to execute and match orders that computers could handle more efficiently.

  As Reg NMS was implemented, the once-bustling NYSE floor, where generations of traders had plied their skills for over a century, grew quiet. A new generation of trading—defined by speed, computation, and automation—had finally infiltrated the core of Wall Street’s empire. The machines had come for the specialists. For some, this was a cause for consternation. For me, it was natural evolution of a market in transition. My intention, in the process, was to make that transition something that benefited investors, increased the healthy functioning of markets, and reduced costs for all involved. I would argue that for all the bumps and bruises along the way, electronic trading has delivered on all of that and more.

  I think it may be some natural law that every major new regulation spawns unforeseen avenues of market evolution. Every new set of rules has unintended consequences, both good and bad: possibilities for legitimate gain, but also for exploitation and even abuse. Closing one loophole may open another. The SOES bandits in the late eighties and early nineties took advantage of the Black Monday rule changes. The ECN explosion in the early 2000s was empowered by a 1997 regulatory overhaul known as Reg ATS. Progress is never a straight line, but the trend line does matter. Has the world of stock market exchanges and trading—even with its problems, breakdowns, and scandals—become more equitable, more transparent, less expensive, more accessible, over the last decades? I think the answer to that question is an unequivocal yes.

  Reg NMS was no exception to this principle of imperfect progress. In fact, I had predicted some of the troubling issues with the new framework before it was passed, centered on the fact that the trade through rule still applied to the entire electronic marketplace.* I would have preferred to see it removed altogether—for reasons that would be borne out in the following years.

  In practice, Reg NMS allowed for a proliferation of exchanges and a fragmentation of the market, creating a much more complex landscape. While the intensive discussion, testimony, and research that led to the SEC rule changes involved economists, traders, brokers, institutions, bankers, academics, exchange experts, and many others, there was one significant group missing from the deliberations—engineers and the people responsible for day-to-day operations. Reg NMS was the first set of regulations that was developed and implemented in a largely computerized trading ecosystem, so this was a regrettable omission. Hence, the actual consequences of Reg NMS implementation on the structure of the day-to-day trading market were insufficiently considered. Not enough thought was given to the downsides of this new structure, how it could go wrong, how resilient it would be under adverse conditions, and how it would evolve. We developed a great engine and a finely tuned transmission, but didn’t think carefully enough about the need for emergency brakes.

  This would come back to haunt all of us in a rather dramatic fashion during the Flash Crash of 2010, when more than $1 trillion of market value was lost and regained in a very short period of time. The exact causes of the Flash Crash are still debated, but it was clear that the new, more fragmented structure of the equity market was deeply implicated. The increased connectivity and proliferation of exchanges may have had many benefits, but they also resulted in new fragilities. Negative feedback loops, driven by computerized trading, presented poorly understood dangers, like those that spun out of control on that day. In the aftermath of that brief but frightening crash, the equity-trading world, in coordination with the SEC, woke up and got very serious about instituting safeguards that were needed in this new trading environment. We developed circuit breakers and new security features. We established limit-up and limit-down mechanisms for individual stocks, instituting a pause in trading in the case of sharp rises or declines. We introduced safeguards in the connections between exchanges, inoculating the overall market against the temporary failure of any particular institution or trading pool. Today, equity markets are much improved as a result of these changes, but the original lesson is still relevant—always consider the downsides and include those who can best anticipate adverse scenarios.

  In the end, no market structure is without weaknesses and trade-offs, and no regulation is a cure-all. Reg NMS was a step along the way—a positive step. Nasdaq was pleased with the outcome. In fact, I think just about every exchange not named NYSE was happy with the new rul
es. When a business doesn’t adapt to changing times, it will get left behind. But when regulations don’t adapt, whole industries can languish. Reg NMS allowed equities trading to change for the better—and no doubt there is more change to come. Today, a new generation of regulators is examining the markets, and efforts to reform Reg NMS have been ongoing for the last few years. As I often say, the right answer today is not the right answer tomorrow. The last vestiges of the old Nasdaq were falling away. In the hallways and conference rooms of One Liberty Plaza, we were already thinking more about Nasdaq’s future than its past. And we’d created a regulatory pathway to pull the industry into that future with us.

  LEADERSHIP LESSONS

  • Don’t Feel Like You’re Above Politics—None of Us Are. Learn to work with it and use it to increase your competitive advantage.

  • Lobbying Is Education. It’s an opportunity to get important perspectives on the table so legislators and regulators can actually make informed decisions.

  • Politics Has Its Own Schedule. Don’t pin all your hopes for success on swift changes in law or regulation.

  • Know Your Stakeholders. Sometimes a business has unconventional stakeholders that are critical to achieve success—politicos, regulators, VCs, community leaders, investors, etc. Build those relationships early and often.

  Chapter Seven

  The Global Imperative

  Nasdaq Lands OMX for $3.7 Billion

  Wall Street Journal, May 26, 2007

  One morning in early 2004, I walked into Chris Concannon’s office. “I have a crazy idea I want to run by you.”

  My EVP of Transaction Services looked at me with a mixture of wariness and curiosity. “What did you have in mind?”

  “I want to buy the New York Stock Exchange.”

  Chris and I had been working together for almost a year and I imagine he was already starting to realize that when it came to the business of Nasdaq, I was determined that we would play second fiddle to no one. Nasdaq was fast becoming a different type of organization, and I was thinking about how we might begin to grow the business through acquisitions.

  NYSE, on the other hand, was reeling. This was well before Reg NMS had passed, but a CEO compensation scandal had just rocked our competitor and their reputation was at a low ebb. John Thain had recently been hired from Goldman Sachs as the new CEO, with a mandate to clean up NYSE’s reputational damage and restore some sense of positive momentum to the old-world exchange. I thought NYSE’s days were numbered, at least in its current form. Sooner or later, I knew that the ruthless efficiencies of capitalism were going to transform the place—whatever its remarkable history. Also, as the financial world became more global, I imagined that there was likely to be consolidation among the various exchanges in developed economies. I intended for Nasdaq to be at the crest of that wave, not get caught behind it. In other words, it seemed a good moment to pounce.

  Even at the time, we knew it was going to be a long shot. First of all, NYSE would have had to agree, and that was unlikely. There is a certain hubris that is almost infused into the grand architecture of the Corinthian-column-lined building on Broad Street and that seeps into many of the individuals who work there. Of course, in some respects it’s a vestigial pride—at that time, NYSE had been the biggest stock exchange in the country for about two centuries, the Goliath of global markets, overseeing capital formation in the most successful economy in world history. By this time, however, we were actually making more money than they were. Nevertheless, they tended to see us as an upstart irritant, always trying to punch above its weight—an attitude that didn’t exactly invite talk of mergers. Moreover, our federal antitrust regulators might have had a thing or two to say about the national listings duopoly of Nasdaq and NYSE becoming one. Still, fortune favors the bold. And I didn’t get paid for being passive.

  Chris called Silver Lake Partners, the private equity group that owned part of Nasdaq, and asked them about financing. They loved the idea—if we could pull it off—and agreed to help provide the money. We were ready, but this was going to have to be a friendly takeover, a merger of equals. We were barely a public company, and NYSE was still a nonprofit, so it wasn’t possible to launch an uninvited bid. I called up John Thain and asked him to get together. We chose a hotel in Soho where we could avoid being seen together by the press. No doubt he was expecting a friendly welcome-to-the-stock-exchange sort of meeting. My actual intention took him by surprise, to say the least, and was not welcomed. It was a short conversation, and that was the end of my first attempt to buy our rival down the street; it wouldn’t be the last.

  In hindsight, perhaps it was for the best. Soon, Nasdaq would buy Instinet, and integrating our new acquisition would keep us occupied over the next year. However, the entire episode awakened in me a new sensibility. I realized that we had to seriously consider how we might eventually expand our national and even global footprints. It seemed to be part of our destiny, for lack of a better word. In trying to buy NYSE, I might have been “ogling the unobtainable” (to paraphrase one my favorite poets, Lawrence Ferlinghetti), but I was nothing if not persistent. In 2005, a different opportunity would present itself.

  The Dawn Raid

  There is a wonderful scene in The Godfather where Al Pacino’s character, Mike Corleone, goes to Las Vegas to buy out a hotel that the family had bankrolled. The hotel’s proprietor, Moe Greene, is offended by the overture. “You don’t buy me out. I buy you out!” he declares. I was reminded of this classic moment of drama during a series of events that unfolded in 2005 and 2006 between Nasdaq and the London Stock Exchange (LSE).

  In 2005, Clara Furse, then CEO of the London Stock Exchange, contacted me with a request. Could we get together in New York? She and her team had something they wanted to talk to us about.

  “What do you think she wants?” I asked Chris and Adena one afternoon as we discussed strategy in my office.

  “She wants to buy us,” Chris responded without hesitation. “She’s seen our depressed stock price and looked at our balance sheet. She thinks we are ripe for acquisition.”

  I thought Chris was correct. I also suspected that there was another issue in play. There had been speculation that Euronext was trying to buy LSE. In London’s view of the financial world, they’re situated at the center, and a bid by rivals in Europe was almost certainly unwelcome. Furse was likely struggling to fend off their overtures and remain independent. That meant she was also looking for a white knight to help protect the company. A merger with Nasdaq could accomplish that. Independent of the strategic consequences, it would increase LSE’s size such that it would be impossible for Euronext to buy.

  When the team from London arrived, we sat down together, and Furse laid out her proposal exactly as we had anticipated. Her manner was gracious and her logic was convincing. She framed a Nasdaq-LSE marriage as a beneficial “merger of equals,” and in many respects it would have been. As she listed the synergies between the two businesses and presented her vision of the combined future global company, I could see the appeal. In fact, I was a little chagrined that I hadn’t come up with the idea myself. I like to always be a step ahead of our competitors, and in this case, I was a step behind. The meeting opened my eyes to Nasdaq’s position in the global ecosystem of exchanges.

  As I reflected on a possible merger with LSE, I became more convinced it could work. But clearly, Furse had assumed that LSE would play the lead role in the aftermath of the deal. In most of these deals, there is a so-called contribution analysis of each company’s share in the future income statement. Based on those numbers, one side generally ends up with more equity in the future company. In her mind, LSE was likely contributing more future profit to the deal and would naturally be the dominant partner. It may have genuinely been envisioned as a merger of equals, but to paraphrase George Orwell, some companies are more equal than others.

  However, there was an interesting twist to the plot. In buying Instinet earlier that same year, not only had w
e purchased a good deal of extra revenue and market share in the deal, but we were also on track to save an incredible amount of money in costs from the combination of companies. All of which meant that our anticipated revenues and profits were actually much higher than our recent earnings statements would have indicated. Our stock price didn’t yet reflect the new and improved Nasdaq. But it soon would. I wasn’t going to do a deal based upon a market valuation that had yet to price in the synergies of the Instinet acquisition.

  At a certain point during that meeting, I got out the latest Nasdaq forecasts. Those numbers, and subsequent analysis by both teams, revealed that Nasdaq’s P&L would be greater than LSE’s by the time any merger was consummated, and therefore we would be contributing more to the future income of an LSE-Nasdaq business. Essentially, that meant that LSE wouldn’t be buying us; we would be buying LSE.

  Furse’s enthusiasm for a merger of equals mysteriously waned after she learned LSE would not be the bigger partner. In fact, we couldn’t even get her to take our calls. The logic of the deal was still appealing to me, however, and I was glad Furse had brought the idea to my attention. A merged company would be in a position to take an extraordinary leadership role in the trading of pan-European equities and become the dominant global listings franchise.

  Like NYSE, LSE had a long and storied tradition—it was one of the original and truly great centers of capitalism, dating all the way back to Elizabeth I. Indeed, it was the epitome of an elite, old-school exchange—the type that probably had a spectacular boardroom, an incredible wine cellar, an expense structure to match, and a bureaucratic infrastructure appropriate for another era. Those were always happy hunting grounds for Nasdaq and the transformations in efficiency and technology that we were championing. Show me an exchange with those characteristics, and I would show you a business that we could revamp and rebuild, unlocking incredible value. A potential Nasdaq-LSE merger had all those enticing elements. We couldn’t just let it go.