The criminal indictment last week of Charles McCall, the former top executive of a once high-flying healthcare software company, was a reminder of the intense pressure to strike deals on expensive information systems that federal investigators blamed for widespread securities fraud at HBO & Co. during the 1990s.
A federal grand jury in San Francisco indicted McCall, 59, on charges that he helped plan and then presided over a long-running practice of fraudulently inflating revenue and net income in an effort to mislead investors, stock analysts and the Securities and Exchange Commission, and preserve its standing as a hot growth company on Wall Street.
Four years after the scandal first broke, the pressure on vendors and their provider customers to time their agreements to quarterly reporting periods is just as intense, but the tactics allegedly used by McCall and other executives at the Atlanta-based company to book sales illegally are not likely to resurface, industry observers said. The McCall indictment is the latest example of a crackdown on white-collar crime in the healthcare industry (March 18, 2002, p. 6). In recent weeks, hospital executives in California and New York also were hit with criminal charges (See related stories).
According to the federal indictment and a separate SEC complaint filed last week, McCall played a key role in hatching the scheme in early 1998 and later figured in a flurry of alleged illegal bookings to prop up financial results during and after HBO's merger with McKesson Corp., a San Francisco-based medical products distributor, in January 1999.
Accounting irregularities that surfaced at HBO after the $12 billion merger triggered a $9 billion drop in McKesson's market value. The government filed fraud charges against HBO co-presidents Jay Gilbertson and Albert Bergonzi, as well as several other former executives in several announcements starting in September 2000. McCall was fired from his new position as McKesson chairman in June 1999, but until now had not been touched by the probe.
The U.S. attorney's office in San Francisco said last week that Gilbertson had pleaded guilty to one count of conspiracy to commit securities fraud and one count of making false statements in an SEC document. In his plea, Gilbertson admitted to a conspiracy involving McCall and other top officers beginning in December 1997. Two other executives also entered guilty pleas.
The SEC complaint charged that during each quarter of 1998, McCall directed top managers to report incomplete sales as revenue, either by hiding unresolved contingencies on sales or by backdating contracts signed after the quarter ended. "Side letters" spelling out those contingencies were kept separate from main sales contracts to throw off outside auditors, according to the complaint. That practice allowed prospects to sign a sales contract but gave them a way out if their remaining concerns were not resolved.
The end-of-quarter rush was then and still is a highly charged atmosphere with high stakes for both vendors and providers, said David Francis, a healthcare analyst with Nashville-based investment bank Jefferies & Co. "Customers always wait until the very end of the quarter because that's when they get the best discounts," Francis said.
The consequences of delayed deals for publicly traded healthcare software companies can be significant when contracts are worth $5 million to $10 million, he said.
McCall allegedly helped broker a $20 million backdated deal in April 1999, after he had become chairman of McKesson and just a few weeks before the company's audit first turned up evidence of accounting irregularities.
The deal enabled the information technology unit of McKesson to report a 21% rate of sales growth in the quarter ended March 31-the first reporting period after its merger with McKesson and the first time that investor analysts skeptical about the wisdom of the combination would get a look at post-merger financial results. Without the fraudulent transaction, according to the SEC complaint, software sales growth would have been only 1%.
Two prominent healthcare software companies that recently failed to book or retain multimillion-dollar contracts saw their stock prices take a pounding. Cerner Corp., which had enjoyed a run of success with its clinically oriented information systems during the past two years, announced in April it would fall $15 million short of analysts' revenue estimates after losing out to competitors on some transactions and being set back by hospital customers with financial constraints. The Kansas City, Mo.-based company's stock priced plummeted 45% on that news.
Last week, a stock analyst at WR Hambrecht + Co. recommended selling shares of IDX Systems Corp., a Burlington, Vt.-based healthcare software company, after learning of one customer's decision to cancel a contract worth $10 million. Shares fell nearly 15% June 5 on the news that Intermountain Health Care, Salt Lake City, planned to terminate its 2001 contract with IDX's Carecast division, Seattle, to develop a patient-care management system for the 21-hospital network.
"(Intermountain) came to the opinion that they wanted to go in a different developmental direction," IDX spokeswoman Margo Happer said. Happer declined to discuss financial details of the contract. Intermountain officials were unavailable for comment at deadline. Carecast will continue to work with the healthcare system on other electronic management systems, Happer said.
To avoid such market setbacks on one or two contracts that get away, "I've seen vendors offer deals that are mind-bogglingly good to try to get the deals to turn over," said David Garets, executive vice president of Healthlink, a Houston-based information technology consulting company.
"It's an extraordinarily competitive environment in which extraordinary measures are being taken to get deals signed," Francis said.
But vendors won't resort to offering side letters and backdating deals to beat the reporting deadlines, Garets said. "Everyone is so jittery about what happened (with McKesson)," he said. "I don't think you're going to see any other company make the same mistake. If they did, that would be dumb, really dumb."
As a result, the pressure on decisionmakers at hospitals has lessened because vendors can't push them like they once might have done, Garets said. "There are a lot of bet-your-job decisions going on (at hospitals)," he said. "People are doing the correct amount of due diligence, and that's what they should be doing."
In stark contrast, alleged improprieties at the former HBO got so heated that a senior sales executive resigned in October 1998, telling McCall that Bergonzi was "out of control" and the sales force was suffering a "revenue hangover" as a result of the use of side letters, according to the criminal indictment. McCall did nothing when the situation was brought to his attention, the indictment charged. That was days before HBO and McKesson announced they had signed a definitive agreement to merge.
In all, HBO improperly recorded more than 300 contracts during 1998 and early 1999, after McCall and other executives met quarterly to discuss using side letters and backdating the close of contracts, the indictment charged.
McCall's attorney, Michael Shepard of Heller Ehrman, San Francisco, did not return requests for an interview last week.
In addition to McCall, criminal fraud charges were leveled against Jay Lapine, 51, former general counsel for HBO. The SEC had named Lapine in a September 2001 complaint along with Timothy Heyerdahl, senior vice president of finance. The government said last week that Heyerdahl pleaded guilty to criminal charges of insider trading. In 2001, he settled the complaint with the SEC, agreeing to pay a $100,000 fine and return $521,000 in "ill-gotten gains" (Oct. 1, 2001, p. 6).
In addition, Dominick DeRosa, former senior vice president of sales, pleaded guilty to aiding and abetting securities fraud. DeRosa settled with the SEC in Sept. 2000 for $411,000 and an agreement not to serve on a corporate board for five years.