A "Pump and Dump" Stock Scheme and a University's "Incredible Gift"

Here is a new twist on how respected academic institutions have gained from less than respectable donors.  As reported by the Palm Beach (FL) Post,

John David Mazzuto and a colleague stole more than $60 million from his former company and its investors, New York prosecutors said Tuesday afternoon.

... the Manhattan District Attorney said today that, while he was in bankruptcy from 2002 to 2009, he siphoned more than $15 million from Industrial Enterprises, and used the money to support 'a lavish lifestyle using millions of company dollars for homes, travel, and personal expenses.'

They included Mazzuto's 7,715-square foot house at 11503 Green Bayberry Drive. Palm Beach County records show a corporation managed by him bought it for $2.6 million in 2007. No mortgage was recorded, suggesting the company bought it outright.

New York prosecutors said Mazzuto also bought a $3 million home in the exclusive Long Island community of Southampton and spent more than $500,000 to fly on private jets.

Palm Beach Gardens police arrested Mazzuto Thursday and investigators from New York were in a Palm Beach County court Monday to collect him.

The New York indictment alleges Mazzuto and Cleveland, Ohio, attorney James W. Margulies, the corporation's general counsel, illegally issued millions of shares of stock and used fraud to inflate its value and deceive investors.

Mazzuto and Margulies are charged with grand larceny, scheme to defraud, conspiracy, falsifying business records, and violations of New York State's securities fraud law.

The district attorney said the two illegally issued millions of shares to family, friends, and associates.

'The defendants stole from the corporation and legitimate investors, and engaged in a variety of fraudulent accounting and securities practices to disguise the theft and pump up the value of the stock,' the release said. It said one outside investor lost more than $20 million.

'This was the wholesale looting of a public company,' Manhattan District Attorney Cyrus R. Vance, Jr., said in a statement.

A 2007 class-action lawsuit filed by investors alleged Mazzuto had a long history of unscrupulous business practices.

It also alleged Mazzuto used more than $100,000 from insider trading to buy a Porsche for his girlfriend.

The suit said the federal Securities and Exchange Commission was investigating Industrial Enterprises for insider trading and accounting fraud during Mazzuto's tenure. The SEC has declined to comment.

Mazzuto and Industrial Enterprises, saying the accounting mistakes were unintentional, agreed in April to settle the lawsuit for $3.8 million, records show. The settlement still is awaiting the court's approval.

Industrial Enterprises has been negotiating since October for Yale to return a gift that paid for a head coach and a new all-weather baseball practice facility.

Lawsuits alleged the bequest included improperly issued stock worth $1.7 million.

The New York Times added some detail about Mezzuto's dontation to Yale:

The news release called John D. Mazzuto one of the 'greatest supporters' of the Yale University baseball team.

Mr. Mazzuto, a 1970 Yale graduate who played shortstop for the team, had donated to the baseball program about $1.5 million worth of shares in a company he owned. The university rewarded him by naming a new practice facility after him and his wife — the John and Theresa Mazzuto Field — and by adding his family name to the baseball coach’s official title: the Mazzuto Family Head Coach of Baseball.

'John has bestowed upon Yale baseball an incredible gift,' John Stuper, the baseball coach at Yale, said in the release, dated April 17, 2009. 'His support of our program has been absolutely phenomenal.'

Manhattan prosecutors said Tuesday that Mr. Mazzuto’s support of his alma mater was illegal.

Mr. Mazzuto, 61, was indicted on charges of fraudulently inflating the value of a company he owned to mislead investors into buying worthless shares. He gave shares of the company, Industrial Enterprises of America, to family and friends and to companies he controlled, and they sold them on the open market, giving some of the profits to Industrial Enterprises, prosecutors said.

Those profits made Industrial Enterprises seem as though it was in better financial health than it actually was, raising its stock’s value, prosecutors said.

'It’s a new twist on a pump-and-dump,' said Garrett A. Lynch, the assistant district attorney handling the case.

Mr. Mazzuto also gave shares of the stock to Yale, prosecutors said. The university sold its shares before their value plummeted and earned about $1.5 million, prosecutors said.

Yale officials did not know that Mr. Mazzuto was issuing stocks illegally, prosecutors said, although some of the recipients of the shares did conspire with him.

A report in the Wall Street Journal added:

Industrial Enterprises, which was based in New York at one point, sought Chapter 11 bankruptcy protection in May 2009. [a month after Yale announced the donation - Editor]

A shareholder lawsuit, filed in federal court in Manhattan in 2007, alleged the company engaged in accounting fraud by 'materially overstating' its revenue between December 2006 to November 2007. The company announced in November 2007 it had overstated revenue by millions of dollars for two quarters that year.

For the sake of fairness, I must emphasize that the allegations against Mr Mezzuto and Mr Margulies are just that. However, there ought to be considerable suspicion that something unethical was going on, at least based on the company's admission of over-stated earnings, Mr Mezzuto's provision of the gift while he apparently was in personal bankruptcy, and (at least in retrospect), the company's filing for bankruptcy weeks after the gift of its stock was announced . Thus, Yale's acceptance of the gift, and its effusive accolades to its donor at best suggest an attitude of "what, me worry."

At best, it seems that our once unimpeachable academic institutions have become so eager to raise money that the provenance of donations is no longer of interest to them.  Furthermore, it seems that anyone who provides a big donation becomes a local hero, regardless of the source of the donation.  Embracing donations arising out of questionably ethical situations implies a tacit endorsement of the means used to provide them.  Our universities ought to remember that their mission is teaching, research, and for academic medical institutions (as Yale is), patient care.  It may be true that if there is no margin, there is no mission, but if margin comes first, regardless of where it comes from, there soon will be no mission. 

Post Title → A "Pump and Dump" Stock Scheme and a University's "Incredible Gift"

FOLLOW the MONEY, Part II

FOLLOW the MONEY, Part II

Recently we looked at some financial aspects of the boundary between Stanford University and Corcept Therapeutics. Dr. Alan Schatzberg, the chair of Stanford’s psychiatry department, received at least $510,000 from Corcept between 2000 and 2007. Senator Grassley asked why NIH received no disclosure from Stanford of Dr. Schatzberg’s realized gain from selling Corcept stock while he was Principal Investigator on a related NIH grant. The Senator also remarked on Stanford’s lowball estimate to him of Dr. Schatzberg’s equity in Corcept, currently between $5 million and $6 million.

Dr. Schatzberg is not the only academic to benefit from Corcept. Dr. Charles Nemeroff, a member of Corcept’s scientific advisory board, also did well. He exercised options to buy 60,000 shares on joining the board in 1998. Dr. Nemeroff diligently promoted Corcept’s drug. Following the style documented for Dr. Schatzberg, Dr. Nemeroff emphasized weak positive trends in the data while suppressing inconvenient negative analyses. In the fall of 2002, Dr. Nemeroff referred to the Stanford-NIH trials as “impressive studies indicating that ... (mifepristone)...is very effective in the treatment of psychotic depression.” The claims “impressive” and “very effective” are indefensible, and may even be fraudulent. Dr. Nemeroff’s exaggerated promotion occurred while the company prepared for its IPO, but he did not disclose his financial stake. Right after the 6-month SEC-mandated lockup period expired, Dr. Nemeroff sold 20,000 shares for $137,500. His cost was $6.60. Help me, what is the right term for this behavior?

A second member of the team who did well is Dr. Joseph Belanoff, Corcept’s co-founder and CEO. Like Dr. Schatzberg, he received around 3 million shares in 1998. Dr. Belanoff began selling as soon as the lock-up period ended. Between November 2004 and November 2006, Dr. Belanoff sold approximately 10,000 Corcept shares each month, realizing over $1 million. His cost for all those shares was around $80. An on-line financial service listed 6 additional quarterly sales, each of 30,000 shares, which netted over $900,000. Dr. Belanoff also received an ample corporate salary. His documented salary increased from $310,500 plus a 10% bonus in 2003 to $1,643,760 in salary ($411,008), bonus ($102,752), and stock options ($1,130,000) in 2007. Not bad, for someone with modest academic credentials.

Stanford University itself has a financial stake. Following a licensing fee of $47,000 that was paid to Stanford in 1999 along with 30,000 shares of stock, Corcept has been obligated to make non-refundable royalty payments of $50,000 a year. That adds up to $497,000 through 2008. Additional payments up to $250,000 are due to Stanford when certain drug development milestones are reached. Stanford has stated that it long ago divested itself of the Corcept stock. However, an on-line information service lists Stanford as a major shareholder as recently as 31 March 2008, with over 47,000 shares in the name of the Board of Trustees. In a second agreement, Stanford receives a $20,000 licensing fee, 1000 shares of Corcept stock, $10,000 a year in non-refundable royalties, and potential milestone payments of $350,000. All of this is in advance of any marketing of products by Corcept. So, Stanford is not exactly a disinterested administrator of the academic-corporate boundary between Dr. Schatzberg, NIH, and Corcept.

We should also note some unusual events involving Corcept stock movements. On 15 August 2005 Corcept stock received a research broker upgrade. Heavy selling followed the upgrade (volume was 613,000 shares, 31 standard deviations above the mean for the previous 10 trading days). For non-statistician readers, 3 standard deviations would tell us that the spike is almost certainly not consistent with the historical fluctuations in volume. So, a spike of 31 standard deviations means any such probability is astronomically small. The stock price moved up 34% from the previous day but quickly sank again. That same day, Dr. Schatzberg sold 15,597 shares for $109,179, at an intra-day high of $7 per share. The cost basis of those shares to him was $5.15.

On Friday 23 September 2005, heavy selling of Corcept stock occurred (871,700 shares). This volume was 35 standard deviations above the mean of the previous 10 trading days. On the following Monday, Corcept announced that a widely publicized study of mifepristone for Alzheimer disease was being halted prematurely for lack of progress. The company also announced slower than expected enrollment in a Phase III study of psychotic depression, for which they projected delayed announcement of results. Over the next month the stock price declined 16%.

These episodes of concentrated stock movement represent coincidences that remain to be explained. Was the August 2005 upgrade and selling spike in which Dr. Schatzberg participated a case of “pump and dump”? Was the September 2005 selling spike ahead of bad news a case of insider trading? Who did all that selling, and how did they know?

The questions just keep coming.

Post Title → FOLLOW the MONEY, Part II

A More Entangled Web: the UnitedHealth Case

More issues are surfacing regarding the question of whether stock options given to top executives of UnitedHealth Group were back-dated. We have posted frequently on this topic, most recently here (and see links within to earlier posts.

According to multiple news sources, (see, for example, this article by Melissa Davis in TheStreet.com), UnitedHealth has delayed its latest quarterly report "due to possible accounting changes that could prove material in nature. The changes, if necessary, would reflect the rising value of options issued to company employees -- including massive grants to CEO William McGuire -- and drive up reported expenses as a result." Several analysts proposed that this delay indicates more severe problems with the stock options than were heretofore anticipated.

Bloomberg News noted that the board of directors that approved the huge grants of stock-options to UnitedHealth CEO Dr William McGuire was itself particularly well compensated, especially in terms of stock options.

UnitedHealth's 10 non-executive directors held $230 million in stock as of March 21, according to the health insurer's most recent proxy. Director Richard Burke, who joined the board in 1977, had $169 million in shares, while Douglas Leatherdale owned $47 million. The directors, including former New Jersey Governor Thomas Kean and former Fannie Mae chief executive officer James Johnson, held more than 3.1 million stock options, whose underlying value is about $175 million.

Each UnitedHealth director makes at least $400,000 a year, counting pay and exercisable options, according to Jesse Fried, a professor at the law school of the University of California at Berkeley. The Corporate Library, a Portland, Maine-based governance group, says UnitedHealth had the eighth-best- compensated board in the nation in 2004, with total compensation of $5.4 million.

The outside directors are paid in a combination of cash and options grants. According to the April 7 proxy, they get an annual cash retainer of $30,000, plus payments for each board and committee meeting attended. They also get an initial one-time option to buy 58,000 shares, plus quarterly options to buy 8,000 shares, or 32,000 options a year for each year they serve.

The initial grants are exercisable over three years, while the quarterly grants can be exercised immediately. The price of the initial options is set by the closing price of UnitedHealth stock on the day the director is elected, which is at the annual meeting. The price of the quarterly options is set by the closing price of UnitedHealth shares the first business day after the quarter ends, the proxy says.

As of March 21, the three members of the compensation committee -- Johnson, 62, the chairman, Mary Mundinger, 68, dean of Columbia University's school of nursing, and William Spears, 67 -- held a total of more than 1.1 million options, the company's proxy shows. Spears also held $3.7 million in stock and Mundinger held $1.8 million.

Some commentators suggested a discrepancy between the magnitude of the board members' compensation and the extent of their efforts supervising McGuire and other top executives. For example, Patrick McGurn, Executive Vice President of Institutional Shareholder, said,

This is the no-show board of all time in terms of the job they did in overseeing compensation.

They handed the reins over to management and played the roles of cheerleader.

Finally, the Pioneer Press has been investigating other potential conflicts of interest affecting the UnitedHealth board of directors. These conflicts are important because,

With options under scrutiny at more than 80 companies so far, regulators and prosecutors haven't the resources to conduct full-blown forensic probes of every company. They often rely on companies' own internal inquiries to do the initial digging that helps authorities decide whom to pursue most vigorously. In addition, the companies rely on these internal probes, either to show the public they've been diligent or to defend against shareholder suits.

In these probes, 'if the government catches wind of issues affecting independence, they will naturally be more skeptical and less trusting of the process and the results,' said W. Scott Sorrels, an Atlanta attorney who has conducted investigations for corporate boards in the past. Sorrels, not speaking of any particular company, said, 'We advise companies to avoid any appearance of impropriety so you don't have the situation blow up in your face six months down the road after the investigation is done.'

One conflict affected board of directors member Thomas H. Kean, former governor of New Jersey, who was a member of the compensation committee.

The same day as the [May 1] board meeting, some UnitedHealth directors and executives were supporting a campaign by Kean's son for a U.S. Senate seat from New Jersey. Some of them attended a fundraiser for Tom Kean Jr. that day, in UnitedHealth's home state of Minnesota.

It isn't clear whether McGuire and his wife attended but each donated $2,000 to the cause. So did Richard T. Burke, who sits on a special board committee that is overseeing the options investigation. All told, UnitedHealth-affiliated donors have contributed $25,000 to the campaign.

When the donations to the Kean Senate campaign were described to former SEC Chairman Harvey Pitt, he said they struck him as 'ill-advised and strange' and something that could be seen as an attempt to influence a witness because of the senior Kean's role on the compensation committee.

A spokeswoman for the Kean campaign said the fundraising came at a 'UnitedHealth breakfast' hosted by Minnesota Republican Sen. Norm Coleman, and there was absolutely no effort to curry favor with the elder Kean. The former New Jersey governor didn't return calls seeking comment.

Another involves board compensation committee member William Spears,

One longtime UnitedHealth comp-committee member, William Spears, is a money manager with the New York firm Spears Grisanti & Brown LLC. The firm appears to manage money for McGuire's family foundation. In tax filings covering two recent years, the foundation put the name of Spears' firm atop a list of its securities transactions. A partner in the firm, Christopher Grisanti, said privacy regulations barred him from saying whether the foundation was a client. Spears didn't return messages seeking comment.

Another involves board compensation committee member Mary Mundinger. We have previously posted about Mundinger, since she is also a Professor and Dean of the School of Nursing at Columbia University. We proposed that Mundinger's fiduciary duties to the shareholders of UnitedHealth may be at odds with her duty to uphold the mission of Columbia University and its School of Nursing. The university's academic medical center must undoubtably deal with managed care organizations that compete with UnitedHealth, or with UnitedHealth directly.

Another longtime member of the health insurer's compensation panel is Mary Mundinger, dean of the Columbia University nursing school. Mundinger has championed the idea that nurse practitioners can provide high-quality primary care, and in the mid-1990s she shepherded a pioneering project to create a nurse-practitioner clinic in New York. The support of health insurers was critical to getting patients to use it, and UnitedHealth was among several insurers to sign on. In media interviews at the time, UnitedHealth officials spoke approvingly of her project.

The anecdote again illustrates the complex relationships between Mundinger's academic work and her duties to UnitedHealth.

There are at least two major issues here for health care.

One is the continued and ever more glaring contrast between UnitedHealth Group's stated mission, to

* Improve access to health and well-being services;

* Simplify the health care experience;

* Promote quality; and,

* Make health care more affordable.

and the largesse it granted to its top leaders, executives and board members.

The second is the more and more apparent web of conflicting interests that entangles many health care organizations who are ostensibly supposed to be operating at arms' length. This web is of particular concern when it entangles leaders of academic medicine with simultaneous duties to uphold the interests of corporate stockholders. The interests of the stockholders may be at variance with the missions of the academic leaders' institutions. (And note that the UnitedHealth Group board of directors includes Donna Shalala, the President to the University of Miami, and hence the leader to which the university's medical school and academic medical center reports, and Gail Wilensky, a well-known health services researcher at Project HOPE.)

Post Title → A More Entangled Web: the UnitedHealth Case

More Lucrative Stock Options for Top Health Care Company Executives

The Wall Street Journal has reported yet another way companies have developed to make stock options more lucrative for their top executives. Two examples cited involved well-known health care companies. (Since the article is not available without a subscription, I will quote extensively.)

On Sept. 21, 2001, rescuers dug through the smoldering remains of the World Trade Center. Across town, families buried two firefighters found a week earlier. At Fort Drum, on the edge of New York's Adirondacks, soldiers readied for deployment halfway across the world.

Boards of directors of scores of American companies were also busy that day. They handed out millions of bargain-priced stock options to their top executives.

The terrorist attack shut the U.S. stock market for days. When it reopened Sept. 17, stocks skidded more than 14% over five days, in the worst full week for the Dow Jones Industrial Average since Germany invaded France in May 1940. But for recipients of options, the lower their company's stock price when options are awarded the better, since the options grant a right to buy shares at that price for years to come. The grants set recipients up for millions of dollars in profit if the shares recovered.

Ninety-one companies that didn't regularly grant stock options in September did so in the first two weeks of trading after the terror attack. Their grants were concentrated around Sept. 21, when the market reached its post-attack low.

Stock options were originally designed to align executives' incentives with the goals of shareholders, encouraging recipients to work hard to improve their companies' stock price. When those options are granted at favorable prices, executives get some of their gain free -- that is, they get a chance to buy in an unusual dip below the price many investors have paid.
There's nothing illegal about granting options after the market plunges. But acting so quickly after a national tragedy drove down stocks shows the eagerness of some companies to increase their executives' potential wealth. These grants also offer important new fodder for an already fractious debate over what constitutes the proper use of options in executive compensation.

UnitedHealth Group

Some of the post-9/11 grants were extraordinarily well-timed, hitting the exact low for the period. At least six of the companies that granted options dated after the attack are under investigation in the wider options-timing probe. That raises the question of whether some grants that appear to have been granted in the post-attack period were actually made later, then backdated.

UnitedHealth, which granted stock options dated shortly after the terror attack, also faces investigations of its other options practices by the Securities and Exchange Commission and federal prosecutors. The former CEO of one UnitedHealth unit, R. Channing Wheeler, received option grants dated on quarterly lows for four straight years, 1999 through 2002. In September 2001, UnitedHealth gave Mr. Wheeler 96,000 options, adjusted for later stock splits, priced at the managed-care company's post-9/11 quarterly low. UnitedHealth declined to comment and Mr. Wheeler didn't return calls.

On UnitedHealth's compensation committee in September 2001 were New York investor William Spears, Columbia University nursing dean Mary Mundinger and former New Jersey Gov. Thomas Kean -- later head of the federal commission that investigated Sept. 11 intelligence failures. Mr. Kean and Ms. Mundinger didn't return calls, while Mr. Spears declined to comment.

Stryker Corp

At Stryker Corp., a Michigan maker of orthopedic products, onetime stock-option-committee member John Lillard said he didn't regret the decision to award options nine days after the attack. 'If you believe the company is going to do well, and here is an external event that is affecting the market and you've made a decision to reward executives, you go ahead with it,' Mr. Lillard said. 'Life goes on.'

At Stryker, in Kalamazoo, Mich., post-9/11 stock-option grants to several executives appear to have been initiated by the chairman and CEO at the time, John W. Brown. They were dated Sept. 20, 2001, at the bottom of a sharp 'V' pattern in the share price.

Mr. Brown would 'periodically tell us if he thought the stock was attractive,' and then the board would decide whether to award options, said Mr. Lillard, the former member of Stryker's stock-option committee. 'We didn't just sit down after Sept. 11th and say, 'Gee, how can we take advantage of this?' ' Mr. Lillard said. Besides, he added, no one could have known whether the stock would rebound immediately or continue to slide.

Mr. Brown said that for the past 10 to 12 years, the company, to compensate for a relatively small number of options given to executives, has tried to 'pick what we think would be the low point of the year. That's what we're gunning for.'

Stryker's option grant came on the lowest closing stock price for the second half of the calendar year. Mr. Brown said he believes that he called both members of the stock-option committee on Sept. 20 to recommend they choose that day to grant options. He added that he couldn't remember a time when the board didn't follow his advice.

Mr. Brown said that while he didn't remember the details of the 2001 grant, 'that was the year of 9/11. I'm sure that the market hammered us and that was the reason I was doing it at that time.'

Mr. Brown, still chairman but no longer CEO, said he could understand how it might strike some as unseemly to give executives stock options so soon after a catastrophe. 'That would be a legitimate point, I suppose,' he said.

He added that in retrospect, he probably wouldn't have advised that the grant be given. Today, Mr. Brown said, Stryker gives its grants during a relatively narrow period in the spring.

This seems yet another illustration about how focused the top leadership of large health care corporations are on the compensation they receive.

Furthermore, as we have commented before (here and here, and see links to earlier posts), there has been a marked contrast between the compensation received by UnitedHealth Group top executives, especially CEO Dr William McGuire, and the company's mission "to make health care more affordable."

And we wonder why health care is so expensive, and why health care costs rise faster than inflation?

Post Title → More Lucrative Stock Options for Top Health Care Company Executives

Now Cyberonic's Executives' Stock Options Questioned

Last year, we posted about the curious goings-on during the US Food and Drug Administration (FDA) evaluation of a device made by Cyberonics touted as a treatment for severe, refractory depression. The implanted electrical vagus nerve stimulator is invasive end expensive. A single, unpublished randomized controlled trial failed to show that it had statistically significant benefit, that is, that any apparent differences in improvement rates in treated and untreated patients were not do to chance alone. Were the benefits real, they would only affect a small number of patients. Nonetheless, the FDA advisory panel seemed more swayed by patient's testimonial evidence.

We then posted about an ongoing investigation by the US Senate Finance Committee that showed how an FDA official approved the device against the advice of staff scientists, who emphasized the device's known adverse effects versus uncertainty about any benefits.

Now, Cyberonics is back in the news again. Yesterday, the Associated Press, and today, the New York Times reported questions about Cyberonics awarded stock options to its top executives. According to the Times,

[Stock analyst Amit] Hazan, who said he was surveying all the companies he follows for potential backdating issues, focused on Cyberonics options that were granted at a special board meeting on the evening of June 15, 2004. That was only hours after a Food and Drug Administration advisory panel recommended that the agency approve Cyberonics's request to market its implantable nerve stimulator as a treatment for severe chronic depression.

Mr. Cummins received options on 150,000 shares at an exercise price of $19.58, the closing price the day before the F.D.A. panel's recommendation. The chief medical officer, Dr. Richard L. Rudolph, and the vice president for regulatory affairs, Alan D. Totah, who played pivotal roles in winning the panel's backing, each received options on 10,000 shares at that price.

The shares soared when trading resumed the next day, June 16, closing at $34.81, as investors bet that Cyberonics might soon be selling a new approach to treating the most severe forms of depression, a condition that affects millions of Americans annually.

'The board acted on an event before investors were able to do so,' Mr. Hazan said yesterday in an interview. 'It's a perfect example of an abusive option. Options are supposed to be an incentive to align executives' interests with shareholders. This was just a reward.'

Mr. Hazan said that because the options were priced below what would become the market value the instant that trading resumed, they should have been accounted for as compensation in that quarter. Because the company did not do so, it might have to restate its earnings for that fiscal year, he said.

Today, Reuters reported that "the chief financial officer of Cyberonics ... denied allegations that certain stock options were timed to create a windfall for executives.... CFO Pam Westbrook said the allegations were 'inaccurate and without merit' and that the company fully followed securities laws in granting the options."

Now that we have been publishing Health Care Renewal for a while, it's fascinating to see how organizations that appear on the blog for one particular management problem often show up again, and sometimes again and again for other management problems. So now, not only should physicians be skeptical about the evidence on which proponents of Cyberonics' vagus nerve stimulator base their advocacy, but also stock holders should be skeptical about the priorities of the company's top leaders.

ADDENDUM (June 12, 2006): The US Securities and Exchange Commission (SEC) is now investigating Cyberonics' stock option grants to executives (see Reuters).

Post Title → Now Cyberonic's Executives' Stock Options Questioned

Caremark Rx Also Under Fire For Timing of Stock Options

Another large health care company has come under investigation over the timing of the stock-options given to its CEO. According to the Associated Press (via the Washington Post), "Pharmacy benefit manager Caremark Rx Inc said Thursday that it has received a federal grand jury subpoena for records about its stock options, a day after UnitedHealth Group Inc. was subpoenaed on the same subject. Caremark also received what it called an 'informal inquire' from the Securities and Exchange Commission (SEC), requesting information about the company's stock options and its relocation program." TheStreet.com further reported the inquiries came "three weeks after TheStreet.com highlighed the particularly well-timed stock option grants that Caremark gave CEO Mac Crawford and other company leaders last year. Caremark gratned those options at $37.92 a share, the lowest closing price of the year. Last week, the Wall Street Journal went on to show that Caremark had displayed some uncanny timing before. Notably, the Journal stated, Caremark issued stock options priced at $3.88 a share - 'which turned out to be tied for the low point of the year' - back in 2000."

Regarding the relocation issue, AP reported, "the Wall Street Journal last week reported that Caremark's chairman, president and chief executive, Mac Crawford, took part in the company's relocation program when it moved its headquarters from Birmingham, Ala., to Nashville in 2003." Furthermore, "Crawford was given a $2.9 million 'equity advance,' but has yet to sell his house in Alabama. A Caremark spokesman told the paper that Crawford's ill wife still lives there and that the home will be sold when renovations on the Crawford's Nashville home is [sic] complete."

Another day, another large health care organization under investigation for questionable practices. Yet patients, physicians, and other health care professionals have to deal with these large organizations every day. And we still wonder why health care is increasingly expensive and decreasingly accessible, while quality stagnates and physicians and nurses are ever more demoralized?

Post Title → Caremark Rx Also Under Fire For Timing of Stock Options

UnitedHealth Gets Subpoena, Lawsuit

We have posted frequently about the lavish compensation given to Dr William McGuire, the CEO of UnitedHealth Group, one of the largest health insurers/ managed care organizations in the US, the contrast between his compensation and the company's stated mission to provide affordable health care, questions about the timing of the granting to Dr McGuire of now $1.6 billion worth of stock options, and concerns about conflicts of interest affecting the company's governance. (See most recent post here, contains links to earlier posts.)

Now further questions have surfaced about the stock options. Various news services (e.g., TheStreet.com here) have reported that the company has been served a subpoena from a US Attorney and received a request for information from the US Internal Revenue Service (IRS) related to these stock options. On top of that, UnitedHealth was just sued by Omnicare over how United dealt with Omnicare vis a vis its Medicare prescription drug business (see Reuters).

It does make one wonder just what the priorities of UnitedHealth Group's leadership were.

Post Title → UnitedHealth Gets Subpoena, Lawsuit

UnitedHealth Group Admits a "Significant Deficiency" in its Handling of Stock Options

We have previously discussed, most recently here and here, the tremendous largesse afforded Dr William McGuire, the CEO of UnitedHealth Group by his board of directors. Although UnitedHealth's mission statement includes improving access and making health care more affordable, Dr McGuire now owns approximately $1.6 billion worth of unexercised stock options. We also discussed (here and here) the potentially major conflicts of interest affecting several UnitedHealth board members who are also leaders of not-for-profit academic and research health care or organizations.

Now various news services (for example, the Associated Press) have reported the UnitedHealth had admitted a "significant deficiency" in its handling of stock options, and warned that it may have to restate its earnings over several years, it is the subject of an "informal inquiry" by the US Securities and Exchange Commission (SEC), it may have an added tax liability for some of the stock options given to managers, seven lawsuits have been filed by shareholders, and that an unidentified shareholder demanded that the board "take action to remedy breaches of fiduciary duties and unjust enrichment by the directors and certain officers in connection with the company's stock option granting practices."

We have discussed how early advocates of managed care called for "breaking up the [physicians] guild" and handing the power to run health care over to managers and bureaucrats, like those who run UnitedHealth. Now people in the investment world may be starting to understand what managers and bureaucrats have done with with this power. We physicians on the ground in the health care world have been seeing these effects for a while.

Post Title → UnitedHealth Group Admits a "Significant Deficiency" in its Handling of Stock Options

Not Passing the "Holy Cow" Test: UnitedHealth Group's Leadership Draws More Criticism

We have previously posted about the tremendous remuneration received by Dr William McGuire, CEO of UnitedHealth Group (see most recent post here). This largesse has attracted considerable media attention, and now has generated public criticism, and drawn the ire of some UnitedHealth Group stock-holders.

The Minneapolis-St Paul Buisness Journal reported that two advisor firms that suggest how institutional investors should vote their proxies, Institutional Sharehold Services (ISS) Inc. and Proxy Governance Inc advised withholding votes from two members of the compensation committee of UnitedHealth's board of directors who are up for election at today's annual meeting. They are Mary Mundinger, who is also Dean of the Columbia University School of Nursing, and James Johnson, a former CEO of Fannie Mae. ISS stated, "the over-$1 billion that Dr [William] McGuire currently holds in paper gains shows that the committee has not applied the 'holy cow' test, as fiduciary duty requires." We previously posted (here) about the apparent conflict of interest between Dean Mundinger's fiduciary duties to UnitedHealth Group and its stockholders, and her role as a thought leader in health services research. Her publications have advocated for advanced practice nurses to take over from doctors in some areas of health care, which would coincidentally lower the costs of health insurers, such as United Health Group. In some recent publications she did not disclose the apparent conflict of interest generated by her position on the board of directors of UnitedHealth Group.

The Associated Press reported that "Minnesota Attorney General Mike Hatch ... [will] press the state's $50 billion investment fund to vote against UnitedHealth Group CEO Bill McGuire for a new term as board chairman to protest McGuire's compensation." Bloomberg News reported that the California Public Employees' Retirement System (CalPERS) demanded a meeting before UnitedHealth Group's annual meeting to discuss the stock options granted to McGuire and other top UnitedHealth managers. CalPERS President Rob Feckner wrote, "these stock option grants are an insult and add injury in a market of skyrocketing healthcare costs in America, and as the third-largest healthcare purchaser, we find this situation intolerable." In response to CalPERS' complaints, the Business Journal reported that UnitedHealth Group offered to reform certain governance practices, and end stock-option grants to a few highly compensated managers, but not to rescind any stock option grants made previously. CEO McGuire also took the opportunity to defend Mundinger and Johnson, who he said have "intimate knowledge regarding our company's areas of focus, are experienced in public company matters, and embody the highest standards of integrity."

McGuire further defended his receipt of stock options. According to the Associated Press, he said "his pay has not come from at the expense of affordable health care." Instead, he said his pay cost shareholders money. His words were, "this isn't a giveaway of money that occurs out of premiums of health care recipients. These are shareholder dollars." However, even he admitted, "but they're still a lot. You can't get away from that."

Meanwhile, a report in the Wall Street Journal (available here through the St Paul Pioneer) suggested that UnitedHealth Group's alleged practice of back-dating McGuire's stock options could lead the company open to a substantial income tax liability, thus potentially costing the shareholders even more.

Finally, it turned out that shareholders are not the only ones upset at the their treatment at the hands of UnitedHealth Group's top managers. TheStreet.com reported that some UnitedHealth Group employees are irate at what they consider to be their own poor health benefits. Reporter Melissa Davis wrote, "UnitedHealth ranks as the most diversified health insurer in the country, a company that takes great pride in offering other companies a wide range of products - including some of the richest benefits available in the marketplace today. Yet the company's 55,000 employees have just three choices when it comes to their own health care coverage. And all of these are so-called 'consumer-driven' health plans." In a recent email to TheStreet.com, an employee wrote,

We UHG [UnitedHealth Group] employees -- who don't earn millions per year but perform a vital function for the company -- are left having to pay much more out of our own pockets. Maybe [McGuire] could give his own employees part of the millions he is using for the butterflies at the University of Florida so that we could have a normal co-pay plan like we used to, and like they offer most other employers ... [Meanwhile] , the UHG benefits people won't even address our concerns with the plan. They just say that is what is being offered, and we have to either take it or not.

The UnitedHealth Group annual meeting is on for today, so we will see what happens there. Of particular interest is how the Dean of the Columbia University School of Nursing will fare as a candidate for continued membership on the UnitedHealth Group board.

Meanwhile, UnitedHealth Group continues to serve as example of a big, influential health care organization that treats its top managers very well. Yet there are questions about how it treats not only its own employees, but also its stockholders, the actual owners of the company. And if these groups may not feel that their well-being is the company leadership's first priority, how should patients and physicians feel about the priority given to them? The most charitable answer I can give is: be very, very skeptical.

ADDENDUM (May 3, 2006): Via the Associated Press and Sacramento Business Journal - at the UnitedHealth Group annual meeting, only one shareholder spoke out about CEO McGuire's compensation, but he was the only such speaker to get applause. Mary Mundinger and James Johnson were both re-elected to the board of directors, but 28% of stockholders withheld votes from them. This is a fairly high rate of disapproval for a corporate board election.

Post Title → Not Passing the "Holy Cow" Test: UnitedHealth Group's Leadership Draws More Criticism

The Questionable Timing of UnitedHealth Group's CEO's Stock Options

A Wall Street Journal article (not yet available on the web, but summarized here) alleged that some prominent US corporations have back-dated the stock options granted top managers with the effect of enhancing their total compensation.

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 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 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 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.

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."

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.

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.
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Post Title → The Questionable Timing of UnitedHealth Group's CEO's Stock Options