For the first time, Texas Health Resources' chief financial officer this year will certify the accuracy of financial statements for the board. Meanwhile, the system's management is performing an audit of governance and corporate practices. It's all an effort to comply with the dictates of new federal corporate accountability legislation.
In essence, Texas Health, based in Arlington, is acting like hundreds of public companies suddenly confronted with new governance standards.
But Texas Health isn't a public company. It's a not-for-profit, and as such, it isn't required to meet the provisions of the Sarbanes-Oxley Act, signed last year. The law establishes a host of provisions intended to raise the bar for governance of public companies (See chart, p. 28).
Like a lot of not-for-profits these days, Texas Health is trying to stay ahead of the good-governance curve. "We've always been committed to high business ethics and effective, efficient governance," says Luanne Armstrong, the 13-hospital system's vice president of governance who describes Sarbanes-Oxley as "another set of information" the 5-year-old system is using to improve its financial practices.
For-profits, such as notable healthcare companies Aetna and HCA, just this year have announced steps to enhance governance in accordance with new standards including the Sarbanes-Oxley legislation passed last summer in the wake of Enron and other corporate scandals. By contrast, many not-for-profit boards began a self-examination three or four years ago in the wake of the industry's financial downturn and alarms about widespread clinical errors.
Gordon Clark, chief executive officer of the Governance Institute, a San Diego-based education firm, says not-for-profit healthcare is ahead when it comes to separating the roles of management and governance. In a survey released this month, only 4% of hospitals surveyed by the company said their chairman and CEO was the same person, a commonplace situation at public companies. The Conference Board's blue-ribbon Commission on Public Trust and Private Enterprise recently proposed that public companies separate the roles of board chair and CEO.
Many not-for-profit boards drew lessons from two major failures. Board members of Pennsylvania's defunct Allegheny Health, Education and Research Foundation were faulted for apparent conflicts of interest and failure to question management's grandiose expansions. And Minnesota's Allina Health System was forced to break off from its health plan in 2001, when Minnesota Attorney General Michael Hatch issued an audit that detailed questionable financial decisions including lavish educational junkets by Allina's board and management.
Staying ahead of the curve
The new fixation on corporate accountability isn't limited to public companies. Many not-for-profits have begun comparing their practices to those being adopted by public companies, partly because it's expected that the same corporate accountability rules eventually will be mandated for not-for-profits.
"The indication is that regulations similar to those contained in Sarbanes-Oxley may be applied to non-profits at some point, and we want to be prepared," Armstrong says.
Given the financial failures, rampant quality problems and outright criminal behavior by some hospital boards in recent years, it's no wonder that government officials, investors and consumer groups view the current corporate accountability craze as a prime opportunity to increase regulation of not-for-profits. "The problems of the inattentive board and the financially troubled hospital are endemic in the state," says William Josephson, assistant attorney general in charge of the charities bureau of the New York attorney general's office, which has called for tougher oversight of not-for-profits.
Governance consultant James Orlikoff says the quality of hospital governance is "even more variable and inconsistent" than institutional differences in clinical care. He predicts there will be a "creep" of governance standards within three to five years by a variety of means--legislation, court rulings and bond covenants--through which not-for-profits will be held to the same corporate accountability standards as public companies.
Further, he says he believes that additional new standards will be piled on, which all companies including not-for-profits will be expected to meet. "Good boards right now are getting ahead of the curve and preparing themselves for not only the established, but also the emerging standards for good governance," Orlikoff says.
Among the recent developments, the Internal Revenue Service has proposed expanding financial reporting requirements for not-for-profits in the mandatory Form 990, and bond insurers and purchasers have explored adding requirements for hospital boards in bond covenants, such as financial education. Some have even argued that hospitals issuing bonds should be subject to Sarbanes-Oxley because their bonds are traded publicly.
In a sign of the increasing emphasis on trustee oversight, outgoing HHS Inspector General Janet Rehnquist in January announced that her office would work with members of the American Health Lawyers Association to develop an educational guide for trustees on compliance issues. The guide is expected to be published this spring.
"You can't have the corporate responsibility issues arise and laws arise without it being exported expectationwise to the not-for-profit world," says Monte Dube, a partner with the Chicago-based law firm McDermott, Will & Emery.
Most of the impetus for heightened regulation of charities is expected to come at the state level. A formal proposal for legislation to extend corporate accountability standards to not-for-profits has been floated in New York, where state Attorney General Eliot Spitzer in January proposed a series of laws to strengthen corporate accountability in that state, including applying Sarbanes-Oxley standards to not-for-profits.
The proposal would require presidents and treasurers of not-for-profits to certify the accuracy of annual reports and financial statements and the adequacy of internal controls, and it would require boards to designate an audit committee of independent directors. Further, it would discourage financial misconduct by authorizing removal of not-for-profit directors and officers for filing inaccurate reports, strengthening laws governing business arrangements between not-for-profits and their directors and officers, and limiting indemnification of directors and officers.
Spitzer thinks more laws are needed to protect the state's charitable assets. "Not-for-profits do not have shareholders monitoring what's going on on a daily basis. (They) are subject only to the activity and engagement of the board members," says Paul Larabee, a Spitzer spokesman.
States getting aggressive
With corporate accountability on the front burner, attorneys general in other states also may grab the opportunity to expand their charity oversight powers. Spitzer is "so prominent, so well-known, that other states will say that if he's done it, it must be OK," says Michael Peregrine, a healthcare lawyer with Gardner, Carton & Douglas, Chicago.
Even without new legislation, attorneys general have been getting more aggressive in blocking transactions and even influencing the composition and functioning of not-for-profit boards. In Florida, the attorney general's office is being urged to step up its oversight of hospital boards (Feb. 24, p. 12). Meanwhile, Minnesota's Hatch recently alarmed not-for-profits by attempting to install two of his own picks on the board of not-for-profit HMO HealthPartners, which is fighting the move.
Peregrine says he agrees with HealthPartners' contention that Hatch lacks the authority to appoint board members except in cases where a corporation is winding down operations. "What you have here is an attorney general really, really, really stretching the law," Peregrine says.
Some governance experts argue that publicizing their spending habits will discourage people from serving on charitable boards, or even attending governance education conferences, which are generally held at luxury hotels in warm-weather locations. "Not a lot of national quality events are held in Minnesota," says Orlikoff, who is part-owner of the American Governance and Leadership Group, Lake Arrowhead, Calif., which happens to be holding its seminars in Scottsdale, Ariz., and San Francisco this year. The group's other major owners are Jerry Pogue, its chief operating officer, and the American Hospital Association.
Yet as more boards pursue fiduciary oversight and quality control, it's the growing time commitment of board service-- not the risk of adverse publicity and legal risk--that is proving to be a bigger turnoff to potential board members, according to one new survey. Some 62% of hospital trustees surveyed this year at conferences held by the Governance Institute say they are spending more time per month on board matters vs. a year ago. Meanwhile, a large majority--83%--say they had never turned down a board position at any type of organization because of personal legal risk, and only 29% deemed directors' and officers' liability coverage to be a "very important" factor in their decision to serve on a healthcare board.
Exempla Healthcare, Denver, has a reputation for solid governance, but CEO Jeffrey Selberg says even at his system, it's getting tougher to recruit trustees to the 15-member board because the time commitment of board service has roughly doubled since the system was formed in 1997. Board members are required to serve on two committees, attend monthly board meetings and participate at two retreats annually. The time commitment is so great that only about one in four accepts an invitation to serve, he says.
Unlike investor-owned companies, not-for-profits generally don't compensate their trustees, although a few large hospital systems are moving in that direction, Dube says. He points to the historical voluntary nature of the industry and the fact that some legal protections may be lost or curtailed if directors receive pay. The newly released Governance Institute survey, based on responses from 497 hospital CEOs, found that 7% of hospitals provided direct compensation to board members in 2002, ranging from $60 to $14,000 annually, with median compensation of $2,000.
Also unlike public companies, not-for-profits generally don't use search firms to find qualified trustees, a tactic that could help hospitals locate candidates from outside the community who might be more objective. However, that, too, might be changing. According to the Governance Institute, 15% of hospital trustees surveyed at their conferences this year say their organization is likely to use an executive search firm to recruit trustees.
Moreover, few standards for boards are in place. The Joint Commission on Accreditation of Healthcare Organizations--which is chiefly occupied with ensuring hospital quality--has had a few minimal governance standards for hospitals since 1986, such as a requirement that boards conduct self-evaluations. But the bar is considered low, and accreditation is not withheld for failing to meet the standards. Dube says Joint Commission standards are "really the beginning of the dialogue" when it comes to improving governance.
Despite heightened concern about accountability, 83% of hospitals don't require board members to receive a defined amount of formal board education, according to the Governance Institute survey. About 35% of board members attended an off-site governance or healthcare leadership conference last year, the survey said.
Some argue for more rules. When the board and management of Manhattan Eye, Ear and Throat Hospital inked what was widely criticized as a fire sale of its assets in 1999 after a series of board-directed snafus, Spitzer's office stepped in to challenge the deal in court, ultimately preventing a closure. Assistant Attorney General Josephson says with stricter financial reporting rules, the attorney general's office "would have had an early warning of that situation and might have averted that disaster."
"We're not trying to do away with the authority of the board," Josephson says. "What we're trying to do is focus the board on its duties."
Oversight and education
Some healthcare industry leaders concede that adopting rules on financial disclosure, conflicts of interest, and separation of accounting and audit functions for the not-for-profit world wouldn't be a bad thing. But it isn't the complete solution, because good governance ultimately relies on boards policing themselves.
"My experience tells me that legislation and regulation can help raise the bar, but it's not going to result in best practices," Dube says. He says a key problem with Sarbanes-Oxley is that it doesn't address one of the most important issues in healthcare: board quality. "That's where I think we inhabit different worlds. Quality I think is ultimately the key accountability criteria for not-for-profit hospitals," he says. Indeed, according to the Governance Institute survey of trustees, the most important factors of good governance are careful CEO oversight and board education--two areas that are hard to legislate (See chart, page 27).
Still, structural qualities only go so far. "You can have all the requirements in place, but if you have the wrong people it's not going to work," Clark says. "I still have some (CEOs) who complain about their board being caught up in micromanaging. They have the right number of people on the board and the right committee structure, but they're dealing with the wrong things; they have a board chair who doesn't control the meeting, so things get out of hand."
According to Orlikoff, good governance comes down to a series of procedures and practices tailored to each organization. He cites the importance of clearly written job descriptions for officers and board members, diversity among board members including those from outside the service area, meaningful self-evaluation, development of annual goals and objectives and frequently reorganizing committee structures to meet them, and extensive board member orientation. Most important, he says, boards need to communicate to CEOs with a unified voice and give clear direction.
An endless series of debacles--everything from massive investment losses revealed last year by the Cleveland Clinic to the decision by Los Angeles' Cedars-Sinai Medical Center to abort a physician order-entry system earlier this year--ultimately can be traced to board decisions, Orlikoff says. "A board can make anyone in an organization change--the CEO, the physicians. But nobody can make a board change, except itself," he says.
Meet the winners of Modern Healthcare's 2003 Trustee of the Year awards--p. 32.
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