1	HEALTHCARE GOVERNANCE/ COMPLIANCE ISSUES AND TRENDS (Five Years After SOX) Robert L. Schuchard, Esq. robertschuchard@dwt.com (213) 633-6878 June 5, 2007
2	WHAT IS CORPORATE GOVERNANCE? BOARD’S OVERSIGHT OF: Institutional Mission Business and Affairs Financial Reporting Senior Management Compliance Medical Staff Board Composition and Performance
3	CHANGE DRIVERS Legal Imperatives California Corporations Code/Fiduciary Duties IRS “Good Governance” Practices JCAHO SOX and other SOX-like legislation
4	CHANGE DRIVERS Business Imperatives Rating Agencies/Bond Holders Constituent Expectations Public Interest and Attention “Front Page” Concerns
5	STATUTORY STANDARD OF CARE (Same for Non-Profits and For-Profits) In good faith Believed to be in the best interest of the corporation Reasonable care and inquiry (as an ordinarily prudent person in a like position would use under similar circumstances)
6	DUTY OF CARE Two important director functions - due inquiry: Decision making Specific decision or board action Oversight function Oversight of day-to-day business operations Investigation when put on notice of a potential problem
7	DUTY OF LOYALTY Good Faith Absence of fraud or illegality Honest purpose Constructive skepticism Best interests of corporation Absence of conflict of interest Confidentiality
8	DUTY OF OBEDIENCE To Charitable Purposes (NP Only) Emerging Concept (from duty of loyalty) Premised in charitable trust principles More in literature than case law or statute Need to focus on purposes stated in Articles of Incorporation Queen of Angels case Challenges in property tax exemption cases “Sword” used by AG’s
9	EFFECT OF SARBANES-OXLEY ACT (SOX) Creates New Standards for Addressing Duty of Care Expectations are now higher for all entities Importance of conflict of interest policies Independent committees – audit, compensation, governance
10	EFFECT OF SOX (continued) Directorial Independence Majority of the Board Certain Committees How Determined − Situational/Relationships − Under "dominion and control" of another "Front page" Test
11	NONPROFIT INTEGRITY ACT: KEY PROVISIONS Charitable corporations with gross revenues of $2 million or more must maintain an Audit Committee. May include persons who are not board members. Cannot include staff members, the CEO/president or CFO/treasurer. Members of the finance committee may not comprise more than 50% of the audit committee.
12	NONPROFIT INTEGRITY ACT: KEY PROVISIONS (continued) Audit committee duties include: Recommending the hiring and firing of independent CPAs. Negotiating the CPA’s compensation, if so requested. Conferring with outside auditors to satisfy themselves that the organization’s financial affairs are in order. Reviewing and deciding whether to accept audits. Approving non-audit services provided by the CPA’s accounting firm.
13	CONSEQUENCES OF FAILURE TO MEET THE STANDARD OF CARE Poor Decisions Litigation by Directors, Members or the Attorney General Governmental Investigations (IRS or AG) Loss of Protection of the "Business Judgment Rule"
14	CONSEQUENCES OF FAILURE TO MEET THE STANDARD OF CARE (continued) Personal Liability Intermediate Sanctions Reimburse Damages Incurred by the Nonprofit Corporation - Fines - Personal Benefit - Lost Opportunities
15	WHAT IS A COMPLIANCE PROGRAM? Structural component - basic framework: includes seven elements articulated by OIG Addresses organization's business activities and consequent risks Educates those whose jobs impact those risk areas Auditing and reporting functions Substantive component - applicable laws (insurance, ERISA, tax, environmental, and privacy) or contract requirements
16	BENEFITS OF A COMPLIANCE PROGRAM Federal Criminal Sentencing Guidelines Designed to mitigate risks - identify them early Addresses duty of care Focus on reasonable inquiry/oversight function 90% of hospitals have them/standard in industry Component of Internal Controls
17	INDUSTRY TRENDS Why Important to Understand Sets Constituent Expectations Is evidence of Community Standard “Best Practices” are suggestions of so-called experts, not statements of the legal standard
18	TRENDS IN HEALTHCARE SYSTEMS Smaller Boards Centralization of Authority/Management Functions Flattening Out Management Structures System CEO with Enhanced Authority (May also be CEO of Key Subsidiaries) Mission and Key Performance Metrics Set/Approved and Evaluated by System Board
19	TRENDS IN HEALTHCARE SYSTEMS (continued) Centralization of Financial/Audit, Information Systems, Legal, and Compliance Functions Strategy and Resources Managed on System Level Quality and Customer Service Goals Overseen on System Level Change in (Some) Subsidiary Boards from Fiduciary to Advisory
20	TRENDS IN HEALTHCARE SYSTEMS (continued) Focus on Governance Practices Succession Planning SOX (Internal and External Audit) and Other Compliance Issues Emphasis on Board Education and Recruitment Education and Career Development Plans for Executives
21	TRENDS IN HEALTHCARE SYSTEMS (continued) Planning for More Active Regulatory Oversight Focused Strategic Planning and Performance Review Financial Goals and Targets Periodic Review of Lines and Business (Make/Buy; Invest/Divest)
22	GOVERNANCE TRENDS Compliance Structure SOX: Need system of internal controls to monitor legal compliance Trends: Two compliance committees: one board committee and one management committee Full-time compliance officer Regular compliance committee meetings
23	GOVERNANCE TRENDS Relationship with Audit Firm SOX: Change lead and review partner every five years Cannot hire certain officers employed by audit firm in past year Prohibition on most non-audit services (bookkeeping, IS design, actuarial, management or HR services)
24	GOVERNANCE TRENDS Relationship with Audit Firm (continued) CEO/CFO certification of each filed report “Fairly presents, in all material respects, the financial condition and results of operation” and “No untrue statement or omission of a material fact”
25	GOVERNANCE TRENDS Relationship with Audit Firm (continued) TREND: Voluntary policies addressing SOX mandates Audit firms imposing initiatives More communication between auditors and board
26	GOVERNANCE ISSUES Audit Committee SOX: All “independent” board members At least one “financial expert” Responsible for relationship with auditor NIA: Not all need to be board members/All independent Distinct from Finance Committee Advice with respect to Audit relationship Must find that “the financial affairs of the corporation are in order”
27	GOVERNANCE ISSUES Audit Committee (continued) TREND: Tend to follow NIA Tend to separate the audit committee from the finance committee More detailed committee charters
28	GOVERNANCE ISSUES Director/Officer Compensation SOX: Reimbursement of bonus, if restatement due to material noncompliance No loans to directors or officers NIA: Board or committee review of CEO/CFO compensation each time it changes
29	GOVERNANCE ISSUES Director/Officer Compensation (continued) IRS: Compensation to board members discouraged Penalties for excessive compensation to insiders (intermediate sanctions) Importance of comparability data TREND: Not seeing reimbursement obligation codified, except where SOX applies Not seeing director compensation, except in public companies More scrutiny over CFO (and other executives) compensation Rebuttable presumption protocols followed by charities Restrictions on perquisites
30	GOVERNANCE ISSUES SOX Proscriptions SOX: Protection of whistleblower (applies to all entities) Prohibition or destruction of records (applies to all entities) IRS: Need to protect whistleblower
31	GOVERNANCE ISSUES SOX Proscriptions (continued) TREND: Add to code of conduct, legal requirements re whistleblowers and document destruction Clarify violations can result in termination
32	GOVERNANCE ISSUES Conflict of Interest Policy SOX: Disclosure of code of ethics, if any IRS: Should have conflict of interest policy TRENDS: All (but a few) have such policies Greater emphasis & stricter guidelines in conflict of interest policy Both financial and situational conflicts addressed
33	GOVERNANCE ISSUES Internal Controls? Process to provide assurances: Reliability of financial reporting Compliance with laws and major contracts Effectiveness of operations Goals: Real-time monitoring Standardized controls Proper documentation Permit attestation
34	GOVERNANCE ISSUES Compliance Plans SOX: Section 404 – assessment of “internal controls” Most non-public entities have not attempted to formally comply
35	GOVERNANCE ISSUES Board Independence Exchange: Majority of Board Independent IRS: Community Benefit Standard Trend: Majority independent Public companies, generally over 75% are independent (substantial majority)
36	GOVERNANCE ISSUES Board Independence (continued) Member of the Medical Staff Hospital Board Physician Director affiliated with another company with: Debtor/creditor relationship Banking relationship 1% of gross revenues Nonprofit with significant contributions Five-year “look back” Personal Services Contract Stock holdings in material vendor/customer Large Donors
37	GOVERNANCE ISSUES Executive Sessions Exchange Rules: Independent directors are to meet in executive sessions, with only independent directors present, at least twice a year Need to specify who chairs executive sessions Other Types: Only management excused Only directors present – staff excused Trend: Becoming more common Usually relates to auditor communications or executive compensation
38	GOVERNANCE ISSUES Term Limits Public companies generally disfavor Can become an issue of independence Trend: Nonprofits: limited to 3 x 3 year terms Public companies: rarely seen, but most have retirement ages (generally 68, 70 and above)
39	GOVERNANCE ISSUES Number of Board & Committee Meetings Public companies: At least eight board meetings At least eight audit committee meetings At least five compensation committee meetings Trend: Monthly board meetings Two or three audit committee meetings per year, unless also serving as compliance committee One or two compensation committee meetings
40	OTHER GOVERNANCE TRENDS Written board member job description More detailed committee charters Better minute taking and review Greater emphasis on “process” and active discussion More formal policy development More publication of policies “Dash Board” reports and MD&A
41	SUGGESTIONS/ADVICE TO THE GOVERNING BOARD Strong conflict of Interest policy Define persons subject to restrictions Who monitors Protocols to be followed Determination of Independence Vendors/service providers Large donors Ten-year Board Member/term limits (UK Commission)
42	SUGGESTIONS/ADVICE TO THE GOVERNING BOARD (continued) Executive Sessions Once or twice a year Agenda/who runs Committee Composition/Direction Nominating Audit Expanded committee charters Importance of Minutes/Documentation Understand and Oversee Compliance Issues
43	SUGGESTIONS/ADVICE TO THE GOVERNING BOARD (continued) Board Selection: Fill necessary skill sets Board Orientations/Continuing Education Annual Retreat (with senior management) to include: Financial statement review Strategy and long range plans Discussion of governance issues Discussion of compliance issues