What CFOs should know—and do—about corporate responsibility: the Sarbanes-Oxley Act of 2002 applies only to publicly traded corporations, but not-for-profit healthcare organizations will feel its effects

Healthcare Financial Management,  Dec, 2002  by Michael W. Peregrine,  James R. Schwartz

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CFOs of not-for-profit hospitals will not be immune from the new focus on corporate responsibility. The wave of accounting scandals and allegations of reckless corporate behavior have centered on the for-profit world. Indeed, the watershed Federal legislation on corporate responsibility enacted in July, the Sarbanes-Oxley Act of 2002, applies only to publicly traded corporations. (a) Nevertheless, many of the public-policy considerations inherent in this legislation and in other organized corporate-responsibility initiatives will spill over onto not-for-profit corporations in general and on health care in particular. (b) The fundamental policy concern--preservation of the integrity of a corporation's financial statements--transcends the basic distinctions between publicly traded (and other business) corporations and not-for-profit corporations.

Financial managers are at the center of this political and regulatory maelstrom. Corporate responsibility finds disparate constituencies (eg, state charity officials, governing boards, the IRS, donors, and bondholders) uniting under a shared interest of ensuring transparency and reliability of financial statements. Attention is also focused on relationships with auditors, creditors' rights and institutional solvency, and investment management--all of which may fall within the CFO's area of responsibility.

This scenario demands that financial managers of not-for-profit healthcare providers understand the core public-policy concerns fueling the corporate-responsibility movement and take steps to ensure their organization's corporate responsibility.

What CFOs Should Know

"In-tune" healthcare financial managers should be aware of the following factors that frame the boundaries of the corporate-responsibility environment.

Health industry examples. Most financial managers know that the allegations of accounting improprieties at high-profile corporations such as Enron, WorldCorn, Adelphia, and Tyco formed the basis for the related Federal legislative response. However, several prominent financial-oversight failures in the healthcare industry illustrate current corporate-responsibility concerns. The spectacular collapse and bankruptcy of the Allegheny Health, Education and Research Foundation, together with the series of other not-for-profit healthcare bankruptcies of recent months, serve as a strong reminder that financial-oversight concerns are not limited to public companies. Indeed, some healthcare providers and other companies have restated their financial statements in the past year to correct misstatements, errors, and other potentially materially incorrect public disclosures of corporate financial status. (c) Such restatements may be required under the continuing disclosure provisions of Section 15c2-12 of the Securities Exchange Act of 1934, by the independent auditor as a precondition to receiving a "clean" opinion for a subsequent fiscal year, and potentially to avoid a default under existing debt instruments. Furthermore, many of the allegations of the Minnesota Attorney General in its controversial business compliance review in 2001 of Allina Health System related to a failure of corporate governance to exercise sufficient controls over corporate expenditures and use of charitable assets. Indeed, the Memorandum of Understanding between the Attorney General and Allina includes the institution of corporate controls and oversight policies on such financial matters as executive compensation, consulting expenses, travel, and entertainment and administrative expenses. (d)

It's all about oversight. Corporate responsibility is about oversight. In a post-Enron environment, a key question is whether corporate boards are fulfilling their duty to oversee both financial affairs and the corporate officers, agents, and employees to whom responsibility for such affairs is delegated. Enron is a spectacular illustration of the catastrophic consequences of a board's failure to oversee-and of management's failure to inform the board about-financial matters. The Enron board concluded that its oversight failed for a number of critical reasons:

* The now-notorious related-party transactions proved to be a flawed concept;

* Board-adopted controls were inadequate and poorly implemented;

* Senior management did not exercise sufficient oversight and did not respond adequately when issues arose that required a vigorous response;

* The board's audit and compliance committees performed only cursory reviews;

* The board was denied information that might have led it to take action;

* The board did not fully appreciate the significance of some of the specific information that came before it; and

* The audit committee was unaware of inadequacies in Enron's internal controls. (e)

Sarbanes-Oxley and public policy The landmark Sarbanes-Oxley Act does not expressly apply to taxexempt, not-for-profit corporations. However, strong public-policy arguments exist to support efforts by state charity regulators and the IRS, for example, to extend similar rules and regulations to not-for-profit entities. Foremost among these arguments is the need to provide potential donors, as well as bondholders, with reliable financial information concerning the organization. Such information is also useful to charity officials as they seek to prevent financial distress (and related reduction in needed services) and other potential abuse of charitable assets. Indeed, the IRS recently recognized the need to address corporate-responsibility issues by including additional questions to its Form 990, Return of Organization Exempt from Income Tax. (f)