Corporate Law & Governance Update


Audit/Compliance Committee Briefing

Several important developments in June merit the attention of the system’s Audit & Finance Committee. These include new DOJ rules that would nearly double penalties under the False Claim Act, and the latest public comments on application of “Yates Memorandum” principles from senior DOJ officials.

DOJ’s interim final rules (issued on June 29) substantially increase both the minimum and maximum per claim penalties. They are set to go into effect on August 1, 2016 and will apply to claims after November 2, 2015. McDermott’s “white collar” attorneys expect that, among other factors, the new rules will likely not result in increases in the actual amounts paid by entities settling cases, because DOJ typically settles for a multiplier on single damages only (2-3 times absent a financial inability to pay), and foregoes penalties altogether.

However—and this is key for the Audit & Compliance Committee—the expectation is that the new rules will increase the pressure on entities, whether for-profit and not-for-profit, to settle cases because of the enormous potential exposure. Bond and other financing could be jeopardized, which may affect settlement decisions in marginal cases. Thus, the “business risk” implications of FCA penalties become potentially far more significant, which is a serious board/committee oversight consideration.

Committee members may also benefit from reading the June 9 speech of Acting Associate Attorney General Bill Baer. In his comments, Mr. Baer discussed the rationale for the government’s commitment to individual accountability, and the core elements of corporate cooperation, in the context of a larger discussion on FCA enforcement.

Charitable Mission Oversight

The board’s “mission oversight” is of growing importance, with increasing legislative, regulatory and media concerns as to whether the operation of large, financially complex health care systems can be accommodated in the nonprofit, tax-exempt entity model. For that reason, a June 9 letter from Sen. Charles Grassley to the IRS Commissioner is relevant.

Sen. Grassley has historically retained close interest in the debt collection practices of tax-exempt health systems and their compliance with the provisions of IRC Sec. 501(r). This interest has most recently been manifested in his scrutiny of Mosaic Life Care, a Missouri nonprofit hospital system that ultimately agreed to restructure what Sen. Grassley described as its “aggressive collection practices” and to forgive almost $17 million in patient debt.

What is particularly noteworthy of his letter to Commissioner Koskinen is perspective that continued, close congressional oversight of the tax-exempt hospital sector is necessary to assure that low income patients are treated fairly. Accordingly, he calls for greater IRS investigation of problematic hospital debt collection abuses and enforcement of Section 501(r) and its provisions. He also asks for an update on efforts of the IRS and HHS to collect information on how hospitals are complying with Section 501(r).

Continued board oversight is necessary to help demonstrate that both the structure of the health system and the totality of its operations support a nonprofit, charitable purpose. Because, in certain circumstances, and to certain constituencies, the operation of, and services provided by, those systems may appear imperceptible from their tax-paying for-profit counterparts.

The board may want to take two related steps: First, confirm that the general counsel has the authority and resources necessary to monitor Sec. 501(r) compliance. Second, more formally incorporate into both the strategic planning effort, and the board decision-making process, consideration of how specific strategic initiatives and particular board decisions are consistent with the charitable mission of the health system.

Competency-Based Governance

Efforts to increase the level of industry-specific competency at the health system board and committee levels receive a “boost” from the results of a new survey conducted by a global consulting firm. The survey results demonstrate the significant value attributed to aligning board member skills with long term corporate strategy.

The survey, “Building a Great Board” (from KPMG), addresses a variety of issues associated with board composition and refinement. While the benefit of competency-based boards is stressed, other key trends cited by the survey include (a) barriers that exist to adding directors with specific expertise needed by the company; (b) the benefit arising from identifying the board’s future talent needs; and (c) the recognition that a board succession plan may be a worthwhile governance mechanism. The survey also notes that an active board approach to refining board composition is supported by individual director evaluations and “director refreshment” protocols.

The general counsel is well-suited to present these issues to the board (and, in particular, to its governance committee). “Competency-based governance” is certainly relevant to assuring the long-term sustainability of the corporation. From a legal perspective, however, increasing the number of board members with specific, identified areas of expertise and perspective are particularly necessary to assuring effective board oversight of operations and senior management.

Conflicts of Interest

The controversy surrounding the board of the Hershey Trust continues to offer a duty of loyalty tutorial of sorts for the health system board. This is particularly the case with respect to the regulatory and reputational risks that can arise from the perception (not just the reality) of conflict of interest.

As mentioned in our June Newsletter, the current controversy arose earlier this year when the Pennsylvania Attorney General expressed concern that the Hershey board had violated certain provisions of a 2013 conflicts of interest settlement. Hershey is one of the largest U.S. charitable entities, with approximately $12 billion in assets. The June issue arose from a series of published reports that in 2015, the then-Chairman of the board worked through the Trust’s CEO to obtain a summer internship for the Chairman’s son with one of the Trust’s money management funds.

According to the media reports, it was the effort to obtain the internship (in the context of the conflicts guidelines set forth in the 2013 settlement) that prompted the Attorney General to seek the removal of three trustees (including the Chairman) and to direct the Trustees to personally reimburse the trust for the reported $650,000 cost of an internal review of the internship issue conducted by outside counsel.

[The media reports provide that while the Chairman did ultimately disclose the internship (through an email to the Vice Chairman), that disclosure occurred well after the internship was arranged, and did not make reference to the role of the Trust’s CEO in helping to arrange for the internship.] While the outside counsel review concluded that the Chairman’s conduct complied with the Trust’s governance policies, the Trust and its board were subsequently subjected to substantial public criticism for the arrangement.

This controversy—which has yet to be brought to conclusion—helps to underscore the need for board members to try to avoid even the appearance of conflict of interest in their corporation-related relationships and arrangements. In many instances, the “perception” of conflict can be as damaging to a corporation’s reputation as can be an actual conflict; and, when a corporation is already under regulatory scrutiny, “perception” can serve to “lengthen the ethical shadow” over the organization and its board.

Director Protest Resignations

The recent resignations by nearly half of the board of a prominent energy company provide a reminder of the circumstances and impact of “protest” resignations by board members. In this case, the directors resigned following their failure to remove the company’s CEO, whom they felt was not well-suited to lead the company’s new business strategy.

Protest resignations” are not wholly uncommon in the nonprofit world and, particularly, in the health care sector. Resignation is a right usually provided in state corporation law and in the bylaws. Catalysts for “protest resignations” typically include disagreements with the board or senior leadership team; perceived change in organizational mission or strategy; concerns with corporate risk profile; discomfort with board composition; and similar matters.

Recent court decisions suggest, however, that there may be particular risks associated with a director’s choice to resign during a period of corporate controversy or distress. The act of resignation itself does not carry with it some inherent breach of duty risk. Yet, a director may not be able to avoid liability exposure for actions arising from board service merely by resigning, no matter what prompted the resignation. For that reason, media coverage of “protest resignations” can serve as a useful opportunity for corporate counsel to discuss with directors the broader topic of boardroom “exit strategies.”

General Counsel Ethical Challenges

Two developments involving the roles and responsibilities of in-house counsel are useful reminders to the board on the ethical limitations imposed on such counsel. One such development involved the challenges arising from internecine controversy, while the other involved the suspension of counsel for allegedly critical remarks about board conduct.

For example, an ongoing controversy involving control of a media company highlights how in-house counsel can be buffeted by conflict between various different corporate constituents—shareholders, management and the governing board. This is not an improbable circumstance in the nonprofit health care sector, where the potential for controversy between similar constituents (substituting “sponsors” or “members” for shareholders) always exists. In such situations, the in-house counsel is guided by Rule of Professional Conduct 1.13(a)—”the organization as the client,” and provide advice consistent with the best interest of the company.

The other controversy involved the decision of the Hershey Trust (there they go again) to place its deputy general counsel/compliance officer on administrative leave for authoring internal letters and memoranda that reportedly expressed concerns about board mysfunction and the expense and distraction caused by responding to internal investigations. This controversy serves as a reminder to both the board and the general counsel of the “reporting up” (and sometimes “reporting out”) obligations arising under Rule of Professional Conduct 1.13(b). [Note: the exact wording of 1.13(b) may well differ from state to state.]


Level of Director Engagement

The June 8 comments of United Airlines CEO Oscar Munoz draw meaningful attention to the critical fiduciary responsibility of “engagement” and the risks that can arise when a governing board becomes isolated from corporate operations.

While not capable of precise measurement, “engagement” generally refers to the broad level of commitment of the director to his/her fiduciary duties given the circumstances at hand. It extends beyond the mere calculation of hours spent by board members in the performance of governance responsibilities, to subjective factors such as attentiveness, diligence, exercise of constructive skepticism, awareness of operational results, sensitivity to trends and developments, and commitment to service (i.e., no over-boarding).

In his comments, Mr. Munoz was critical of the United board’s level of engagement. Indeed, he attributed much of the operational decline of the airline in recent years to the board’s isolation—reflected in part by the infrequency of its meeting schedule. This, according to Mr. Munoz, resulted in lack of operational insight and the board’s inability to respond more quickly to problems, such as the company’s challenging reservations system.

When scrutinizing board conduct, regulators and third-party interest groups increasingly focus on evidence reflecting the level of board engagement generally, and on particular board agenda items in particular. As health systems agendas become increasingly more complex, important third parties will likely expect a level of engagement by board members that is commensurate with that complexity. As Mr. Munoz suggested, infrequent board meetings may manifest to some a lack of necessary engagement.

Strategic Planning Committee & Antitrust

The Department of Justice’s recent antitrust initiatives in health care—outside of the “M&A” arena—continue to provide noteworthy “fodder” for Strategic Planning Committee attention. The newest initiative was its June 9 antitrust suit against Carolinas Healthcare System, alleging that CHS imposed “steering restrictions” into its commercial payor contracts, in violation of Section 1 of the Sherman Act.

The complaint alleges that the CHS steering restrictions in its payor contracts are anticompetitive, because they (1) prevent payors from offering consumers tiered-network and narrow-network health plan options that lower costs, while preserving patients’ access to “comparable or higher quality alternative healthcare providers” to CHS, and (2) weaken the competitiveness of CHS’s rival hospitals. As to the latter, DOJ alleges that because inclusion in a top tier or narrow network can lead to higher patient volume, smaller hospitals, to qualify for selection into these types of plans, are incentivized to improve quality and efficiency. According to the complaint, as a result of CHS’s ability to block payors from offering such plans, those incentives – and therefore the procompetitive effects they engender – do not materialize.

This complaint is the latest DOJ antitrust effort focusing on payor-provider contracting. [In the last half-dozen years, DOJ also issued a consent decree resolving charges that alleged monopolist United Regional Health Care System imposed anti-competitive terms in payor contracts that excluded rivals from payor networks, and sued Blue Cross Blue Shield of Michigan over most favored nations clauses in its contracts with hospitals.]

Health systems (and payors) with sizable market shares need to keep DOJ’s enforcement history regarding provider-payor contracts in mind when considering negotiations over exclusivity or other restrictive provisions. This is noteworthy for board committees (e,g., Strategic Planning and Compliance) with oversight for system payor contracting practices. Rigorous internal antitrust compliance should extend beyond the “dealmakers” contemplating mergers and strategic transactions, to include Payor Contracting, HR, Finance, Marketing, and all departments where potentially anticompetitive conduct – such as price (or wage) fixing, conspiracies not to compete or anticompetitive exclusionary practices – could materialize.

Tax Exemption Enforcement

The long term future of the Exempt Organizations (EO) Division of the Internal Revenue Service in terms of regulating the tax-exempt organizations sector is the subject of a June 8 report of the IRS’ “Advisory Committee on Tax Exempt and Government Entities” (ACT). As such, it is worthy of notice by the Board’s Mission, and Audit & Compliance committees.

ACT is an organized public forum for discussion of relevant exempt organizations; tax-exempt bonds and other tax issues. It enables the IRS to receive regular input on the development and implementation of IRS policy concerning the EO community. ACT members are selected by the IRS Commissioner and appointed by the Department of the Treasury.

The ACT report mirrors the perspective of many tax-exempt organizations that the EO enforcement and technical educations functions of the IRS have significantly declined over the past several years. As a result, the ACT report expresses concern that the IRS may be unable to regulate the EO community “consistently and effectively.” Accordingly, the ACT makes a series of recommendations intended to assist the IRS in reclaiming its role “as a regulator of tax-exempt organizations” instead of what ACT described as “its nearly exclusive focus on tax administration.”

The ACT report can serve as a reminder to health system boards and their legal risk evaluation function that compliance with exempt organization tax laws remains important, and that there are credible public voices calling for the IRS to return to more active oversight of the exempt organization sector.

The Board and "MACRA"

It is exceedingly important for the health system board—and its key committees—to be briefed on the strategic implications of CMS’ recently released proposal to implement the physician payment reforms required under “MACRA.” Given the legal and compliance components of MACRA, the system general counsel is well-positioned to provide this briefing.

As most general counsel know, MACRA will impact how CMS pays physicians for services provided to Medicare beneficiaries by substantially linking such payments to performance metrics and incentivizing physicians to reduce hospital utilization and to participate in alternative payment models that bear substantial financial risk. MACRA will create powerful incentives that will accelerate the reshaping of the physician services market.

MACRA will likely encourage physicians to consolidate into larger groups, enter into arrangements with physician specialty management companies, or, most likely, become employed by or otherwise contractually aligned with health systems in order to have access to the IT and other care management infrastructure that they will need to achieve the MACRA metrics. Accordingly, MACRA presents a significant opportunity for health systems to create greater clinical and financial alignment with their physicians (and to manage the hospital utilization incentives described above) —as well as a greater risk of losing this opportunity to their competitors. MACRA will create futher impetus for the creation of hospital and physician systems that are fully integrated, clinically, operationally and financially.

The need for board awareness lies in the profound change these reforms are expected to have on health systems, their physician relationships, strategic planning and legal compliance. MACRA will affect the roles and responsibilites of key board committees such as Strategic Planning; Audit & Compliance; Physician Compensation and Finance, to say the least. The general counsel can be a highly effective advisor to governance in all MACRA-related briefings.