As Allegheny Health, Education and Research Foundation muddles through its high-profile bankruptcy reorganization, the spotlight of public scrutiny has turned on the trustees who were supposed to act as guardians of the prestigious not-for-profit system.
A host of attorneys, including staffers of the Pennsylvania attorney general's office, have promised to study every move made by AHERF directors in the past several months. And the many local captains of industry who sat on the board are suffering under the hot light of publicity this summer.
AHERF had assets of $1.6 billion and was awash in $1.3 billion in debt when it filed for Chapter 11 bankruptcy protection last month (July 27, p. 2). Much of the debt was accrued through acquisitions of hospitals and physician practices some critics believe were overpriced. Five of AHERF's operating subsidiaries lost money during the first half of fiscal 1998.
Aside from the questionable purchases, the 19-member AHERF system board has been taken to task for what some critics contend were conflicts of interest. Even before the filing, the trustees and executives came in for some public bashing as the financial troubles of the system began surfacing.
The Philadelphia Inquirer profiled Sewickley Heights, Pa., home to Allegheny board Chairman William Penn Snyder III and board member David Sculley, as well as the current and former chief executive officers of the system. The story reported the estimated value of some of their homes in the "tony borough," a one-time vacation spot that "has evolved into the year-round home of corporate CEOs craving a special apartness."
"When things fall apart, the board members usually take the heat," said Charles Ewell, chairman of the Governance Institute of La Jolla, Calif. "And they should take the heat, since they are the final buffer."
But whether a new board will be forged out of such an inferno remains to be seen.
To begin with, hospital trustees typically aren't directly liable for the financial chaos they oversee.
"To my knowledge there has not been a member of a not-for-profit board who has had to write a check out of (his) own pocket," Ewell said. "There's very little risk (to) being on a board like Allegheny's."
Among the reasons: Hospitals and systems usually insure their directors and officers against financial catastrophes that may arise from their actions, and they usually agree to pay the legal bills of their directors.
"You have to demonstrate due diligence, but some boards try and sidestep that with their liability insurance," said Thomas Holland, a professor at the University of Georgia's School of Social Work who specializes in hospital governance.
But even holding trustees individually liable for fiduciary malfeasance is difficult. Although state attorneys general hold jurisdiction over most boards and can investigate their actions and even sue, personal liability is rare. As long as not-for-profit trustees follow the loyalty and duty of care doctrine-eschewing rash or illegal behavior and conflicts of interest and acting in what they believe to be the best interest of the system-they usually cannot be held liable. That contrasts with the for-profit world, where actions are tempered by angry shareholders and their potential lawsuits.
"What is often the issue when these things go awry is that the board was extremely careful and loyal, and then they approved dumb decisions," said Michael Peregrine, a healthcare attorney in the Chicago office of Gardner, Carton & Douglas.
"Doing a bad job doesn't necessarily mean you're liable," agreed Paul DeMuro, a San Francisco-based partner in the law firm of Latham & Watkins.
There were some warning flares in the AHERF case, however. According to the Inquirer, the system repaid an $87 million line of credit to a consortium of lenders last April, even as it was stalling payments to suppliers. The group was led by Mellon Bank, one of Pittsburgh's largest and oldest financial institutions. Mellon Chairman and CEO Frank Cahouet, Mellon director Ira Gumberg and former Mellon chairman J. David Barnes all serve on the AHERF board.
"There was absolutely no Mellon influence in that decision," said AHERF spokesman Thomas Chakurda.
Chakurda said the three Mellon executives abstained from voting on issues relating to Mellon bank. It is unclear, however, whether they discussed the issues with other trustees during meetings-something that would constitute a conflict of interest, governance experts said.
AHERF CEO Anthony Sanzo, a board member, and other board members were not available to answer questions on this or other subjects, Chakurda said.
Yet even if the three had abstained from discussions, the experts said AHERF's subsequent financial turmoil casts doubts on the board's intentions.
"It's double-dealing on the face of it," Holland said.
Added Barry Bader, a governance consultant in Potomac, Md.: "It's well recognized that a board member cannot serve two masters. . . . It's vital for the board not only to do the right thing but also to appear to do the right thing."
And unlike in the for-profit sector, there are few checks and balances that cause immediate reactions to controversial board decisions. It's a phenomenon attorney DeMuro calls a "lurking liability."
"Companies like AHERF can lose money for a substantial period of time, and nothing happens. In a for-profit chain, investors can look at quarterly and annual reports and serve as an outside monitor. You would see the market and the stock react (to a loss)," he said.
Yet AHERF was under considerable pressure to gain leverage in competitive markets slowly being dominated by managed care's tightening grip.
"While I feel strongly about the ultimate responsibility being in the hands of trustees in order to make not-for-profit hospital systems work, I'm also aware of managed care and insurance domination, and a system like AHERF had been trying to get ahead of the wave," said Monsignor Andrew McGowan, director of community relations for 308-bed Mercy Hospital of Scranton (Pa.) and a governance expert.
But trying to get ahead of the market can be a little like playing chicken, McGowan added.
"AHERF's strategy was a big winner for a while. But they were caught by a series of quickly changing circumstances: decreases in Medicare and Medicaid reimbursement, and managed care demanding steeper discounts," he observed. "If they had not all happened at the same time, they might have been able to persevere, but they had become too big and had too much debt."
In some instances, the pressures to gain market share can create a board dominated by the system's executive suite or CEO.
"An aggressive, entrepreneurial (CEO) is what you want, but sometimes you get some hotshot who so wants to make a mark that not as many trustees are looking over their shoulders as they should," Holland said.
Indeed, some industry sources said they believe that former AHERF CEO Sherif Abdelhak so dominated the board during his 12-year tenure that he was asked few probing questions about proposed deals, despite a preponderance of seasoned executives on the board. Abdelhak was ousted from his position in early June as bankruptcy loomed. He was unavailable for comment for this article.
"He viewed himself more as an entrepreneur than an executive," said the Governance Institute's Ewell.
"Most healthcare executives are consensus builders and are generally risk-averse. The consensus-building personality is not something you see attached to most hard-driving entrepreneurs," attorney Peregrine said. "They usually want to move fast, act on their own judgment and seek limited counsel. I think the AHERF CEO falls into that . . .category."
So what are the general guidelines for boards in today's wheel-and-deal world? Governance experts agree that seeking outside counsel-such as a respected consultant-before approving transactions is critical. So is asking tough questions of executives.
"They need to know what the purchase's return on investment will be, and they need to have enough knowledge of how their market might react in the future," Peregrine said.
If an individual trustee has doubts about being able to decipher balance sheets and other information pertinent to making a deal, Holland said, he or she should either seek training or delegate the work to the board's financial subcommittee to render a report.
The board's composition should also be held under a strong light. "Have they had enough turnover to stay fresh?" Peregrine asked. He added that tenures longer than 10 years often create insiders rather than trustees. (An AHERF spokesman could not immediately provide the length of tenure for its trustees, or the positions many held in the community.)
AHERF trustee David Sculley, who also is chairman of the subsidiary Allegheny General Hospital Board, was a senior executive at the H.J. Heinz food company. Cahouet holds seats on the Allegheny Teledyne and Avery Dennison boards. Trustee Douglas Danforth is a former chairman and CEO of Westinghouse Electric Corp. Trustee Robert Hernandez is vice chairman and chief financial officer for steel giant USX Corp. Gumberg is an officer or director in various ventures incorporated in Pennsylvania, including an area shopping mall.
Bader said he believes that as not-for-profit hospital systems reach the size of AHERF, with revenues and liabilities in the billions of dollars, they should recruit trustees from beyond the community at large. Nationwide recruitment makes sense.
"The Allegheny situation represents that hospitals are no longer sole community enterprises; they are major regional and national economic systems, and that means governing board members are going to have to demonstrate the same independence and objectivity that directors of public companies do," he said. "Ten years ago, it was understandable that the local banker would serve on the hospital board and remain away from the questions of who did the banking. Today, it's a much bigger ballgame."
Peregrine said the AHERF situation eventually will alter the way system trustees are selected: "I think we will learn from this and focus on what the appropriate mix of competence and background is for a healthcare system," he said.
-Scott Hensley contributed to this report.
