An independent auditor's opinion is supposed to be the gold standard in healthcare accounting.
The audit provides reasonable assurance that an organization's financial statements do not contain material misstatements. It is particularly important in not-for-profit healthcare because most hospitals and health systems don't have shareholders looking over their shoulders.
But the recent firing of a Big Five accounting firm by a major healthcare system in bankruptcy reorganization raises questions about the credibility of external audits.
At the center of the discussion is Pittsburgh-based Allegheny Health, Research and Education Foundation, now the focus of a probe by the Securities and Exchange Commission. That investigation will focus on AHERF's responsibility to disclose timely and accurate financial information to bondholders.
AHERF is also in the embarrassing position of admitting that its 1997 audited financial statements are unreliable and should not be used, raising more questions about its dubious financial condition. Discovering errors that artificially boosted income, AHERF ended a century-old relationship with the Pittsburgh office of Coopers & Lybrand, now PricewaterhouseCoopers.
AHERF's risky expansion into the Philadelphia market, costly acquisition of physician practices and perilous move into risk-sharing contracts resulted in a Chapter 11 bankruptcy filing in July to restructure $1.3 billion of debt. The filing covers the holding company and four subsidiaries, including eight of nine Philadelphia-area hospitals. It excludes AHERF's five Pittsburgh-area hospitals and its Willingboro, N.J.-based hospital.
At the time of the filing, AHERF said its revenues for fiscal 1998 were about $2.2 billion and its annualized loss for the period was $324 million.
Some of AHERF's reserves to cover liabilities were incorrectly classified as income. The system also said earlier this month that earnings and trading gains from some restricted accounts may have been incorrectly reported as "net assets released from restrictions." AHERF is continuing its investigation and has not yet detailed the gravity of the auditing errors.
Pennsylvania officials are looking into the audit issue as part of a larger investigation, said Howard Burde, the state's deputy general counsel.
Although some observers dismiss AHERF's auditing mistakes as an isolated incident, others say it could be a harbinger of more healthcare organizations' running into financial roadblocks caused by rapid and expensive expansion.
"This should be a major wake-up call for all the trustees that are sitting out there in nonprofit entities," said William Hanna, chairman of the Pilot Group, a Wexford, Pa.-based healthcare consulting firm. It is time, he said, for finance committees of boards to re-examine their auditing relationships.
Coopers' Pittsburgh office, which conducted the audits, hasn't been accused of any wrongdoing. But observers say it's only a matter of time before the firm gets swept up in litigation.
"It think anyone who has a litigator on retainer probably is looking at taking a shot at Coopers," said one attorney close to the situation, who asked not to be identified.
Just two years ago, the same Coopers office was sued in civil court by investors in Phar-Mor for negligence in failing to uncover an embezzlement scheme that led to the financial collapse of the Youngstown, Ohio-based discount drugstore chain. Phar-Mor emerged from bankruptcy in 1995.
The accounting firm was found guilty but chose not to appeal the Phar-Mor judgment, and the amount of the damages was sealed by the court, said David Nestor, a New York-based spokesman for PricewaterhouseCoopers.
Although AHERF relieved Coopers of ongoing auditing responsibilities, the accounting firm continues to help the system reassess past financial statements.
Asked for comment, Nestor said, "It is the firm's policy not to discuss client situations, and they are still a client. AHERF management, as is their prerogative, decided to make a change."
AHERF has hired Deloitte & Touche to help with the system's bankrupt Philadelphia-area hospitals; KPMG Peat Marwick will serve as outside auditor for the system's other hospitals.
The auditor's job is to ensure that an organization's financial statements are presented fairly and conform to generally accepted accounting principles. Lenders and bond buyers rely on that independent stamp of approval to help verify a provider's credit worthiness. That confirmation assists Medicare and Medicaid program administrators who look for stable, solvent healthcare contractors.
Annual audits can cost as little as $15,000 for a small freestanding hospital or as much as hundreds of thousands of dollars for a large system.
Much like medicine, auditing is not an exact science. One set of numbers can be interpreted many ways, each of which may be correct. Finance experts say healthcare accounting rules allow a great deal of leeway in accounting for investment income, for example. Some systems may classify those earnings as "nonoperating income." Other systems lump investment income with "other revenue."
But the process can be undermined by cozy auditor-client relationships. Reluctant to bite the hand that pays them, auditors may go soft on their duties, critics charge.
"It's the old issue of how many masters can you serve," said John Weiss, president of the Audit Group, a Labadie, Mo.-based auditor of healthcare accounts payable. "I think we're going to see more of it now with health systems."
With systems, the amount of money at stake is larger, mistakes can be bigger, and the auditing becomes more complex.
Indeed, the likelihood that a large error could cause a system's downfall grows as more hospitals integrate, said Arnold Silver, publisher of the Phoenix-based newsletter Rate Controls.
In not-for-profit healthcare, "there's not as much oversight as there would be in a public company," he said. "And when hospital organizations start to get to be the size of a public company, they're subject to the same kinds of issues you're seeing with Allegheny."
Thomas Prince, a professor of health management and accounting at Northwestern University's J.L. Kellogg Graduate School of Management, Evanston, Ill., said lax auditing has been "an ongoing problem for a long time. It has nothing to do with mergers and acquisitions," he added.
Prince, who draws his data from certified financial statements, said he has noticed a disturbing pattern of fluctuations in hospital and system net assets reported from one year to the next. Those fluctuations are at least 5% and represent millions of dollars. He figures about 7% of hospitals' audited financials reflect such variances, often with no footnote explaining why the numbers have been adjusted. Prince said he suspects the adjustments reflect more-rigorous audits performed by newly hired accounting firms.
He did not offer specific examples, because he has not yet published his findings.
But Prince said he believes the problem merits action. He suggested that states safeguard community interest in the financial health of not-for-profit hospitals by requiring the submission of audited financial statements.
Accountants are quick to point out the limitations of what they do. The audit is not intended to represent a clean bill of health (See chart). Management has ultimate responsibility for ensuring that financial statements are accurate.
"We sell our independence and objectivity," Nestor said. "We would not do anything to compromise that."
"The thing to remember . . . is that financial statements are always management's responsibility because they have the most insights into the operations," added Rick Gundling, technical director in the Washington office of the Healthcare Financial Management Association.
In fact, the American Institute of Certified Public Accountants' Auditing Standards Board, which develops auditing performance standards and practice guidelines, recently clarified the requirement that auditors obtain written representations from management for all financial statements and reporting periods.
But auditors have a responsibility too. "Audits mean something, and people rightly rely on audits," said an attorney who represents shareholders in securities fraud cases, who did not want to be identified. "It seems unfair for an auditor to claim they're the best in the business and then when something goes wrong say it's not my fault."
When an auditor gets sloppy, the repercussions can be sweeping.
In the early 1990s, the accounting firm of Ernst & Young paid the federal government some $400 million to settle charges that it played a part in the collapse of the nation's savings and loans. Other firms, too, paid to settle claims related to the scandal.
More recently, shareholders of FPA Medical Management, the San Diego-based physician practice management company that filed for Chapter 11 bankruptcy protection in July, have brought suit against the company's outside auditor, Deloitte & Touche, in a number of states. The suits, which have been stayed pending action in a federal case against FPA, allege that Deloitte & Touche was involved in defrauding FPA investors.
An attorney for shareholders, who asked not to be identified, said Deloitte is likely to be named as a defendant in the federal case.
The New York-based American Institute of Certified Public Accountants doesn't track statistics on the rate of litigation or amounts paid to settle complaints against CPA firms. But it's not uncommon for stockholders to sue a company's auditor when financial irregularities are uncovered.
Because of the low default rate in not-for-profit healthcare, there have been relatively few complaints against audit firms, said William Cleverley, an accounting professor and cofounder of the Center for Healthcare Industry Performance Studies in Columbus, Ohio.
Moody's Investors Service, though, recently warned of increased volatility among healthcare credits as providers make the transition to larger integrated systems (See related story, p. 76).
Although the New York-based credit-rating agency stopped short of predicting defaults, some bankruptcy attorneys say they've noticed an increase in hospital filings compared with several years ago (Jan. 12, p. 22).
If more healthcare providers go bankrupt, "you're going to see more and more people bring suits against auditors," Cleverley contended.