Richard Scrushy, former CEO of HealthSouth, may have argued that there was plenty wrong with the Sarbanes-Oxley Act of 2002 in his failed suit challenging the law's constitutionality, but not-for-profit hospital and health system board members have found plenty to like.
The passage of Sarbanes-Oxley led to a wave of improvements in governance practices among not-for-profit healthcare providers, changes that would be implemented and relied upon whether or not Sarbanes-Oxley had been ruled unconstitutional as a result of the Scrushy suit.
The reasons behind the creation of the law-corporate scandals at companies like Enron Corp. and HealthSouth Corp.-provided enough inspiration for the healthcare industry to act on its own. Moreover, there is enough momentum from other industry players, such as ratings agencies, bond insurers, state attorneys general, state legislators, the Internal Revenue Service and Congress, that not-for-profit hospitals have plenty of other reasons to keep governance procedures up-to-date with industry best practices.
The long-term effect of the improved governance should be a financially stronger industry.
Sarbanes-Oxley has "had a very significant impact on most not-for-profit hospitals and health systems," said Ed Kazemek, chairman and chief executive officer of consultancy Accord. Pretty much across the board, hospital boards are looking at how they can adapt Sarbanes-Oxley to their governance practices, he said; "It's for real," with even smaller hospitals tackling the law to some degree.
But because Sarbanes-Oxley is not mandatory for not-for-profit hospitals, facilities can pick and choose which parts of the law to follow. And Sarbanes-Oxley provided a blueprint for the healthcare industry, so hospitals and systems did not need to start from scratch.
Executives for Baptist Health South Florida, a seven-hospital system based in Coral Gables, are looking to adopt as much of the law as possible. "I view Sarbanes-Oxley to be sort of best practices," said Ralph Lawson, chief financial officer at Baptist Health. "So much of what Sarbanes-Oxley is about is transparency and being open," which should be goals for all not-for-profit healthcare organizations, Lawson said. "We really shouldn't have any secrets."
As a result, Baptist Health officials have adopted most of the major requirements of Sarbanes-Oxley that apply to a not-for-profit, such as requirements concerning conflicts of interest, external and internal audits, and board independence.
The system's already strict rules on conflicts of interest were made even stronger, Lawson said. "On a scale of one to 10, we like to say (the policy is) a 14." If you do business with Baptist Health "in any way, shape or form," you can't be on the system's board, he said.
Baptist Health changed its audit oversight by creating a separate audit committee composed of three financially astute directors, including a former Knight-Ridder CFO. The system also took the unusual step of requiring all board members to be independent of the system. "Believe me, they are independent. That was a little bit of a culture shock, but it's worked out well," he said.
Plus, the internal audit function was given an elevated role in the organization, reporting directly to the system board; and Lawson and the system's CEO sign off on the financial statements, Lawson said.
Lawson also said a requirement by Sarbanes-Oxley that an external auditor cannot also perform consulting services for its audit client did not affect Baptist Health much, because it never used its auditor for much consulting work anyway.
But that requirement has had a big effect on the industry in general, with many healthcare providers splitting the role of auditor and consultant, said Richard Kusserow, president of compliance firm Strategic Management Systems. That is the No. 1 change he's seen, he said.
Where Baptist Health may be going a step further than most other healthcare providers concerns a controversial Sarbanes-Oxley requirement that an independent auditor sign off on the adequacy of the organization's internal controls. Public companies are raising a squawk about that part of the law, called Section 404, and many not-for-profits are taking a wait-and-see attitude.
"We have started down that road, but we are watching the difficulties public companies are having," said David Bixby, senior vice president and general counsel for Banner Health, Phoenix. "The question is, `Do you go the full nine yards?' " Banner has adopted the rest of Sarbanes-Oxley, as applicable, which led to changes such as creating a hard quarterly cutoff date for its accounting close, he said. "The bottom line is, we're being much more transparent in how we report to the board."
The board and management at seven-hospital Methodist Healthcare system are in a similar position. Methodist, in Memphis, Tenn., has adopted the principles of the first phase of regulations in Sarbanes-Oxley, CFO Chris McLean said. "We've done all that."
But the second phase of Sarbanes-Oxley, which includes the external auditing of internal controls, is going more slowly. "We're trying to not rush into that phase," he said. "It's very time consuming. It's turned into a lot of effort and a lot of cost."
Similarly, executives at Iowa Health System, Des Moines, undertook an extensive governance update project that used Sarbanes-Oxley as a model, said spokesman Jim Zahnd. The system stopped short of taking on the external audit of internal controls phase of the law, he said.
A rough and conservative estimate of the cost to comply with the external audit provisions of Sarbanes-Oxley would be in the $400,000 to $500,000 range per year, McLean said. Some public companies have estimated the annual costs of that portion of Sarbanes-Oxley in the millions or tens of millions of dollars.
But Baptist Health officials are going to give it a go in the name of adopting best practices. "It may cost money in the short term but will save money" over the long haul, Lawson said, since improved controls are likely to lead to cost savings in how the system does business.
The first step in tackling Section 404 is figuring out how to do it, Lawson said. "It's like a mountain, but we're going to move it."
Industry executives said the cost of getting governance procedures on par with Sarbanes-Oxley-excluding Section 404-should not be excessive. "At this point, the costs have been negligible," McLean said.
Kusserow said that complying with Sarbanes-Oxley is not as daunting as one would think. "You don't have to build a car, you just have to go to a mechanic to adjust the car," he said. The general cost range for Sarbanes-Oxley projects that Strategic Management has worked on is $10,000 to $30,000, he said.
Industry experts say the costs of adopting Sarbanes-Oxley are well worth it in the long run. John Nelson, managing director for Moody's Investors Service, said governance at hospitals and health systems in general has lagged both the public world and other not-for-profit organizations. Healthcare has been hobbled by its highly technical nature and its high reliance on local residents as board members, Nelson said. "We have always thought that governance at hospitals is very weak."
With Sarbanes-Oxley taking hold so strongly in the industry, the quality of boards should improve, thereby making hospitals better run and perhaps better off financially, he said. Neither Moody's nor Standard & Poor's, though, have made Sarbanes-Oxley compliance a formal part of their ratings process.
Hospitals and health systems may have to deal with a Sarbanes-Oxley-like law anyway. There are already movements in the Massachusetts and New York state legislatures to apply governance regulations to not-for-profit organizations and the U.S. Senate Finance Committee is looking at the issue as well. "I think it's a matter of time before we see more of that," said Ed Bryant, lawyer at Gardner Carton & Douglas.
He said it's likely that several provisions of Sarbanes-Oxley are going to become part of new laws that would apply to not-for-profit healthcare providers.
James Orlikoff, president of governance consultancy Orlikoff and Associates, said that it's unlikely that not-for-profits will remain unregulated on governance while for-profits are. "It's very rare you'll have disequilibrium in governance standards," he said.
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