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Conversion fight heats up

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By Todd Cohen

A skirmish has erupted over plans by Blue Cross and Blue Shield of North Carolina to become a for-profit business and initially place all of its stock in a huge new health foundation for the state.

Taking aim at Blue Cross, and threatening to block its conversion plans, are state regulators and its own trade group, which differ sharply with one another and with the insurer over the role in its critical corporate decisions the foundation should play.

The Department of Insurance and the Department of Justice, charged by state law with deciding whether to approve any conversion, have sent Blue Cross separate letters criticizing a revised conversion plan it submitted to the Insurance Department July 26.

The regulators say they will not approve the plan unless it gives the proposed Health Foundation for North Carolina a bigger role in Blue Cross’ key corporate decisions.

The Blue Cross and Blue Shield Association, which owns the rights to the valuable “Blue Cross” and “Blue Shield” names and marks, has sent a letter to both regulators saying it will not approve the plan unless it gives the foundation a smaller role in the insurer’s decisions.

And Blue Cross’ CEO says the insurer will “continue to work constructively with regulators toward a plan that upholds high ethical standards and is in the best interest of our customers, our company and the public.”

Fueling the dispute are concerns by all the parties, as well as consumer advocates, about the impact on Blue Cross stock of key actions by Blue Cross or the foundation.

Investment bankers advising the Insurance Department estimate Blue Cross will be worth $2 billion to $3.5 billion if it becomes a for-profit company, says department spokesman Chrissy Pearson, who adds the stock could be worth $1 billion more because of a per-share premium a single buyer typically might pay for buying all the stock.

In an Aug. 13 letter to Blue Cross, the Justice Department says curbs the insurer wants to put on the foundation could reduce or limit the value of its stock.

Blue Cross, the letter says, wants to restrict the foundation’s ability to select or remove directors of the insurer’s board, keep it from initiating shareholder proposals and limit its ability to sell its stock privately or tender shares to a possible buyer.

“These restrictions either diminish the value of the stock conveyed to the foundation, or eliminate opportunities for the foundation to realize the full value of the stock as conveyed,” J.B. Kelly, the Justice Department’s general counsel, says in the letter.

That’s important, Kelly says, because state law says the insurance commissioner should not approve a conversion unless “it provides a benefit to the people of North Carolina equal to the value of the corporation at the time of conversion.”

State law also says that if the foundation gets the insurer’s value in the form of all the new company’s stock, it is “conclusively presumed” that the foundation will get the company’s “fair market value.”

But because of the restrictions it wants to place on the foundation – restrictions Kelly says state law does not require – Blue Cross might not be able to presume the stock it gives the foundation represents the insurer’s fair market value, Kelly’s letter says.

The letter does not address what Blue Cross might need to do to ensure that the foundation gets its fair market value, although it simply could give the foundation cash in addition to stock to compensate for a possible loss of stock value caused by restrictions on the foundation’s shareholder role.

The letter also cites an “inherent tension” the Blue Cross plan would create between the foundation’s need to sell its stock to generate cash so it can fulfill its legislative mission of addressing the health care needs of North Carolinians – and Blue Cross’ need to make “strategic business decisions.”

After initially owning all Blue Cross’ stock, the foundation under the conversion plan would be required to reduce its share, in intervals, to less than 5 percent over 10 years.

That could create a natural clash between Blue Cross moves intended to generate long-term benefits and the foundation’s desire to reap the value of its stock in the short-term while it still owns it, Kelly’s letter says.

“As a result,” the letter says, “we could look favorably on a conversion plan that balances these competing interests through limiting some rights of the foundation to sell or retain its shares so long as the foundation can protect its investment during the period of divestiture.”

Kelly’s letter also calls on the insurer to change its plan by ensuring it would engage in “best practices for corporate governance.”

Consumer advocates want the foundation to play a watchdog role to help keep Blue Cross from engaging in the kinds of financial and accounting abuses that have hurt big U.S. corporations recently.

Governance practices the Justice Department proposes for Blue Cross include an ethics policy; independence of directors from the company; treating stock options for officers, directors and employees as expenses when granted; barring loans to directors, executive and other officers; prohibiting loans to corporate directors, executives or other officers; forbidding independent auditors to provide consulting or other services to the company or its subsidiaries for at least five years from the time of the most recent audit; and certification by Blue Cross’ CEO and chief financial officer of the accuracy of financial statements.

Blue Cross CEO Bob Greczyn, in a statement Aug. 15, says it is “essential that we do everything possible to ensure appropriate oversight of corporate actions.”

Blue Cross backs the intent of the Justice Department’s comments on corporate governance and already has taken steps on some issues raised by Kelly in addition to strong ethics and accountability policies it already has in place, Greczyn says.

In a separate letter to Blue Cross on Aug. 9, the Insurance Department takes a tougher tone, saying it is “deeply troubled” by Blue Cross’ plan, and calling the July 29 letter from the Blue Cross and Blue Shield Association “considerably more draconian” than the position the association took in previous talks among the parties.

Memos from two law firms advising the Insurance Department criticize in detail the role carved out for the foundation both in the Blue Cross plan and in the association’s letter.

The department’s long-standing position, its lawyers say, is that the foundation “must have at least some of the basic protections that a majority shareholder of any company normally would have,” protections the department says are needed to “maintain the value of the foundation for the benefit of its intended beneficiaries, the citizens of North Carolina.”

The Blue Cross and Blue Shield Association, for example, says it will not approve the conversion plan if it gives the foundation the right to name at least one Blue Cross director – a right the Insurance Department favors and that Blue Cross’ plan proposes.

But the trade group’s own rules let a single shareholding entity suc
h as the foundation elect a majority of the board of a Blue Cross organization, the Insurance Department’s lawyers say.

And they say the conversion plan would let the foundation name a single Blue Cross director only if both groups “mutually agree” on the director – a requirement the lawyers say “severely limits” the foundation-designated director contrary to an agreement Blue Cross made with regulators before submitting its plan.

The Insurance Department’s lawyers also say the Blue Cross plan undermines the insurer’s previous agreement that directors “independent” of Blue Cross make up a majority of its board.

That’s a key issue because, for a variety of critical corporate decisions, the Blue Cross plan lets a majority of the independent directors determine the voting of the foundation’s stock – 95 percent of which initially would be placed in a trust.

But the plan actually would let Blue Cross create a board on which a majority might not be independent of the insurer, and on which the foundation’s right to vote would be “meaningless,” the Insurance Department’s lawyers say.

The Blue Cross and Blue Shield Association says its rules on conversions aim to strengthen Blue Cross insurers in a “for-profit, publicly traded world…in which corporate raiders or even government agencies can gain control of our licensees to the detriment of millions of Blue Cross Blue Shield subscribers.”

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