U.S. regulatory authorities are investigating the pay packet of Richard Grasso, the New York Stock Exchange chairman, who received a $139.5m lump-sum payment this month; and floor traders are circulating a petition to force him out.

Among other outrages, Mr Grasso got a bonus of $10.6m in 2002, a year when the exchange's own net income hit a recent low of $28m--down 61 percent from two years earlier. His salary and bonus were set by a compensation committee whose members were selected by Mr Grasso himself.

But is the stock exchange not a private business, and should any private business not pay its boss what it pleases? Well, no.

The New York Stock Exchange is two things: it is a business and it is the regulator of a business that happens to be itself. It is a not-for-profit organisation, founded 211 years ago, that is owned by its members--brokerage houses, specialist firms that trade on its floor and individual well-heeled investors.

While the Securities and Exchange Commission oversees the entire US securities industry, the SEC has also designated the NYSE a "self-regulatory organisation" (SRO). The insurmountable conflict between the two roles is the reason that Mr Grasso was paid so much. After all, what company--given the opportunity--would not pay its regulator a hefty sum?

Critics who see the storm over Mr Grasso's pay as another instance of greed run amok are therefore missing the point. They are also missing a simple solution to this scandalous anomaly: caused separate the regulator and the regulated.

The regulator does not have to be a government agency, although it could be. And the exchange would not be a completely passive party. It would choose its regulator and be responsible for the choice. Investors could judge for themselves whether this selection was merely self-serving or whether the regulator was serious about protecting them.

The model already exists. The National Association of Securities Dealers is a separate organisation that regulates the Nasdaq stock market. The NASD is a private entity with an annual budget of $400m and a staff of 2,000. It oversees both the Nasdaq and 5,000-plus securities firms. It could regulate the NYSE as well, or the NYSE could choose another regulator, but it is nonsense for the NYSE, in an age of serious concerns about corporate governance, to continue regulating itself.

The NASD used to own the Nasdaq but three years ago, as the NASD says on its website, "we decided to sell Nasdaq, in order to concentrate solely on our core mission, ensuring market integrity and investor confidence".

Unfortunately, the process of separation between NASD and Nasdaq is not yet complete, having been stalled inexplicably by the SEC. William Donaldson, the SEC chairman, should move swiftly to complete the cycle by granting Nasdaq independence and allowing it to register as an exchange--the legal status now enjoyed by the NYSE. The SEC can then establish a simple regulatory regime for both of the main U.S. markets.

Apart from Mr Grasso's flamboyant compensation, the current conflict of interest has played a role in a series of scandals and embarrassments that have plagued the NYSE over the past year, including alleged abuses by the specialist firms that match buyers and sellers on the trading floor. The specialist process itself is a costly anachronism but specialists are important owners of the NYSE and many of them sit on the exchange's board, so it is unlikely they would put themselves out of a job.

The exchange's management, naturally, wants to keep its shareholders and board members happy; but it also has to retain and enhance the trust of investors--a function that requires it to discipline those very shareholders and board members.

It is an untenable situation. Mr Grasso himself has said that he sees his job as "two-thirds businessman and one-third regulator"--a division of labour that appears troubling.

But the answer is not to send Mr Grasso packing, or to promulgate minor corporate governance reforms. Instead, the entire structure needs an overhaul: make the Nasdaq a true stock exchange, regulated by the NASD, and stop letting the NYSE regulate itself. Until that happens, there is little doubt that the scandals will continue.

James K. Glassman is a resident fellow at the American Enterprise Institute.