With McGuire gone, UnitedHealth regroups

Unitedhealth has announced a broad range of measures designed to correct problems related to stock options. But the company is still under pressure from powerful and vocal critics who aren't satisfied; critics like Pat Macht of CalPERS, the California Public Employees' Retirement System. The country's largest pension fund is suing UnitedHealth.

"They need to right the ship of this company very quickly and do more than they've been doing," says Macht. "The problems there are more severe than we first believed."

The big problem at UnitedHealth was its "backdating" of stock options. A stock option allows an executive to buy shares in the future. The cost is typically the price on the date the option was granted. But with backdating, executives pick a date in the past when the stock price was especially low. The practice can create an instant paper profit.

Backdating options is not illegal, as long as it's properly disclosed to investors and regulators. But UnitedHealth --and more than 100 other U.S. companies -- are being scrutinized for failing to adequately monitor and report backdating.

UnitedHealth hired outside lawyers to investigate itself. Their report found a pattern of likely backdating, and an undisclosed conflict of interest involving the head of the board's compensation committee and CEO William McGuire.

The company's remedies include bringing in new board members, hiring a chief ethics officer, and eliminating management's authority to make stock awards. McGuire is not only leaving the company, but he's also giving up any benefit from backdated options. That'll cost him about $200 million.

"We are not satisfied they have made enough changes," Macht says.

Macht says the big pension plan wants a more stringent policy on executive compensation, and more power for shareholders to oust board members. And CalPERS wants company directors to be be given the boot if they can't win a majority vote from shareholders. As it now stands, CalPERS says they can remain on the board.

Last week, CalPERS got one thing on its wish list. A federal judge temporarily blocked McGuire from cashing in stock options worth well over $1 billion. McGuire agreed to the freeze.

McGuire can't exercise any stock options until 30 days after a special UnitedHealth committee decides how to address problems with stock option grants.

The court also barred UnitedHealth from making any payments to McGuire under his retirement plan until the litigation is concluded.

Macht says CalPERS also has reservations about UnitedHealth's new CEO, Stephen Hemsley, because he also received backdated options. But CalPERS isn't making a big issue out of his ascension, at least not now.

"Obviously we have some concerns," says Macht. "He does appear to be conflicted. He was tied up in the options backdating. He was the number two person after McGuire. We're not absolutely thrilled with the leadership."

But UnitedHealth dismisses suggestions that Hemsley is a tainted leader. A spokesman points out Hemsley's giving up any benefit from backdated options. He says the board named Hemsley to the top job after considering the findings by outside lawyers. The report found Hemsley had a more limited role in granting options than McGuire.

UnitedHealth also argues it has aggressively addressed past shortcomings in internal controls and oversight. The health insurer says a number of investor watchdog groups have praised the company's initiatives to improve corporate governance.

CalPERS is not alone in wanting further changes. Pat McGurn, executive vice president, of Institutional Shareholder Services, wants a complete make-over of UnitedHealth's board.

"Clearly, I would hope over the next three to five years been there'd be something akin to 100 percent turnover in this boardroom," says McGurn, whose organization advises large shareholders on corporate governance.

"This was clearly a situation where there was a dysfunctional governance culture in place and absence of setting the correct tone at the top of the organization," adds McGurn. "Simply changing out the senior executives isn't going to be enough."

McGurn, though, is less critical of UnitedHealth than CalPERS is, and like other watchdog groups says the company has made important corrections.

McGurn says the company has established polices that should help prevent future backdating problems. And helped itself in the process.

"They've done a lot already to soften the blow from activist institutions and potentially regulators as well," says McGurn. "The makeover may continue. But by and large the heavy lifting has been done."

McGurn says UnitedHealth still needs to restore investors' confidence in its financial disclosures. The stock is down about 13 percent since news of the backdating problem surfaced. But even critics like McGurn say the company itself is sound financially.

"The good news -- if there is any from the investor perspective -- is this doesn't appear to be an Enron or WorldCom situation where the underlying business is rotten," says McGurn.

Others agree there's nothing in the backdating scandal that's likely to dump thousands of employees out onto the street.

University of Minnesota business professor Steve Parente, who closely monitors the health care industry, says there's little question UnitedHealth's operations are also in good shape.

Parente says United has shown big employers that it can efficiently deliver health care nationwide. And the backdating scandal hasn't affected its operations.

"In terms of its core business model, that's all been very sound," says Parente. "There's not a firm quite akin to it in the country in terms of its size, scope or mission."

McGuire has been reluctant to speak about the backdating controversy. Last spring, during an appearance before the media, he dodged questions about whether he'd resign.

"I have no response beyond we will do what the company and its independent people find," McGuire said at the time.

But UnitedHealth has not shied away from fessing up to its backdating misdeeds. It posted the findings of the investigation by outside lawyers on the Web.

Legal experts say that could help -- or hurt -- the company and McGuire. Some members of the Twin Cities legal community suggest the internal investigation could hurt the company by providing a roadmap for federal prosecutors.

The U.S. Securities and Exchange Commission and the U.S. Justice Department are expected to grill UnitedHealth intensely as they pursue their own investigations. The Internal Revenue Service may also want some money. That's because options backdating can result in underpaying federal taxes.

But Michael Koenig says it's too early to divine the legal consequences facing the company, McGuire and other execs. Koenig is a former Justice Department attorney who prosecuted securities fraud. He's now in private practice in Washington, D.C., with the firm of Dewey Ballantine.

"I think United will certainly face continuing SEC investigation," Koenig says. "But what ultimately happens, there is no way to predict."

What's the worst scenario for most companies caught backdating options illegally? Koenig expects they'll be hooked into agreements that let them escape prosecution as long as they meet certain conditions.

He says criminal prosecution for companies and individuals is likely only in the most extreme cases.

"One of the things the department of justice and SEC are looking into when they are making their decision is the level of egregiousness," Koenig says. "Backdating where there is particularly egregious conduct, making up options for people who don't exist. Such as happened in the Comverse case."

At Comverse Technology, two executives have pleaded guilty to fraud for backdating options. And the firm's CEO has been charged with illegally backdating options.

Legal experts say prosecutors pursuing backdating cases will look for signs of criminal intent, especially attempts to conceal misdeeds. So, UnitedHealth's decision to go public with its investigation may help. "If you are a publicly held company and you find out internally that something is wrong, the philosophy of the government is you get a good mark if you come and tell us," says B. Todd Jones, a a former U.S. attorney for Minnesota.

Jones, who is now in private practice, with Robins, Kaplan, Miller & Ciresi, also doubts most backdating cases will result in criminal prosecution.

"It's telling that to this juncture there have only been two or three criminal prosecutions related to options backdating," says Jones. "I think for most companies you're not looking at a criminal examination because of this conduct. You're looking at re-filing situations, maybe some regulatory fines and penalties."

Earlier this year, UnitedHealth said it would cost about $286 million to correct its accounting for back-dated options. Now, the company says the cost will be significantly higher. How high, it's not saying yet.

Whatever the eventual cost, analysts expect UnitedHealth could likely absorb it without too much trouble. The company is one of the largest, strongest and most profitable health insurers in the nation.

Through the first nine months of this year, UnitedHealth had about $54 billion in revenue. And it posted a profit of $3 billion.

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