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The legal battle between New York Attorney General Eliot Spitzer and Richard Grasso, the former head of the New York Stock Exchange (NYSE), will be fought in state, not federal, court a federal judge ruled Thursday. The decision by Southern District Judge Gerard Lynch in State v. Grasso rejected Grasso’s claim that federal laws pre-empted Spitzer from bringing a suit against a federally regulated entity like the exchange. Supreme Court Commercial Division Justice Charles Ramos will preside over the case first filed by Spitzer on behalf of the New York Stock Exchange on May 24. The attorney general’s essential argument is that Grasso’s compensation package of $187.5 million was unreasonable under New York’s laws governing nonprofits and should be returned. It is a significant victory for Spitzer to have fended off Grasso’s move to change jurisdiction. Judge Lynch made it clear in his decision that the federal laws regulating the exchange do not prevent the attorney general from bringing an action based on state claims. This was a key defense presented by Grasso in his court filings. Lawyers and nonprofit experts, however, point out that Spitzer faces significant legal hurdles in showing that the former stock exchange CEO and chairman violated New York’s nonprofit laws. They note that the nonprofit laws are ambiguous about whether they cover all nonprofits or just traditional charities; the exchange, a quasi-public entity, is not easy to categorize; and determining the reasonability of Grasso’s salary will be a challenge. Two months after Spitzer filed his suit, Grasso’s team of lawyers at Williams & Connolly struck back with a counterclaim against the exchange, represented by Dan Webb of Winston & Strawn, and its current chairman, John Reed, in federal court. They argued that Grasso was immune from a state suit because he performed duties delegated to him by the Securities and Exchange Commission (SEC). Lynch disagreed. “[T]he AG’s claims are all founded directly and explicitly on state law,” he said. Spitzer largely relied on provisions of New York’s non-for-profit laws requiring “reasonable compensation … commensurate with services performed” for officers and directors of nonprofits, the judge added. “No reference is made to federal law, and it is difficult to see how federal law could play any role in deciding the case.” The stock exchange is a Type A nonprofit, a sub-category used for trading boards and exchanges under New York law. Yet, it derives much of its power from federal securities laws. “[T]he NYSE and its officers often act as a de facto agency, or at least at the direction of the SEC,” wrote Lynch. Namely, the exchange has set up financial disclosure and other rules for its listed companies and has the power to discipline them. “These are regulatory powers delegated to the NYSE by federal securities laws,” Lynch said. This federal grant, however, did not preclude the application of state laws in dealing with areas left ungoverned by federal law. As a nonprofit entity chartered in New York, the exchange must comply to state laws, the court held. LEGAL HURDLES Despite the victory on jurisdiction, some attorneys said Spitzer will face a difficult challenge in proving that Grasso’s compensation package was unreasonable because New York’s laws are ambiguous as to whether the provisions governing nonprofits cover entities like the exchange or were only meant to apply to charities and foundations. “I do believe that this case could be the Achilles’ heel for the attorney general,” said Marc Powers, head of the securities litigation and regulatory group at Baker & Hostetler, who is not involved in this case. Spitzer has filed a suit lacking a strong precedent in case law and significant portions of the law relied upon by the attorney general remain murky, he said. NYSE HARD TO CLASSIFY Lawyers and consultants from the nonprofit world add that the exchange is difficult to classify. In many instances, nonprofits study market rates to determine the level of executive compensation — a process known as looking at “comparables.” Experts in nonprofit compensation, including James Abruzzo, head of the nonprofit group at the executive search firm DHR International, said the difficulty in proving unreasonableness in compensation lies in selecting comparables. According to a 2004 survey conducted by the Chronicle of Philanthropy, not a single charity, university or nonprofit hospital pays its executives as much as Grasso earned. But in Grasso’s court papers, he claims his salary should resemble that of Wall Street executives because the exchange intended to attract and retain talented executives. “I thought it was a smart move for Grasso” to try to move the case to a federal court, said Powers. “You don’t want to be in state court with the attorney general on the other side.” ‘COMPELLING CASE’ “The attorney general feels that we have a compelling case … regardless of the venue,” said Marc Violette, a spokesman for Spitzer. “But the attorney general wanted to make a point,” that the New York Stock Exchange is a nonprofit registered in New York and subject to state laws.

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