A Huge Options Backdating Case Raises the Question of Prosecutorial Standards

The $600 million settlement announced on Thursday against William W. McGuire, M.D., former Chief Executive Officer and Chairman of UnitedHealth Group, is not only one of the largest in the options backdating scandal, but also the first settlement with an individual involving the SOX “clawback” Section 304. Under that Section generally, executives who profit from conduct which causes a restatement of the financial statements can be required to give back financial benefits. Viewed in that context, the case also raises questions concerning the standards of prosecution being used by the SEC in these cases.

In Dr. McGuire’s case, the SEC alleged that, over a twelve year period, he repeatedly caused the company to grant undisclosed, in-the-money stock options to himself and other employees. The compensation expense for these grants was not properly recorded in the company’s books and records. In addition, the company’s filings contained false and misleading statements concerning the true grant dates of the options.

Between 1994 and 2005 Dr. McGuire received more that 44 million split-adjusted options, most of which were backdated. Approximately 11 million of those backdated options were exercised for an in-the-money gain of more than $6 million. In addition, according to the SEC’s complaint Dr. McGuire received about $5 million in incentive-based cash compensation in 2005 and 2006 which was tied to earnings per share targets that UnitedHealth would not have achieved had the financial statements been properly prepared.

Under the terms of the settlement, Dr. McGuire consented to the entry of a statutory injunction prohibiting future violations of the antifraud, reporting, record keeping, internal controls, proxy statement, certification and securities ownership reporting provisions. He also consented to the entry of a ten-year officer-director bar.

In the financial terms of the settlement, Dr. McGuire agreed to disgorge over $10 million, pay prejudgment interest and a $7 million civil penalty. Under SOX Section 304, Dr. McGuire agreed to reimburse the company for all incentive- and equity-based compensation received from 2003 through 2006, which totals about $448 million. Dr. McGuire’s obligations under the terms of the settlement can be satisfied by returning to UnitedHealth about $600 million in cash and options. This resolves employment claims and shareholder derivative lawsuits against Dr. McGuire. SEC. v. McGuire, Civil Action No. 07-CV-4779 (D. Minn. Filed December 6, 2007). The Commission’s Litigation Release is available here.

To date, the SEC has brought approximately 21 option backdating cases. In addition, a number of issuers have announced that they have received closing letters. The case against Dr. McGuire returns to the type of intentional conduct on which the SEC has typically based its options backdating cases. This contrasts sharply with negligence based action recently brought against former Maxim International Products CEO John F. Gifford discussed here. There, the Commission more than pushed the edge by basing an action on the theory that Mr. Gifford should have known that the CFO disregarded his written instructions to properly record the option expenses without explaining how he should have known that. Since backdating options to obtain a better exercise price involves scienter-based conduct, hopefully as the Commission works through its huge inventory of these cases, it will exercise its prosecutorial discretion to bring cases in the McGuire rather than the Gifford mold.