Reforming United Health (cont.)

McGuire has responded by claiming that his CEO experience gave him an ability to select when the company's shares were at a low. But after August 2002, Sarbanes-Oxley required disclosure of executives' options grants within two days - and McGuire suddenly lost his extraordinary power to pick such profitable dates.

There were other problems McLucas uncovered. On Sept. 16, 1999, UnitedHealth issued a press release announcing that both McGuire and Hemsley had "entered into new, long-term employment agreements" - even though the contracts weren't done. (McGuire reportedly told McLucas that he approved the false statement because he wanted to reassure Wall Street that he had no plans to leave.)

It also turned out that McGuire had a conflict of interest with Spears, a New York money manager who chaired the special board committee negotiating the new contracts. Spears had managed as much as $55 million for McGuire since 1996; the CEO had also invested $500,000 in Spears' firm. The two men insist the board knew about the matter, citing a brief, late-night e-mail, sent in October 1999 by UnitedHealth's general counsel to an outside lawyer, seeking advice about the conflict. The e-mail said: "Bill Spears has disclosed [the conflict] to the full board." Yet only one UnitedHealth director could recall hearing anything about the relationship, leading McLucas to conclude that its "nature and full extent" were probably not disclosed.

There are also indications that two giant sets of grants McGuire and Hemsley received in 1999 were backdated to Oct. 13, when UnitedHealth shares closed at $40.125, their low price for the year. The first set was for their signing bonuses, made "effective" on that date even though the contracts weren't approved until three weeks later.

The second, which also involved other executives, came after UnitedHealth shares, trading at $60.50 on Sept. 29, dropped $20 by mid-October on news of class-action lawsuits. Days later, citing "employee morale and retention," McGuire sought board approval to "suspend" about two million underwater options priced above $46.50 and replace them with options priced at $40. McGuire, who had privately denounced repricing as "rewarding bad performance," would get 750,000 of the new shares himself. In fact, by the time the comp committee met on Oct. 26, the stock had already rebounded to $49, and many of the "suspended" options - including all of McGuire's - were back in the money. Yet the replacement options were issued anyway, with an "effective date" of Oct. 13. Ten months later, with UnitedHealth trading at nearly $82, the company "reactivated" the suspended options. McGuire's profit on this double-dip grant is now about $280 million.

In a statement, McGuire's lawyer, David Brodsky, said the CEO believed the options process at UnitedHealth was "transparent and appropriate" and that directors and other senior managers involved in the decisions "never raised concerns at the time."

"We sleep with good conscience," McGuire told analysts not long after the Journal story appeared. But by July 11, with McLucas far from finished, McGuire sought to take charge, presenting a five-page memo to the board proposing steps to restore UnitedHealth to "its full luster." They included repricing his own options upward and forfeiting his grants and bonus for 2006. McGuire offered to "orchestrate an orderly retirement," although he wrote, "Such an action is not my preference."

But when the directors received McLucas's report in October, they decided that their CEO needed to go. "There were a number of issues, no one of which would have done him in," says Leatherdale. "When they all added up, it became quite clear to the board that a change needed to be made."

And what of Hemsley, whose own options total had grown to $662 million by the end of 2005? He had received misdated options too, as well as the "reactivated" 2000 shares and a 1997 grant dated before he had even started work. McLucas's report concludes that Hemsley was essentially an innocent bystander, even letting McGuire negotiate the size of his awards. "Steve is a guy who didn't really pay much attention to how much he was being paid and how many options he got," says Leatherdale. "The board was very comfortable with Steve's role."

On taking over as CEO, Hemsley agreed to reprice his misdated options to the highest price of each year, pay back excess gains from shares he'd sold, and forfeit all options "reactivated" in 2000 - moves that will cost him about $190 million. He recently closed one chapter in the scandal by completing a $1.5 billion restatement of UnitedHealth's earnings dating back to 1994. Eager to show Wall Street that the company hasn't lost its mojo, Hemsley has promised to buy back $4 billion in stock in 2007 and announced a $2.6 billion acquisition. He is projecting profit growth of 15% this year.

So far Wall Street is giving him the benefit of the doubt. UnitedHealth's stock, which fell to $42 after the company announced it was under federal investigation, has climbed back above $50. It hasn't hurt that Warren Buffett recently reported buying a million shares.

A governance overhaul is underway too. The board has named a nonexecutive chairman, is recruiting five independent directors (Spears has resigned), and plans to require directors to attend training and stand for reelection annually by majority vote. The CFO and general counsel have been replaced; executive perks have been curbed; the compensation committee will approve all future stock awards on a quarterly basis.

Even so, it won't be easy to purge UnitedHealth of McGuire's ghost. While the investigations drag on, negotiations for a settlement with the former CEO are frozen. Although McGuire will also reprice his questioned options - giving up about $200 million - he has not agreed to forfeit the reactivated shares. The UnitedHealth board has appointed a special litigation committee to address whether the company should pursue claims against McGuire or anyone else. The ex-CEO is barred from selling any options or collecting retirement pay until the committee presents its findings, due July 30.

For a time after the board's Oct. 15 decision to replace McGuire, it seemed that he'd never leave. The company's succession announcement noted that McGuire would retain his title until Dec. 1 to "assist in an orderly transition." Instead of withdrawing from the scene (as is usually done), McGuire kept coming into his office until that date, summoning subordinates, weighing in on problems, saying goodbyes, and sometimes venting about the injustice of how he'd been treated - all while Hemsley was trying to grab the wheel from his own office 20 feet away.

"At some points, Bill didn't quite understand what all this was about," says UnitedHealth director Leatherdale. "He's still struggling a little bit with it all. He's a brilliant, highly respected man who ran one of the 25 largest companies in the United States. It's there one day - and not the next. In human terms, it's very sad."

Reporter associate Doris Burke contributed to this article. 

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