The Grasso depositions

Back in the spring of 2004 Eliot Spitzer got lots of publicity for suing former NYSE head Dick Grasso and Langone, the head of the NYSE’s compensation committee, for Grasso’s allegedly excessive compensation.  I wrote on this mess at the time, linking to a particularly insightful analysis by Holman Jenkins.  Spitzer is attempting to collect the rent on this litigation for his gubernatorial campaign.  Unfortunately for him, Grasso is fighting this case hard. 

Kimberley Strassel has an interesting description of the depositions in this case.  It seems that the rest of the board knew very well what was going on, which should take care of the case against Langone that he misled the board.  Indeed, this seems so obviously true that one wonders why Spitzer didn’t just sue the whole board for making a bad decision.  But, as I discussed in my spring 2004 post, Spitzer “gets securities industry political support if he handles this so only Grasso gets hurt.” Langone was the sacrificial lamb because Spitzer couldn’t get around the fact that the board had approved the compensation.

An additional imponderable here is where Spitzer gets off second-guessing a compensation decision.  Shouldn’t this be subject to the business judgment rule which, after all, gave the Disney board considerable coverage in the Ovitz affair? Well, the NYSE is a non-profit, and so gets Spitzer’s solicitous stewardship under an arguably stricter rule. But one wonders why the business judgment rule wouldn't apply here, since non-profits have to operate under the same conditions in hiring executives that the for-profits do, and courts aren't any better able to review compensation in a non-profit. 

In any event, Strassel’s review of the depositions indicates that Spitzer is facing problems on this issue too, pointing out that

the members certainly provided "reasonable" explanations for their decisions. . . . They all praised Mr. Grasso, believing the Big Board could not afford to lose him and it was important to pay him well. . . . Defense attorneys also gleefully pointed out that the NYSE's own choices to replace Mr. Grasso came not from the non-profit world, but were former Citigroup chief John Reed (who they noted left that firm with $384 million in stock and options) and John Thain (who they said held $300 million in Goldman stock).

Odds are that Spitzer is not going to be able to use this particular case to win what I've described as the “costliest governor election campaign in history.”

Comments

[Bill Sjostrom]

I did a little research on the application of the BJR to non-profit boards for a post I did on Business Law Prof relating to the NYSE/Archipelago deal and some then pending litigation. Here's what I wrote:

The fact that the NYSE is currently a non-profit corporation makes this case more interesting. Plaintiffs can argue that the business judgment rule does not apply to non-profit corporations. Some courts have held this to be the case, others have held the opposite, although I do not believe that a New York court has ruled on this issue. One of the primary justifications of the business judgment rule is the recognition that building a successful business entails taking risks. Because potential profits often corresponds to potential risk, the law should not discourage corporate risk taking. Therefore, the business judgment rule takes out of the equation director concerns about personal liability for a risky decision turning out poorly, absent bad faith, failure to be adequately informed or self-dealing. This rationale obviously does not apply with the same force for a non-profit, although other BJR rationales may (encouraging competent individuals to serve as directors, courts ill equipped to second guess business decisions, etc.)

[Larry E. Ribstein]

The question is why non-profits are assumed to take less risk. Despite the misleading nomenclature, the only difference between a "non-profit" and a "for-profit" is distributions, not the existence of profit. In other words, only the beneficiaries differ -- the owners vs. somebody else. Owners of publicly held firms presumably diversify and therefore aren't averse to firm-specific risk. Perhaps that isn't true of the beneficiaries of non-profits. But I'm not sure how this distinction relates to either the amount of executive compensation or the board's decision to pay it.

[Bill Sjostrom]

I agree that the issue of risk taking doesn't seem to relate to a board decision concerning executive compensation. Also, I didn't intend to imply that I think non-profits take less risk than for-profits. Isn't the broader question whether non-profit law should be designed so that it does not discourage risk taking?

[Larry Ribstein]

Yes, but only to the extent that this is consistent with the other goals of nonprofits, including protecting contributors.

[Robert Schwartz]

This is a very interesting, however the New York Not-for-Profit Corporation Law contains a specific provision on point, to-wit:

§ 202. General and special powers.

(a) Each corporation, subject to any limitations provided in this chapter or any other statute of this state or its certificate of incorporation, shall have power in furtherance of its corporate purposes:

(12) To elect or appoint officers, employees and other agents of the corporation, define their duties, fix their reasonable compensation and the reasonable compensation of directors, and to indemnify corporate personnel. Such compensation shall be commensurate with services performed.

The coresponding provision of the BCL, reads:

(10) To elect or appoint officers, employees and other agents of the corporation, define their duties, fix their compensation and the compensation of directors, and to indemnify corporate personnel.

Clearly there is a statutory limitation on compensation. There will no doubt be issues as to burdens of broof and standards of reasonableness. But, the statutory playing field is different than the one for business corporations.

[Larry E. Ribstein]

The "reasonable" compensation limit is a standard feature of non-profit law, as I understand it. But it doesn't clarify the non-application of the business judgment rule. Among other things, the bjr is properly viewed as a limited on judicial interference (see Bainbridge) rather than a limit on the level of compensation.