Whatever happened to the Securities and Exchange Commission (SEC) investigation into Senator Bill Frist's sale of his shares in HCA, the nation's largest for-profit hospital chain?
This is a question that popped into many minds Monday, when HCA, the company that the senator's family helped found, announced that it is selling to a group of private equity investors that includes the likes of Kohlberg Kravis Roberts and Merrill Lynch, as well as Dr. Thomas Frist, Jr.-- HCA's former chief executive, and the senator's brother.
The $33 billion buy-out comes at a time when HCA is wrestling with sliding earnings, slow growth, and spiraling costs. More than half of the beds in HCA's 176 hospitals are empty, and in the most recent quarter, net income dropped 27 percent. By purchasing the company, the parties involved are betting that HCA's fortunes will improve.
Senator Frist is not involved in the buyout, but the announcement does revive questions about his sale of HCA shares last year -- shortly before the stock peaked at $58 and change.
At the time, the Senate majority leader was not the only one dumping the stock. In the first half of 2005, a parade of HCA's top executives headed for the door, unloading shares worth roughly $42 million in May and June alone. That's when Senator Frist joined the party. On June 13, he instructed the manager of his blind trust to sell all of his HCA shares. (The trust is blind in the sense that Frist does not know precisely what he owns on a given day -- but not so blind that he can't direct sales.) By July 8, his shares had been liquidated, along with shares owned by his wife and children.
Just five days later -- on July 13 -- HCA announced that its second quarter earnings would fall below analyst's estimates, and the stock plunged to just over $50. For most of the next 12 months, it would trade well below that amount. (Even under the generous terms of the buyout announced Monday, shareholders will receive only $51 a share -- roughly $7 less than HCA insiders pocketed if they sold at the highpoint.) Did Frist decide to bail out because insiders at HCA had tipped him that earnings were going to disappoint? This is the question that piqued the curiosity of both the SEC and the federal prosecutors who have been looking into Frist's sale.
But if the buy-out renews questions about Senator Frist's sale, it also invites a closer look at the Frist family empire -- an empire that has helped to shape and reshape the U.S. hospital industry for nearly forty years.
This is not the first time that HCA has found itself in financial trouble. Indeed, the history of HCA, like the history of so many of the nation's largest for-profit hospital chains, has been marked by boom and bust cycles. Time and again, a promising company gains strength and begins to flourish, acquiring one hospital after another until its domain stretches coast to coast -- and then implodes. Success is followed by forced sell-offs. Scandal stalks the sector.
The story begins in 1968 when Senator Frist's father, Dr. Thomas Frist, Sr., and his brother, Dr. Thomas Frist, Jr., joined forces with Kentucky Fried Chicken promoter Jack Massey and formed Hospital Corporation of America. Later known as HCA, the company would become the nation's first for-profit hospital chain. Before long, other companies joined the fray.
In the late 1960s, money was streaming into the hospital industry. Success seemed all but assured. By 1965 more than 70 percent of the U.S. population was covered by hospital insurance. And that year, with the passage of Medicare, seniors joined the ranks of the well-insured. With both government and private insurers greasing the wheels of commerce, medicine was quickly turning into a high-growth business. Enter the entrepreneur.
The industry's founders began with a nearly doctrinal conviction that they could reap a profit. In a competitive market, they reasoned, innovative businessmen would make the hard-headed decisions needed to turn the hospital business into a money-making proposition. And at the outset, these executives did introduce some much-needed reforms. Realizing that there was money to be saved by buying in volume, for example, for-profit chains began snapping up everything from wheelchairs to laundry services in bulk.
Meanwhile, both private insurers and the government reimbursed "fee-for-service," paying for every pillow, pill, and procedure that a hospital provided. The system encouraged extravagance. The more services a hospital lavished on a patient, the more it would be paid. There was no incentive to economize. Moreover, hospitals were reimbursed, not just for the services they provided, but for a share of the capital that they invested in new equipment. This open-handed system spurred unbridled investments in new technology, even if a hospital was merely duplicating equipment already available at another facility down the street.
All in all, a business that had begun as a place for the poor to die had turned into an irresistible investment opportunity. "From the late 1960s until the early 1980s it was difficult not to make money operating hospitals," Bradford Gray observes in The Profit Motive and Patient Care. By 1983 investor-owned hospital companies owned more than 13 percent of the general hospitals in the United States and managed another six percent. With 200 hospitals, HCA remained the industry leader.
Investors delighted in double-digit returns. What nearly everyone had forgotten, Gray notes, is that "historically, hospitals have been unprofitable institutions. In 1963 the average hospital was losing $6 for every $100 of patient care revenue that it took in." Even with the advent of Medicare, most not-for-profit hospitals continued to lose money -- in part because, unlike the for-profits, many were located in impoverished neighborhoods where large numbers of patients lacked insurance. It was not until the 1980s that the average American hospital operated in the black.
The industry's golden age began to fade when Ronald Reagan became president in 1981, decrying the federal government's "blank check mentality." In 1983, Medicare shifted its payment policy from fee-for-service to paying a set amount per patient, based on the patient's diagnosis. The new system allowed hospitals to keep any difference between their costs and the government's established price, thus creating an incentive to become more efficient.
At first, Medicare's prices were fairly generous, but with time and mounting budget pressures, reimbursements slid. Meanwhile, private insurers began to clamp down. By 1985 HCA, like most of the other large chains, had begun selling hospitals. That year, it announced that its longtime pattern of uninterrupted earnings growth was ending. Wall Street's response? Panic selling.
The 1970s and early 1980s had marked a period of unprecedented prosperity for hospitals, an era that overlapped neatly with the growth of investor-owned hospitals. The serendipity created the impression that for-profit hospitals were doing something innovative -- that they had found a winning formula. In retrospect it would become apparent that the for-profits succeeded so handsomely "not because of managerial magic," Gray notes, but because they had learned to take advantage of the incentives to overspend and overtreat that were built into the fee-for-service system.
In the late 1980s, HCA continued to sell off properties. Fearing a hostile takeover, Thomas Frist, Jr., led a leveraged buyout of the company in 1989. Then, as now, HCA hoped that by going private, cutting costs, and boosting cash flow, it could buy time until its fortunes improved. And indeed, by 1992 the company was once again able to sell shares to the public, yielding big gains for the Frist family and other private investors who participated in the buy-out.
But looking back, some observers question just how HCA managed to hike revenues, pointing to a story that whistle-blower James Alderson told in 1993. An accountant who served as chief financial officer at a HCA facility in Whitefish, Montana, Alderson later testified that his bosses had asked him to keep two sets of ledgers: one set showing the expenses the hospital claimed when billing Medicare, the second containing more accurate information. When Alderson refused the bookkeeping assignment, he was fired. His family was forced to sell their home, and Alderson found himself locked in a battle with his former employer that would last for years. In the end, he helped the government recapture $1.7 billion. Under the whistle-blower's law, Alderson won an $8 million reward.
Unfortunately, Alderson's story is just one of many tales of corruption in the for-profit hospital industry. In recent years, the nation's leading hospital companies have joined the likes of Enron and WorldCom in the ranks of corporate crime.
Time and again, it seems that the most successful investor-owned hospitals have been able to “make their numbers” (Wall Street's earnings targets) only by making them up. Some bilked both taxpayers and private insurers (Tenet and Columbia/HCA); others bribed doctors (National Medical Enterprises and Columbia/HCA); still others gulled investors (HealthSouth). In the most harrowing cases, health care providers have resorted to shanghaiing patients, incarcerating them in psychiatric hospitals until their insurance ran out (National Medical Enterprises) or performing heart surgery on otherwise healthy patients (Tenet).
As for HCA, the plot thickened in 1994 when HCA merged with Columbia Healthcare, a chain created by Fort Worth financier Richard Rainwater and Rick Scott, a Dallas lawyer. Under the terms of the union, Scott became CEO of Columbia/HCA Healthcare, while Tommy Frist, Jr., stayed on as chairman.
The marriage did not last. Three years later, FBI agents raided Columbia/HCA in five states. Within weeks, three executives were indicted on charges of Medicare fraud, and the board had ousted Scott, naming Tommy Frist, Jr., both chairman and CEO. In 2000 HCA pleaded guilty to no fewer than 14 felonies. Over the next two years, it paid a total of $1.7 billion in criminal and civil fines.
Columbia's Rick Scott took most of the heat while Tommy Frist denied any knowledge of wrongdoing. But skeptics pointed out that the federal probe went back to the years before Rick Scott came on the scene. And even after the merger, Frist served first as chairman and later as vice-chairman, earning $800,000 in 1995 and 1996. It was only in 1997 -- a few months before the FBI raid -- that Frist began to disassociate himself from the company.
To be sure, not all publicly treaded hospitals have stooped to turn a profit. Yet the industry's checkered history suggests that Wall Street's unrealistic expectations may drive hospitals to overreach.
During the industry's brief but misleading golden age, investors learned to think of hospitals as "growth stocks." But the simple fact is that hospital cannot be expected to make double-digit returns. First, skilled labor accounts for 60 percent of a hospital's costs -- and while many industries are able to boost productivity by downsizing, hospitals have learned that if they try to "right-size" their nursing staff, patients die. Secondly, hospitals must spend enormous sums on plant and equipment, and the cost of medical technology is spiraling. Finally, hospitals must absorb the cost of caring for the poor and uninsured at a time when Medicare, Medicaid and private insurers are cutting reimbursements.
Not-for-profit hospitals also are under financial pressure -- but at least they are not subject to the stock market's relentless drive for growth. Rather, such hospitals find much of their financing in the bond market where investors are far more interested in stability than in growth. This may explain why they are much less likely to overreach. In an ideal world, hospitals might be run like old-fashioned utilities -- subject to some government regulation -- while paying a modest, but steady dividend.
But investors will not willingly give up memories of the years when the industry was awash in cash. Indeed, as The Wall Street Journal reports, the buy-out deal announced on Monday "is intended to produce annual returns of greater than 20 percent for the buy-out group . . . Investors expect to hold HCA for about five years, after which they anticipate selling shares to the public."
Meanwhile, Bloomberg News reported this week that options to buy HCA shares shot up dramatically in the two weeks preceding Monday's buy-out announcement -- raising suspicions of insider trading by those who knew that the deal was imminent. Plus ca change…
Maggie Mahar is the author of Money-Driven Medicine: The Real Reason Health Care Costs So Much (HarperCollins, 2006). Portions of this article were adapted from the book.
