HMO Decision Is Stiff First Test for Regulator : Watchdog: Corporations Commissioner Thomas Sayles hopes that his ruling on the proposed leveraged buyout of Health Net will set a precedent.

Thomas Sayles had just been appointed head of the state Department of Corporations in June when he was handed a major test: Decide whether the management of Health Net, the state’s second-biggest health maintenance organization, can proceed with its controversial plan for a leveraged buyout.

Five months later Sayles has yet to rule because he’s been busy learning not only the Health Net case but also how his agency works overall. He expects to decide the matter by year-end, but he won’t publicly discuss specifics until then.

Nonetheless, Sayles is aware of the widespread interest in his decision.

“I certainly want what I do to be used as precedent, in terms of how my administration views HMO conversions,” he said. “I’m either going to reject the transaction on the terms proposed or accept it on terms I find acceptable.”

Sayles, a 40-year-old former corporate lawyer for TRW Inc. who took a pay cut for the $99,805-a-year commissioner’s job, said he has other goals that will affect the agency long after his Health Net ruling is forgotten. But it’s the Health Net decision that has put him in the spotlight.

The 850,000-member HMO based in Woodland Hills wants to convert from nonprofit to for-profit status. Under state law, such a conversion requires the HMO to donate a sum equal to its “fair market value” to a public charity, and Health Net contends that its value is $127 million.

In the second step of the deal, Health Net’s management wants to buy the HMO for $1.5 million, an investment that could yield enormous profits to the executives if Health Net should later go public or is resold.

Critics are outraged at the plan, saying the public will be shortchanged because $127 million vastly understates the HMO’s value. Health Net has shunned several outside bidders who have offered up to $300 million for the HMO. Critics also charge Health Net with self-dealing, because its board is dominated by members of the management buyout team.

Before Sayles, the agency cleared 28 HMO conversions in the state. In some, the HMO’s executives did indeed reap huge profits in subsequent public offerings. Health Net’s proposal gave critics an opportunity to renew complaints that the agency was a lax regulator in the earlier conversions. Consumers Union, publisher of Consumer Reports, griped about the agency’s “mild-mannered approach” to conversions, “which is looting the public trust.”

Such complaints add to a public relations problem that has dogged the agency in recent years. Despite being one of the state’s most powerful business authorities, the agency still must persuade legislators, lawyers, business people and the general public that it is an active watchdog over California commerce and not, as some critics have charged in the past, a regulatory paper tiger.

“I don’t think we’ve gotten our message out as I’d like to,” Sayles said. “Often people don’t know how much we do.”

Based in Los Angeles, the agency has a 420-person staff--including 60 lawyers. It also regulates securities transactions, consumer lending firms, credit unions, check-cashing firms and certain real estate escrow firms.

But instead of making headlines by cracking down on fraud, the agency was the subject of critical stories in the late-1980s stemming from the collapse of Irvine-based Lincoln Savings & Loan. Lincoln’s parent, American Continental Corp., sold $200 million of ill-fated junk bonds to the public after getting agency clearance. Thus, Sayles is under scrutiny by a state Legislature that doesn’t want more scandals.

“We know that the DOC is the first line of defense against fraud, and the Legislature will be watching closely this time,” said Gwen Moore, (D-Los Angeles), who chairs the Assembly’s Utilities and Commerce Committee.

Sayles won’t comment on his predecessors, Christine W. Bender and Franklin Tom, who headed the agency for most of the 1980s.

But he acknowledged that the Lincoln affair hurt the agency’s morale. “The department took a beating from a PR standpoint,” he said.

In his effort to bolster that image, Sayles said he “will be making myself more accessible to the public and not sitting here in a cloistered ivory tower.”

With an annual budget of $23 million, the agency has the authority to bring court action to get receivers appointed for ailing enterprises or to shut down illegitimate businesses.

“We are the only state agency other than the attorney general’s office, so far as I’m aware, that has independent litigation authority,” Sayles said.

After getting a political science degree from Stanford University in 1972 and a law degree from Harvard University in 1975, Sayles was a deputy attorney general in California and then an assistant U.S. attorney in Los Angeles. In 1982, he became general counsel for TRW’s Space & Technology division based in Redondo Beach.

A political appointee, Sayles contends that he has no political ambitions and seems unruffled about any political fallout that might stem from his Health Net decision.

“I’m not going to run for office,” Sayles said. “I hope, when I make my decision, that it’s good public policy. What the politics are, so be it.”