After the corporate scandals that dominated the headlines two years ago, bringing down some of the biggest names in American business, every company in the country could read the writing on the wall: governance would be a sensitive issue for some time to come; executive compensation would be under intense scrutiny; board independence would be increasingly important.
So how did the New York Stock Exchange, the board on which most of the largest companies are traded, remain oblivious to the changing public mood? How did it allow itself, only months later, to become embroiled in a controversy involving an astronomical payment to its CEO and apparently lax oversight from a board of dubious autonomy?
Those were the questions public relations professionals were asking this week after NYSE chief executive Richard Grasso was forced to resign as questions about his compensation—and his handling of those questions—made his position at the helm of one of the world’s largest and most financial institutions increasingly untenable.
By the end of the week, there were even more questions, as critics of the Exchange began to ask whether its trading model was fundamentally flawed.
“Dick Grasso’s downfall was the assassination of the Archduke Ferdinand,” says Michael Weiser, president of The Weiser Group. “It was the opening competitors and critics of the NYSE have been waiting for. The NYSE’s historic opposition to trading floor automation, its heavy-handed approach to competitive issues, controversial regulatory issues and questionable governance decisions had created a long list of those willing to pounce when the opportunity arose.”
Grasso had demonstrated his tin ear once before, when Grasso came under fire in March when he nominated Citigroup chief executive Sanford Weill to become one of the exchange’s so-called “public” members—on the board to represent the best interests on investors—after Citigroup’s Salomon Smith Barney unit had agreed to pay $400 million to settle allegations that it misled investors with tainted stock research. Weill later withdrew.
In the wake of that brouhaha, the Securities & Exchange Commission asked various exchanges, including the NYSE, to study their own corporate governance practices and report on the findings. “If you’re going to set standards for other people, you’ve got to set standards for yourself,” said SEC chairman William Donaldson.
Grasso was reappointed chairman in June, and on August 27 the Exchange made its first public disclosure of his compensation, indicating that he would collect $139.5 million in deferred retirement benefits and a pay package of at least $2.4 million this year. Carl McCall, chairman of the compensation committee, said the NYSE board felt Grasso was worth the money, and that the release of the pay figures was part of a broader NYSE effort to improve transparency. But Donaldson—himself a former NYSE chairman—expressed concern.
Donaldson asked for more details of Grasso’s compensation, and on September 8 the NYSE board acknowledged that Grasso was entitled to an additional $48 million in future compensation. Some board directors said they were surprised by the additional compensation, with one member telling reporters that Grasso’s employment contract was so complex it was difficult to decipher his deferred compensation. The announcement prompted some to question whether Grasso could remain.
The New York Times noted that Grasso has done the impossible: “Making Wall Street gasp in astonishment at someone else’s compensation.”
With reporters clamoring for access to 1,200 pages of documents relating to the chairman’s retirement package, the NYSE said it would restrict distribution of those documents “in the interests of saving the world’s forests.” A day later, the Exchange changed its mind, saying it would make available documents specifically requested by reporters. Each news organization was allowed to send two reporters to the exchange to examine the documents for two hours. The reporters could take notes but couldn’t take documents or make copies of them.
According to The Wall Street Journal, “Many news organizations said they were convinced it was a ploy by the Big Board to hide bad news, especially when the information would likely become public at some point through a Freedom of Information Act request.”
Said Stephen Shepher, editor in chief of BusinessWeek, “They are compounding their stupidity. All it does is foster the further impression they are covering something up. Any crisis manager would tell you, if you have bad news, get it all out at once, and they are following that advice in reverse. It is dribbling out and the controversy lingers and lingers and lingers.”
“The NYSE has always been about as transparent as the Kremlin but today the intrigue and secrecy reached new heights,” said Thor Valdmanis, senior Wall Street reporter for USA Today
Robert Zito, the NYSE’s executive vice president for communications responded that the NYSE was under no obligation to make the documents public in the first place. “There is nothing to hide. We did not have to do this,” he told reporters.
A week later, the heads of four of America’s largest public pension funds, representing combined assets of $401 billion, called on Grasso to step down. Said California state treasurer Phil Angelides, “This pay package is out of line and it’s part of a sickness of culture in this country where too many at the very top have forgotten what’s right and fair in the American economy and what average workers make in this country.”
The next day, Grasso was gone.
His decline and fall seemed to happen overnight, but some observers felt his fate was sealed by earlier missteps and a failure to understand changing expectations.
“Grasso was a good leader, fostering growth and a series of operational and organizational improvements for the NYSE,” says Rich Taubmann, senior vice president and head of the investor relations practice at The MWW Group. “But he quickly became the latest scandal de jour for the investment community and media.
“His previous missteps serving on corporate boards and mishandling the Weill appointment put some chinks in his integrity. The announcement of this enormous pay package was the final straw; made worse by the fact that it was approved by a NYSE board comprised of heads of companies he oversaw. His imperial-style help and communications missteps assured that this would be his downfall.”
Critics say the Big Board is governed for and by a small group of specialists, members, regional brokerages and listed companies should be long gone. The previous head of the NYSE’s compensation committee was Kenneth Langone of Home Depot, whose board Grasso sat on. Many of the other Big Board directors were chosen by Grasso.
But others believe it was the cover-up (or at least the appearance of a cover-up) that did more harm than the crisis.
“Grasso would have likely survived the pay issue,” says Evan Goetz, senior vice president in the New York office of international investor relations firm Financial Dynamics. “However, once the news of the additional $48 million package broke, that PR disaster is what ultimately caused this chain of events.”
The failure to disclose the additional $48 million in the initial disclosure, couple with the NYSE’s decision to restrict access to compensation documents, created the impression there was something to hide, and prolonged the crisis.
“The compensation issue was the key factor leading to Grasso’s resignation,” says Taubmann. “The sheer size and the fact that the NYSE is a non-profit, quasi-regulatory body made it lethal in the post-Enron era.”
But Grasso’s “cavalier attitude surrounding the issue, his failure to adequately address questions in a timely fashion and the NYSE board’s seeming incompetence on the matter just hastened his demise and brought a panoply of other NYSE activities under the spotlight,” Taubmann adds.
“The decision to limit media access to Grasso’s employment contract immediately created an air of skepticism,” adds Goetz. “Skepticism about the exchange’s desire for open sharing of information, for transparency—the very principles that NYSE listed companies are required to abide by. The resulting press coverage, from The Wall Street Journal on down, captured the confusion of the day down to the minute detail, which negatively affected public perception of the situation and quickly became a communication debacle.”
Like many of his corporate peers, Grasso seemed shocked that anyone would question whether he was worth all those millions.
“In public relations, hubris kills,” says Weiser. “The lack of contrition exhibited by Grasso in the course of answering serious questions about the size of his compensation package and the governance process that awarded it to him fueled his critics and made him a juicy tabloid target. Once he became a punch line, it was too late.”
Says Peter Hirsch, who heads the corporate practice at Porter Novelli, “Grasso should have known that in the harsh light of the post-Enron era that his compensation package would cause an uproar. The NYSE board, no stranger to controversy at this point, should have undertaken a thorough review of every perception issue and figured out that they needed to persuade Grasso to renegotiate his package.”
Given his past performance, many observers were surprised that he failed to grasp the severity of his situation.
“Grasso had been a master of communications, effectively raising his and the NYSE’s profile while making himself a media star with frequent interviews and stunts like the bell-ringing photo-ops with celebrities,” says Taubmann. “In this instance he did not quickly enough grasp the importance of the story and understand the impact on his key constituencies. He retreated to the bunker, pretended this was not a big issue and saw his goodwill with the media quickly evaporate.
“The bumbling NYSE board did not help matters but Grasso seriously miscalculated the depth of the problem and his need to deal with it effectively. He did not get out in front of the news, allowing the media to focus on the huge numbers of his pay package and past missteps rather than all he had done for the NYSE. A quicker give back of compensation or charitable contribution may also have helped.”
If there’s one thing on which public relations experts are agreed, it’s that Grasso’s resignation will not kill the larger story.
“While normal crisis management wisdom indicates that the forced resignation of Richard Grasso should ease the media pounding the NYSE has sustained over the past weeks, nothing of the kind will take place,” says Al Tortorella, veteran crisis counselor and head of the corporate practice at Ogilvy Public Relations Worldwide. “The Grasso palaver over pay is just Act One of a Wall Street morality play. Act Two is a revised board. Act Three is more control by the SEC.”
In particular, questions about the Exchange’s board of directors are likely to intensify.
“The mishandling of the compensation matter by Grasso and the NYSE Board has unleashed a wider assault on the Exchange,” says Taubmann. “Legislators, regulators and the media all joined the fray and as Grasso inevitably resigned the focus was already turning to reforming the institution.
“Governance, trading methods, organizational operations and technology are all now being hotly debated. Grasso’s replacement will need to be someone from outside the NYSE with a reputation beyond reproach. It will likely be someone with a government or regulatory background.”
Grasso’s resignation “has created a once-in-a-generation opportunity to improve the Exchange’s commitment and ability to serve the public interest,” says Muriel Siebert, chief executive of Siebert Financial and the first woman to own a seat on the NYSE. “But if the board and management of the exchange close ranks and resist further change, investors will know that they can expect business as usual in the post-Grasso era.”
There are two important immediate challenges for the Exchange, says Gordon McCoun, senior managing director at Financial Dynamics. “First, it has to repair the immediate damage to the credibility of the management of the Exchange. Second, it has to justify the auction market as a legitimate market structure.”
The first order of business, says McCoun, is to appoint an appropriate successor. That individual “will need to have a high level grasp of the financial markets and an unimpeachable reputation for candor and fairness.”
“Not all CEOs or famous businessmen are anathema to the media and regulators,” Tortorella says. “Some, like Warren Buffett, Robert Rubin, and John Chambers should immediately be recruited to put the issue of pay into perspective and defend the soundness of the NYSE. The exchange should also fund an advertising campaign directed to major cities and Capitol Hill since the SEC and Congress will be the most important participants in the NYSE’s future”
(As this story went to press, the Exchange announced that it had hired John Reed, former chief executive of Citibank, as interim head. The search for a permanent replacement is ongoing.)
Once the right individual is in place, the Exchange must redress the damage to the credibility of the board of directors, McCoun says, since it was the directors who approved Grasso’s compensation. “Dick Grasso did not pay himself,” says Tortorella. “If he had he probably would have taken less than what was given to him by those who did pay him.”
Peter Hirsch goes even further.
“This is one more example of something that starts as a crisis of trust becomes a crisis of legitimacy,” he says. “The board needs to decide whether it should resign en masse and be reconstituted in a dramatic way or for individuals to quietly not receive renewed terms while the process of restoring the legitimacy of the institution gets underway, because it is the legitimacy of the institution that is under threat.”
However the board is reformulated, the new directors should not be insiders. “The proposal put forth by Goldman Sachs’ Henry Paulson to exclude executives of securities firms and listed companies from the Exchange’s Board would be a step in the right direction,” McCoun believes.
Taubman agrees. The NYSE board will need to be reformed “with less emphasis on Wall Street heads. This was a wake-up call for the way the NYSE operates from A-to-Z and one should expect lots of changes in an effort to restore credibility, while Grasso takes his leadership skills to a lucrative private-sector assignment.”
The new leadership, both the chief executive and the board, will have to address some larger questions.
“There is an argument that the NYSE, as an auction market, is inherently less efficient for executing trades than Nasdaq, a dealer market,” says McCoun. “This question has existed for some time, but the level of the debate has been elevated by the investigation into the specialists’ activities, which has created the perception that there is a group of privileged people on the floor of the exchange that are profiting from the institution without providing a valuable service.”
To defend the auction model, “the NYSE should carry out an information campaign that publicizes the execution strength of the Exchange,” says McCoun. “The point will have to be made that investors benefit from the auction model, where stocks trade in one location and there is human intervention to ensure fair execution of trades.
“During the boom and bust of the recent market cycle, the NYSE has remained competitive with Nasdaq in attracting new listings because it has convinced corporate managements that their shares will be traded efficiently and volatility minimized. The same case needs to be taken to the investing public in a way that is comprehensible to the average person.”
Clearly, there are challenges ahead, but most experts are confident the New York Stock Exchange will emerge intact and possibly even strengthened by the crisis, provided it embraces change and listens to legitimate criticisms.
“The NYSE is one of the few business organizations in the world that has a reservoir of goodwill from which to draw,” says Weiser. “Clearly, it needs to address its critics but its biggest mistake would be act too quickly in initiating reforms that will be a model for U.S. corporations. The most important thing it can do is to make its reform process as transparent as possible. It should not be afraid of criticism. Rather, its goal must be to avoid inviting cynicism.”