This article is reprinted with permission
from the
edition of
New York Law Journal.
© 2003 NLP IP Company.
Disney/Ovitz and NYSE/Grasso
Compared
By Joseph E. Bachelder
The debate continues over what to do about
the $140 million payment by the New York Stock Exchange [NYSE] to Richard A. Grasso in 2003 [NYSE/Grasso
Matter]. In
This column focuses primarily on issues of
fiduciary responsibility raised in these two matters.
Disney/Ovitz, NYSE/Grasso Compared
1. Amounts involved.
§ Disney/Ovitz Case: Approximately $140 million.
§ NYSE/Grasso Matter: Approximately $140 million.
2. Immediate circumstances associated with
the amounts involved.
§ Disney/Ovitz Case: A forced termination due to Mr. Ovitz's
apparent failure to perform satisfactorily [after 14 months of employment].
§ NYSE/Grasso Matter: An apparent
forced termination due to Mr. Grasso's receiving the
lump-sum payment of approximately $140 million [after many years of employment
by the NYSE, including approximately eight years as CEO].
3. Significant role of another fiduciary.
§ Disney/Ovitz Case: Michael D. Eisner, a close personal
friend of Mr. Ovitz, is alleged to have had direct and substantial involvement
in the hiring and firing of Mr. Ovitz.
§ NYSE/Grasso Matter: Kenneth G. Langone, a close personal friend of Mr. Grasso,
was appointed by Mr. Grasso to the compensation
committee in 1998 and as chairman from 1999 to June 2003.2 Mr. Langone was actively involved in the compensation committee
process during 2002 and early 2003 leading up to the August 2003 $140 million
payout [although Mr. Langone had stepped down as a
member and chairman of the compensation committee in June 2003].3
4. "Elephant-in-the-living-room"
issue.
In both Disney/Ovitz and NYSE/Grasso, the directors involved apparently did not see the
"elephant-in-the-living-room" issue that resulted in a huge corporate
mistake and public relations disaster for each institution.
§ Disney/Ovitz Case: The "elephant" overlooked was
the enormous size of the severance package if Mr. Ovitz's employment as president
and a director of Disney did not work out. After only 14 months of employment
Mr. Ovitz left Disney.
§ NYSE/Grasso Matter: The
"elephant" overlooked was the public outcry and huge repercussions of
the enormous lump-sum payment to Mr. Grasso. Within
weeks of the payment to him of $140 million Mr. Grasso
left the NYSE.
At an earlier stage of the Disney/Ovitz case,
the Delaware Supreme Court noted, among other things, that
the Board failed to realize that the contract
gave Ovitz an incentive to find a way to exit the Company via a non-fault
termination as soon as possible because doing so would permit him to earn more
than he could by fulfilling his contract. Brehm v.
Eisner, 746 A2d 244, 252 [Del. 2000].
Although it is possible that a person of Mr. Grasso's apparent dedication would stay on notwithstanding
receipt of an enormous lump-sum payment like $140 million, the NYSE directors
apparently failed to take into account that a direct consequence of the huge
payout could include Mr. Grasso's forced termination
of employment.
It must be noted that the allegations in the
Disney/Ovitz complaint go far beyond the public "allegations" made
thus far in the NYSE/Grasso Matter. For example, the
Court of Chancery stated in the Disney/Ovitz Case:
[A]ll of the alleged
facts, if true, imply that the defendant directors knew that they were making
material decisions without adequate information and without adequate
deliberation, and that they simply did not care if the decisions caused the
corporation and its stockholders to suffer injury or loss. 825
A2d at 290.
If one contrasts [a] the allegations in the
Disney/Ovitz Case with [b] what is publicly known about the NYSE/Grasso Matter, one must conclude that the alleged circumstances
in the Disney/Ovitz Case, if true, are much more egregious than what thus far
has surfaced in the NYSE/Grasso Matter. For example,
the NYSE Compensation Committee received advice on the lump-sum distribution of
approximately $140 million from at least two expert consultants at a meeting in
October 2002 and again received advice at a February 2003 meeting before
recommending the lump-sum payment to the full board.
Nonetheless, there are legitimate questions
regarding the handling of the NYSE/Grasso payout.
Role of Directors Other Than Mr. Grasso
1. Was the compensation committee
sufficiently independent of Mr. Grasso in reaching
its decision? As noted above, the chairman of the NYSE Compensation Committee
during the fall of 2002 and into the spring of 2003 [when the lump-sum payment
was being deliberated], Mr. Langone, has been
described as a long-time close personal friend of Mr. Grasso.
As also noted above, Mr. Langone had served since
1999 as chairman of the committee. Several members of the compensation
committee during the deliberations on the lump-sum payment were heads of
investment firms which, in certain matters, were subject to regulation by the
NYSE.
Mr. Grasso has
stated that he made no effort to influence the compensation committee in its
decisions as to his own compensation. Yet one of the outside consultants to the
compensation committee repeatedly indicated in written reports to the committee
in 2002 and 2003 that Mr. Grasso wanted accelerated
payment of elements of his accrued package making up the $140 million. The
reports include statements such as "the CEO would like the Exchange to
accelerate and pay approximately $51.5 million of the projected July 2006
pension benefit to CEO's SESP on
2. On what basis did the compensation
committee, and the board as a whole, conclude that the payout of the $140
million was in the best interests of the NYSE? A major purpose of compensation
is to retain and motivate someone in the employer's service, not to encourage
him to leave. For most people [albeit Mr. Grasso
does not appear to be "most people"], the receipt of $140 million,
whether in the lottery or from an employer, would not seem designed as an
incentive to render future services to the employer. Even if Mr. Grasso were vested in the entire $140 million, it is a safe
bet that had the committee decided not to authorize payout of a lump-sum $140
million, Mr. Grasso would have been inclined to stay
around to receive payment of the $140 million at a later date.4
Minutes of the compensation committee suggest
various benefits to the NYSE including cost savings in making a lump-sum
payment. Did the committee carefully weigh these benefits against the potential
harm and public relations disaster that could result if the payment backfired
[which, in fact, it did]?5
3. Why was Mr. Grasso's
request for a lump-sum payment of $140 million not a red flag to the
compensation committee? Why did the enormous build-up in earlier years not
represent a series of red flags? One wonders how compensation committee members
over the several years preceding 2003 failed to see where they were heading
[or, if they saw it, failed to "stem the tide"], with huge awards in
each year. Please see Table 1 for a comparison of Mr. Grasso's
compensation awards and the NYSE net income for the four most recent years for
which data was obtained in connection with the preparation of this column.
|
Table 1 |
||
|
Year |
Mr. Grasso’s |
NYSE |
|
1999 |
$11.3 million |
$75.2 million |
|
2000 |
$21.8 million |
$72.9 million |
|
2001 |
$31.3 million |
$31.8 million |
|
2002 |
$12.0 million |
$28.1 million |
|
*Note: the compensation figures do not include the very
substantial pension accruals that occurred each year. |
||
Why didn't compensation committee members
along the way see red flags building up year after year? The ultimate red flag
was Mr. Grasso's request in 2002 for the lump-sum
payment of $140 million.
Just months after Mr. Grasso's
departure, with $140 million, someone independent of what went on, the new
chairman, John S. Reed, asked Mr. Grasso to pay back
$120 million of the $140 million. Which raises the point, why didn't someone
sit down with Mr. Grasso and say, simply, "we
seem to have 'overshot the mark' on your compensation and perhaps you might be
willing to reduce the amount, in consideration for a lump-sum payment ahead of
schedule?"
Mr. Grasso's
Fiduciary Role
1. Did Mr. Grasso,
as chairman of the board and chief executive officer of the NYSE, actually
consider that it was in the best interest of the NYSE to pay out to him in a
lump sum an amount that greatly exceeded the net income in the aggregate of the
NYSE for the three years preceding the lump-sum payment?
2. Did Mr. Grasso
ever question whether the amounts being awarded to him over the years were a
"good fit" with the nature of the NYSE as a not-for-profit
institution? In 2001, for example, Mr. Grasso's pay
equaled approximately 100 percent of the net income of the NYSE.
3. Did Mr. Grasso
consider the lump-sum payment of $140 million to himself to be an appropriate
example to set for other senior executives at the NYSE with deferred
compensation and pension arrangements?
4. Finally, did Mr. Grasso,
as chairman of the board, gave adequate consideration to the difficult
fiduciary situation his proposal created for the NYSE Compensation Committee
that took the initial steps leading to the $140 million payout? Should Mr. Grasso, as chairman of the board, have refrained from
making his proposal in 2002-2003 to members of a committee who must have felt,
along with other considerations, the weight of their loyalty to the person who
had appointed them and, in some cases, governed them?
The Delaware Court of Chancery, in its May
2003 decision, spoke of Mr. Ovitz's responsibility as president and a director
of Disney in being sure his own pay was reasonable.
[O]nce Ovitz became a fiduciary of Disney on
* * * *
... Because Ovitz was a fiduciary during both
the negotiation of his employment agreement and the non-fault termination, he
had an obligation to ensure the process of his contract negotiation and
termination was both impartial and fair. The facts, as plead[ed],
give rise to a reasonable inference that, assisted by Eisner, he ignored that
obligation.
In its conclusion in the Disney/Ovitz Case,
the Court of Chancery made the following observation:
[O]ur corporation
law's theoretical justification for disregarding honest errors simply does not
apply to intentional misconduct or to egregious process failures that implicate
the foundational directoral obligation to act
honestly and in good faith to advance corporate interests. Because the facts
alleged here, if true, portray directors consciously indifferent to a material
issue facing the corporation, the law must be strong enough to intervene
against abuse of trust.
As noted above, the egregious actions and
omissions alleged in the Disney/Ovitz Case do not appear to represent the
circumstances in the NYSE/Grasso Matter. This column
is not implying that. However, the observations as to corporate governance and
fiduciary responsibility made by the
NYSE/Grasso and the
Not-for-Profit Corporation Law. In
contrast to the Disney/Ovitz Case, the NYSE/Grasso
Matter involves a not-for-profit corporation. Section 719[a] of the New York
Not-for-Profit Corporation Law [Not-for-Profit Law] provides that, except for
certain payments and distributions permitted under § [515, a director who votes
for, or concurs in, a payment or distribution of cash or property to a member,
director or officer shall be liable for injury resulting to the corporation
from such payment or distribution. Section 515[b] permits payment of
"compensation in a reasonable amount." Distributions are also
permitted under § [515[c] "as authorized by this article" but there
does not appear to be any other clearly applicable exception to warrant the
$140 million payment to Mr. Grasso.
A director otherwise liable under § [719[a]
for such a distribution is not to be held liable if, under Not-for-Profit Law §
[717[a], he has otherwise discharged his responsibility in the matter "in
good faith and with that degree of diligence, care and skill which ordinarily
prudent men would exercise under similar circumstances" in a like
position. This exculpation from the liability imposed by § [719[a] is provided
in § [719[e].
The initial question under the Not-for-Profit
Law would seem to be whether the directors involved in the NYSE/Grasso Matter [including Mr. Grasso]
were satisfied, in good faith, after diligent inquiry, and applying due care
and skill, that the lump-sum payment was in the best interests of the NYSE and
its members. If the directors satisfied this general fiduciary test, § [719[e]
would protect them. If they did not satisfy this test, the question then would
become whether the payment of $140 million [and/or the year-by-year awards as
they built up prior to 2003] represented "compensation in a reasonable
amount."
FOOTNOTES:
[1] Observations in the column on the NYSE/Grasso Matter are based on statements in the press and
other media and on materials released by the NYSE including minutes of meetings
of the compensation committee and reports of consultants to the compensation
committee. Observations in the column on the Disney/Ovitz Matter are based
largely on observations by the Delaware Court of Chancery in In Re The Walt Disney Company Derivative Litigation, 825
A2d 275 [Del. Ch. 2003] and the Delaware Supreme Court in Brehm
v. Eisner, 746 A2d 244 [Del. 2000]. Each court is addressing allegations
contained in a complaint, not established facts.
[2] The Charter of the Human Resources Policy
and Compensation Committee during the period starting in 1998 [when the first
charter provision was examined in preparing the column] until a new charter was
adopted on Aug. 7, 2003 contained the following provision:
RESOLVED, that the HUMAN RESOURCES POLICY AND
COMPENSATION COMMITTEE shall consist of such number of Directors as shall be
appointed by the Chairman and approved by the Board, one of whom shall be
selected by the Chairman to serve as presiding member ...
[3] During most of the year-long process of
deliberations over Mr. Grasso's employment agreement,
including the proposed lump-sum payment, the compensation committee received
reports regarding Mr. Grasso's compensation
arrangements from at least three consultants. In summer 2003, a new committee,
with a new chairman, was appointed. H. Carl McCall, presumably with Mr. Grasso's approval, became chairman and four of the
remaining five members of the committee carried over from the committee that
served for the 2002-2003 period. The new committee under Mr. McCall met on
[4] Mr. Grasso's
then-current contract was scheduled to expire
[5] The minutes suggest cost savings for the
NYSE by "freezing" Mr. Grasso's covered
compensation at the level of his compensation for the years 1999, 2000 and
2001. This particular saving seems unlikely since Mr. Grasso's
covered compensation [salary plus bonus] for 2000 and 2001 was by far the
highest in the history of his career and from the perspective of 2002/2003 not
likely to be repeated in the foreseeable future. Another justification given
was the "removal of an unfunded liability" from the financial
statements.
[6] The NYSE Compensation Committee chose, in
establishing Mr. Grasso's compensation, a "comparator
group" made up of very large financial institutions, such as American
Express Company, Citigroup Inc. and Merrill Lynch & Co. In doing that, it
would seem to have subordinated, in its determination of appropriate pay for
the NYSE CEO, the fact that the NYSE is not a large, for-profit financial
institution but is, rather, a privately owned self-regulatory body organized
under the