For a book that heralds Philadelphia’s important historical role in the world of finance, Robert Wright’s The First Wall Street: Chestnut Street, Philadelphia, and the Birth of American Finance offers faint praise in its final chapter.  Since the 1830’s, when New York surpassed Philadelphia as the nation’s center of finance, and beyond the Great Depression, the collapse of Philadelphia's dominating railroad companies--the Pennsylvania, the Reading, the Budd Company, Baldwin Locomotive Works—and general postwar industrial decline, Philadelphia has slid and become “an economic and business backwater.”  Wright offers the backhanded complement that the Philadelphia Stock Exchange has “done an admirable job of staving off extinction by nimbly responding to niche needs.¹”  Those words, although sharp, are true:  even San Francisco—Wall Street of the West—no longer has an independent exchange of its own after the Pacific Exchange was purchased by Archipelago which in turn was bought by NYSE.

In 2003, the Philadelphia Stock Exchange’s members voted to change the structure of the organization from a not-for-profit mutual organization to a for-profit corporation, the Exchange demutualized.  Demutualization in turn, allowed Citigroup, Credit Suisse, Morgan Stanley, UBS, Citadel and Merrill Lynch to purchase nearly 90 percent of it in 2005.  In 2006, the Exchange ended the traditional floor-trading of the stock exchange that began in with formalized trading in 1790².

Conventional wisdom is that the demutualization of the exchange was necessary to remain competitive in the current economy.  Citigroup, Credit Suisse, Morgan Stanley, UBS, Citadel and Merrill Lynch would have likely ignored the Exchange in 2005.  Before demutualization, these firms could not ‘invest’ in the organization; they could only buy a membership, which would afford them limited control.  Had Philadelphia not demutualized, its days as an exchange would be numbered, like any one of the regional exchanges that it gobbled up in their post-war era, including the Baltimore, Washington, and Pittsburgh exchanges³.  Demutualization allowed it to raise capital for keeping the exchange competitive and separating trading rights from being tied to ownership.  Securities and Exchange Commission regulations stipulate, “no registered exchange may have institutional or individual investor members, but may only have broker-dealer members⁴”, but institutions and retail customers may buy the shares of a demutualized exchange.

The capital that its new owners infused in the exchange allowed it to be more competitive with its competitors.  The Exchange’s “powerful brokerage-firm owners like Morgan Stanley and Merrill Lynch & Co., …have helped the exchange boost its market share to 13% from about 11% in 2002.⁵” In a mutual organization, like a tradition stock exchange, a yacht club, a co-op, or a bowling league, money is raised by dues.  If a capital project is undertaken, dues are duly increased or an assessment is charged.  The traditional sources of revenue for an exchange were membership dues, transaction fees, listing fees, and selling information such as current prices and other market data⁶.  In the competitive world of international stock exchanges, raising fees or dues may precipitate members and listed companies considering trading elsewhere.

As exchanges around the world started to demutualize in the 1990s, other exchanges were faced with a dilemma, they needed to modernize with the rapid changes in commerce and communication to stay competitive and they needed to keep their fees and their dues low to stay competitive.  It is no coincidence that the trend towards demutualization and mergers corresponded with the major technological changes in exchanges and the transformation of exchanges from seemingly chaotic trading pits to glorified mostly automated computer networks.  The capital infusions that demutualization allowed trading to liberated from being membership-based and it allowed exchanges to remain in business by being both competitive in cost and technology.

Although demutualization passed the vote of PHLX’s members overwhelmingly, it was not without its detractors.  In June, 2007, PHLX settled a deal in the class action lawsuit made by a former member on behalf of the minority shareholders.  The deal decreased the six firm’s stake and Chairman Sandy Meyer’s compensation for the deal⁷.  San Francisco’s Pacific Exchange was the first in the United States to demutualization in 1999.  When the New York Stock Exchange demutualized it allowed it to purchase Archipelago in 2006, the electronic trading company that purchased the Pacific Exchange in 2005, and merge with European amalgamated exchange company Euronext, which it fully completed in Spring of 2007.  Chicago Mercantile Exchange’s decision to demutualize and go public in 2002 “gave it a competitive edge over the CBOT [Chicago Board of Trade], putting it in position to offer its $8 billion buyout⁸”.

The Philadelphia Exchange's heritage as the nation’s oldest matters very little in the scheme of things, the ability to raise money, utilize technology, and be nimble is everything to the survival of exchanges in today’s market.  Philadelphia is currently the third largest options exchange in the country, behind the Chicago Board Options Exchange, founded in 1973, and the International Securities Exchange, founded in the year 2000 as the first fully-electronic options exchange.  The ISE provided “cheaper and faster service allowed it to steal business from the manual trading floors of its stodgier competitors,⁹” and now Philadelphia too is an electronic-only exchange.  The Atlanta-based 24-hour and fully electronic InterContententalExchange, also started in 2000, was by the Summer of 2007 competing with the Chicago Merc in a $9.7 billion bidding war to take over the CBOT¹⁰.

Philadelphia’s Exchange has the vulnerability to be acquired, absorbed, and forgotten about.  When Sandy Frucher, Chairman of the Exchange, appeared on PBS’s Nightly Business Report in 2006 it was put to him be the interviewer thnat, “Philly exchange might make a nice snack for some larger player to come in given everything that the Philly exchange has that some larger player may want to acquire.”  Mayer responded, “our aspiration is to become, you know, the third exchange with New York and NASDAQ out there.  Whether or not we succeed at it, time will tell.¹¹”

The Nasdaq indeed, on April 11, 2007 it was first reported in the Wall Street Journal reported that New York’s NASDAQ was in ongoing talks with the Philadelphia Stock Exchange¹².  The speculated value of the exchange was between $200-$300 million, “small compared with the value of many exchanges.”  The Nasdaq, itself founded in only 1971 as the world’s first electronic exchange, became a public traded corporate exchange in 2002 and is the largest in the US by shares volume and the world’s third largest by market capitalization.  The Nasdaq has been trying to expand and in 2007 was rebuffed by the London Stock Exchange and the Scandanavian exchange, Nordic OMX. It wants to break into the options market that Philadelphia holds third place in.¹³  “In February, Nasdaq's [CEO] Mr. Greifeld said on a conference call that Nasdaq hoped to launch an options business in 2007 that would expand its market share of the overall options business to 20%.”¹⁴

On May 25^th, the Nasdaq-PHLX talks were repeated again in an article which focused on the Nasdaq’s effort to purchase the OMX¹⁵.  By August, the Emirates-based Borse Dubai bested Nasdaq’s $3.7 billion bid, an offer that had been accepted by the OMX’s board, $4 billion.¹⁶  However, by August 17^th, the OMX hired investment bank Greenhill & Co to search for buyers or peruse an Initial Public Offering.¹⁷  Greenhill was also hired by Nasdaq to acquire the London Stock Exchange earlier in the year.¹⁸  Nasdaq acquired a nearly one third stake in the exchange but was soundly rebuffed by the shareholders and announced its intention to sell its stake on August 30.

Philadelphia’s biggest competitor, the largest American options exchange, the Chicago Board Options Exchange, is also demutualizing.  Chief Executive William Brodsky at the Swiss Futures and Options Association's annual conference announced that The Chicago Board Options Exchange “is months, not years”, away from demutualization¹⁹.  The CBOE has legal hurdles to mount.  Although independent, the CBOT founded the CBOE.  The CME now owns CBOT.  As the parent of the CBOT, the CME claims equity rights in the CBOE if it is demutualized.  Nevertheless, as the CBOE demutualizes it will also attract attention and perhaps capital to its competitors.  The CBOE, which “founded the listed options business in 1973, it has been the leader in options volume every single year.”  In 2006, the CBOE was up 44% over the previous year²⁰ in trade volume, the PHLX equity options market was up 69.9% in the same year.²¹

London is increasingly replacing New York as the world’s financial capital and America’s dominance in international finance.  Momentum started in 1986, when the United Kingdom passed the Financial Services Act under a Margaret Thatcher-lead parliament, “Britain’s financial services sector was changed overnight,” creating a “big bang” for economic growth²².  The rigorous requirements and strenuous accounting that public companies must go through due to the Sarbanes-Oxley, the 2002 legislation that was passed after the collapse of ENRON, are making many firms weary of going public and is driving global companies to list in London instead. In fact many firms are delisting from American exchanges and listing in Europe instead²³.  In August of 2006, The Independent reported, “London is outpacing New York as a destination for stock market flotations… [London’s Alternative Investment Market,] AIM has become the No 1 destination for smaller American firms searching for a stock market listing²⁴”

In the late 1990’s the SEC pressured the PHLX to merge with the American Stock Exchange, but it resisted.  After the September 11^th attacks in New York, 600 AMEX options traders came to Philadelphia and the exchange was opened to them²⁵.  Demutualization transformed the organization from an association of mostly firms, many locally owned, to a corporation just like the ones it trades.   This decade, the Philadelphia Stock Exchange went from being a not-for-profit mutual organization with membership seats and an open outcry trading floor to an all-electronic exchange with major investment bank owners.  The same decade saw the World Trade Center attacks, which forced firms to consider hedging their safety with non-New York exchanges.  The past ten years have seen exchanges start up from nothing to become major players.  It has seen traditional open outcry trading-floors close nearly everywhere.  It has seen an increased regulatory environment for public companies in the United States (SARBOX, specifically) and the resurgence of Europe in global finance.

Although Philadelphia’s options volume has been “increasing steadily in recent years, outpacing the growth in stock trading and some parts of the futures market, where investors make similar bets on stocks, bonds and commodities²⁶,” it still needs to be ever vigilant to stay alive.  In the world of increasing global trade and faster communication and financial technology, resources, jobs, and institutions can move around the world in a minute.  The Exchange has been an innovator and a first adopter in the past, it needs to leverage that ability and demutualization allowed it to secure the capital to do so.

In 2007, Democratically-registered Philadelphian primary voters elected a former investment banker from days of the high-flying 80s and Wharton School of Business graduate²⁷, Michael Nutter, to the become the Democratic nominee and likely mayor.  Nutter ran on a reform platform to cut taxes and streamline city services and regulations²⁸.  Nutter’s background in finance and pro-business policies might help make the environment right for the exchange to become more competitive versus those located in other American cities.  Although Nutter can only lobby Philadelphia’s powerful congressional delegation to make the country more competitive in global finance by reforming Sarbanes-Oxley, he still will have a great deal of power to create the environment in Philadelphia to reemerge as a center of finance.

In turn, the Exchange, which announced an 83% increase in equities options trading volume and 236% increase for World Currency Options for August 2007²⁹, will make its decisions based on the shareholders interests as a demutualized organization, rather than the interest of its members like it would have as a mutual organization.  Likewise, as its shareholders are major firms based out of New York and Switzerland, its loyalty to the region is limited at best, ambivalent at worst.  As reported, CEO "Sandy" Frucher “has been thinking for more than a year about whether to pursue an initial public offering of stock or to sell to a larger exchange,³⁰” but the valuation reported in April of $200-$300 million has already increased.  With the tremendous growth the Exchange is having, selling out to a firm that will absorb it will seem like a great loss.  While the country overall might benefit from the comparative advantage offered by merger of exchanges, the city of Philadelphia, at least in its role as a financial center, will most certainly not.