The $140,000,000 Man

What Dick Grasso's excessive payout reveals about how he runs the New York Stock Exchange

It is as vital a ritual as the ringing of the opening bell, but no celebrities are present, save one -- Richard A. Grasso. At about 7:30 every morning, the chairman and CEO of the New York Stock Exchange is handed a set of papers at his desk on the sixth floor of 11 Wall St. This 57-year-old, wiry, bald man is the best-known -- and notoriously the best paid -- stock market executive in the world. Ever since it was announced on Aug. 27, his $140 million compensation package has been a subject of intense criticism -- and an investigation by the Securities & Exchange Commission. But no matter how bad the sniping from that and other crises, the numbers on those daily pages are solid, consistent -- and reliably glorious.

The papers have no special name -- "my overnights," he calls them -- but they explain why Grasso is Wall Street's $140 million man. They are market-share statistics for each of the top 100 NYSE-listed stocks. For years, the NYSE's share of trading in its listed stocks has been 80% or better -- an extraordinary performance, considering the growing number of competitors that face the NYSE. The comparable figure for the NASDAQ market is just 16.4%.

To Grasso's detractors, what matters most is not his financial performance but his moral leadership -- and in that realm, they maintain, Grasso is sorely wanting. On Sept. 2, SEC Chairman William H. Donaldson fired off a letter demanding that the NYSE explain, in detail, how it determined Grasso's pay package. And as if to drive home the point, the SEC released the letter, which contained an extraordinary public bawling-out of a sitting NYSE chairman. "In my view," Donaldson wrote, "the approval of Mr. Grasso's pay package raises serious questions regarding the effectiveness of the NYSE's current governance structure."

Even before the paycheck bombshell, institutional investors were going public with long-festering complaints about improper practices on the NYSE trading floor. Criticism was mounting over the NYSE's lack of transparency and unique version of governance, under which Citigroup Chairman Sanford I. Weill, then under regulatory scrutiny, was offered a seat on the NYSE board of directors -- not in his role as a financier but as a representative of the "public."

As a "private entity with a public purpose," to use a phrase often employed by Grasso, the stock exchange is expected to take the high moral ground -- to set standards. Since becoming chairman in 1994, Grasso has firmly staked out that ground and parlayed that into unparalleled financial success. "He has waved the flag often enough to persuade investors and the world and public opinion that the NYSE is an American icon," observes former SEC Chairman Arthur Levitt.

Somehow, the high ground has slipped away. How did it happen? Interviews with NYSE insiders, the exchange's competitors, critics, and allies -- and Grasso himself -- paint a picture of a complex institution that is superbly managed as a private enterprise yet is, as its critics contend, a parody of corporate governance. Far from serving as the gold standard for Corporate America, Grasso instead presides over an institution that has only grudgingly and belatedly engaged in reform of its internal governance -- despite its public responsibility as a regulatory body.

Grasso's NYSE has an uneven record as a regulator, nabbing insider traders with admirable alacrity but often criticized for not adequately regulating the behavior of its floor traders and member firms -- such as the specialists who manage trading of NYSE stocks. To be listed on the NYSE, companies must meet certain standards of governance, giving the exchange a voice in the national dialogue over corporate reform.

At a time when public policy is tilting toward stronger, more independent boards, the NYSE's board of directors falls short. The board -- which includes such non-Wall Street luminaries as Avon Products (AVP ) CEO Andrea Jung, Viacom (VIA ) President Mel Karmazin, and former Secretary of State Madeleine K. Albright -- is virtually handpicked by Grasso, who essentially determines the board's composition despite a supposedly "independent" nomination process. Indeed, Grasso's assertions that the board member-selection process is independent -- even more independent than that of most public corporations -- have been so vociferous that he appears to have provided incomplete or even misleading testimony on that subject to the Senate Banking Committee in May.

So what did Grasso do to earn his $140 million? Simply put, he took good care of his primary constituency -- the 1,366 men and women who own memberships, or "seats," that enable them to trade on the NYSE floor. Even though some seat holders say they were stunned when they learned of the pay package, most appear to have accepted it with equanimity. Robert W. Seijas, ex-CEO of Merrill Lynch Specialists and an exchange veteran, says the reason is simple: "The seat holders are the [NYSE's] shareholders, and they've seen an extraordinary increase in the value of their shares."

That's because Grasso is an undeniably talented manager. Early in his tenure as chairman, he made the NYSE into a powerhouse for initial public offerings, grabbing business that once belonged to NASDAQ. Even his sharpest critics agree that Grasso's has almost single-handedly built up the exchange's public image -- which, along with an intense detail-oriented approach, has helped maintain the NYSE's superb market-share numbers. In 1999, seat prices reached an all-time high of $2.6 million. Even today, despite a three-year bear market, exchange seats are selling for $2 million -- the same as they were during the tail end of the bull market in 2000. By contrast, seat prices were as low as $760,000 when Grasso took over the NYSE in 1994.

Few investments outside of the NYSE -- and fewer stocks of listed companies -- can boast such impressive results. Former NYSE board compensation committee chairman Kenneth R. Langone, who owns two NYSE seats, notes that he leases out both of his seats -- and that, with annual lease prices in the $200,000 range, the rate of return from the leases is a healthy 10% or better, even for seats that were purchased at the height of the market. Indeed, for longtime NYSE members -- in the 1970s, seats could be bought for as little as $35,000 -- owning an exchange seat is a real gold mine.

With seat sale and lease prices so healthy, the exchange's intense public-relations campaign under Grasso generated little controversy even though it irritated some traditionalists who disliked Grasso's PR stunts. Grasso's leadership on September 11 -- when the exchange swiftly resumed trading despite fearsome damage to Lower Manhattan -- cemented his reputation for crisis management, as did his performance during the recent blackout. Unfortunately for Grasso, September 11 was followed by a wave of corporate scandals that focused attention on the NYSE's weak spot -- its corporate governance.

If "governance" at the NYSE were to be judged solely on the basis of its CEO's relationship with his shareholders, Grasso's could hardly be better. Grasso has a special relationship with the floor: He meets with seat holders often, in sometimes tempestuous informal gatherings and also in one-on-one meetings -- no difficult feat, considering the manageable number of seat holders and the fact that most of them work in his building. They are not just his corporate overlords and ultimate bosses. They are his friends -- in a sense, his family.

Grasso's hardscrabble early life has, if anything, burnished his reputation on the trading floor -- a blue-collar stronghold where college degrees are strictly optional. Grasso's father left the family when Richard was an infant, and he was raised in a working-class neighborhood in Queens, N.Y., by his mother and two unmarried aunts. Young Grasso, like many traders at the exchange, was a "street kid." An indifferent student at Newtown High School, he dropped out of New York's Pace University and subsequently served two years in the U.S. Army in the 1960s. It is the stuff of internal folklore how he landed a clerk's job in the NYSE's stock lists department two weeks after leaving the army in 1968, adapted rapidly to the NYSE's arcane procedures, and quickly became a rising star.

Grasso made friends easily and became a favorite of the floor community. In the early '80s, he even had a chance to become a specialist, in the employ of his good friend, veteran specialist William Johnston. But Grasso turned down the job because of an even more promising alliance with the man who became his mentor and patron -- and, in later life, his neighbor in Long Island's fashionable Locust Valley. The taciturn ex-Marine and second-generation specialist John J. Phelan Jr. became president of the Big Board in 1980 and then chairman, and Grasso rose along with him. In 1988, Grasso became president of the exchange.

Phelan's successor was Donaldson, educated at Yale University and a founder of the brokerage firm Donaldson, Lufkin & Jenrette. In an ironic twist -- given Grasso's recent conflict with Donaldson -- Grasso owes his career to the current SEC chairman. The working relationship forged between these two very different men was a tribute to the political savvy and the pragmatism of both. Grasso had considered resigning when Donaldson got the appointment in 1991 but stayed on after meeting Donaldson for a leisurely dinner at a Manhattan restaurant. Donaldson offered Grasso what the latter describes as a "partnership." Grasso accepted.

As managers, the two men were polar opposites -- Donaldson detached and aloof, a delegator. "Bill Donaldson brought a more professional, CEO-kind of management," says Catherine R. Kinney, now co-president of the NYSE and executive vice-chairman of the board of directors. "Bill delegated to Dick. He was the advocate, the visionary, the outside person, and Dick was very much the chief operating officer and ran the exchange," says Kinney.

The two men differed in ways that had important internal symbolism. Grasso came to the trading floor almost every day, glad-handing and slapping backs, and almost never missed a retirement dinner -- whereas Donaldson rarely could be seen at such occasions. It's not just "shareholder relations," say friends. Grasso genuinely enjoys these events, posing eagerly for photographs with retirees as eagerly as he appears in daily photo opportunities during the ritual ringing of the opening bell.

Grasso brought the same hands-on approach to the NYSE's external relationships, at the same time as he intensely focused on the nitty-gritty of market share and competition for listings. He raised the exchange's public image, gaining free publicity by persuading celebrities to ring the opening bell -- and engaging in publicity stunts such as a charity boxing match and appearing in an episode of the HBO series Sex and the City.

Grasso also mended Donaldson's uneasy relationship with Arthur Levitt's SEC. Indeed, the difference in the two men's approach to the SEC is instructive, particularly in light of recent events. As NYSE chairman, Donaldson had wanted to encourage overseas companies to list on the exchange by pressing the SEC to relax rules requiring the application of generally accepted accounting principles (GAAP) to non-U.S. companies. Levitt refused, straining relations with the NYSE. But instead of irritating Levitt and the SEC by pushing that losing cause, Grasso and Levitt agreed that the SEC chairman, a former chairman of the American Stock Exchange, would join him in a campaign to attract overseas companies. Levitt said the deal was that "the two of us will go around the world attracting listings." After all, he told Grasso, "I'm a pretty good listings salesman." Grasso agreed, avoiding a nasty political battle.

Grasso's hands-on approach to the exchange's management extends to its highest echelons. The NYSE board of directors, unlike most corporate boards, does not nominate its own members. Theoretically, that makes it more independent than corporate boards -- a point Grasso has repeatedly emphasized in his public statements and in his appearance before the Senate Banking Committee on May 7, in which he was questioned sharply by Senator Paul Sarbanes (D-Md.) on his role in the Weill affair. He has explained time and again that the exchange has a nominating committee, independent of the board, that appoints members of the board. Nominating committee members, a mix of financial and public representatives, are not allowed to serve on the board. The current committee includes such prominent members as Prudential Financial President Arthur F. Ryan and New York University President John Sexton. The committee has a long history, dating back to the early 1970s, and in theory it should insulate the board from Grasso and provide a genuinely independent source of board members, who serve two-year terms.

In practice, it doesn't quite work that way -- something that is of more than academic interest in the wake of the Weill fiasco and the selection of homemaking guru Martha Stewart to the board not long before her recent travails. Even though the nominating committee picked Weill, Grasso concedes that the idea for selecting him -- and all other board members, for that matter -- was actually his. In his interview with BusinessWeek, which took place prior to recent pay imbroglio, Grasso explained that he has an annual "audience" with the nominating committee, in which he provides names of potential board members from which the nominating committee makes its selections.

The nominating committee is not obliged to accept Grasso's choices, but it invariably does so. "We have a dialogue every spring," Grasso told BusinessWeek. "I lay out usually five to seven candidates. And they're not compelled to listen to those five to seven. They can do whatever they want." By contrast, Grasso's Senate Banking Committee testimony emphasized the independence of the process and testified that "there is separation of the chief executive from that nominating process." An NYSE spokesman, Ray Pellechia, denies that Grasso was misleading in his testimony and says that time constraints prevented a fuller explanation. He also pointed to an Apr. 3 press briefing in which Grasso briefly mentioned, without elaboration, that he has an "audience" with the nominating committee.

Although CEO "audiences" with the nominating committee long predate Grasso, the practice -- and the committee's failure to make independent choices -- ensure that the board is not exactly a hotbed of dissent. Or, as board member William B. Summers Jr. puts it, "people have great collective respect for one another." Indeed, the NYSE board appears to be almost entirely free of strife and factionalism -- and according to Langone, the board's votes on compensation issues have been unanimous for years. Langone, a former chairman of Home Depot (HD ), served as head of the human resources and compensation committee from 1998 until June, 2003. He is a close friend of Grasso, so close in fact that Grasso served on the Home Depot Inc. board until adverse publicity caused him to resign. Langone left the NYSE's compensation committee as a result of the controversy. Grasso's earlier term on the board of Computer Associates International Inc. (CA ) had also drawn fire, in part because of that company's lavish executive compensation.

Blessed with such a harmonious board, filled with friends such as Langone, it was little wonder that Grasso wound up with a sweet pay package when his contract was last negotiated in 1999. The compensation committee, based on recommendations from the consulting firm Hewitt Associates, used as benchmarks the pay of financial-services executives. Grasso was given the option, which he exercised, of deferring his pay and bonuses at a risk-free rate of 8% a year -- although Summers and Langone say they do not know whether that interest was yielded by an investment contract with an independent investment manager, or was simply paid by the NYSE.

According to Summers, the pay package that was provided to Grasso in 1999 -- and its controversial interest rate for accrued pay -- reflected the soaring prospects of the exchange and the fact that Grasso was not eligible to receive the stock options that were all the rage at the time. There was, he maintained, no sentiment for pegging Grasso's salary to the pay scale of regulators. That would have cut his pay -- which includes but is not limited to a base salary of $1.4 million and an annual bonus of $1 million -- to just a fraction of its current level. (Donaldson, by contrast, earns about $140,000 a year at the SEC.)

Summers could shed no light on the combination of pay and previous bonuses that led to Grasso's $140 million accumulated pay, which he will receive in a deal that extends his contract expiration from 2005 to 2007. "It was put in place at a time when 8% did not raise eyebrows," says another person familiar with the board's decision. The exchange has declined to elaborate on the composition of the package -- or how much Grasso was paid each year -- beyond saying in a statement that $40 million was from "his savings account balance," another $51.6 million consisted of a "previously accrued retirement benefit," and another $47.9 million were "relating to prior incentive awards."

The decision to extend Grasso's contract through 2007 -- although only recently announced -- actually took place in late 2002, according to a person familiar with the chain of events. Harvey Pitt was leaving as head of the SEC, Paul H. O'Neill was departing as Treasury Secretary, and Grasso was widely named as a possible successor to both of them. That led the compensation committee -- then under Grasso's pal Langone -- to send a member to approach Grasso to discuss a possible extension of the contract. Grasso was agreeable to extension of the contract -- but only for two years. Thus Grasso's decision to stay at the stock exchange was actually made long before the contract extension was announced. People familiar with the decision vigorously deny that Grasso cashed out his deferred compensation -- thereby ending his 8% interest bonanza -- because of the potential for adverse publicity. But if that were the motive, it backfired, judging from the vociferous reaction.

Grasso himself has long been mum on the subject of his compensation, saying that he has had no input into his pay and that the only words he has given the board on the subject are "thank you." He is likewise serene on the other hot-button subjects concerning his tenure, including the age-old debate over whether the NYSE provides better service to his customers than the competition. His competitors' business models are, he says, "very compelling." His deadpan expression hardly changes, not even into the second hour of a three-hour interview with BusinessWeek, but his words are laced with sarcasm. "I guess they should feel pretty happy about that," he says. "That must mean they think they're going to put us out of business."

Grasso has seen to it that even after he is gone, change at the NYSE is likely to be incremental at best -- with the interests of his seat holders remaining a matter of paramount importance. Elimination of the exchange's floor-trading system, as urged by some exchange critics, would be the equivalent of burning the wallets of those 1,366 members -- and it is not about to happen. The specialists are the exchange, and the exchange is Grasso. "Some people say: 'The exchange will die in 100 years. Kill yourself tomorrow.' Forgive me if I don't elect that strategy," he says.

Specialists and floor brokers are likely to continue to hold sway at the exchange, for the simple reason that they own it and dominate its corporate culture. When Grasso became chairman and CEO, he appointed his specialist friend and would-be employer Johnston as president. After Johnston's retirement at the beginning of 2002, Grasso elevated two longtime insiders whose careers, like his own, had been spent entirely at the exchange: Kinney and Robert Britz both hold the title of president -- exchange officials eschew the term "co-presidents" -- and their experiences and temperaments dovetail as neatly as Donaldson's and Grasso's. The outgoing Kinney, who began as a regulatory trainee in 1974 and moved into marketing under Grasso's tutelage, is the "Ms. Outside." The more taciturn Britz, a 30-year exchange veteran who began in the Grasso manner as a listings rep, is the "Mr. Inside." The two complement each other while not, as it happens, posing anything resembling a threat to Grasso.

When it comes to threats, Grasso is an old and seasoned warrior. Internal threats? Not very likely, with Grasso effectively controlling the board. Competitive threats? Asked about them, Grasso's reaction is reminiscent of George W. Bush on the subject of Iraqi guerrillas -- Bring 'em on. "We learn from them," he says of his competitors. "I think we're very good at adapting technology." But Grasso is more than just an apt pupil. His attitude toward competitors is a combination of bemusement and condescension. Asked about one upstart named Liquidnet, a computer system that joins the trading desks of institutional investors electronically, Grasso is suitably restrained. "What are they doing? About 6 million shares a day?" asks Grasso. "If they're good, they'll draw liquidity. What draws liquidity is better pricing." Investors who believe they can get better prices elsewhere, he maintains, should go elsewhere.

Many institutional investors contend that Grasso is wrong. Traders, they maintain, flock to markets where they can most easily find a buyer or seller -- even when pricing is not the fairest. And indeed, they charge that at the NYSE, large block trades get worse prices than smaller ones. Sam Lek, a vocal Grasso critic whose Lek Securities has 15 seats on the exchange floor, says being the No. 1 exchange "doesn't give you the right -- nor is it smart -- to antagonize your customers and say: 'If we're not so good, don't come here.' Because that's going to become a self-fulfilling prophecy."

Only Bill Donaldson can make such prophecies a reality. Dick Grasso's ability to deal successfully with Donaldson's SEC is likely to be the biggest test of his career. Grasso could go a long way toward defusing this crisis by redefining the composition of the compensation committee to ensure that no executive of a company regulated by the NYSE can have a say in his paycheck. He could also ask the board to use more modest compensation benchmarks than Wall Street's executive payroll. He might even consider giving back some of the money.

Grasso has managed to charm his way out of vexing difficulties before, dating back to the days when he was a fatherless boy in Queens. Traders are avid gamblers, and -- while there are no formal odds on the subject -- the betting on the trading floor is that in a one-on-one match, Grasso vs. Donaldson, the guy who went to Yale loses to the guy who went to Newtown High. Period.

That would be a smart wager if not for one thing -- the public's patience with the NYSE is growing short. For years, Dick Grasso has been the undisputed overlord of a private entity that all too often has paid lip service to its public purpose. It's a long-running act. But an experienced showman like Grasso ought to know better than anyone when a long-running act is starting to wear thin.

By Gary Weiss

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