The Application of Sarbanes-Oxley to the Non-Profit Healthcare Sector Presented to: American Society of Law, Medicine & Ethics and Seton Hall University.

The Application of Sarbanes-Oxley to the Non-Profit Healthcare Sector

Presented to:American Society of Law, Medicine & Ethics

and Seton Hall University School of Law

Health Law & Policy ProgramApril 25, 2003

James R. SchwartzManatt, Phelps & Phillips, LLP

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• Corporate Responsibility Initiatives Apply to Non-Profits as Well as For Profits

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I. Introduction

• Hershey Trust• Health Partners• Health Midwest• CareFirst

• Bishop Trust• AHERF• ALLINA• United Way of the

National Capitol Area

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• Bishop Trust– Criminal Prosecution (unsuccessful) of Two

Trustees

– Forced Resignation of Entire Board

– Restructuring of Trust Through Civil Action in a Manner Inconsistent With Trust Document

• AHERF– Criminal Prosecution of CEO - CFO - GC

– Massive Civil D&O Liability Action

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II. There are Consequences for Real orPerceived Failures in Corporate Governance

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• ALLINA– AG “Compliance Audit” (no lawsuit)

– Resignation of Virtually Entire Board

– Forced Restructuring of Corporation

• Hershey Trust– Proposed Sale of Corporate Assets Blocked

– Restructuring of Board With Resignation of Existing Board Members

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II. Consequences (cont’d.)

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• Health Partners– AG Compliance Audit

– AG Demand That Board Appoint Two Individuals of AG’s Selection to Board (Including Chair)

– In Litigation

• Health Midwest– Challenge By Missouri & Kansas AGs to Proposed

Sale of Nonprofit Health System Assets to HCA• Litigation in Both States

• AGs Seeking Control of Sale Proceeds

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II. Consequences (cont’d.)

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• CareFirst– Md. Insurance Commissioner Rejected Proposed Sale

of Md. Blue Cross Plan to Wellpoint

– Challenged: • Executive Compensation

• Due Care of Board

• Independence of Outside Financial Consultants (MEETH Revisited)

• United Way of the National Capitol Area– “Slater Report”

– Begins Application of Sarbanes-Oxley to Non Profits

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II. Consequences (cont’d.)

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• Regulators are in an Aggressive Mode– State Attorneys General See Parallels Between

• For-Profit Companies Disclosure Requirements to Shareholders and

• Non-Profits Disclosure to the Public

• There Are “Spill-Over” Effects ofSarbanes-Oxley– State Attorneys General will look to:

• More Proactive Boards

• Vigorous Board Oversight in Key Areas

• CEO/CFO Certifications of Financial Statements

• Board Responsibility for Conflicts of Interest7

III. The Message Is:

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• Expect Legislative Proposals to Apply Selected Portions of Sarbanes-Oxley to Non-Profits• New York - AG 2

– Mandatory Executive and Audit Committees

– Responsibility for Appointment, Compensation, Oversight of CPA Firm

– CPAs Report Directly to Audit Committee

– Independence of Audit Committee Members

– President/Treasurer Certification of Financial Reports and Internal Controls

– “Whistle Blower” Procedures/Protections

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III. The Message Is: (cont’d.)

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• Expect Legislative Proposals to Apply Selected Portions of Sarbones-Oxley to Non-Profits (cont’d.)– Incorporation of IRC 4958 “Safe Harbor” Standards and

Voidability of Related Party Transactions That do not Meet Standard

– Executive Compensation Requires Full Board Approval

– Limitations on Officer/Director Indemnification

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III. The Message Is: (cont’d.)

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• Adopt “Best Practices” to Protect Your Corporation and Your Board

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IV. Solution: Stay Ahead of the Curve

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• Steps You Can Take Consistent With Sarbanes-Oxley Provisions1. Establish an Independent Audit Committee

• Independent Members

• “Financially Literate” with at Least One Member a “Financial Expert”

• Oversight of Outside Auditors and Internal Audit Staff

• “Whistle Blower” Investigation Responsibility

• Authority to Engage Independent Experts/Counsel

• Meets with Auditors Outside of Presence of Management

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IV. Solution (cont’d.)

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• Steps You Can Take Consistent With Sarbanes-Oxley Provisions (cont’d.)2. Insure Independence of the Corporate Audit

Througha)Prohibition on the Provision of Specified Non-Audit Services

by Outside Auditors

b)Rotation of Audit Partner

c)Confirmation of Auditor Compliance With Rules Governing Auditor Professional Conduct

• Prohibit any Corporate Officer from Improper Influencing of the Corporate Audit

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IV. Solution (cont’d.)

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• Steps You Can Take Consistent With Sarbanes-Oxley Provisions (cont’d.)3. CEO/CFO Certification of Financial Reports

• Quarterly Certification From Affiliates

4. Establish Written Conflict of Interest Policies and Code of Ethics for Officers, Directors and Senior Financial Managers• Full Disclosure with Ongoing Responsibility to Update

• Internal Controls to Assure Review of COI Disclosures in Transaction Reviews

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IV. Solution (cont’d.)

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• Steps You Can Take Consistent With Sarbanes-Oxley Provisions (cont’d.)5. Establish Written Professional Responsibility

Guidelines for Disclosure of Material Violations of Law or Breaches of Fiduciary Duties to Appropriate Corporate Officials

6. Develop Internal “Whistle Blower” Protection Policies

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IV. Solution (cont’d.)

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• Steps You Can Take Consistent With Sarbanes-Oxley Provisions (cont’d.)7. Develop Document Retention Policies That Comply

with All Rules Re: Destruction, Alteration or Falsification of Corporate Records

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IV. Solution (cont’d.)

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A. Duty of Care• Develop Internal Procedures to Bring “Red Flag”

Issues to the Board’s Attention• Investments

– Periodic Review

– Compliance with Guidelines/Performance

• Restricted Fund Issues– Develop Compliance Program to Monitor

• Executive Compensation Issues

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V. Practical Examples for Non Profit Health Care Organizations

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A. Duty of Care (cont’d.)– 4958 Standards/Safe Harbors

– Consultant/Outside Contractor Agreements

– Are Consultants Truly Independent (Non-Conflicted)?• MEETH

• Carefirst

– Does Board Get Complete Information From Advisors?

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V. Practical Examples (cont’d.)

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A. Duty of Care (cont’d.)• Provide Board Access to Senior Management,

Beyond CEO• Does General Counsel Attend Board and Key

Committee Meetings?

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V. Practical Examples (cont’d.)

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B. Duty of Loyalty – Conflicts of Interest• Is There a Formal Conflicts of Interest Policy• Is There Full Disclosure by Board Members,

Officers and Senior Management of Potential Conflicts of Interest

– Is it kept current

– Is there a mechanism to utilize it

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V. Practical Examples (cont’d.)

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C. The World Has Changed• Public and Regulators Expect Higher Standards

for Non-Profit Corporations – Both Boards and Management

• Expect “Best Practices”

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V. Practical Examples (cont’d.)

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Document ID # 40605487.1