Scandal blame game (cont.)

As a practical matter, it is also clear that the company had a big stake in isolating Hemsley from the problem. Because he is so widely respected as an operations man, Hemsley's elevation did much to limit the Wall Street damage of McGuire's departure. Notes Goldman Sachs analyst Matthew Borsch: "The impact to the stock was significantly mitigated with the retention of Hemsley. If Hemsley and McGuire had both been forced to leave the company, then investors would have looked at it as a wholesale management change."

With the October 2006 completion of UnitedHealth's investigation, the company announced Spears' departure from the board, which he'd joined back in 1991. At issue was Spears' relationship managing millions for McGuire, even while he had led the ad hoc committee negotiating the CEO's contract.

Spears, a graduate of Princeton and Harvard Business School, in 1992 began serving as trustee for accounts benefiting McGuire's two daughters. In 1994, he started managing a pot of McGuire's personal money, with the total climbing to more than $55 million by 2006. Spears also helped manage investments in McGuire's charitable foundation. Finally, McGuire in 1999 invested $500,000 to help the money manager buy back his firm (then named Spears Benzak Salomon & Farrell) from a financial conglomerate called KeyCorp.

McGuire and Spears insist the board knew all about their conflict. Their strongest evidence is a brief e-mail, sent at 11:43 p.m. on October 12, 1999 by UnitedHealth general counsel David Lubben, seeking advice from the company's outside corporate lawyer, William Alt, with the Minneapolis firm of Dorsey & Whitney. It reads: "Bill Spears' company provides investment advice/manages money for Bill McGuire. Bill McGuire has a small investment in Bill Spears' company. Bill Spears is the chairman of our compensation committee. Other than the conflict, which Bill Spears has disclosed to the full board, is there anything about which I should be concerned from a [public] disclosure standpoint or otherwise?"

Lubben and Alt had a follow-up conversation concerning the matter, but reportedly concluded the matter did not require public disclosure. Lubben also made handwritten notes during a February 1999 meeting of the board audit committee that referred to a conflict between McGuire and Spears. (Lubben's attorney and Alt would not comment on this matter to Fortune.)

Yet only one board member says he recalls hearing anything about the conflict, while others were adamant that they would have remembered any such revelation. This led McLucas to conclude that the conflict's "nature and full extent" were probably not disclosed to the board during 1999, when the new executive contracts were being negotiated.

Spears' attorney, Carl Loewenson with the New York office of Morrison Foerster, insists that the contemporary documentation should be given greater weight than the seven-year-old recollections of embarrassed directors. "The e-mail shows that Bill Spears' firm's relationship with Dr. McGuire was fully disclosed to the company and both its general counsel and outside counsel knew all of the relevant facts. Beyond that, it was the company's obligation to determine whether to disclose that information to the public."

There is, of course, also the question of broader board responsibility. It is clear that McGuire held the directors - who made millions themselves from hefty options grants - in his thrall. ("We're so lucky to have Bill," Columbia nursing school dean Mary Mundinger, a longtime compensation committee member, gushed to the Wall Street Journal in 2006. "He needs to be compensated appropriately so that his business model has believability in the market.")

McGuire's remarkable 1999 contract gave him discretion (subject to compensation committee approval) to personally select grant dates - even for his own shares - and guaranteed him huge annual cash and stock awards, as well as a "signing bonus" of one million options. It also included an array of company-paid perks, including tax assistance, security services, an annual expense allowance and personal travel on the corporate jets.

It's clear that the compensation committee - including directors who remain on the board, such as Mundinger and 9/11 commission co-chairman Thomas Kean - provided weak oversight. The committee's actions were so poorly documented that McLucas and his forensic team couldn't fully reconstruct precisely what the board had authorized and what it hadn't.

It is also true that directors regularly signed paperwork approving stock grants bearing an exercise date that was weeks earlier, when the share price was much lower. For example, a "written action" signed by Spears, Mundinger and Kean and authorizing hundreds of thousands of options for the company's top eight executives, was dated "effective January 17, 2001" - and priced at that date's close, $52.69. But board minutes suggest the undated document may not have been signed until sometime around the committee's meeting on February 13, when the stock had already risen to around $59. (This gave McGuire an instant paper gain of about $4 million on his own award.)

The board's defense is that it wasn't familiar with the precise legal process required for granting options (weren't contracts routinely made retroactive?) - and that it trusted others to tell them if something was wrong. That, of course, is also McGuire's story. The difference is that directors believe the primary burden was on management to get it right. And besides, McGuire wasn't replaced because of procedural and paperwork problems - he lost his job because the board didn't buy his denial that he'd set low dates with the benefit of hindsight.

To the board, investigator McLucas offered only a minor rebuke. "Although it might have been better if members of the Compensation Committee....had focused more on the prices at which options were granted, the Directors were entitled to presume that matters brought before them for action were procedurally proper and consistent with applicable legal and accounting standards."

Rather than give any other board members the boot, the company has responded to these oversight failures with a raft of governance changes, as well as plans for director training and the addition of five new independent members (the first was named just last week). "In hindsight, it was obvious that there were some board governance issues that we should have dealt with earlier," says Leatherdale. "That's hindsight."

Finally, where were the lawyers and accountants? In his brief statement to Fortune, McGuire's attorney pointedly noted that the business of awarding options at UnitedHealth wasn't a one-man show: Among those who failed to raise concerns - in addition to company directors and various senior executives - were "other experts familiar with the processes."

Outside lawyers and auditors routinely review official corporate documents, especially in an area like issuing stock options, which presents tricky bookkeeping and tax issues. Yet clearly improper practices went on for years at UnitedHealth, leading to a $1.55 billion restatement of earnings dating back to 1994. (While it is actually legal to grant "in the money" options, companies rarely do that. Such grants have to be publicly disclosed, given special tax treatment, and accounted for as an expense, which hurts profits.)

"You say, 'Why the hell wasn't somebody aware of this?'" notes Leatherdale. "...There was substantial sums of accounting fees paid to auditors to make sure we were in compliance. And nobody picked this up." That "nobody" would be UnitedHealth's outside audit firms - Arthur Andersen through 2001, and Deloitte Touche thereafter. Deloitte remains the company's audit firm for 2007. (The firm did not respond to a request for comment.)

And so it goes in the messy business of corporate scandal. All of which isn't to suggest that Bill McGuire was pure - just that there's plenty of blame to go around.

Reporter associate Doris Burke contributed to this article. 

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