UnitedHealth Cites 'Deficiency' In Options Grants
As SEC Steps Up Probes, Insurer Warns Restatement Could Total $286 Million [WSJ]
By JAMES BANDLER and CHARLES FORELLE
May 12, 2006; Page A1
Widening the scandal over stock-option grants, giant health insurer UnitedHealth Group Inc. warned that a "significant deficiency" in how it administered and accounted for such grants could force it to restate results for at least three years -- cutting net income by as much as $286 million over that period.
MORE ON OPTIONS
• Read more about stock-options grants made to UnitedHealth, Comverse and other companies' executives in The Perfect Payday (March 18) and see charts of the option grants. Plus, a summary of the latest developments.
RECENT DEVELOPMENTS
• ACS Says Some Options Carried Dates That Preceded Approvals
05/11/06
• Backdating Probe Widens as 2 Quit Power Integrations
05/06/06
• Comverse Faces U.S. Criminal Probe
05/05/06
• Jabil Finds No Backdating of Stock Options
05/04/06
The company also said the Securities and Exchange Commission was conducting an informal inquiry into its options-granting practices -- a step beyond its previous disclosure that it had received an SEC call on the issue. In recent weeks, the SEC has ramped up an examination of options timing and is now conducting reviews of about 20 companies, said people familiar with the matter.
UnitedHealth is the highest-profile company so far to draw scrutiny for the timing of its stock-option awards. Late yesterday, another of those companies, semiconductor-equipment manufacturer Brooks Automation Inc., said it would restate up to seven years' worth of financial statements because it believes it recognized too little compensation expense for options granted to executives.
Stock options, a popular way to pay senior executives, are intended to give managers an incentive to improve their company's share price. Generally, each option represents the chance to buy a share of company stock at a certain "strike" price on a future date. Thus, a recipient stands to gain only if the share price rises.
But analysis of options awards at some companies has shown that executives benefited from extraordinary timing, getting grants dated at times when share prices hit lows. The "strike price" on options generally is equal to the market price on the day they are granted by a company's board. The lower the strike price, the greater the chance for future profit.
The SEC is examining whether the effective dates on some of those options were deliberately and improperly changed -- a practice known as backdating -- securing extra pay for executives regardless of the stock's performance.
UnitedHealth's filing left some questions unaddressed. The company said nothing about options dating, who was responsible for the accounting problems or what its outside accountants were told. But the disclosure likely will increase investor pressure on longtime Chief Executive William McGuire.
A pulmonologist-turned-corporate-chieftain, Dr. McGuire has drawn wide praise from investors for molding UnitedHealth into a major force in U.S. health care in his 15 years as CEO, during which shares have risen 50-fold in value.
But in recent weeks he has drawn fire for his own gains through stock options -- nearly $200 million realized in the past four years, and another $1.8 billion in unrealized gains as of the end of last year, about $1.6 billion of which can be exercised at any time.
Most of Dr. McGuire's fortune has come from a steady, strong increase in the company's share price during his tenure. But an analysis by The Wall Street Journal, detailed in a March 18 article examining options grants at six companies, found that each of the 12 grants received by Dr. McGuire between 1994 and 2002 was dated just before a substantial run-up in the company's share price. Three were dated at the stock's lowest closing price of that particular year. The Journal analysis found that the odds of such a fortunate pattern occurring by chance would be one in 200 million or greater.
Yesterday's disclosure by the Minnetonka, Minn., company, which provides health insurance and other services to 65 million Americans, sent its shares down nearly 4%, or $1.80, to $44.37 in 4 p.m. composite trading on the New York Stock Exchange. Since questions were raised about UnitedHealth's options-granting practices in mid-March, its shares have dropped 22%, shedding almost $17 billion in market value.
In its filing, UnitedHealth, which reported $3.3 billion in net income last year on $45.37 billion in revenue, said its internal review had had uncovered a "significant deficiency" in the way the company administered, accounted for and disclosed past option grants and that it may be required to take certain accounting adjustments for "stock-based compensation expense." It said that could reduce operating earnings by up to $393 million in the past three years, but added that the company's management believes any adjustments would not be "material." (Read UnitedHealth's discussion of possible impacts.)
UnitedHealth didn't detail the potential effect on earlier years' results, though it said the review goes back to 1994. The biggest impact in the past three years, the company said, would be in 2005, when it could take a 4.5% hit to earnings, dropping them by $150 million, or 11 cents a share.
Accounting experts said the language in the filing suggests that options may have been granted to employees at below-market prices, or that the options-granting process was at the least muddled. The company declined to comment beyond its filing.
"These numbers are pretty staggering," said James Cox, a professor of corporate and securities law at Duke University. "Quite frankly, this isn't just a little material. This is a lot material for this kind of issue."
Prof. Cox said the disclosures raised questions about the independence of UnitedHealth directors and the stewardship of its management. "I read this first as a lawyer, but if I was an investor, I would be thinking this is a ship -- at least in terms of its internal controls -- that seems to be listing seriously," he said.
The company's accounting assessment stems from a review by management, assisted by outside lawyers and accountants. A separate probe is being conducted by a committee of directors. UnitedHealth, which previously maintained that its option-grant practices were "appropriate," stressed that the reviews -- both of which began in March -- were continuing and that neither had reached conclusions.
The company also said its board had taken away the authority of management to grant any options, saying that power would now belong only to directors. That followed significant changes, announced earlier this month, to its procedures for granting stock options -- including ending option grants to Dr. McGuire and Chief Operating Officer Stephen J. Hemsley. Several of Dr. McGuire's top lieutenants, including Mr. Hemsley, also received grants with favorable dates.
In recent weeks, six companies profiled in the March 18 Journal article -- including UnitedHealth, Brooks, Comverse Technology Inc. and Vitesse Semiconductor Corp. -- have announced internal probes into their granting practices, and several have admitted problems with past practices. Eight top officials have left their posts at various companies. Federal prosecutors are examining options practices at Comverse.
In its filing, UnitedHealth also hinted at tax problems. The tax code permits companies to take deductions when employees exercise options for profit. But those deductions can be disallowed for gains pocketed by the CEO and other top-paid executives if grants were made at below-market prices.
UnitedHealth said it "may be required to pay additional taxes and interest" to make up for any deductions it shouldn't have taken. It said it didn't believe any amount it might have to pay would be material.
The company also said it could lose future tax deductions -- which are potentially much larger, given that the five most-highly compensated executives together held $2.7 billion in unrealized options gains at the end of last year, most of which can be exercised at any time.
Securities lawyers said the company appeared to be suggesting yesterday that its auditors were not given the correct information by management about proper grant dates. Armed with the correct information, these securities lawyers said, the auditors almost certainly would have applied a very different accounting treatment to the options grants.
"The kindest explanation is that there was a failure to communicate, that somehow or other the correct dating and pricing information never made it to the auditors," said Joseph Grundfest, a former SEC commissioner who is now a professor of law and business at Stanford University. "At the other extreme, the company knew what it was doing and simply lied to the auditors."
Deloitte & Touche LLP was UnitedHealth's outside auditor in all three of the affected years. A Deloitte spokesman declined comment. |
