Legal Affairs
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A Platinum Parachute

How Richard Grasso lost his job at the New York Stock Exchange. And how the exchange lost nearly $150 million.

By Nicholas Thompson

AT 213 YEARS OLD, THE NEW YORK STOCK EXCHANGE is an icon of American capitalism. Its morning bell-ringing makes for a nice segue into financial segments of the evening news, and pictures of its frenzied traders are tableaux of American industriousness. The business of running the exchange, however, doesn't require much industry, and the company that runs the exchange isn't a terribly involved one—which may be why its chief executive had the time to organize and execute perhaps the most appalling salary scam of the late-'90s boom.

As CEO of the exchange from 1995 to 2003, Richard Grasso had a job that was relatively straightforward. He managed a medium-size corporation that set the rules about how stocks are traded and that kept the lights on in the room where the traders make their deals. The company's top executives lunch with executives who run the world's biggest financial outfits, but the corporation's net income in 2002 was $28 million. The exchange is worth less than Urban Outfitters.

Nonetheless, in 2003, Grasso was able to pocket $139.5 million and was scheduled to receive $48 million more in deferred compensation and benefits when news of his stratospheric compensation broke in late August that year. The New York press took the story and ran with it, while the Securities and Exchange Commission, led by Grasso's predecessor, William Donaldson, who had never been paid more than $2 million annually in the job, demanded an explanation. Grasso renounced his claim to the unpaid $48 million, but it was too late: Three weeks after the NYSE announced his big payday, he'd become a liability on the exchange's balance sheet, and its board of directors sacked him.

Eventually, someone will write a book about the way Grasso hustled his way to a king's ransom he has yet to return. For now, however, we must rely on a document titled "Report to the New York Stock Exchange on Investigation Relating to the Compensation of Richard A. Grasso," written by an investigator named Dan K. Webb, a partner at the Chicago law firm of Winston & Strawn who gained a national reputation prosecuting John Poindexter during the Iran-Contra scandal.

The so-called Webb report was commissioned for the exchange's internal use soon after Grasso's payout triggered the firestorm that led to his dismissal. It was completed in December 2003 but kept confidential. Anonymous insiders buzzed about its fierceness, but it wasn't released to the public until a little more than a year later. That's when a New York state judge ordered the exchange to give a copy of the report to Grasso, as it was a crucial part of the upcoming case against Grasso being brought by Attorney General Eliot Spitzer of New York. Apparently piqued, the NYSE gave the report to Grasso and to the media, which soon put it online, giving it to the rest of the world, too.

Audits of corporate compensation practices don't typically make for scintillating reading, but the Webb report has a great tale to tell, and it tells it with remarkable and commendable clarity. If Grasso goes on trial next year, as is likely, the report and the transcripts of the interviews Webb conducted in the course of his investigation will be among the most powerful weapons in Spitzer's arsenal. That doesn't bode well for Grasso, or for the NYSE's board of directors. The report's conclusion is that the men who set Grasso's salary—the NYSE's board's compensation committee, itself made up mainly of directors of big financial firms—padded the salary of a friend of theirs who ran a company that regulated them. At the very least, they looked the other way as that friend gorged himself on the fruits that were supposedly under their guard.

WEBB'S TASK WAS TO DETERMINE whether Grasso's compensation was excessive, and his answer is a resounding yes. Over the eight years during which Grasso was CEO of the NYSE, he was paid about $150 million more than he deserved, according to Webb's calculations, which were based on the assumption that Grasso did excellent work and that his salary should have roughly matched the salaries of people in comparable positions at other corporations. The salary was so exorbitant that it significantly drained the NYSE resources—and ultimately sullied its reputation, a significant, if intangible, devaluation. Paid what he was worth, Grasso would have earned about one-fifth as much, and the exchange's profits would have been 50 percent higher for much of the period of his chairmanship.

The exchange plays by a different set of rules from the ones governing the companies traded on its floors. The CEOs of the publicly traded corporations on the NYSE are accountable to their shareholders. The NYSE, on the other hand, was set up as a nonprofit venture to serve the companies traded on the exchange. (As a nonprofit, it's allowed to make profits, but it's supposed to use the money to improve its operations, not line the pockets of its chief executive.) In theory, Grasso was accountable to the NYSE's 24-member board, of which he was chair. In reality, Grasso was semi-accountable to a subset of the board, its eight-member compensation committee, which met once a year to determine Grasso's salary based on his performance the previous year.

Although that may seem fair enough, the Webb report explains that Grasso had substantial influence over who got put on the board of the exchange, and, perversely, had complete control over the selection of the members who served on the compensation committee. Not surprisingly, he stacked the committee with close friends of his, many of them highly paid CEOs in their own rights. The chairman of the compensation committee during the period when Grasso earned the most money was Kenneth Langone, a founder of Home Depot. Langone was close enough to Grasso to complain to The New York Times about Grasso's mother's homemade meatballs. ("I have a dog," Langone said, "and that son of a gun will eat your shoes if you let him. He wouldn't touch them.") Langone may have figured he had enough political capital stored up from when he had arranged for Grasso to serve on Home Depot's board and its compensation committee to speak freely on the subject.

Yet Grasso could not have so generously lined his personal coffers through cronyism alone. He was also the beneficiary of a system for calculating compensation, one that was ripe for the goosing. The setting of Grasso's annual contract began when Frank Ashen, who served as a vice president of the NYSE and the chief liaison to the compensation committee, would present a benchmark salary to the committee during its February meeting. Ashen's benchmark was based on the salaries of a "comparator group," the CEOs of (supposedly) similar companies. But these CEOs weren't managing similar entities. No other stock exchange, or for that matter nonprofit, was included in the comparator group. Instead, the comparative salaries were those of executives at big firms like AIG, the insurance giant, and Merrill Lynch, which has about 50,000 employees worldwide. The NYSE has about 1,500 employees, all based in New York City.

Ashen took the mean of these salaries and then deducted 10 percent—a small nod to the reality that running a large financial services firm differs from running a small regulatory body. According to the Webb report, Grasso's benchmark salary would have been vastly lower under a more appropriate standard. Taking the mean of salaries of chief executives at every company listed on the NYSE, for example, would have dropped the benchmark salary by about 65 percent.

After Ashen used this dubious peer group to come up with his benchmark, however, he would multiply that number by a rating that purported to indicate the exchange's success in meeting its own yearly targets. Grasso was directly in charge of determining most of those targets, and, not surprisingly, during every year of Grasso's chairmanship, the exchange exceeded them substantially. On average, Grasso declared that the exchange had outstripped its annual goals by 50 percent. His salary was increased by a commensurate percentage of its already absurd level.

It was then that Grasso's friends on the compensation committee would show up to place a cherry on top. During several years of Grasso's tenure, the compensation committee decided to boost Grasso's benchmark well above the number recommended by the formula. For 2000, the committee granted Grasso $26.8 million, more than twice what Ashen's formula suggested. For 2001, the committee increased Grasso's compensation, without explanation, from $18.6 million to $30.6 million. (See the section of the Webb report entitled "Capricious Upward Adjustments From Already Inflated Benchmarks.") Ostensibly, the committee threw in such goodies because it didn't want Grasso recruited away by another company, perhaps one that could offer him stock options. But Grasso was extremely loyal—he started at the exchange as a clerk making $82.50 a week in 1968, and accumulated 35 years of seniority as he rose to the top. He was hardly a flight risk, and there is no indication that he ever seriously considered leaving, or even flirted with another company.

GRASSO'S ANNUAL SALARY WAS OUTRAGEOUS, but its disclosure might not have sunk him. Grasso had become something of a public figure in 2001, with recognition beyond the financial sector, when he reopened the exchange less than a week after the September 11 attacks and earned a reputation as the Rudolph Giuliani of Wall Street. The public, and the many companies that pay to have their stocks listed on the exchange, probably could have countenanced a couple of years of inflated salaries.

What got him was the pension policy. The Webb report explains that at the exchange, a senior employee's annual pension derives from his length of tenure and the average of his salary during his three consecutive highest-earning years. Unlike at many other companies, there are no caps on the pension benefits that an employee can accrue, and, because executives receive no stock options, almost all compensation counts toward the pension calculation. An employee with Grasso's years of service would be due an annual retirement payment of 65 percent of his average salary during his highest-paid three-year period, an enormous sum for Grasso given the heights his compensation had hit in 2000 and 2001. In 2003, the total value of Grasso's pension plan was around $140 million. This was about six times the average pension account of men whose very high salaries were counted as part of Grasso's comparator group.

Grasso tracked his pension accruals carefully, and, in the fall of 2002, when the tech-stock fueled boom had clearly ended, he wanted to get that money out of his retirement account and into his pocket. One-hundred-million-dollar pensions might not have looked that odd in 2001, but they did in 2002. The Webb report alleges that Grasso knew that the accumulation of funds in his pension was getting to the point where it might shock even his inattentive board.

If that's the case, his assumptions were likely correct. One director who joined the committee shortly before it began considering Grasso's huge payout in the fall of 2002 said that he thought the amount was a typo. But everyone on the board agreed that Grasso had earned it, at least in the sense that his contracts said he was owed it. Most people get their retirement benefits when they retire; in exchange for agreeing to a contract extension, Grasso swung a deal to get his money at the ripe old age of 57.

SOME TIME IN THE NEXT YEAR, Grasso will likely end up in court facing Spitzer. The attorney general is bringing a case on the grounds that New York State's not-for-profit corporation law gives him the power to sue any nonprofit that pays excessive salaries. Grasso has countersued the exchange. Spitzer wants Grasso to give back his excessive pay. Grasso says he's owed the $48 million he renounced in an effort to save his job.

A major challenge for Spitzer is going to be showing that Grasso intentionally deceived the board, and on this count, the Webb report is somewhat ambivalent. Grasso comes off in the report as the epitome of greed, but it's Frank Ashen who is most closely tied to the specific deceptions that satiated that greed. The formula for calculating Grasso's salary was extremely complicated, and Ashen seems to have used the intricacies to deliberately disguise its excesses. He frequently didn't disclose important details to the board—for example, that Grasso would still be owed $48 million even after the $139 million in pension funds was paid. Ashen kept two sets of compensation documents during the two years in which Grasso reached his highest compensation levels. One set, which he kept in his desk, listed Grasso's many forms of compensation and added the totals up. The other, which he distributed to board members, didn't list the total sum being paid out. The second set also didn't remind board members of a special bonus created in 1998, called the capital accumulation plan, which added a few million dollars to Grasso's annual salary. And it didn't mention Grasso's use of a private plane at the exchange's expense, or his two chauffeurs, each paid $130,000 a year.

Ashen has already settled with Spitzer, but taking the blame for Grasso was not a condition of his deal. The former CEO could obviously have been more open about his salary, volunteering to the board information about the vast sums accumulating in his pension. But the report never fingers Grasso directly as having lied to the board, and the former CEO has declared publicly that he didn't provide answers because the key questions were never asked.

With Ashen out of the picture, it's clearly in Grasso's interest to pin the remaining blame on his board of directors. The board—made up primarily of experienced chief executives who should have known better—was certainly practicing the wrong kind of oversight. But it's unclear whether the board members were maliciously duped, were actively helping Grasso stuff his pockets, or were turning a blind eye.

The Webb report runs over with examples of negligence—H. Carl McCall, formerly New York State's comptroller and at the time chairman of the compensation committee, never read Grasso's last complete contract before signing it—but it doesn't impute motives. The report doesn't have an answer for why the debacle happened; Webb's sole task was to describe whether Grasso got paid too much. Though he may deflect the blame to others now, Grasso will have to answer in court for much of what Webb, the former Poindexter investigator, uncovered. As if in acknowledgment of that impending challenge, Grasso has retained as his counsel Brendan Sullivan, formerly the lawyer for Oliver North. ...

Nicholas Thompson is a senior editor of Legal Affairs.

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