Unitedhealth, Delaware, and the Problem of Special Litigation Committees

Last week, UnitedHealth and the former CEO William McGuire were back in the news.  In early December, the Special Litigation Committee approved a settlement with Dr. McGuire involving the "payment" of $600 million to settle a raft of suits alleging backdating (mostly, apparently, in the form of returned stock options).  At the same time, he settled fraud allegations with the SEC.  We have discussed both of these developments here.

The most recent development concerns statements by the trial judge about the settlement.  As the WSJ reported, Judge Rosembaum issued an order expressing some concern with the settlement.  The issue before the judge was whether to continue an injunction prohibiting McGuire from disposing of certain personal assets.  Judge Rosenbaum had to determine the likelihood that he would approve the  settlement, thereby allowing the court to release funds in excess of the $600 million.  As part of that analysis, the judge reviewed the role of the court in overseeing the decision made by the Special Litigation Committee.

The case confronts the pro-management bias inherent in the special litigation committee process.  Whether in response to demand or, in some cases, after the establishment of demand futility, boards form special litigation committees to examine the merits of the law suit.  Invariably, the committees opt to seek dismissal of the suit or to settle it on highly favorable terms.  

When a court reviews the conclusion of the special litigation committee, it is largely limited to the process used by the committee in arriving at its decision.  As long as the directors on the committee and the advisors are independent, their decision on the disposition of the law suit will generally be upheld.  Delaware does go further and provides that courts can make their own business judgment about the conclusions of the committee, suggesting that proper process will not be enough, but in practice they never do.  

Although limiting the analysis to process, the Delaware courts have not adequately ensured the integrity of the process.  As we have noted on this Blog often, courts treat as independent directors those who are not. And while the committee usually uses "independent" advisors (law firms, accountants, etc.) with no current financial ties to the company, they are invariably entities that have a business interest in absolving, or minimizing the consequences to, management. In other words, the analysis relies on process without actually ensuring that the process will result in a decision in the best interests of shareholders.

It is this problem that provides some context for the comments made by Judge Rosenbaum.  The report issued by the SLC recommended that the case be settled, with McGuire contributing a total of $600 million.  Judge Rosenbaum had no problem with the independence or expertise of the members of the SLC. "All information available to the Court suggests the SLC was properly constituted under Minnesota law. The SLC’s members are two retired Minnesota Supreme Court justices. The Court knows its members to be persons of unquestioned integrity and probity."

On the other hand, he was clearly concerned about the failure of the SLC to engage in a meaningful analysis of McGuire's behavior.  The report issued by the SLC did not make "any of its own factual findings concerning Dr. McGuire’s wrongdoing" and "fearlessly declare[d]" that “some of the claims against Dr. McGuire may have merit.”  In other words, the SLC opted to accept a settlement that would result in an end to the derivative suit but without making any clear findings on the culpability of McGuire. 

The SLC's failure was particularly noticeable given the available data.  The court noted McGuire's settlement with the SEC over fraud charges and that the settlement "explicitly bar[red] Dr. McGuire from denying the substantive allegations in the SEC's complaint."  The court also noted an earlier report made to the board stating that there were "'[c]ertain facts run contrary'" to McGuire's assertion that "he had not selected dates for option grants using the benefit of hindsight."  In other words, the SLC had plenty of evidence of wrongdoing but chose not to make any findings on the issue.  Yet at the same time, without making such findings, was apparently able to conclude that the settlement was appropriate.  As the court noted:

• The Special Litigation Committee, has apparently made a business judgment favoring settling the Board’s and UHG’s possible claims against its former officers on terms outlined in its report. But its lack of any findings leaves no tracks showing why or how its business judgment can be considered reasonable.

The court opted to certify to the Minnesota Supreme Court the question of whether it was limited to a review of process, making "an SLC an impenetrable 'black box,' whose decisions and evaluative processes are immune from review in a shareholders’ derivative suit," or whether the court had some ability to review the SLC's business judgment.  See Zapata Corp. v. Maldonado, 430 A.2d 779, 788 (Del. 1981).

Whatever answer the Minnesota Supreme Court provides, it will not significantly change the pro-management bias inherent in the special litigation committee process.  These committees are devices used to dispose of derivative suits but do not ensure that in fact the best interests of shareholders have been addressed.  What would make the process more likely to produce this result?  Ensuring that the advisors to the committee are truly independent, perhaps by allowing plaintiffs a voice in their selection.