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A Board With Its Back To The Wall


Why does United-Health Group (UNH) CEO William W. McGuire remain in his job? It's a question that has baffled corporate governance experts since The Wall Street Journal reported in March that UnitedHealth and other companies might have backdated options grants for officers to boost compensation. In the post-Sarbanes-Oxley world, boards are acting on the first whiffs of legal or ethical lapses. Already 15 executives and directors from the 50 or so companies under investigation for backdating have been forced out. Heck, Raytheon's board even docked CEO William H. Swanson a million bucks in May for plagiarizing passages of his book -- not even a criminal offense.

Yet despite shareholder suits, federal and state investigations, a possible earnings restatement, and the disappearance of some $17 billion in market value, UnitedHealth's McGuire remains in his post, sitting on unrealized options gains now worth around $1 billion.

Paul Hodgson, senior research associate at the Corporate Library, a governance tracker, blames a weak board that remains too deferential to its dynamic CEO. But directors have other reasons to let McGuire stay. For one, given his strong leadership -- shares soared from a split-adjusted $1 when he began in early 1991 to a high of $64 in December -- investors aren't pressing for his ouster. "No one wants to see him dismissed," says David Dreman, chairman and chief investment officer of Dreman Value Management, which recently bought 781,000 shares.

There's another important reason: While boards at companies that have pushed out executives appear not to have known about the alleged backdating, UnitedHealth's board allowed McGuire to pick his options grant dates. To dump him would be to admit that some wrongdoing occurred -- a position that could increase the legal risks for directors themselves. Instead, they're hunkering down.

MULTIPLE INVESTIGATIONS

It's a high-risk strategy. The longer the scandal drags on, the more UnitedHealth's shares are likely to sag. "If they put out a release tomorrow saying the issue was resolved and that he was leaving, the stock would go up," says analyst Carl McDonald of CIBC World Markets Inc. (BCM).

Neither McGuire nor directors would comment for this story. Probes by the U.S. Attorney's Office in New York, the Securities & Exchange Commission, and the Internal Revenue Service are under way. In addition, UnitedHealth has set up an independent board committee and has hired former SEC Enforcement head William R. McLucas to review its practices. A spokesman says the board has acted "promptly and appropriately."

Going back to 1994, McGuire has received grants that coincided with lows in the stock. If backdating occurred, it appears that UnitedHealth's board may have known about the practice and approved it. According to McGuire's 1999 employment contract, he could choose the grant dates and notify the compensation committee. Legal experts say board awareness would bolster his case that the grants were proper.

VIOLATION LURKING?

But even if the board approved the timing of McGuire's options, that would not absolve him or UnitedHealth's directors entirely. While backdating itself isn't illegal, it must be disclosed to shareholders and accounted for properly. Options that have a strike price equal to the share price on the day they're granted are tax-deductible for the issuing company; backdated options aren't, according to a tax law enacted in 1993.

Sources close to the investigations say executives or directors aware of backdating could face charges related to the lack of disclosure and for overstating earnings. Analysts say UnitedHealth appears to have accounted for its options improperly: In mid-May, it said it might restate earnings for the years 2003-05 by up to $286 million after review of earlier options grants.

McGuire also faces another potential securities law violation. If a company improperly accounted for backdated options, and if that leads to restatements for the years since Sarbanes-Oxley went into effect, in 2002, investigators say the CEO and CFO could face charges of certifying false financial statements. While that theory has yet to be tested, it's an idea regulators are studying.

Meantime, board members are digging in for another reason. Any concession of wrongdoing could increase their exposure to shareholder lawsuits. Already, directors have been named personally in a suit brought by the Ohio Attorney General. One high-ranking ex-SEC official says directors-and-officers insurance might not pay for people involved in securities violations. With their own wealth potentially at risk, "my guess is that their legal counsel is advising them to be very cautious," he says. "You won't see that board do anything until it's forced to."

By Jane Sasseen, with Joseph Weber in Chicago


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