PLANS/TECH/POLICY: WSJ finds a slight flaw in options awards

A while back there was a boring argument interesting exchange in THCB on whether the options awards to a certain health plan CEO were really part of compensation or costs to the company (and hence to its shareholders and customers). I suggested that option grants that were “in the money” certainly were. Of course if you really want to play the option and stock trading game really well, you’re better off if you are transported back in a time machine and you could then place bets on a game of which you already knew the result. OK, if you haven’t mastered time-travel, you could just be allowed to backdate the timing of your option grants (and hence the strike price) to the lowest closing price of the year. And the WSJ has a rather interesting article showing that apparently both the certain health plan CEO and the CEO of the largest Medicaid technology outsourcing company did just that. Nice work if you can get it. But of course none of this is costing us —the suckers paying premiums and the taxpayer paying the tab for Medicaid—any money, is it?

Below the jump are the graphs about UnitedHealth’s McGuire and ACS' Rich:

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 "astronomical," said David Yermack, an associate professor of finance at New York University, who reviewed the Journal's methodology and has studied options-timing issues.

Options grants are made by directors, with details often handled by a compensation committee. Many companies make their grants at the same time each year, a policy that limits the potential for date fudging. But no law requires this. 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 "like 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."

UnitedHealth called the process by which its grants were awarded "appropriate." It declined to answer specific questions about grant dates but noted that on all but two of them, grants were made to a broad group of employees. William Spears, a member of UnitedHealth's compensation committee, said the October 1999 grant wasn't backdated but was awarded concurrently with the signing of Dr. McGuire's employment contract. Mr. Spears said a depressed stock price spurred directors to wrap up negotiations and get options to management. The board revised terms of the employment contract last year and will start making stock-option grants at a regular time each year, Mr. Spears added.

And the lead about ACS’ rather approporiately named (now former) CEO Jeffrey Rich

On a summer day in 2002, shares of Affiliated Computer Services Inc. sank to their lowest level in a year. Oddly, that was good news for Chief Executive Jeffrey Rich.

His annual grant of stock options was dated that day, entitling him to buy stock at that price for years. Had they been dated a week later, when the stock was 27% higher, they'd have been far less rewarding. It was the same through much of Mr. Rich's tenure: In a striking pattern, all six of his stock-option grants from 1995 to 2002 were dated just before a rise in the stock price, often at the bottom of a steep drop.

Just lucky? A Wall Street Journal analysis suggests the odds of this happening by chance are extraordinarily remote -- around one in 300 billion. The odds of winning the multistate Powerball lottery with a $1 ticket are one in 146 million.

SNIP

At ACS in Dallas, Mr. Rich helped turn a small technology firm into one with more than $4.4 billion in annual revenue and about 55,000 employees. ACS handles paperwork, accounting and data for businesses and government agencies. It is a major outsourcer, relying on global labor. "It is a pretty boring business," Mr. Rich told the University of Michigan business school in 2004, "but there is a lot of money in boring."

While most of Mr. Rich's stock-option gains were due to rises in ACS stock, the exceptional timing of grants enhanced his take. If his grants from 1995 through 2002 had come at each year's average share price, rather than the favorable dates, he'd have made about 15% less.

An especially well-timed grant, in which Mr. Rich received 500,000 options at $11.53, adjusted for stock splits, was dated Oct. 8, 1998. This happened to be the bottom of a steep plunge in the price. The shares fell 28% in the 20 trading days prior to Oct. 8, and rose 60% in the succeeding 20 trading days.

ACS's Ms. Pool said the grant was for Mr. Rich's promotion to CEO. He wasn't promoted until February 1999. Ms. Pool said there was a "six-month transition plan," and the Oct. 8 option grant was "in anticipation" of his promotion.

Mr. Rich would have fared far worse had his grant come on the day ACS announced his promotion. The stock by then was more than twice as high. The grant wasn't reported to the SEC until 10 months after the stated grant date. Ms. Pool said that was proper under regulations in place at the time.

A special board committee oversaw Mr. Rich's grants. Most years, its sole members were directors Frank Rossi and Joseph O'Neill. Mr. Rossi declined to comment. Mr. O'Neill said, "We had ups and downs in our stock price like any publicly traded stock. If there were perceived low points, would we grant options at that point? Yes."

Mr. Rich said grants were made on the day the compensation committee authorized them, or within a day or so of that. He said he or Chairman Darwin Deason made recommendations to the special board committee about option dates.

Mr. Rich, who is 45 years old, resigned abruptly as ACS's chief executive on a Thursday in September to "pursue other business interests." Again, his timing was advantageous. In an unusual separation agreement, the company agreed to make a special payment of $18.4 million, which was equal to the difference between the exercise price of 610,000 of his outstanding stock options and the closing ACS stock price on the day of his resignation.

But the company didn't announce the resignation that day. On the news the next Monday that its CEO was departing suddenly, the stock fell 6%. Mr. Rich netted an extra $2 million by cashing in the options before the announcement, rather than on the day of it.

Mr. Rich said ACS signed his separation agreement on Friday, using Thursday's price for the options payout. He said it waited till Monday to release the news because it didn't want to seem "evasive" by putting the news out late Friday.