Attorney General Eliot Spitzer announced the action against Grasso and former stock exchange board member Kenneth Langone, a close friend of Grasso's, on his Web site. The suit, which also names the NYSE itself, followed a four-month investigation.
The attorney general's suit asked that a judge rescind the pay package and determine a "reasonable" level of compensation for Grasso.
"This case demonstrates everything that can go wrong in setting executive compensation," Spitzer said in a statement. "The lack of proper information, the stifling of internal debate, the failure of board members to conduct proper inquiry and the unabashed pursuit of personal gain resulted in a wholly inappropriate and illegal compensation package."
Grasso resigned as chairman and CEO of the exchange in September as the controversy surrounding his pay reached its peak. Grasso has received $139 million of his compensation package.
The NYSE, for its part, has already asserted that Grasso should return the bulk of his compensation. In February, interim NYSE chairman John Reed wrote to Grasso's lawyer, demanding the return of $120 million; Grasso refused.
Langone, who headed the board's compensation committee from 2000 to 2003, is considered a close friend and confidante to Grasso, and would have been a key player in getting board approval for his compensation package. A spokesman for Langone, who left the NYSE board of directors last year, had no immediate comment.
Spitzer's suit alleges that Grasso's pay package violated New York State law requiring executive compensation to be "reasonable." The attorney general further alleged that the formula used to generate the pay package " was inappropriately driven by a comparison with the salaries of top executives in the world's largest corporations."
"In addition, the investigation found that Grasso, in effect, set his own performance targets, which he easily exceeded," Spitzer's release said.
One of Grasso's deputies, Frank Ashen, has admitted providing "incomplete, inaccurate and misleading" information about the pay package to the NYSE board, and Mercer Human Resource Consulting, Inc., which analyzed the pay package for the board, claims its presentation contained "inaccuracies and omissions."
The NYSE board had asked state and federal regulators to investigate how Grasso was awarded his large pay package.