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Post date: April 29 1999

Executive Summary

On May 28, 1998, after years of public efforts to free Long Island from the burden of the highest electric rates in the country, the Long Island Lighting Company ("LILCO") was formally taken over by the Long Island Power Authority ("LIPA"), a public benefit corporation created by state statute, that issued $2.5 billion in municipal revenue bonds to complete the transaction. Simultaneously, a new company, MarketSpan Corp. ("MarketSpan"), now doing business as KeySpan Energy ("KeySpan"), was formed by uniting the holding company of the former Brooklyn Union Gas ("BUG") and the LILCO electric generating and gas distribution assets.

Following LILCO's dissolution and combination with BUG, it was revealed that on the eve of the closings, LILCO had paid its top level executives "severance" compensation payments totaling over $67 million. Of this total, William Catacosinos, the Chief Executive Officer ("CEO"), received $42 million, which included $37 million in retirement and golden parachute benefits pursuant to his 1984 employment contract (the "1984 contract"), a further $2.1 million golden parachute payment (three years of salary) and $3 million in transaction-related bonuses. These retirement and severance benefits were paid in spite of the fact that Catacosinos and fellow LILCO senior officers were assured comparable and lucrative jobs with the new company.

Disclosure of the payouts drew intense media coverage and public criticism from ratepayers, shareholders, and state and local government officials. Many claimed the severance payouts were not only outrageous, because for many years LILCO customers paid the highest electric rates in the country, but also unjustified, because LILCO's senior officers, like its office staff and skilled workers who did not receive severance compensation, would continue their employment with KeySpan. Governor Pataki denounced the payments as "disgraceful" and stated this was "a sorry finish for a company with a history of disturbing and ill-advised decisions that benefited a select few at the expense of consumers." LIPA officials asserted that LILCO had violated the LIPA acquisition agreement, pointing to language that provided for the continuing employment of all LILCO employees with the new company and that "no one would receive severance or any other benefits as a result of the merger."

A. Origin of the Attorney General's Investigation

On June 4, 1998, Governor Pataki asked the Attorney General's Office (the "Office") and the PSC to investigate the validity and legality of the LILCO "severance" payments and whether LILCO's ratepayers had paid for them. Simultaneously, the State Assembly launched an investigation and shareholders commenced at least a dozen lawsuits against LILCO, Catacosinos, and other LILCO officers and directors in state and federal courts.

In accordance with the Governor's request, the Office immediately undertook the investigation of the LILCO executive compensation payments. The Office's first concern was whether LILCO had charged its customers for the payments given to Catacosinos and other senior officers. The investigation has concluded that LILCO made the payments out of shareholder profits and that LILCO's rates were not affected by the payments.

The Office was also concerned with whether LILCO or Catacosinos violated the Martin Act, General Business Law Article 23-A, which gives the Attorney General authority to bring an action against any person or corporation involved in the "issuance, distribution, exchange, sale, negotiation or purchase" of securities for activity involving "any fraud, deception, concealment, suppression, false pretense . . ." or "[a]ny representation or statement which is false, where the person who made such representation or statement" knew, should have known, made no effort to know or did not have the knowledge. The investigation focused on whether there had been proper disclosure to investors of LILCO's intention to trigger the payment of these sums and the magnitude of the payments in the event they became payable.

The investigation included subpoenas to Catacosinos, LIPA, LILCO and MarketSpan and several former LILCO officers and directors to testify and produce documents. From mid-June until mid-September 1998, this Office conducted the deposition of Catacosinos and depositions of former LILCO officers, former directors from LILCO's Compensation Management Appraisal Committee, former BUG officers, and LILCO's outside consultants. Numerous other parties were interviewed, and over thirty boxes of records from the parties were obtained and reviewed.

As the inquiry unfolded, KeySpan's Board conducted its own inquiry with the assistance of outside counsel and subsequently took certain actions that, in effect, partially mitigated LILCO's actions. At a Board meeting on July 31, 1998, Catacosinos resigned as Chairman and CEO of KeySpan. The Company reaffirmed in a letter agreement that it would protect Catacosinos from loss or injury pursuant to contractual and statutory provisions. Most importantly, KeySpan also promptly instituted a policy that recipients of the LILCO golden parachute payments either return the payments and remain with the company, or resign.

B. Attorney General's Conclusions

1. LILCO did not charge its customers for the Executive Compensation Payments.

The investigation has established that the payments at issue were paid from shareholder equity, and not from ratepayer revenues. Because the golden parachute and other severance payments were not an expense until actually paid, LILCO could not ask to recover such expenses in rates until payment became certain and the PSC never received such a request. LILCO ceased to be an operating utility in May 1998, simultaneously with the payment of the severance monies, and can thus no longer file a rate request with the PSC. Therefore, the money used to pay the golden parachutes necessarily came out of the retained earnings of LILCO, not out of its ratepayers' pockets, a conclusion eventually confirmed by the PSC.2

2. The proxy statement employed by LILCO in securing shareholder approval of the transaction failed to meet the legal threshold of full disclosure of related management compensation.

The Attorney General finds that LILCO's officers and directors failed to make full and timely disclosure to its shareholders and to users of its Securities & Exchange Commission ("SEC") filings, i.e., LIPA and BUG, of LILCO's intention to assert that certain golden parachute and severance payments would be triggered by either the LIPA or BUG transactions, and the magnitude of the payments.

There is evidence of LILCO officers' planning related to the severance packages as early as December 1996 (prior to conclusion of negotiations of both the BUG and LIPA transactions). Thus, there was no excuse for the failure of LILCO's officers and directors to have included complete information on the severance awards in the June 26, 1997 Joint Proxy Statement ("Joint Proxy"), which was disseminated to secure the approval for the combination and transaction by the LILCO and BUG shareholders. The Joint Proxy omitted the fact that $64.3 million had by then been amassed in trusts to secure the payment of the present value of LILCO officers' golden parachute contracts, and that $29.5 million had been deposited on May 2, 1997, after new calculations of the projected benefits for Catacosinos and other officers were received from LILCO's actuarial firm.

Furthermore, Catacosinos and other LILCO officers failed to disclose fully the fact that anticipated but undisclosed salary and bonuses to Catacosinos would materially increase the retirement benefits under his 1984 contract. While there was some disclosure in the Joint Proxy and other related documents concerning the existence of the severance and other similar compensation benefits for LILCO officers, the disclosures were incomplete and conflicted, in part, with the true facts. The Joint Proxy indicated that an annual retirement payment of $895,000 would be due Catacosinos in the event of his termination or retirement, even when the undisclosed present value was actually equivalent to $2 million in annual benefit.

In sum, the Attorney General finds that Catacosinos and LILCO withheld material information regarding transaction-related compensation from the Joint Proxy for the LILCO-BUG combination and from LILCO's subsequent SEC reports. Those statements fail to comply with the Supreme Court's admonition that a proxy statement must inform and not challenge the "reader's critical wits." Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1097, 111 S. Ct. 2749, 2761 (1991).

3. LILCO's officers withheld from the LILCO Board of Directors and its relevant Committee material information relating to both the planning of executive golden parachute payments and their computed present value.

During the Attorney General's investigation, this Office obtained numerous documents from LILCO and its outside consultants that set forth revised executive compensation scenarios. The record shows that the calculations were repeatedly prepared at the request of certain LILCO officers, and included present value calculations particularly for the purpose of making deposits to fund the five trusts supporting the retirement and severance compensation benefits. However, there was no evidence that LILCO officers ever furnished this information to the LILCO Board or its Compensation and Management Appraisal Committee ("CMAC"). The members of the CMAC were consequently not equipped with the information necessary for performing their designated function.

4. The LILCO Board of Directors failed to ask appropriate questions that would have resulted in full and timely disclosure in the Joint Proxy.

The minutes of LILCO's May 28, 1997 Board of Directors meeting reveal that although Catacosinos informed the Board of a May 2, 1997 deposit of $29.5 million made to the compensation trusts ($16.6 million of which went to trusts for Catacosinos), no inquiry on the subject ensued. The Board also failed to consider whether or not to include in the Joint Proxy a discussion of the golden parachutes. Not until December 1997, when Catacosinos presented the Board with an escalated demand for a $63 million severance package, did the Board rouse itself and ultimately reject the demand. Furthermore, while the present value of the five trusts securing the retirement and severance benefits was disclosed in the annual report that LILCO filed with the PSC, the disclosure failed to draw either notice or comment from the Board or CMAC.

5. The record supports a strong inference of Catacosinos' concealment of executive compensation facts.

An analysis of the record made under the applicable New York law strongly suggests that the actions of Catacosinos demonstrate concealment of executive compensation facts:

  • Catacosinos stated that LIPA was not informed because, "they were not paying for it. It was something that was not negotiated as part of the contract. It was not their business, effectively." (Catacosinos Dep. at 74.)
  • Catacosinos particularly did not want LIPA apprised of the payouts prior to the closing because he knew that LIPA's Chairman, Richard Kessel, had been a critic of his compensation since 1984 and had "highly sensitized the media and the public" to it. (Catacosinos Dep. at 73.)
  • Catacosinos attested to his belief that "if there was a premature disclosure of those [$67 million in officers'] payments, the critics of the transaction . . . would use that as a rallying cry to try and prevent the transaction from going forward." (Catacosinos Dep. at 74.)
  • Finally, Catacosinos testified that LILCO's Board discussed the potential "negative impact" on the transactions flowing from a premature disclosure of the golden parachutes. (Catacosinos Dep. at 74-75.)

Plainly, LILCO, and its officers and advisers determined that any disclosure of the golden parachute payments before they were made was "premature." The record shows that on several occasions, LILCO officers failed to disclose pertinent compensation information and were less than candid to their counterparts at BUG. They withheld executive compensation information from the drafts of LILCO's 1997 10K that were provided to BUG and LIPA representatives prior to the closing. Further, Catacosinos discouraged LILCO officers from disclosing information concerning the expectation that the LIPA transaction would trigger severance compensation payments. Finally, Catacosinos made inaccurate representations to the LILCO Board that BUG and LIPA would be or had been appropriately apprised of LILCO's intention to pay the severance compensation.

These misdeeds do not mark the limit of Catacosinos' conduct. When the sequestered trust funds for his benefits were approaching $40 million, Catacosinos presented the LILCO Board in December 1997 with a $63 million demand. Instead of acceding to Catacosinos' demands, the CMAC hired, for the first time, its own law firm and compensation expert to assist them in their effort to evaluate the proposal. In March 1998, however, Catacosinos, without the directors' knowledge or consent, obtained the transfer of $27.6 million to the trust fund for his benefit, premised solely on his claim of entitlement to his full $63 million demand. The activities of certain LILCO officers involved in this secret series of transfers provoked one LILCO director to proclaim that he had long been deceived by Catacosinos on compensation matters and would decline to serve with him on the KeySpan board when the companies combined. The $27.6 million transfer was finally returned to LILCO on May 28, 1998, after the Board refused to bow to pressure tactics for the $63 million award.

C. The Attorney General's Assessment of Potential Remedies

Despite the LILCO officers' conduct, the Attorney General has determined that further legal action is unwarranted due to the following facts and considerations:

  • Shareholders, not ratepayers, were ultimately the parties affected by the payments.
  • Catacosinos resigned from KeySpan on July 31, 1998, without the payment of any further retirement or severance award, thereby mooting the issue of the "premature" payment on May 27, 1998.3
  • Other former LILCO officers who received golden parachute payments were required by KeySpan either to return those sums if they wished to remain as officers or to resign.
  • The $27.6 million that Catacosinos had transferred to his retirement benefits trust was returned to LILCO prior to the closing.
  • At the time the retirement and severance compensation benefits were paid to Catacosinos, he and LILCO entered into a mutual satisfaction and release from any obligation or claim for additional sums due under Catacosinos' employment contract.
  • Catacosinos is protected by corporate indemnification agreements that hold him harmless from any cost, liability or legal expense relating to his conduct as a former officer and director of LILCO.4 Thus, KeySpan, and hence its shareholders, would bear sole responsibility for all of Catacosinos' legal expenses during the pendency of any such litigation brought by the Attorney General.
  • Catacosinos' employment contract at issue here was originally executed in 1984, which raises statute of limitations issues.
  • The shareholder settlement combined with money KeySpan has already paid to LIPA compares very favorably with any potential recovery by the Attorney General: the $7.9 million settlement of the shareholder litigation when added to the $6 million in payments made by KeySpan to LIPA pursuant to the December 21, 1998 LIPA-PSC Settlement and the $1.5 million KeySpan payment to the Attorney General's Office produces total settlement payments of $15.4 million -- nearly equal to the $16.6 million undisclosed May 1997 addition to the trust securing the payment of Catacosinos' contractual retirement benefit. Indeed,the fair settlement of the shareholder litigation may cast some doubt on the Attorney General's ability to proceed with certain options.

While the events at LILCO, as described in this report, show that Catacosinos and certain LILCO officers abused the public trust, trampled on the requirements for disclosures by public companies, and sacrificed the public interest in favor of individual aggrandizement, further proceedings against Catacosinos or other LILCO officers and directors would, especially in light of the indemnification and release contracts and the class action settlements, achieve no further public benefit or more timely and valuable resolution than that described in this report. If sued, Catacosinos would, pursuant to the indemnification provisions, require KeySpan to expend millions of dollars of shareholder equity in paying for his defense. Such a prospect is neither in the interest of the public nor KeySpan's shareholders, and would surely reopen the wounds of a scarred history that should instead be allowed to heal.

D. The Attorney General's Office Supports KeySpan's Settlement of the Shareholder Action and Closes Its Investigation

The Attorney General and KeySpan have entered into a Settlement Agreement, dated March 18, 1999. To a large extent, the course the Attorney General has chosen was dictated not by the magnitude of wrong perpetrated by Catacosinos and LILCO -- which was great -- but by the reality that additional remedies were, at best, speculative and severely constrained by the indemnification and release agreements protecting Catacosinos and the other senior officers. The essential terms of the agreement, more fully described below, are that KeySpan will institute certain important corporate governance changes pursuant to the settlement of the Shareholder Actions and payment to the Attorney General of $1.5 million to defray costs of the Office's investigation and to be used for investor protection and education. The collective efforts by the Attorney General, LIPA, the PSC, the courts and the lawyers on behalf of the former LILCO shareholders have achieved the following resolutions of their respective legal actions and inquiries:

  • LIPA and the PSC concluded their investigations and executed a settlement agreement with KeySpan dated December 21, 1998. Under that agreement, KeySpan paid LIPA $5.2 million for the cost of the postage-paid bill return envelopes that would be sent to LIPA customers for three years, plus approximately $765,000 for legal costs.
  • Pursuant to a Memorandum of Understanding dated March 12, 1999, the shareholder actions were resolved through payment of $7.9 million to a settlement fund that will be distributed, after an award of fees to class counsel, to former LILCO shareholders. Additionally, KeySpan agreed to implement certain corporate governance and executive compensation procedures. The Attorney General supports the court-approved settlement of the shareholder actions.
  • Under the March 18, 1999 agreement, KeySpan has agreed to pay the Attorney General $1.5 million, which will be used to defer costs of the investigation and for investor protection and education. KeySpan also is obligated to notify the Attorney General as to implementation of the corporate governance procedures required by the settlement of the shareholder actions.

Concerning the subject of executive compensation, the Attorney General recognizes that LILCO and other utility companies are entitled to structure a sound compensation program that rewards loyal executives and attracts new talent. The objectives of any executive compensation plan, of course, are to maintain and strengthen the link between pay and performance and to ensure the increase of shareholder value. However, LILCO failed this test when it allowed Catacosinos to take egregiously inappropriate advantage of corporate events for personal gain at the expense of shareholders. Golden parachutes are normally meant to compensate the employee who loses his or her job. Catacosinos, however, merely traded one chairmanship for another, and with the assistance of other LILCO officers and directors, improperly triggered golden parachute payments.

For these reasons and others discussed in more detail below, the Attorney General believes that, on balance, entering into an Agreement with KeySpan as well as public dissemination of a detailed report is in the public interest.

E. The Attorney General Supports Policies to Address Executive Compensation Payments

This report identifies, among other things, the problems with LILCO's disclosures and executive compensation practice, the genesis of those problems, and corporate "best practices" for avoiding such problems in the future. Further, the policy recommendations contained in this report, see Section V below, identify changes in state and federal law that would reduce the likelihood of a recurrence of these events at companies similar to LILCO. The Attorney General urges other corporations, issuers of securities and, especially, public utilities to adhere to the following principles to ensure full disclosure and consent to their executive compensation agreements, plans and payments:

  • Executive compensation disclosure should be comprehensible and not delivered in coded language.
  • Where there are multiple benefit plans, summary disclosures should be provided of the present estimated cost of the plans.
  • Where a plan will provide a future benefit on the fulfillment of a contingency, e.g., retirement, a change-in-control, or satisfying bonus criteria, the company should provide an impact statement of the reasonable expected cost of the benefit at the time the contingency is met. The impact should be disclosed both in its income statement effect and its dilutive impact on per share earnings.
  • Directors should obtain from management, at least annually, the accrued cost, the projected cost and underlying assumptions of all executive compensation plan. Benefit changes should not be agreed without prior determination of their financial impact.
  • Where a material corporate event occurs, directors should fully inform themselves and assure that appropriate information is disclosed.
  • Where a corporation is led by one person serving as both Chairman and CEO, the independent directors should designate one of their members as a lead director.
  • Corporations should require -- and the Business Corporation Law should mandate -- that payment of executive compensation in excess of a defined threshold to officers of a public company shall require approval by a majority of the vote in a separate shareholder vote before the payment.