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Speech by SEC Staff:
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| The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Mr. Weinstein and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff. |
Good afternoon. On behalf of the SEC's Office of Municipal Securities, I thank you for your invitation to participate in this year's AICPA National Healthcare Industry Conference. I appreciate the opportunity to speak to you today about some very recent and very important enforcement proceedings involving health care and accounting.
My name is Steve Weinstein, and I am an attorney with the Office of Municipal Securities of the U.S. Securities and Exchange Commission in Washington. Before beginning, I am required to remind you that my remarks here today represent my own views, which are not necessarily shared by my colleagues on the Commission staff or by the Commission.
That enforcement activity, relating primarily to the Allegheny Health, Education and Research Foundation, referred to by its initials as "AHERF," may have sparked some renewed interest among some of you in the Commission's activities in the municipal securities market. I would like to use this our time together this afternoon to discuss the legal responsibilities of you and your colleagues in the accounting profession under the federal securities laws when you are working for public sector clients in the healthcare industry.
If you can put the AHERF enforcement actions in the context of the Commission's overall activities in the municipal market, what you hear today will be much more useful. My comments are prepared with that goal in mind. In addition to the specifics of AHERF, I will talk about three related things today: the health-care sector of municipal securities; disclosure in the secondary market as well as upon initial issuance; and the significance of antifraud actions in other areas. I also want to emphasize the importance of clarity in communications between you and your clients who issue municipal bonds; misunderstandings can cause unwanted troubles for both of you.
AHERF, at its height, was the largest nonprofit health care organization in Pennsylvania. From 1987 to 1997, AHERF expanded rapidly, acquiring other non-profit healthcare organizations, including several in the Philadelphia metropolitan area: the Medical College of Pennsylvania, United Hospitals, Inc., Hahnemann University Hospital and the Graduate Health System. The acquired entities became direct or indirect subsidiaries of AHERF. On July 21, 1998, AHERF and four of its subsidiaries filed for protection under Chapter 11 of the U.S. Bankruptcy Code.
As an umbrella holding company, AHERF managed and provided centralized corporate support services for the acquired entities, but did not assume liability for their pre-existing debt. The obligation to repay debt within AHERF was placed on collections of one or more of its non-profit subsidiaries known as "obligated groups." By 1997, AHERF had five obligated groups: Allegheny General Hospital, Allegheny University Medical Centers, Allegheny Hospitals, Centennial, and Allegheny Hospitals, New Jersey and several subsidiaries collectively known as the Delaware Valley Obligated Group ("Delaware Valley"). By the time of the bankruptcy in July 1998, AHERF's obligated groups were responsible for repaying at least thirteen bond issues, with outstanding debt of more than $900 million.
The individual issues ranged from $12.7 million to $306 million, the latter incurred on behalf of Delaware Valley in a 1996 refinancing of its older bonds. At least $400 million of AHERF bonds were not supported by a letter of credit, bond insurance or other credit enhancement.
The obligated groups, through AHERF as their agent, provided Annual Secondary Market Disclosure Reports ("Disclosure Reports") to Nationally Recognized Municipal Securities Information Repositories ("Repositories"). The Disclosure Reports contained audited financial statements, debt coverage ratios and other information with respect to certain of AHERF's obligated groups. The Disclosure Reports were made available to the public through the Repositories and were the most easily accessible source of information for investors and potential investors in AHERF bonds. The obligated groups also were required by contracts with their underwriters to periodically disclose financial information to, among others, credit enhancers and bond trustees, and some of the agreements required certifications by company officers as to the accuracy of the submitted information.Between December 1996 and February 1998, AHERF and Delaware Valley issued annual financial statements and Disclosure Reports that materially misrepresented, among other things, AHERF's and Delaware Valley's net income. AHERF, through certain members of its senior management and in violation of Generally Accepted Accounting Principles ("GAAP"): (1) overstated Delaware Valley's 1996 net income before extraordinary items and change in accounting principles by approximately $40 million (by failing to adjust Delaware Valley's bad debt reserves to reflect uncollectible accounts receivable); (2) overstated Delaware Valley's and its own 1997 net income through the inappropriate transfers of approximately $99.6 million in reserves (that were utilized to address the bad debt reserve shortfall not addressed in 1996, as well as an additional shortfall in 1997); and (3) overstated AHERF's 1997 net income by misclassifying certain restricted trust funds (the "Lockhart Trusts").
The misclassification of the restricted funds and the transfers in the Disclosure Reports resulted in the overstatement of AHERF's consolidated net income for the period ended June 30, 1997, by approximately $114 million, and overstated Delaware Valley's net income by approximately $60 million. Significantly, both Delaware Valley and AHERF would have posted substantial net losses for fiscal year 1997 without the fraudulent reporting activity.
To date, the Commission has instituted injunctive proceedings in federal district court in Pennsylvania against David W. McConnell, the former chief financial officer, executive vice president and treasurer of AHERF, and Charles P. Morrison, the former chief financial officer of Delaware Valley and an AHERF senior vice president, charging them with securities fraud. Simultaneously with the filing of the complaint, McConnell consented, without admitting or denying the allegations, to a permanent injunction enjoining him from violating Section 10(b) of the Exchange Act and Rule 10b-5 and ordering him to pay a civil monetary penalty of $40,000. That settlement, along with the case against Morrison, remains pending.
The Commission also instituted and settled three administrative proceedings as a result of its inquiry into this matter. Two of those proceedings involved senior officials in AHERF's accounting department. Without admitting or denying the Commission's findings, Albert Adamczak, former AHERF vice president of corporate support services and senior director of accounting, and Stephen H. Spargo, former senior vice president of AHERF's corporate support services, agreed to orders to cease and desist from committing or causing any violation and any future violation of Section 10(b) of the Exchange Act and Rule 10b-5. (Both Adamczak and Spargo are certified public accountants.) In addition, the orders barred Adamczak and Spargo from appearing or practicing before the Commission as an accountant, pursuant to Rule 102(e) of the commission's Rules of Practice, with the right to reapply after three years.
The third administrative proceeding involved AHERF itself. On June 30, 2000, the Commission entered an Order to which AHERF consented, without admitting or denying its findings. The Order found that AHERF had violated the antifraud provisions of federal securities law and ordered AHERF to cease and desist from committing or causing any violations of Section 10(b) of the Exchange Act and Rule 10b-5.
Specifically, the Commission said:
"AHERF, through certain of its senior officers, violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. As described [in the Order] AHERF materially overstated Delaware Valley's net income before extraordinary item and change in accounting principle by, approximately, $40 million, in the 1996 Delaware Valley audited financial statements and Disclosure Report. It further overstated its consolidated net income by $114.3 million and Delaware Valley's net income by $59.6 million in the 1997 AHERF audited consolidated financial statements and consolidating schedules and the 1997 Disclosure Report. In both Disclosure Reports, AHERF hid its true financial condition from the public through its misleading disclosures and omissions as to Delaware Valley accounts receivable, the transactions related to its transfer of $99.6 million from Graduate and its misclassification of the Lockhart Trusts. Finally, its statements to trustees and others permitted AHERF to continue unchecked in its conduct."
The materials on all of these AHERF-related proceedings may be found on the Commission's web site at www.sec.gov/enforce.htm. The Commission's investigation into this matter is continuing.
As we all well know, the antifraud provisions of the federal securities laws apply to the municipal as well as the corporate securities markets. They also apply to both the initial issuance and secondary trading markets. All of the Commission's guidance and enforcement activities relating to the antifraud provisions are pertinent to understanding fundamental responsibilities of the healthcare sector issuers who are your accounting clients. But I am deliberately focusing on disclosure responsibilities in the secondary market here today because that has recently been the subject of important actions by the Commission. That market is comprised of previously issued and outstanding securities that are now available for sale or purchase by means of secondary trading.
AHERF is the second instance of enforcement action in the municipal market involving fraud in secondary market disclosure, both over the course of the last year. The first was comprised of administrative proceedings involving the City of Miami, Florida, and two of its top former officials, filed last fall. Federal courts have long supported application of the antifraud provisions to disclosures to the secondary market. Further, the Commission's reiteration of this point in the 1994 Interpretive Release was widely discussed and received broad coverage in both the national and municipal trade press.
The Commission stated this point in the AHERF order as follows:
"Section 10(b) of the Exchange Act and Rule 10b-5 thereunder make it unlawful to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. Any issuer that releases information to the public that is reasonably expected to reach investors and trading markets will be subject to the antifraud provisions. [citing Texas Gulf Sulphur1]. The antifraud provisions are equally applicable to disclosures in the secondary market for municipal securities [referring to the March 1994 Interpretive Release2]].
The City of Miami proceedings regarding secondary market disclosure involve both the City itself and two of its former officials, the City Manager and the Director of Finance. Earlier this spring, Cesar Odio, the former Miami City Manager, without admitting or denying the findings, consented to the entry of an order finding that he had violated the antifraud provisions through his activities with respect to certain offerings of the City of Miami and his signing of the Letter of Transmittal contained in the 1994 "CAFR" which failed to disclose the City's true financial condition. The other official involved in the enforcement proceeding is Manohar Surana, the former City Finance Director. Proceedings against the City of Miami and Surana are still pending. Post-hearing briefs have recently been submitted to the Administrative Law Judge in that matter.
The AHERF and Miami enforcement actions convey important reminders to the healthcare sector and to the municipal market in general. The message to issuers and to those professionals, such as yourselves, who may assist issuers in preparing information to be disclosed to the secondary market, is that the antifraud provisions apply to trading of outstanding as well as new issues of municipal securities. Beyond this point, each instance is considered within the facts and circumstances presented. Searching for safe harbors that do not exist may be far less practical and far more risky than rigorous understanding and strict adherence to the antifraud provisions themselves.
Discussion of secondary market disclosure leads to the next element that may help to place AHERF in a larger context. In March of 1994, the Commission noted in its Interpretive Release that "for some conduit entities, annual information may not be sufficient and investors may need more frequent periodic financial information," and included healthcare financings in the group. Unlike many issuers in the housing sector that have moved to quarterly reporting following guidelines developed by the National Council of State Housing Agencies, most health care conduits report on the annual basis set out as the minimum under a contract compliant with Rule 15c2-12. A consistent complaint of the National Federation of Municipal Analysts since the early days of the Rule has been the delay in providing information to the secondary market by health care conduits in particular.
Information released to the market has to be complete and accurate to comply with the antifraud provisions. That is the case under the law at the time of any such release. Good practice may dictate further that material information be released promptly. Compliance with Rule 15c2-12 requires at least annual reporting of financial information. Healthcare issuers may wish to consider whether they should report publicly on a more frequent basis.
This disclosure framework is fundamental to health care and all municipal issuers. Practitioners in the health care sector, including accountants, must be particularly vigilant to ensure the completeness and accuracy of all disclosure in the context of the current volatility of the health care sector throughout this country. Last September, one rating agency reported: " Moody's believes that U.S. not-for-profit hospitals overall will continue to experience financial difficulties over the near term. Over the intermediate term, we expect ratings volatility. We believe that even some of the strongest entities in our portfolio will experience weakening credit quality." The situation has been deteriorating since, with ongoing press reports of increasing financial stress and downgrades in the sector, continuing right up to our meeting here today.
A volatile situation can only increase the risk of misleading disclosure that falls short of providing all the material information known to an issuer at the time the disclosure is made. The needs of investors, those in newly issued securities and those who trade in the secondary market, for current, not stale, information are heightened during such times. The AHERF proceedings serve as a good reminder of the application of the antifraud provisions to secondary market disclosure in general, and to health care conduit borrowers and those who help prepare their disclosure, including today's audience.
While the AHERF orders may well get the attention of the health care sector, the presence or absence of enforcement actions in any specific market sector should signal neither overdue concern nor unwarranted relief. The antifraud provisions apply to all participants in all sectors of both the municipal and corporate markets. Nothing in them parses out greater or lesser liability for, say water and sewer issuers as opposed to airport issuers.
Recent Commission enforcement proceedings in the municipal market are available on the Commission's web site, at the location referenced earlier. The more than one hundred antifraud-based municipal market enforcement actions brought over the last six years, as complied by the Office of Municipal Securities, also may be found on the internet, at: www.sec.gov/info/municipal/mbonds/omstoc.shtml.
A few of the proceedings you may find interesting, aside from AHERF and the City of Miami, include the Commission's Orders regarding:
Maricopa County, Arizona, involving the use of stale and, under the circumstances, misleading financial statements in connection with two offerings of municipal securities;
Syracuse, New York, involving misleading financial data fraudulently presented as in accordance with GAAP;
Orange County, California, involving the use of financial statements in an official statement of the issuer with the auditor's "consent" when no consent was given; and
In the Matter of Ronald Blaine, involving an engagement partner's causing of violations of the antifraud provisions by allowing financial statements be included in an offering circular and causing certain misrepresentations and omissions of material facts to investors.
Broad awareness of applicable antifraud interpretive guidance and enforcement action can only further the interests of your accounting practices and the interests of your healthcare clients.
Next, I would like to share my thoughts with you about clarity in communications. That might cause you to think I am going to speak about Plain English disclosure. I am not. Rather, I refer to communication between you and your clients, in particular about what you and your municipal health care clients actually agree to in terms of the use of an audit. You may perceive the audit as a limited product with a limited content for a limited use. At the same time, your clients may perceive the presence of your audit in a disclosure document as a shield against liability for any materially misleading statements or omissions found in the financial information contained in the official statement. This is a fertile field ready for plowing.
Whose property is an audit in the health care industry? What are the conditions for its publication or other application by the client? What consents are granted or required for its use by the client either initially or subsequently? What is the import of an audit that is disclosed to the investing public on liability of both accountants and issuers under the antifraud provisions? How does the content of the audit relate to the content of other material information that may be disclosed in tandem with it, in the form of a printed official statement or an electronic web site?
These perceptions and questions may be as potentially troublesome to you as to them, to the accounting profession as well as the healthcare issuer community. You may wish to review the terms of your engagements with your municipal issuer clients in straightforward terms that are clear to each of the parties. Those terms should ensure both of you that your responsibilities for presentation of financial information in municipal securities disclosure documents are mutually understood. This is true for both primary and secondary markets. Enhanced communication between auditor and client can clarify the answers to many of the questions I have posed. Your clients may genuinely fail to comprehend the appropriate and authorized use of an audit unless you call it to their attention. And you may overlook an obvious risk by not addressing it at the outset.
Accountants, like issuers, lawyers, bankers and other participants in municipal healthcare industry disclosure, should clearly understand their responsibilities under the antifraud provisions of the federal securities laws. Those who participate in disclosure must accept the full reality of their liabilities in the event that the provisions are violated. Finger pointing among participants is pointless and counterproductive. After-the-fact attempts at divorcing from disclosure responsibility that are tied to the titles at the tops of your letterheads are of limited value to you, and such distancing does not serve the interests of your auditing clients either. Healthcare issuers and auditors alike should mutually understand this element of an engagement from the beginning.
Having communication as my last point today allows me to mention one of our own efforts to improve communication and practices in the municipal securities market – the Second Annual Municipal Securities Roundtable, which will be held this year on October 12th in the William O. Douglas Conference Room at Commission headquarters here in Washington. Our purpose in starting these roundtables is a simple one: to help you make the best use of the disclosure framework and continue to improve communication with your investors.
Five years ago we established the framework for municipal market disclosure by amending Rule 15c2-12 to provide for continuing secondary market disclosure, joining the mechanical steps for primary offering disclosure already existing under that Rule and Municipal Securities Rulemaking Board Rules. Issuers, investors, underwriters, advisers and counsel must constantly be mindful of taking whatever steps are required to comply fully with the primary and secondary market requirements of that Commission rule, while also bearing in mind the applicability of the antifraud provisions to all communications to investors.
The roundtables bring different groups of market participants, such as issuers, bond lawyers and investors, face to face to discuss their perspectives on current market practices, and to the extent perspectives differ, provide an opportunity to begin to bridge the difference.
Health care finance figured prominently in last year's roundtable -- the transcript of which is also on our web site: www.sec.gov/info/municipal/roundtables/participants.htm . Health care will likely figure prominently this year as well. We hope many of you will join us there in October. Thank you.
| 1 | SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied sub nom, Coates v. SEC, 394 U.S. 976 (1969). |
| 2 | See Statement of the Commission Regarding Disclosure Obligations of Municipal Securities Issuers and Others, Exchange Act Rel. No. 33-7049, 1994 SEC LEXIS 700 (March 9, 1994). |
http://www.sec.gov/news/speech/spch406.htm
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