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Shakeup in UnitedHealth follows probe

Shakeup in UnitedHealth follows probe

MINNETONKA, Minn.—UnitedHealth Group Inc. last week made a slew of changes to its corporate governance and management--including the replacement of its top executive--in the wake of a stock options probe that found several stock option grants awarded to company executives were backdated.

While most observers agree the management overhaul is unlikely to have a major impact on Minnetonka, Minn.-based UnitedHealth's bottom line, many say outgoing Chairman and Chief Executive Officer Dr. William W. McGuire--and possibly the health insurer itself--could face civil and criminal charges by regulators.

Dr. McGuire, who has led UnitedHealth since 1991 and helped grow revenues to $70 billion from $600 million in that time, stepped down last week as chairman and as a UnitedHealth director amid allegations of improper options practices.

Dr. McGuire will continue in his CEO post until his departure from the company on or before Dec. 1, in order to "assist in an orderly transition to new leadership," UnitedHealth said in a statement.

Stephen J. Hemsley, UnitedHealth's president and chief operating officer since 1999, was selected by the company's board of directors to succeed Dr. McGuire as CEO.

Richard T. Burke, the founding CEO of UnitedHealth, replaced Dr. McGuire as nonexecutive chairman.

Also, William G. Spears, a member of the board, and David J. Lubben, general counsel and secretary, have resigned, UnitedHealth said.

The departure of more company executives remains a possibility, UnitedHealth noted. UnitedHealth's board has instructed Mr. Hemsley to "review the conduct of senior executives in the legal, human capital and accounting functions of the company and recommend any additional personnel actions to the board should they be necessary," the insurer said in its statement.

At the same time UnitedHealth announced its sweeping management changes, it released findings of an independent review of the company's stock option grant program, which concluded that many option grants awarded to executives between 1994 and 2002 were backdated (see related story). In one 1999 instance, grants of 1 million options and 500,000 options to Messrs. McGuire and Hemsley, respectively, were "likely backdated," though the report notes Mr. Hemsley "had little or no role in the negotiation of, or the process leading up to, the option award in his contract."

In a conference call with analysts and investors last week, UnitedHealth's Mr. Hemsley said, "We are deeply disappointed by, and apologize to you, for the shortcomings in the stock option program."

UnitedHealth announced additional reforms to bolster the company's corporate governance, following steps taken by the board earlier this year (see box).

Also last week, UnitedHealth posted earnings of $2.97 billion for the first nine months of 2006--up from $2.31 billion in 2005--but said its filing of financial reports for the past two quarters with the Securities and Exchange Commission will be delayed due to the options probe and company changes.

New York-based Moody's Investors Service cut the company's debt ratings a notch, and downgraded its UnitedHealthcare Insurance Co. unit's financial strength rating to A1 from Aa3, following the announcements. Other rating agencies placed the company under review.

"It is only a few people that have left and it's not a wholesale change in management--that's the good news," said J. Paul Newsome, vp and senior equities analyst with A.G. Edwards & Sons Inc. in St. Louis. Dr. McGuire's departure represents "a clear loss" to the company, "but companies like UnitedHealth are vast companies, and the ability of one man or woman to really change the prospects is remarkably limited."

"The bad news," Mr. Newsome said, "is the special report is a pretty harsh read, with pretty clear evidence of backdating, or having backdating as a policy at the firm in some cases."

UnitedHealth may face financial penalties from the SEC as a result of its previous stock options policy, said some observers.

"A resolution of the options investigation will likely result in the payment of a fine to the SEC (in the range of several million dollars), but the bigger monetary risk could be the payment of additional taxes, interest and penalties to the IRS for the underpayment of taxes over a multiyear period," said Carl McDonald, an analyst with CIBC World Markets, in a research note.

In regulatory filings, UnitedHealth has said it faces inquiries into its options practices from federal authorities that include the SEC, Internal Revenue Service and the U.S. Attorney for the Southern District of New York.

Additionally, Minnesota Attorney General Mike Hatch earlier this month won the right to conduct a separate investigation into UnitedHealth's executive compensation practices--a ruling UnitedHealth said it would appeal.

"The dollars involved, the profile of this CEO in the industry, as well as the industry placement of the company, are what make this investigation significant," said Jacob S. Frenkel a former SEC enforcement lawyer who is now a partner at Shulman, Rogers, Gandal, Pordy & Ecker P.A. in Rockville, Md.

"The allegations that already are public suggest that SEC charges are more likely than not," said Mr. Frenkel. "I would be shocked to see criminal charges against (UnitedHealth), but it's much too early to tell how this will play out with the individuals."

"The number of incidents and the nature of the backdating allegations are such that joining the ranks of Comverse and Brocade is not out of the question," Mr. Frenkel said. Executives at Brocade Communications Systems Inc. and Comverse Technology Inc. have been charged by federal authorities with securities fraud as part of a broad regulatory probe into stock-option practices.

"On balance, that report does not cast Mr. McGuire in a good light," said Michael L. Koenig, a former federal prosecutor and now a defense attorney with the firm of Dewey Ballantine L.L.P. in Washington.

Mr. Koenig predicted that the outside report will intensify investigations of UnitedHealth, as it "provides a roadmap" for prosecutors and regulators. Also, it "contains information that can only be viewed as...helping the plaintiffs," bringing shareholder securities lawsuits against UnitedHealth, he said.

An SEC spokeswoman declined to comment on whether the office plans to pursue charges against UnitedHealth Group Inc., Mr. McGuire or other executives. A spokeswoman for the U.S. Attorney's Office for the Southern District of New York said the office "cannot confirm or deny the existence of an investigation."

In May, UnitedHealth said it might be forced to restate several years of financial results stemming from improper oversight of options grants, cutting earnings by as much as $286 million.

However, it has since withdrawn that May estimate. Last week, a company spokesman said UnitedHealth "does not have an estimate of the maximum potential impact and probably won't until it files its late second-quarter and third-quarter 10Qs, for which there is no pronounced timing."