For the first time in the history of not-for-profit healthcare, the Securities and Exchange Commission charged hospital system executives with securities fraud--a violation historically reserved for executives of publicly traded companies--for misleading investors in the system's publicly traded bonds.
"It's a very strong signal to the industry to pay attention to their securities laws disclosure requirements," said Robert Zimmerman, a healthcare and municipal securities lawyer at Foley & Lardner in Chicago. "I suspect there are going to be more actions like this."
Last week, the SEC charged four former executives of Allegheny Health, Education and Research Foundation with falsifying financial statements to conceal the health system's deteriorating financial condition before its 1998 bankruptcy. Their fraud, the SEC said, deprived bondholders of crucial and timely information concerning investments.
Bond investors need "complete and accurate" data about a health system's financial status, said Ronald Long, district administrator of the SEC in Philadelphia.
The absence of that information about AHERF harmed investors holding more than $550 million in tax-exempt bonds from three subsidiaries of the 14-hospital system. The subsidiaries were included in AHERF's bankruptcy filing on July 21, 1998.
Since the filing, all AHERF hospitals have been or are being sold.
Not-for-profit corporations that tap the municipal bond market aren't required to file quarterly financial statements with the SEC as for-profit companies must. But AHERF provided allegedly fraudulent information to investors through secondary market disclosure reports maintained by independent clearinghouses that serve municipal bond buyers.
This case, Long said, marks the first time that the SEC has brought enforcement actions against not-for-profit healthcare executives concerning statements related to bonds that are already on the market.
Former AHERF Chief Financial Officer David McConnell agreed to settle a civil complaint filed last week in U.S. District Court in Philadelphia for $40,000 with no admission of guilt. He also agreed to abide by securities laws in the future. Charles Morrison, who oversaw the finances of AHERF's Philadelphia operations, will contest the SEC's civil charges against him.
Stephen Spargo, a former senior vice president in the AHERF accounting department, and Albert Adamczak, a vice president in the same area, were charged directly by the SEC and have agreed to settlements that bar them from appearing before the SEC and certifying public financial statements for three years.
McConnell allegedly inflated net income figures for AHERF and various subsidiaries in 1996 and 1997. Morrison allegedly overstated income for some of AHERF's Philadelphia operations.
On Sept. 2, 1998, AHERF said in a press release that its financial statements for 1997 were inaccurate and could not be relied on.
"We are very disappointed that the SEC has chosen to bring this lawsuit against Mr. Morrison," said his lawyer, Michael Holston with Drinker Biddle & Reath in Philadelphia. "We intend to fight the case to the end, and we expect that he will be vindicated."
Morrison has been cooperating with "all federal and state agencies for over a year," Holston said. He added that Morrison has been working for the court-appointed AHERF bankruptcy trustee for the past two years.
Indeed, Morrison was granted immunity in exchange for testimony before a Pennsylvania grand jury. The grand jury's investigation led to criminal charges against McConnell, former Chief Executive Officer Sherif Abdelhak and former general counsel Nancy Wynstra in March (March 20, p. 2).
A preliminary hearing in that case is scheduled for May 25 in Pittsburgh.