The SROs and the Definition of Independent Director: The Case of UnitedHealth

The Denver Post revealed today that the managing partner of the local office of Hogan & Hartson, Tom Strickland, was leaving to take the position of chief legal officer at UnitedHealth.  In addition to a well known lawyer in the local metropolitan area,  Strickland is a political mover and shaker, having twice run for the US Senate.  Last summer he hosted a fundraiser at his home for Senator Menendez of New Jersey with Bill Clinton, among others, in attendance. 

The article in the Denver Post provides an opportunity to revisit the situation at UnitedHealth, a company embroiled in a backdating scandal.  After publication of an article in the Wall Street Journal about possible backdating, the Board began an investigation, hiring Wilmer Cutler to conduct an independent review.  The law firm issued a report on Oct. 15, 2006.  In a quick succession of  current reports, the company disclosed the existence of the Wilmer Hale report, the resignation of the CEO, William McGuire, and an inquiry from the SEC over the matter, and announced that certain financial statements could no longer be relied up.  The current reports and the WilmerHale report are on the DU Corporate Governance web site. 

For our purposes, the most interesting aspect of the scandal was the disclosure in the WilmerHale report about one of the directors, William Spears, who also served as the chair of the compensation committee during most of the period covered by the report.  According to the report:

• "Beginning in 1992 Mr. Spears served as a trustee for two trusts for the benefit of each of Dr. McGuire's children.  From 1994 through mid-2006, Mr. Spears acted as an investment manager for certain assets of Dr. McGuire and his family.  The amount of assets managed for Dr. McGuire fluctuated over time, from approximately $15 million in 1996 to over $55 million in 2006.  In June 1999, Mr. Spears accepted an investment of $500,000 from Dr. McGuire in connection with Mr. Spears's repurchase of the money management firm that bears his name from the financial conglomerate that had earlier acquired it.  Dr. McGuire had unwound that investment by early 2003." (footnote omitted)

These relationships were never disclosed in the company's proxy statement.  How well were these relationships known inside the company?  The report addressed that as well.

• "Handwritten notes made by David Lubben, the Company's General Counsel, in connection with an Audit Committee meeting in February 1999, make clear that Mr. Lubben was aware of some 'conflict' issue involving Mr. Spears and Dr. McGuire.  Although it is possible that the notes indicate that Mr. Lubben discussed this relationship with the Audit Committee, neither Mr. Lubben nor any member of the Audit Committee recalls such a discussion.  Mr. Lubben also sent an e-mail to outside counsel on October 12, 1999 generally outlining the McGuire/Spears relationship and indicating that disclosure of some 'conflict' had been made to the 'full' Board.  In addition, Dr. McGuire and Mr. Spears have each stated that they believed the Board was aware of the money-management relationship.  However, there are no minutes or other documentation to confirm that such disclosure took place in that time frame.   . . . All Directors believed that they first learned of the investment that Dr. McGuire made in Mr. Spears's firm after the commencement of this investigation."

The report does not disclose what response, if any, was received by the outside law firm. 

The report indicates a serious amount of finger pointing.  McGuire/Spears claim the board knew; the directors contend they did not.  The general counsel and outside counsel played some indeterminate role. 

What can be concluded with certainty is that the relationship was never disclosed.  Thus, despite the fact that the chairman of the compensation committee engaged in outside business activities with the CEO, he was treated as independent.  Moreover, even had the board been aware of the relationship, it is not at all clear that it would have disqualified Spears as independent under the NYSE definition.  Then and now, the applicable standards was that a director could not have a "material relationship with the listed company".  See NYSE Rule 303A.02.  Spears' potentially "material" relationship was with McGuire, not UnitedHealth.  Thus, a director can apparently have significant business interaction with the CEO and still be treated as independent under the definition of the SROs (and, by the way, under the definition employed by Delaware, discussed at length here). 

At least the SEC has taken steps to stop the finger pointing.  Freshly minted Item 407(a)(3) of Regulation S-K requires disclosure "by specific category or type, any transactions, relationships or arrangements" considered by the board in determining whether a director is independent.  The requirement is discussed in Exchange Act Release No. 54302A (August 29, 2006).  Had this been in place during the time period covered by the WilmerHale report, it would likely have required disclosure of any consideration by the board to disclose the business relationships between Spears and McGuire had they considered them.