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UnitedHealth Executives Forfeit $390 Million in Options
By Steve Stecklow and Vanessa Furhmans
The Wall Street Journal
November 9, 2006

The two top executives of UnitedHealth Group Inc. agreed to forfeit about $390 million in stock-option compensation, by far the biggest sum returned to a company under scrutiny for backdating options awards.

The giveback was announced at the same time the giant health insurer disavowed more than a decade's worth of earnings statements.

Last month, an internal inquiry found that the two executives -- outgoing Chief Executive William W. McGuire and his successor, Stephen J. Hemsley -- received options that carried dates prior to the dates on which they were actually granted, making them more valuable than they otherwise would have been.

Other senior UnitedHealth executives will also return unspecified options gains. Paul Hodgson, senior research associate at Corporate Library, a corporate-governance research group in Portland, Maine, said the $390 million giveback by Dr. McGuire and Mr. Hemsley may be the largest voluntary forfeiture by corporate executives ever. "This is certainly the biggest that I'm aware of," he said.

UnitedHealth is one of the largest companies to be ensnared in the options-backdating scandal, in which companies manipulated the dates that options were awarded to provide additional compensation to executives. More than 130 companies are under investigation by the Securities and Exchange Commission, and many of those are also being probed by the Justice Department.

UnitedHealth also disclosed that it would have to take "significantly greater" charges related to its backdated stock options than it had previously estimated and that it expects the charges to affect the past 12 years of previously reported earnings. The Minnetonka, Minn.-based health-insurance giant didn't specify what the new charges would be. It had previously said it might have to restate up to $286 million in earnings, stemming from three years' worth of earnings.

UnitedHealth also said its chief financial officer, Patrick Erlandson, resigned his post and will be succeeded by G. Mike Mikan, the company's senior vice president of finance. Mr. Erlandson will be reassigned to other "operational duties," the company said. A UnitedHealth spokesman declined to say whether Mr. Erlandson's move was related to the stock-options issue.

More than 40 executives have lost their jobs to date in the options imbroglio, including Dr. McGuire, who agreed last month to step down as UnitedHealth's chairman. He will leave his post as chief executive by Dec. 1, after 15 years at the company. UnitedHealth's internal probe concluded that Mr. Hemsley, the company's chief operating officer, received backdated grants, but it made no finding that he had a role in their creation.

UnitedHealth's options troubles followed a page-one article in The Wall Street Journal in March that showed that Dr. McGuire had received stock options grants at favorable times, including awards received in 1997, 1999 and 2000 whose dates coincided with those years' lowest closing share price. The article reported that the odds of such a favorable pattern occurring by chance were at least one in 200 million. At the time, UnitedHealth called its options-granting process "appropriate."

Options are intended to give recipients the opportunity to profit if the company's share price rises in the future. Usually, the recipient can buy shares in the future at the price of the stock on the day the option was awarded. Backdating involves pretending that the grant was awarded on an earlier day, when the share price was lower, giving the recipient the potential for greater profit. If not disclosed to shareholders, the practice can result in serious accounting and tax consequences.

UnitedHealth, in fact, faces a slew of noncash charges related to stock-based compensation, as well as cash charges resulting from tax liabilities. It said yesterday it would have to further delay filing its third quarter Form 10-Q to the SEC.

Both Mr. Hemsley and Dr. McGuire agreed last month to allow the exercise prices of previously granted options to be reset to the highest share price during the grant year after a board-commissioned review concluded that several option grants had likely been backdated.

The company said Mr. Hemsley and other unnamed senior executives had agreed not only to give up paper gains on unrealized stock options with questionable grant dates, but also to forfeit some money already made on previously exercised options. For Mr. Hemsley, the actions -- including forfeiting a complex tranche of grants that were suspended and then reactivated in August 2000 -- will reduce his past stock compensation by $190 million in both unrealized gains and money he would return. "My decision is in keeping with my personal goal of avoiding even the appearance of any unintended benefit from any past option grants to me," he said in a statement. Before joining UnitedHealth in 1997, Mr. Hemsley was chief financial officer at the accounting firm Arthur Andersen LLP.

Dr. McGuire has also agreed not to benefit from any grants with problematic dates that he has already exercised, although it isn't yet clear how this will be done, according to a person familiar with the situation. His attorney, David Brodsky, said, "Dr. McGuire is pleased to have reached an agreement to reprice his options. The agreement to forgo approximately $200 million means that Dr. McGuire will receive no benefit at all from dating issues in connection with his options."

But Dr. McGuire hasn't yet agreed to forfeit the reactivated options in which he and other employees were effectively able to get the same options twice, at favorable prices. For Dr. McGuire alone, those extra options are now valued at about $250 million. The issue of those options hasn't been resolved between Dr. McGuire and the company, according to people familiar with the situation.

At the end of 2005, Dr. McGuire had a cache of unexercised options valued at $1.78 billion. Mr. Hemsley's options at the time were valued at more than $650 million.

UnitedHealth spokesman Mark Lindsay wouldn't provide any details on the formula the company is using to determine how much executives have to return to the company from previously exercised grants. He added that the company was still working out the details on how the money would be paid back.

However the payback is handled, executive compensation experts said the move to undo past compensation is likely to complicate the tax liabilities that UnitedHealth faces from backdated grants. "The IRS doesn't like that sort of thing," said James Reda, managing director of a New York-based pay consulting firm James F. Reda & Associates.

The company's board also set new rules for its independent directors, prohibiting business relationships that involve payments from company executives or any direct compensation from the company, other than for board service, within the prior three years. That is tougher than New York Stock Exchange requirements, which limit other direct compensation for independent directors to less than $100,000. The more stringent rules come amid the resignation last month of William Spears, a UnitedHealth board member for 15 years, after the company's probe revealed undisclosed financial entanglements with Dr. McGuire.

UnitedHealth also said it reached a new, four-year employment agreement with Mr. Hemsley that is remarkably spartan compared with his and Dr. McGuire's previous contracts. Under its terms, Mr. Hemsley will receive a base salary of $1.3 million, $1 million less than Dr. McGuire earned as CEO. Far from the power Dr. McGuire enjoyed to negotiate and, in some years, set the date for his own option awards, Mr. Hemsley's contract doesn't set any minimum or target level for bonuses or other incentive-linked compensation. Rather, any additional bonuses are "solely at the discretion" of the board's compensation committee, the company reported in a filing with the SEC. "It's unusual for someone to relinquish that much control over how his bonus gets set," Mr. Reda said.

Shares in UnitedHealth fell $1.57 to $48 in 4 p.m. composite trading on the New York Stock Exchange.

Write to Steve Stecklow at steve.stecklow@wsj.com and Vanessa Fuhrmans at vanessa.fuhrmans@wsj.com

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