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NYSE board to feel heat over Grasso

By David Weidner, CBS.MarketWatch.com

Last Update: 2:16 PM ET May 25, 2004

Last Update: 5:06 PM ET Mar 21, 2006

NEW YORK (CBS.MW) — Should Eliot Spitzer’s much-anticipated lawsuit against Richard Grasso finally make its way to the courtroom, the case could prove to be the biggest of recent scandals to hit Wall Street.

The 27-member New York Stock Exchange board under Grasso was a who’s who of financiers. The chiefs of Goldman Sachs, J.P. Morgan Chase and Merrill Lynch sat on it, among others. So did former Clinton cabinet member Madeleine Albright. The high-profile board would be compelled to testify in a civil trial.

“It has the potential to be a knockdown, drag-out affair,” said Sean O’Shea, a former federal prosecutor on Wall Street who is now in private practice. “You have a high-stakes game of chicken going on here.”

Spitzer, the New York state attorney general, filed a lawsuit Monday in state Supreme Court alleging that Grasso, the former head of the New York Stock Exchange and a key board member, and the NYSE violated state statutes governing not-for-profit companies by approving Grasso’s $188 million compensation package. See full story.

Grasso responded to the suit by penning an opinion in Tuesday’s Wall Street Journal. In it, he promised that “those who thought they could break me with their repeated media leaks badly underestimated my character and resolve.

“I look forward to addressing them in court where they can no longer hide behind Mr. Spitzer’s cloak.”

Grasso also wrote that he will file a counterclaim for $48 million he believes he is owed under his contract. He has received $139 million.

As Grasso’s response suggests, his divorce from the Big Board last year may be laid out before the courtroom and the public. Two key players in the Grasso flap have already cut deals with Spitzer to aid the prosecution.

Through depositions given to Spitzer’s office in investigating the package, there have already been some embarrassing revelations. Bear Stearns (BSC: news, chart, profile) CEO Jimmy Cayne said he was advised that the head of a specialist firm — the companies that run trading on the floor of the NYSE — would benefit from being on the NYSE board of directors.

Bear Stearns has a controlling stake in Bear Wagner Specialists.

Another board member, who was not identified by Spitzer, had reservations about approving Grasso’s salary. Spitzer said that Grasso confronted him and that the board member relented to approving the package.

“This man was also our regulator, and I’m a member of the New York Stock Exchange,” the board member testified. “… And when he’s … your supervisor, or your regulator, you have to be careful.”

Star-studded board

The NYSE’s boardroom was a gathering place for some of the most powerful financial figures in the world. Among the members were CEOs Hank Paulson of Goldman Sachs (GS: news, chart, profile), William Harrison of J.P. Morgan Chase (JPM: news, chart, profile) and Stan O’Neal of Merrill Lynch (MER: news, chart, profile).

It also included other Fortune 500 CEOs such as Juergen Schrempp, chairman of DaimlerChrysler (DCX: news, chart, profile), and Mel Karmazin, president of Viacom (VIA: news, chart, profile). (Viacom is a substantial shareholder in MarketWatch.com, publisher of this report.)

“If this goes to trial, both sides know there will be a airing of their dirty laundry,” said Stuart Meissner, a former assistant to Spitzer in the investor protection and financial crimes bureaus who’s now in private practice. “It very well could be embarrassing for many people.”

Outside of the corporate world, the board also included such notable figures as former U.S. secretary of state Madeleine Albright and former New York state comptroller Carl McCall.

Scott Harshbarger, a former Massachusetts attorney general and one-time Democratic nominee for governor there, believes the board should be ashamed about the rubber stamp they applied to Grasso’s pay.

“Either they knew what they were doing, because they are experts and CEOs, and were tone deaf and lost total contact with reality, or they didn’t pay any attention,” said Harshbarger, now president and CEO of the good-government group Common Cause.

It’s “a major critique of corporate governance — people who were asleep at the switch,” he added.

The third possibility is the one Spitzer alleges, and it’s the most damaging: that the executives were in the pocket of Grasso. Harshbarger indicated it isn’t yet clear if that scenario existed, but it could be by the time the case gets to court.

Spitzer’s gamble

So far, some legal analysts believe that any pressure former NYSE board members may feel not to testify hasn’t worked. And they believe Spitzer is risking his reputation on a case that has very little upside.

Count O’Shea, the former prosecutor, is in this camp. “It’s already been tried and played out,” he said. “All of the sideline arm-twisting has been tried and it’s failed.”

Ultimately, the case will at least stake out new ground in many areas, according to Roy Smith, a professor of finance at New York University and former partner with Goldman Sachs.

Not since former NYSE chairman George Whitney was convicted of stealing pension funds in 1938 has the exchange seen such a scandalous matter. What’s more, never have so many Wall Street executives been caught up in a potentially damaging civil suit.

“Nothing ever like this has happened to the exchange before — any exchange,” Smith said. “Public prosecutors — from Thomas Dewey to Rudy Giuliani — have brought big juicy suits against Wall Streeters before, but even then they were enforcing federal securities laws.”