The failure of two major not-for-profit hospital systems to notify investors promptly of Internal Revenue Service bond audits last month highlights the need for better financial reporting by hospitals, investment analysts say.
In fact, top executives of one system declined to disclose the government inquiry even as they addressed a conference intended to foster better relations between not-for-profit hospitals and Wall Street.
Texas Health Resources and Christus Health, both of Irving, Texas, acknowledged May 26 that the giant tax-exempt issues used to capitalize their formations are under examination (See box). Their disclosures, which were prompted by inquiries from MODERN HEALTHCARE, came 22 days after the IRS notified the issuing authorities that it would audit the bonds.
By contrast, Ascension Health in St. Louis alerted investors within 48 hours of being notified of a similar IRS review of its bonds last month (May 22, p. 8). A fourth issue, by MedStar Health in Columbia, Md., is also under IRS scrutiny.
All of the deals involve a strategy called acquisition financing, which has become common in healthcare mergers. Typically, a corporation is formed to acquire the assets of the merger partners and issues new debt to pay off existing bonds. The IRS reportedly wants to determine if the issues should be classified as refundings rather than new issues, which would subject the bonds to strict guidelines regarding tax exemption. Debt refunding typically is used to take advantage of lower interest rates or other market conditions.
So far, there is no evidence that the IRS suspects illegality, and all of the issues under review are supported by legal opinions from the hospitals' bond counsels.
It's the latest example of why not-for-profit hospitals are under fire by investors for incomplete and slow disclosure of financial information. Investors complain that many hospitals keep news secret unless compelled to disclose it, even when the information could affect bond prices. Healthcare bonds have become increasingly volatile because of the industry's financial deterioration.
Texas Health Resources kept its audit under wraps even as its top financial officials, Chief Executive Officer Douglas Hawthorne and Chief Financial Officer Ronald Bourland, spoke to investors at a forum aimed at opening communication between the hospital industry and Wall Street. The conference, held May 18 and 19 in New York, was sponsored primarily by the American Hospital Association and drew executives from 28 major hospital systems. Approximately 200 investors attended, according to the AHA.
Bourland said Texas Health Resources had planned to disclose the IRS audit on May 29 in an annual public filing, even though he believes the 12-hospital system was probably not legally obligated to do so. SEC rules and bond documents require the annual financial statement.
Bourland said he and Hawthorne didn't mention the audit at the investor conference to avoid "providing a part of the investment community with information that could affect the pricing of our bonds." The Ascension Health audit was addressed at some of the sessions.
In a written statement, Christus said it didn't consider the IRS audit to be a "material event" that required disclosure under the terms of its bond documents. Nevertheless, it decided to confirm the audit after the MODERN HEALTHCARE inquiry in order to "keep all parties informed."
Christus President and CEO Thomas Royer, M.D., said the system didn't disclose the audit immediately because "we didn't see it as an extraordinary event."
He added, "We're just so accustomed to the audit process in healthcare, having our Medicare and Medicaid payments being audited, and the IRS has been in most systems across the country doing routine reviews."
Royer said that Christus, which operates 30 hospitals in Texas and Louisiana, finally decided to release a statement after it "kept getting phone calls and people wanted something more definitive."
Dina Kennedy, chairman of the National Federation of Municipal Analysts (NFMA), said anything that might affect the price of bonds should be disclosed. A lack of disclosure can disrupt the market if rumors begin to circulate, said Kennedy, who is assistant chief underwriting officer at Financial Security Assurance, a New York bond insurer.
"If there's an investigation going on and it's benign, (a hospital) should put out a statement saying, `There's an investigation, and we don't think it's important,' " she said. "If there's a rumor and (investors) don't know whether it's a big deal or not, then the market really goes crazy."
Martin Arrick, a director in the healthcare group of credit-rating agency Standard & Poor's, said the audits won't affect the systems' bond ratings unless the IRS declares the financing deals illegal and takes action to yank the bonds' tax-exempt status or penalize the issuers.
Nevertheless, Arrick says the systems should have disclosed the audits to the market right away: "I think anything that has a material impact or could have a material impact on the financial health of a system is fair game to be reported."
The SEC set minimum standards for municipal bond disclosure in 1994. But investors and analysts say the SEC rule, which lists 11 disclosure events, has set a ceiling for disclosure rather than a floor. "Once you report something, it becomes the standard. The incentive is to report as little as possible," Arrick said.
The NFMA plans to issue a set of voluntary best practices for hospital bond disclosures this month. They were developed with advice from the AHA and the Healthcare Financial Management Association.
Emmeline Rocha-Sinha, who is co-chair of the NFMA committee that drafted the best practices, said they will give CFOs discretion in determining what is material information for investors. "If we don't have trust in that senior management, we never should have invested in those bonds," said Rocha-Sinha, who is senior managing director in charge of the public finance section at MBIA Insurance Corp., a bond insurer.
Bourland agreed that lack of standards agreeable to both hospitals and investors has been a problem. But he also acknowledged last week that not-for-profit hospital systems are "not very experienced in dealing with investor relations. Most systems don't have an organized investor relations department like an investor-owned company would."
Though Bourland said he's comfortable with the way his system handled disclosure in this case, he said, "I think clearly I'm going to have to take more personal responsibility, working with the office of the CEO and our PR department and legal department to coordinate an investor program. It's incumbent upon us to act according to the investment community's requirements."