The Securities and Exchange Commission had impeccable timing earlier this month in charging four former executives of the Allegheny Health, Education and Research Foundation with securities fraud.
It marked the agency's first enforcement action brought against not-for-profit healthcare executives for misleading the secondary bond markets, said Robert Long, the SEC's Philadelphia district administrator (May 8, p. 2).
The action comes just as bond investors have been urging not-for-profit healthcare issuers to provide more frequent and detailed financial disclosure, particularly for the secondary markets.
Put the two together--unprecedented enforcement action and market demand for frequent reporting--and you have a potential new legal snare for healthcare executives.
"The more you do something, the more opportunities you have to make a mistake," says Monty Humble, a partner in the Dallas office of the Houston-based law firm Vinson & Elkins.
SEC officials decline to say whether they have other investigations pending against not-for-profit hospital executives, but attorneys say healthcare is clearly on the agency's radar.
Without accurate and timely information, investors find it difficult to trade healthcare bonds on the secondary market, particularly given the industry's increased volatility. To make their new offerings more attractive to investors, many hospitals are agreeing to issue quarterly financial reports rather than the annual standard required under 1995 law.
Paul Maco, director of the office of municipal securities for the SEC, has been speaking about the importance of accurate and timely disclosure by hospitals to healthcare groups, particularly underwriters and bond counsel, for several years. He has expressed concern about the potential for "stale" disclosure, such as that alleged in the AHERF case, in which financial professionals knowingly release information that is outdated by the time it reaches investors.
Maco calls the timing of the SEC's action against AHERF coincidental, but adds, "It should nonetheless serve as a heads-up to all who prepare disclosure related to healthcare borrowings." He advises providing information "to all investors as quickly as possible," much as investor-owned companies do.
Some attorneys agree that the case serves as a wake-up call that not-for-profits are subject to federal standards of accuracy and completeness.
Humble says more disclosure, not less, is advised. "The more information that a hospital makes available, the better argument it has that a single erroneous statement was either unintentional . . . or immaterial," because there was other correct information in the marketplace, he says. Humble says hospitals should develop a process to make sure information is properly reviewed before it's released.
But the AHERF case is so unusual that it might not be instructive for the rest of the industry. To constitute a legal violation, a financial professional must make a misstatement knowingly or recklessly.
AHERF and its obligated groups were required by their bond documents to maintain certain financial ratios and disclose information to bond insurers and trustees. Some agreements required certification of accuracy by company officers.
David McConnell, former AHERF chief financial officer, and Charles Morrison, former CFO of AHERF's Philadelphia subsidiary, were charged with overstating income to conceal the system's deteriorating finances.
McConnell settled a civil complaint for $40,000 with no admission of guilt, and Morrison has contested the charges.
In one instance, according to the complaint, the executives overstated 1996 net income for the Philadelphia operations by $40 million by failing to adjust audited financial statements after a decision was made to write off receivables. In another instance, the complaint alleges, they overstated net income for AHERF and its Philadelphia subsidiary by $59.6 million by failing to account for a fraudulent transfer of reserves.
In effect, the allegations involve extreme behavior.
"If we accept the premise that most of the industry is honest, (the case) shouldn't have a big impact," says Jan Weiss, managing director at Financial Security Assurance, a New York-based healthcare bond insurer.