To quote the article,
The Securities and Exchange Commission is examining whether some option grants carry favorable grant dates for a different reason: They were backdated. The SEC is understood to be looking at about a dozen companies' option grants with this in mind.The article particularly emphasized how UnitedHealth Group, the large commercial managed care organization, granted stock options to its CEO, Dr William W McGuire.
The Journal's analysis of grant dates and stock movements suggests the problem may be broader. It identified several companies with wildly improbable option-grant patterns. While this doesn't prove chicanery, it shows something very odd: Year after year, some companies' top executives received options on unusually propitious dates. (An explanation of the methodology is below.)
The analysis bolsters recent academic work suggesting that backdating was widespread, particularly from the start of the tech- stock boom in the 1990s through the Sarbanes-Oxley corporate reform act of 2002. If so, it was another way some executives enriched themselves during the boom at shareholders' expense. And because options grants are long-lived, some executives holding backdated grants from the late 1990s could still profit from them today.
Stock options give recipients a right to buy company stock at a set price, called the exercise price or strike price. The right usually doesn't vest for a year or more, but then it continues for several years. The exercise price is usually the stock's 4 p.m. price on the date of the grant, an average of the day's high and low, or the 4 p.m. price the day before. Naturally, the lower it is, the more money the recipient can potentially make someday by exercising the options.
A key purpose of stock options is to give recipients an incentive to improve their employer's performance, including its stock price. No stock gain, no profit on the options. Backdating them so they carry a lower price would run counter to this goal, by giving the recipient a paper gain right from the start.
Companies have a right to give executives lavish compensation if they choose to, but they can't mislead shareholders about it. Granting an option at a price below the current market value, while not illegal in itself, could result in false disclosure. That's because companies grant their options under a shareholder-approved "option plan" on file with the SEC. The plans typically say options will carry the stock price of the day the company awards them or the day before. If it turns out they carry some other price, the company could be in violation of its options plan, and potentially vulnerable to an allegation of securities fraud.
The Journal's analysis raises questions about one of the most lucrative stock-option grants ever. On Oct. 13, 1999, William W. McGuire, CEO of giant insurer UnitedHealth Group Inc., got an enormous grant in three parts that -- after adjustment for later stock splits -- came to 14.6 million options. So far, he has exercised about 5% of them, for a profit of about $39 million. As of late February he had 13.87 million unexercised options left from the October 1999 tranche. His profit on those, if he exercised them today, would be about $717 million more.These allegations seem to clash with UnitedHealth Group's mission statement, which expressly includes, "making health care more affordable." Making huge stock option grants to its CEO, as we have mentioned before, hardly seem to be a way to make health care more affordable. Gimmicking the timing of the grants to increase his compensation just adds salt to the wound, and reinforces the concern that large health care organizations may be run more for the benefit of their top executives than for any other purpose.
The 1999 grant was dated the very day UnitedHealth stock hit its low for the year. Grants to Dr. McGuire in 1997 and 2000 were also dated on the day with those years' single lowest closing price. A grant in 2001 came near the bottom of a sharp stock dip. In all, the odds of such a favorable pattern occurring by chance would be one in 200 million or greater. Odds such as those are 'stronomical,'said David Yermack, an associate professor of finance at New York University, who reviewed the Journal's methodology and has studied options-timing issues.
Until last year, UnitedHealth had a very unusual policy: It let Dr. McGuire choose the day of his own option grants. According to his 1999 employment agreement, he is supposed to choose dates by giving "oral notification" to the chairman of the company's compensation committee. The agreement says the exercise price shall be the stock's closing price on the date the grants are issued.
Arthur Meyers, an executive-compensation attorney with Seyfarth Shaw LLP in Boston, said a contract such as that sounded 'ike a thinly disguised attempt to pick the lowest grant price possible.'Mr. Meyers said such a pact could pose several legal issues, possibly violating Internal Revenue Service and stock-exchange listing rules that require directors to set a CEO's compensation. "If he picks the date of his grant, he has arguably set a portion of his pay. It's just not good corporate governance."
One wonders what sort of oversight the UnitedHealth Group board of directors was providing. Maybe director Donna Shalala, who also has the seemingly conflicting job of being president of the University of Miami, and hence the person ultimately responsible for the operation of its medical school and academic medical center, was too busy enjoying her lavish lifestyle.