UnitedHealth's Options Scandal Shows Familiar Symptoms

By Steven Pearlstein
Wednesday, October 18, 2006

Anyone with health insurance from UnitedHealth Group knows what happens if you fail to fill in every box on the form, or attach the requisite back-up material, to get reimbursed for a $40 prescription. You're not going to see a dime until you've been put on hold for 30 minutes, faxed the paperwork twice to somebody in Minnetonka, Minn., and demanded to talk to a supervisor.

So imagine my surprise when I read this week about the loosey-goosey process UnitedHealth used to issue billions of dollars' worth of stock options to top executives over the past few years. According to a report prepared by lawyers at WilmerHale, the board of directors and its compensation committee didn't bother keeping good notes about their decisions regarding pay negotiations and stock options. And the documents authorizing those options conveniently left the date blank, so that someone -- even today, it's not exactly clear who -- could later pick the date that just happened to make the options as valuable as possible.

Isn't it odd that a company could be so persnickety when it comes to pinching pennies from doctors and patients, and so cavalier when it comes to lavishing executives with hundreds of millions of dollars of shareholders' money?

Or maybe it's not. Maybe what we have here is the most outrageous corporate scandal since Enron and WorldCom.

The crux of the UnitedHealth story concerns employee stock options. Just to review, an option lets the employee buy a share of the company stock at a predetermined "strike" price -- usually the market price at the time of issue -- and then sell it in the future, when and if the stock is worth more. The benefit to the employee is the difference between the strike price and the subsequent sales price. The cost to shareholders is that all their stock is now worth a bit less because the newly issued shares dilute their stake.

Thanks to clever reporting by the Wall Street Journal earlier this year, we now know that corporate executives have been routinely setting strike prices on dates when the shares hit temporary lows -- rather than the dates on which the options were issued, which is what most people assumed. It's yet another game played by corporate executives at dozens of companies to pick the shareholders' pockets. And it's the latest evidence of how executive compensation has become a cancer, eating away at the souls of even the most successful American corporations.

Consider the case of William McGuire, who over the past 15 years has transformed UnitedHealth from a struggling regional insurer in Minnesota into the second-largest health insurer in the country, largely through acquisitions of companies like Mid Atlantic Medical Services of Rockville. One in six Americans is a UnitedHealth customer. Under McGuire's leadership, the company's market value has risen to $60 billion. During that same period, he amassed stock options more valuable than those of any chief executive in history: $1.5 billion.

Even by today's standards, McGuire's compensation has been obscene. The big change came in 1999, when, in negotiations over a new contract, he demanded a pay package that would give him 2 percent of UnitedHealth shares. Significantly, McGuire insisted that he alone get to decide the timing of those options. And he wrote in a provision that he could be fired only upon a felony conviction, or failure to rectify a serious problem after repeated notices from the board.

The board of directors that agreed to such a lavish, one-sided contract included several luminaries: Tom Kean, the former governor of New Jersey and later chairman of the 9/11 commission; James Johnson, the former chief executive of Fannie Mae who created the culture that led to that company's costly accounting scandal; Gail Wilensky, a respected health-policy expert who once ran the Medicare and Medicaid programs; and former vice president Walter Mondale.

What were these directors possibly thinking? We have some insight on that from William G. Spears, a Wall Street money-manager who was a member of the compensation committee in 1999. He explained to the Journal that if the board had refused to go along with McGuire's piggy requests, "Bill would take it as a signal that directors weren't enthusiastic about his leadership. That would be a distraction, at the very least. Bill takes these things as a benchmark of how directors feel about him."

Well, we wouldn't want Bill to feel unappreciated, would we? Particularly if you're Spears, and you're also managing millions of dollars in McGuire's personal assets, and serving as trustee for two trusts set up for the benefit of McGuire's children, and you just accepted an investment of $500,000 from McGuire to help finance the repurchase of your firm from a financial conglomerate. Such potential conflicts of interest are supposed to be reported to other directors, of course, as well as the shareholders in the company's annual proxy report. But that was just another tiny detail that somehow slipped through the cracks.

McGuire was not the only one to benefit from the directors' ineptitude. There was also his trusty chief operating officer, Stephen Hemsley, who upon being hired in June 1997 was presented with 400,000 stock options with an issue date of five months earlier. Hemsley told the WilmerHale lawyers that he "didn't recall focusing at the time" on the $2.9 million gimme he'd just been handed as a result of the backdating.

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