TICKER - The reign of thain the new merrill ceo leaves behind a formidable challenge

John Thain couldn’t have picked a better time to leave his job as CEO of NYSE Euronext and take on another reclamation project as the new leader of troubled brokerage giant Merrill Lynch & Co.

The 52-year-old former Goldman Sachs Group president deserves credit for shepherding the Big Board through perhaps the darkest chapter in its history. When Thain took over in January 2004, the exchange was reeling from two major scandals: the resignation under pressure of his predecessor, Richard Grasso, following the disclosure of his nearly $190 million pay package, and a public condemnation by the Securities and Exchange Commission for failing to prevent improper floor trading that cost customers $155 million. The NYSE also was falling behind in the wave of automation and deal making by globally ambitious competitors. Thain soothed angry regulators and customers and engineered a series of deals — most notably a merger with electronic exchange operator Archipelago Holdings and the acquisition of Paris-based rival Euronext — that turned the Big Board from an anachronistic, member-owned cooperative into a publicly traded, diverse global powerhouse. Today, NYSE Euronext boasts a market capitalization of some $22 billion; when Thain took over, the value of the exchange, based on the price of memberships, was just $1 billion.

Still, for all his achievements, the one thing Thain couldn’t fix was the NYSE’s dysfunctional U.S. stock trading business. Only about 40 percent of the shares traded in NYSE-listed stocks change hands on the floor of the exchange. That’s down from more than 90 percent during much of the 1990s and 82 percent as recently as 2005. Sweeping new U.S. trading regulations being phased in nationwide this year have opened the NYSE’s market to unprecedented competition. Thain’s answer to that threat — a hybrid market that combines automated execution with elements of the floor-based auction — has failed to stem the decline in market share.

Although Thain’s deal making has diversified the NYSE into faster-growing options and futures trading, as well as into Europe, the sickness of its U.S. stock business remains a significant problem. The exchange’s trading market share is intimately linked to its listings and market-data businesses, which together account for 20 percent of NYSE Euronext’s annual revenues. The iconic, bustling floor is a critical part of the brand that the exchange markets to listings clients. But companies that see the majority of their shares trading away from that floor may choose to switch their listings. Among the defectors that in recent months have crossed over to the Nasdaq Stock Market, which is gaining much of the share that the Big Board floor is losing, are DirecTV Group, Liberty Media Corp. and Cadence Design Systems.

Now, as Thain succeeds the ousted E. Stanley O’Neal and tries to shore up the risk controls that led to outsize credit market losses at Merrill, among other challenges, the job of how to save the NYSE’s core business falls to Duncan Niederauer, Thain’s key adviser on trading issues when the two were colleagues at Goldman, and his handpicked successor.

Since joining the Big Board in April, Niederauer, who previously headed Goldman’s Spear, Leeds & Kellogg trading unit, has lit a fire under the institution’s sleepy sales team, encouraging them to more aggressively solicit orders from trading firms.

“They call and visit now, which is a huge change,” says the CEO of an agency brokerage firm that does lots of business on the NYSE. “I never used to hear from their people at all.”

Niederauer, renowned in the industry as a champion of automation, appears committed to maintaining the floor in some form even as he fights to reverse the market share decline. On December 4, for instance, he welcomed Lehman Brothers’ formation of a floor-based market-making firm, completed through its acquisition of Dutch firm Van Der Moolen Holdings’ NYSE specialist operations. Lehman will gain responsibility for maintaining orderly markets in 308 Big Board stocks.

The deal appeals to Niederauer, say people familiar with his thinking, because Lehman has investment banking relationships with many of these companies. The CEO favors this “integrated specialist” model, believing that such firms will have a greater incentive to make the most efficient markets in NYSE-listed stocks than do firms whose only business is trading. Premier investment bank Goldman operates in this way through Spear, Leeds & Kellogg, which in addition to offering the popular RediPlus electronic trading engine, runs a big specialist firm on the floor.

Niederauer is also pursuing a revision of the NYSE’s trading rules that, according to people familiar with the plans, aims to give floor personnel greater latitude to discreetly expose nondisplayed liquidity to the market, a move it hopes will boost its market share. In late October, just two weeks before Thain announced his departure, Niederauer struck a partnership with Block Interest Discovery Service, a private trading network for institutional-size trades that is operated by a consortium of big brokerage houses. Under the deal, BIDS and the NYSE will jointly operate a block-trading facility.

It’s too soon to judge whether Niederauer will succeed where Thain failed, but the new chief doesn’t have the luxury of time. The NYSE remains the only major global stock exchange to rely meaningfully on a floor. If continued market share declines hurt new listings more than the brand value of the floor boosts them, he will come under pressure to simply shut the doors and automate all trading.