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NY Court of Appeals Dismisses Attorney General’s Challenge against NYSE Chief’s Pay
New York v. Richard A. Grasso, et al.
04-401620, State Court of Appeals of New York, 06/25/2008
Holding
The State Court of Appeals of New York upheld the dismissal of the Attorney General’s claims that challenged the legality of the $187.5 million compensation of a former head of the New York Stock Exchange (NYSE). The Attorney General filed an action to invalidate the compensation awarded by the NYSE to its then Chairman and Chief Executive Officer Richard Grasso for being excessive, and an indication of a breakdown of corporate governance. The State Court of Appeals however rejected such causes of action since the Attorney General did not have the authority to institute actions of this type under the state’s Not For-Profit Corporation Law (N-PCL). According to the Court of Appeals, the Attorney General crafted such claims with a lower burden of proof than that required by the statute, thus disregarding the fault-based scheme specified by the law. The Attorney General merely sought to ascribe liability on the basis merely of the size of Grasso’s compensation package, contrary to the higher burden of proof called for by the legislature. The Court of Appeals however sustained the authority of the Attorney General to bring two claims, namely, unlawful transfer of properties and breach of fiduciary duty. In this connection, the Court of Appeals held that the legislature specifically provided for the Attorney General's role as an overseer of not-for-profit corporations, and requires that he prove an officer's fault to sustain these claims.
Detailed Summary
This appeal arises out of compensation in the total amount of $187.5 million paid by the New York Stock Exchange (NYSE) to Richard A. Grasso, Chairman and Chief Executive Officer from 1995 until his resignation in September 2003. At all times relevant to this appeal the NYSE was a New York not-for-profit corporation regulated by the N-PCL. This appeal concerned four of the eight causes of action brought by the Attorney General alleging that the compensation paid to Grasso was excessive.
By way of background, three agreements, executed in 1995, 1999 and 2003, governed Grasso’s compensation by the NYSE. From 1995 through 2002, his base salary was roughly $1.4 million, but his bonus awards escalated from $900,000 in 1995 to $10.6 million in 2002. The 2003 agreement provided Grasso with an immediate lump sum payment of $139.5 million and an additional $48 million payable over four years—compensating him for past and future work. The Attorney General alleged that the payments contemplated by the 2003 agreement were not reasonable or commensurate with the services performed by Grasso, and therefore violated N-PCL 202 (a) (12) and 515 (b). Opinion, p. 2.
The complaint described the situation as “a fundamental breakdown of corporate governance” predicated on numerous breaches of fiduciary duty, beginning with the composition of the Compensation Committee—its members hand-picked by Grasso—which ignored a benchmark system designed to calculate Grasso’s compensation. Id., pp. 2-3.
In 1999, 2000 and 2001, the Compensation Committee provided Grasso with awards exceeding the benchmark by 64%, 141% and 65%, respectively. In addition, the Attorney General alleged that information provided to Committee and Board members regarding the extent of Grasso’s compensation under various benefit programs were inaccurate, incomplete and misleading. Id.
The complaint asserted eight causes of action –- six against Grasso, one against Kenneth Langone (Chairman of the Compensation Committee from 1999 through June 2003), and one for declaratory and injunctive relief against the NYSE. The causes of action against Grasso can be separated into two categories – the statutory causes of action and the nonstatutory causes of action that are the subject of this appeal. The two statutory claims against Grasso –- the second and third causes of action—were for unlawful transfer of corporate assets and breach of fiduciary duty. Id., p. 4, citing N-PCL 720 (a), (b)). Section 720 (b) expressly authorizes the Attorney General to bring these two causes of action and that authority was uncontested in this appeal. Id., p. 5.
The four nonstatutory claims against Grasso were premised on provisions of the N-PCL but clothed in the common law. The first and fourth causes of action for a constructive trust and payment had and received, based on a theory of unjust enrichment, were premised on the reasonable compensation provisions of the N-PCL. Id., citing see N-PCL 202 (a) (12); 515 (b)).The fifth cause of action asked for restitution of certain benefit awards, alleging that a majority of the Board failed to approve them as required by N-PCL 715 (f). Id. Finally, the sixth cause of action alleged that the NYSE’s advance payments from a retirement plan violated the prohibition against loans to officers under N-PCL 716 and that the NYSE is entitled to reasonable interest thereon. Id.
Grasso moved to dismiss the four nonstatutory claims on the ground that the Attorney General lacked authority to maintain them. The Supreme Court denied defendant’s motion to dismiss, holding that the Attorney General had standing to sue under the parens patriae doctrine to vindicate the interests of the investing public. Id., pp. 5-6.
On appeal, a majority at the Appellate Division, voting by 3-2, reversed and dismissed the four nonstatutory causes of action against Grasso, viewing them as an attempt to circumvent the fault-based claims provided by the N-PCL. The dissenting Justices would have permitted the claims to proceed based on the parens patriae doctrine. Parens patriae is a common law standing doctrine that permits the state to commence an action to protect a public interest, like the safety, health or welfare of its citizens. To invoke the doctrine, the Attorney General must prove a quasisovereign interest distinct from that of a particular party and injury to a substantial segment of the state’s population. Id., p. 6, citing Alfred L. Snapp & Son, Inc. v Puerto Rico, ex rel., Barez, 458 US 592, 607 (1982)). Hence, the Attorney General filed this appeal.
The State Court of Appeals affirmed the Appellate Division’s dismissal of the first, fourth, fifth, and sixth causes of action (the nonstatutory claims) on the ground that the Attorney General was not authorized under the N-PCL to institute these types of action. Specifically, the State Court of Appeals held that these four claims were based on an assertion of parens patriae authority. Here…”we need not and do not reach the scope of any such authority. Instead, a side-by-side comparison of the challenged claims and the statutory claims reveals that the Attorney General has crafted four causes of action with a lower burden of proof than that specified by the statute, overriding the fault-based scheme codified by the Legislature and thus reaching beyond the bounds of the Attorney General’s authority.” Id., p. 8.
The Court of Appeals reasoned that the four nonstatutory causes of action were devoid of any fault-based elements and, as such, were fundamentally inconsistent with the N-PCL. For example, the first and fourth causes of action—for a constructive trust and payment had and received—relied on the reasonable compensation provisions of the N-PCL and sought the same relief as the statutory claims, yet they lacked any element of knowledge or bad faith. Rather, under these claims the Attorney General needed only prove that Grasso’s compensation was unreasonable and, therefore, unlawful under the N-PCL and constituting an ultra vires act. Abandoning the knowledge requirement of N-PCL 720 (a) (2) and the business judgment rule, they would impose a type of strict liability.
The same principle should apply with respect to the sixth cause of action—that certain advance payments from Grasso’s supplemental retirement plan constituted an improper loan under N-PCL 716 and sought interest on the loaned amounts. Just like the other three statutory claims, this claim would require the Attorney General to overcome a business judgment defense, whereas the action pleaded disregards the knowledge element that other unlawful transfers must allege. Id., p. 11, citing N-PCL 719 (e); 720 (a) (2).
With respect to the two statutory actions, the Court of Appeals upheld the authority of the Attorney General to bring them. According to the Court of Appeals, these claims asserted against Grasso, in addition to those provided in N-PCL 719, rested on the fault-based provisions enacted by the Legislature to remedy not-for-profit corporate wrongdoing. The second cause of action, which was for an unlawful transfer, permitted an action “to set aside an unlawful conveyance, assignment or transfer of corporate assets, where the transferee knew of its unlawfulness.” Id., p. 9, citing N-PCL 720 (a) (2).
The other statutory cause of action, which was for breach of fiduciary duty, permitted an action for the “neglect of, or failure to perform . . . duties in the management and disposition of corporate assets” and for an officer’s “acquisition . . ., loss or waste of corporate assets due to any neglect of, or failure to perform . . . duties.” Id., citing N-PCL 720 (a) (1) (A), (B). This claim required a showing that the officer or director lacked good faith in executing his duties. The Legislature specifically provided for the Attorney General’s role as an overseer of not-for-profit corporations, and requires that he prove an officer’s fault to sustain these claims.
On the basis of the foregoing, the State Court of Appeals affirmed the Appellate Division’s dismissal of the Attorney General’s nonstatutory causes of action against Grasso.
View a PDF of the judicial opinion.Service
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