Despite recent outrage over executive compensation and windfalls that many CEOs have received upon the sale of their companies, the idea that an announced deal would be quashed because a public company target's CEO was paid too much is almost unthinkable. For William Jews, the operative words are "public company" and "almost."
The CEO of CareFirst Inc. stood to make $40 million upon the sale of the Owings Mills, Md.-based Blue Cross Blue Shield to Thousand Oaks, Calif.-based WellPoint Health Networks Inc. for $1.37 billion. Because CareFirst is a nonprofit corporation, Maryland Insurance Administration Commis-sioner Steven Larsen had to approve the deal-- and the pay packages that went with it. After a review process that included 15 days of formal hearings, 10 consultants' reports and more than 85,000 pages of board minutes at a cost of $5 million to WellPoint, Larsen on March 5 issued a 352-page report in which he rejected both the proposed sale of CareFirst and its conversion to a for-profit company.
Larsen said the price offered for CareFirst was too cheap, while the consideration Jews would receive was "essentially a ransom a bidder would have to pay for the right to purchase the company."
"There's no question that the company and its directors misjudged the degree to which there would be a negative public reaction to the compensation issues," said Robert W. Smith Jr., a partner at Piper Rudnick LLP in Baltimore who represented CareFirst in the sale. "I think that colored from the beginning the reaction to the transaction. We never really recovered from that."
The world of Blue Cross
Created in 1937, the Maryland corporation now known as CareFirst owns and operates Blue Cross plans in Washington, D.C., Delaware and Maryland, insuring more than 3 million people. Each plan is regulated under the laws of the jurisdiction in which it operates, and regulators in all three jurisdictions had to approve the deal.
Jews took over CareFirst in 1993 and the next year floated a plan to put its health maintenance organizations into a for-profit subsidiary, a proposal rejected by Maryland's insurance commissioner. Not dissuaded by his inability to change the company's corporate form, Jews changed the corporation's substance. According to Larsen, CareFirst "assumed all the operating characteristics and corporate goals and mission of a for-profit company."
Though some community activists saw that change as a bad thing, others, such as Walter Smith, the executive director of the DC Appleseed Center for Law and Justice Inc. in Washington, thought the more profit-conscious CareFirst was better able to fulfill its nonprofit mission of providing affordable healthcare to the public.
Nor was CareFirst the only Blue Cross Blue Shield that tried to become a for-profit company. There have been 18 such conversions, according to Clifford Hewitt, a healthcare analyst at Legg Mason Wood Walker Inc. in Baltimore. And the only two that have encountered difficulties are CareFirst's and that of the Kansas Blue Cross Blue Shield, which also sought to convert to a for-profit company and be bought at the same time.
"It takes five or six years from announcing the intention to convert to completing it and being independent as an organization and thinking, 'Where do we want to go from here,'" said Hewitt. "It's a longer process, but a cleaner process" than combining a conversion and sale.
Larsen said that CareFirst's 21-member board breached its fiduciary duties in its bid to become a for-profit company, but Hewitt says the outcome would likely have been different had CareFirst not attempted to sell itself at the same time. "In retrospect, that would have been the wiser thing to do, and I suspect, going forward, unless you're talking about a company that's in trouble, doing a conversion will be the preferred route," Hewitt said.
In a conversion, the state creates a foundation that receives the proceeds from the sale of the nonprofit, and that foundation is then charged with carrying out the mission of the nonprofit. WellPoint itself converted to a for-profit in the early 1990s and then bought Blue Cross plans in Georgia and Missouri and several other insurers. (WellPoint used Gary Horowitz, a partner at Simpson Thacher & Bartlett, on the sales.)
"CareFirst considered the alternatives of converting and doing an IPO and converting and engaging in a sale," said Piper's Jay Smith, who began work on the matter in March 2001, at which point his clients were well into the sale process. "I don't believe that they perceived one to be that much more risky than the other. If you do a conversion with a sale, you have a more complicated process, but I don't believe there was a perception that it was from a regulatory standpoint more risky."
A rigged auction?
Perhaps because of the payment Jews was to receive if the deal closed, Larsen was skeptical of the way CareFirst structured its auction. The most logical buyer for the company may have been Trigon Healthcare Inc., the for-profit Blue Cross in Virginia that last year sold to Anthem Inc. for $3.7 billion. Larsen said in his report that Trigon representatives testified that they were prepared in January 2001 "to open with an offer of $1.4 billion to $1.5 billion for CareFirst, but received information from CareFirst executive David Wolf that Trigon could offer less money, if it would offer more Trigon board seats to former CareFirst directors." Jews denied the charge but said he did ask for more board seats.
A month after the auction began in earnest in February 2001, WellPoint was bidding $1.25 billion for CareFirst compared to Trigon's offer of $1.3 billion. Target management told its banker, Credit Suisse First Boston, to seek a higher price from WellPoint, but Trigon was never asked to raise its bid. A CSFB banker wrote in his work notes, "If this is an auction, how do we go about not choosing the highest bidder?" Larsen seized on that comment. At the news conference where he announced his decision, Larsen said that the "the auction was designed to end in a tie," thus allowing Jews and his board to choose their suitor based on factors other than price.
Piper had advised CareFirst that it could take such considerations into account, which from a legal standpoint made sense. Since the target is a Maryland corporation, it doesn't have to auction itself for the highest price available once it has decided to sell, the so-called Revlon duty that Delaware corporations face. But in reality, Revlon did apply. The monies from the sale of CareFirst would be going to Maryland, Delaware, and Washington, D.C., to set up healthcare nonprofits. CareFirst should have anticipated that anything less than a vigorous auction would get close scrutiny.
Walter Smith says Jews had good reason to prefer WellPoint to Trigon. Larry Glasscock, now Anthem's CEO, had been the CEO of the Washington, D.C., Blue Cross, which CareFirst bought in 1997. "Jews and Glasscock didn't get along," Smith says, and had Trigon bought CareFirst, Jews might have been out of a job.
Though Larsen relied on analysis done by Blackstone Group that put the value of CareFirst at between $1.45 billion and $2.27 billion, his perspective on the auction was "a bit simplistic," said David Funk, a partner at Funk & Bolton in Baltimore who began representing CareFirst on regulatory issues in the summer of 2001. "My experience in these things suggests that CareFirst conducted a very competitive process between Trigon and WellPoint," Funk said.
But the valuation issues didn't motivate Larsen's decision, Hewitt believes. "I have no reason to second-guess the number offered by WellPoint," he said. "There's a vast range of opinion. There were a lot of assumptions on the upper end of those ranges that were quite dubious. I'm not saying it should have gone for more. It reached a point where politics was driving it rather than the underlying value."
Whatever the quality of the auction, on Nov. 20 WellPoint announced that it would buy CareFirst for $1.3 billion, with Jews and his executives to manage a WellPoint regional subsidiary based in Owings Mills after the deal closed. As the deal negotiations were winding down, the CareFirst board adopted a bonus plan for its executives under which they would have received about $120 million.
Too much money
Larsen found that those payments violated the state statute governing the conversion, a reasonable ban given that such bonuses would have reduced the amount of money received by the state to subsidize healthcare. Though CareFirst restructured the payments, the damage was done.
"That was a flashpoint issue in a public relations sense," said Funk. "The principal problem was that the press and people in Annapolis were uncomfortable with the size of the bonus."
Larsen hired consultants to look at the compensation arrangements, and CareFirst hired consultants to justify the payments. But Walter Smith said the target's argument was unpersuasive, since many of the benchmarks were for-profit companies. "The only example of a not-for-profit Blue Cross CareFirst's compensation expert gave was Cerulean. They said that the package here was not out of line if you compared it with Cerulean," the Blue Cross plan in Georgia that converted to for-profit status in 1996 and sold to WellPoint in 2000 for $700 million in a contested auction where Trigon was the losing bidder.
Jay Smith defended his client's approach on the payments. "We and the company approached the executive compensation issue in the same manner. The company is a nonprofit entity, it is a regulated entity, and you had to take those additional factors into account."
Other nonprofits considering a conversion can learn from the furor. "If you are advising a nonprofit board, you are going to take note of the reaction to the compensation issues," Jay Smith said. "You can do something different on the compensation level to make it easier to accomplish the transaction. You'd have to be less aggressive than the arrangements were in this case." |
