The spectacular collapse of Allegheny Health, Education and Research Foundation remains a major event in the history of not-for-profit healthcare, but it hasn't had a major effect on the way chief financial officers do their jobs.
Although the implosion of the 14-hospital Pennsylvania health system back in 1998 caused financial markets to hiccup and led to distress for the local economies, on a national scale AHERF hasn't had much of a direct impact on the industry's corps of finance executives, industry observers say.
The indirect effect, though, has been significant. As one of several financial scandals to rock the country in recent years-such as Enron, WorldCom and Tyco-boards overseeing hospitals are doing more to try to ensure that an AHERF or an Enron doesn't repeat itself at their operation. As a result, boards members are paying closer attention to the work of hospital management, including that of the CFO.
"Financial reporting requirements are more burdensome" as a result of the accounting and management scandals, says Mitchell Goldman, partner in the healthcare practice of the Duane Morris law firm. AHERF predated Enron, but it was a similar situation and was lumped in with the others, Goldman says.
A mountain of debt
AHERF filed for bankruptcy under a mountain of $1.3 billion in debt, much of which resulted from a slew of acquisitions made under the direction of then-Chief Executive Officer Sherif Abdelhak. Abdelhak had built the system from a single community hospital, but ran into financial problems with his plan and was accused of bullying a conflicted and overly compliant board. He pleaded no contest in 2002 to a misdemeanor charge that he authorized the raiding of hundreds of charitable endowments to prop up the system. More recently, MBIA Insurance Corp., an insurer of AHERF bonds, took some heat for the way it handled the situation.
The passage of the Sarbanes-Oxley Act of 2002, which was at least partly induced by AHERF's unraveling, created a huge incentive for board members to be more aggressive with their oversight of hospital operations, particularly an organization's finances. Sarbanes-Oxley lays out specific standards for management and board members to follow, including potentially stiff penalties if they're not met.
And even though Sarbanes-Oxley mainly concerns for-profit companies, a growing number of not-for-profit hospitals and systems are adopting large chunks of Sarbanes-Oxley voluntarily. That, in turn, is increasing the amount of oversight, auditing and compliance demanded of the financial side.
Moreover, CFOs are likely to face more scrutiny from auditors inside and outside their hospital or system as a result of AHERF and similar scandals. "Auditors have gotten much more conservative," Goldman says. Even if Sarbanes-Oxley's stiff auditing and oversight rules don't apply directly to not-for-profits, it may end up as the de facto standard. "That's where everyone is headed. That will be the standard," he says.
The shift has been gradual, though. "It's not a uniform reaction, but one that is spreading," says Gerald Griffith, partner with the law firm Honigman Miller Schwartz and Cohn. The industry doesn't turn on a dime, but in general more attention is being paid to matters such as compliance, auditing and operational transparency, Griffith says.
"I've noticed somewhat of a change," particularly as it concerns board members, says Brian Derrick, CFO at Albert Einstein Healthcare Network in Philadelphia, which recently acquired a former AHERF affiliate hospital from Tenet Healthcare Corp. One of the things boards learned from AHERF is that they need to ask more questions," Derrick says. "Boards are more plugged in to asking the right questions and doing due diligence."
For example, when Albert Einstein managers shift money within the system from one pool of funds into another with perhaps different restrictions on it, board members are attuned to the fact that they need to pay close attention to how that money is being allocated, he says. There hasn't been a drastic change in the industry, he says; rather, it's been more gradual over many years, he says.
In a similar vein, Pam Vukovich, senior vice president and CFO for Legacy Health System, a four-hospital system based in Portland, Ore., says board members at her organization have a heightened sense of what's expected of them as a result of the scandal at AHERF and other organizations. "Boards are so much more sensitive to meeting their fiduciary duties," Vukovich says. "We use AHERF as an example of what not to do."
Paying a penalty
Financial markets grew more wary of the healthcare sector for a while after AHERF fell apart. Richard Clarke, president and CEO of the Healthcare Financial Management Association, says that after the AHERF bankruptcy many CFOs experienced an "interest penalty" when pricing or repricing deals. "They felt penalized (in paying a higher price) because after AHERF, bondholders were more concerned about hospitals."
And Clarke says not-for-profit hospitals shouldn't think that Sarbanes-Oxley does not pertain to them. "Bonds are securities as well and it's likely that Sarbanes-Oxley may one day apply to tax-exempt organizations as well. And in the wake of AHERF, hospital boards are asking tougher questions of management."
AHERF's failure also raised the issue of board members facing personal liability, certainly an eye-opener among board members who, among not-for-profits, generally don't get paid for their services. "They could have personal liability," Goldman says.
Nevertheless, AHERF was viewed as a unique situation and didn't get the attention that resulted from most of the other major governance scandals in recent years. That's partly because there weren't large numbers of shareholders across the country to raise a stink. AHERF "was viewed as an anomaly. (It) wasn't viewed as a trend," Goldman says. The people most affected by AHERF's collapse were members of the communities the system served, he says.
Some also would argue that the lessons of AHERF have been lost on current board members in the industry.
"I think the vast majority of board members are unaware of what happened at AHERF and why," says healthcare governance consultant Dennis Pointer.
-with Mark Taylor