Lawyers aren't exactly known for their creativity. But Eliot Spitzer is not a typical attorney. Ignoring traditional regulatory boundaries, the politically ambitious New York attorney general has turned a little-known state statute, the Martin Act, into a surprisingly powerful tool for policing analysts, investment bankers, and mutual-fund managers.
Now Spitzer has unveiled a new legal innovation. He's using New York's obscure Not for Profit Corporation Law to try to force ex-New York Stock Exchange Chairman Richard A. Grasso to return more than $100 million in compensation.
Will the gambit work? In law and business alike, most bold risks flop. That could certainly happen in this case. Spitzer's case is a very rare lawsuit indeed -- one with almost no direct precedents. Neither side can confidently predict how judges or jurors will react to their arguments. "This is completely uncharted territory," says James J. Fishman, a professor at Pace University Law School who is a co-author of New York Nonprofit Law and Practice.
The Not for Profit Corporation Law is, like most other statutes, quite vague. It says that an officer's compensation should be "reasonable" and "commensurate with services performed." Spitzer's defenders like to point out that these words were successfully used in 1998 to force Adelphi University President Peter Diamandopoulos to refund part of his compensation -- which soared, in 1996, to the then-shocking sum of $837,000.
This seemingly close precedent would appear to bode well for Spitzer. But there's a big difference between the case against Diamandopoulos and the one against Grasso. Under New York law, Adelphi is a "Type B" nonprofit -- a category that encompasses educational, religious, scientific, and cultural institutions. In contrast, NYSE is considered a "Type A" nonprofit, which includes trade associations, country clubs, labor unions, and consumer cooperatives. The salient difference between the two: Type B nonprofits have charitable public missions. They owe a broad duty to the citizens. In contrast, Type A nonprofits tend to be private. They're legally responsible to their owners. "The two are totally different creatures," says Fishman. "There is less of a halo around Type A" nonprofits.
The distinction could wind up having a substantial impact in this case. Plenty of trade associations provide their leaders seven-figure incomes. And there is broad legal authority, outside of the narrow confines of New York State's nonprofit case law, for the notion that charitable and noncharitable boards of directors should have wide discretion over how much money to pay top managers.
But the fact that NYSE's board may have had a lot of room to set Grasso's pay does not mean that it had no ceiling whatsoever. Sure, some industry lobbyists, college football coaches, and symphony directors may make more than $1 million annually, but it's doubtful that too many of them earn more than $40 million and consume almost all of their organization's net income.
Grasso's compensation had no obvious parallels in the nonprofit world -- and it's not clear at all that his pay package was fully disclosed to the directors of the stock exchange. In these circumstances, a jury could well decide that the vague words "reasonable" and "commensurate" in New York's Not For Profit Corporation Law have concrete meaning as limits on executive compensation.
Assuming the case goes to trial, about the only way Grasso's attorneys can defend his pay package is by arguing that he deserves as much money as the Wall Street tycoons he regulated. But that position is a stretch. Compared with, say, Goldman Sachs (GS), Merrill Lynch (MER), or Citigroup (C), the NYSE doesn't have equal "revenues, income, or employees. And its mission does not include a search for profits," says Daniel L. Kurtz, a New York nonprofit legal specialist who used to lead the state AG's charities bureau. Nor did Grasso face any personal business risk.
Bottom line: Both sides have much to lose in going to court. That's why many observers predict a settlement. But if the hard-charging Grasso refuses to cut a deal, a fascinating battle is all but guaranteed. And Spitzer's status as a legal innovator will be put to a test.
By Mike France