Lawsuit Over Morgan Stanley Pay Faces Key Test TomorrowSean Griffith in Forbes, September 15, 2010
A lawsuit accusing Morgan Stanley directors of awarding $45 billion in pay to executives while the bank was in danger of collapse faces a critical test tomorrow, when lawyers will argue whether the case should be dismissed. The hearing is at 10:30 a.m. in the courtroom of New York Supreme Court Judge Shirley Kornreich.
In the lawsuit, attorneys with Grant & Eisenhofer say Morgan Stanley directors had “scant regard for the interests of …shareholders” and had “instead operated the Company principally for the benefit of its employees.” The lawsuit is a so-called derivative action, brought on behalf of the corporation because presumably the directors are too conflicted to file such a suit themselves.
Morgan Stanley is represented by Cravath Swaine & Moore, who will likely argue the case should be thrown out under the business judgment rule, which says courts aren’t supposed to second-guess the decisions of corporate managers.
“Derivative suits for excessive executive pay are usually losers,” said Sean Griffith, an expert on corporate law and director responsibilities at Fordham Law School. “Typically in a case like this, unless there’s some reason to doubt the loyalty of the board, some connection between the members of the board and the people they offered these pay packages to, the case will be dismissed.”
The suit says Morgan Stanley increased pay 27% in 2006 — including $41 million for former Chairman John Mack — based on profit and revenue growth obtained only by taking on excessive risk. Even as profits plunged over the next few years, the suit says, compensation climbed to 57% and then 62% of revenue. The complaint reads like a mini-history of the financial meltdown, including numerous quotes from newspaper articles and occasionally jarring details, such as when it describes commercial real estate company Crescent Real Estate Equities as a “subprime lender.” No matter — the meat of the complaint is Morgan Stanley paid its executives as if they were doing something of value when all the hard work came from others:
Morgan Stanley’ s 2009 performance is attributable directly to the extraordinary assistance and intervention of the federal government, specifically the injection of $10 billion into Morgan Stanley under the federal government’s emergency Troubled Asset Relief Program (“TARP”), which allowed Morgan Stanley to stay afloat. It is attributable also to the injection by the federal government of tens of billions of dollars into AIG, which then proceeded to funnel these bail-out funds to counter-parties such as Morgan Stanley, allowing Morgan Stanley to salvage otherwise worthless contracts held with AIG. Furthermore, Morgan Stanley’ s very existence in 2009 depended on a highly dilutive $9 billion capital injection from a Japanese financial institution at the end of 2008.
The complaint says the directors are “beholden” to management in part because of their $335,000-a-year stipends and substantial stock benefits they get for sitting on the board. But Griffith says derivative suits face a tough challenge in proving disloyalty to shareholders. Director pay may not make it. Otherwise plaintiffs must show gross negligence — a standard of stupid, reckless behavior that has almost never been met. Even Time Warner’s boneheaded purchase of AOL failed the test.
The plaintiffs in this case include the Laborers union, which isn’t exactly skimpy on pay. According to Labor Dept. reports, 11 of its executives pulled down more than $260,000 in 2009 (compared with average pay of $262,000 per employee at Morgan Stanley in 2008) and Laborers President Terence O’Sullivan earned $415,680.