AHERF It May Have Started with a Bang but Did It End in a Whimper

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Oct 2004

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Before the for-profit
corporate scandals of Enron, Global Crossing and Tyco, the nonprofit health
care community experienced its own corporate scandal: the demise of
Allegheny Health, Education and Research Foundation (AHERF). As with most
corporate scandals, AHERF had its "cast of
characters"—corporate executives and professional advisers
accused of wrongdoing by the public, the government or both. Articles, case
studies, commentaries, papers and essays flourish on the corporate
governance, operational and management lessons that can be learned from the
AHERF debacle. Rather than examining the systemic breakdowns that
contributed to AHERF's downfall, the focus of this article is to look
at some of the people behind the organization and review what happened to
those AHERF protagonists.

<h4>Prologue</h4>

AHERF's collapse was thrust into the public
spotlight in the summer of 1998, when it filed the then-largest nonprofit
health care bankruptcy in this nation's history. At the time of its
bankruptcy filing, AHERF was losing almost $1 million a day and was $1.5
billion in debt. When it was finally concluded, AHERF's unsecured
creditors received roughly 12 cents on the dollar from the bankrupt estate.

Just 13 months prior to filing for bankruptcy,
AHERF's economic forecasts had been much brighter. In its fiscal year
1997, AHERF and its affiliates reported $2.05 billion in revenues and $1.18
billion in incurred debt. At that time, AHERF was comprised of 15 hospitals
in the Philadelphia and Pittsburgh markets, with a total of 29,500
employees, as well as the Philadelphia-based Allegheny University of Health
Sciences, which enrolled about 3,300 students a year, and a physician
practice management firm with more than 500 physicians. The decline of this
once-booming mini-empire captured the attention of the health care, legal
and government communities, along with the residents of the greater
Pittsburgh and Philadelphia areas. In addition to the publicity surrounding
the bankruptcy came government and public scrutiny of the actions of
certain members of and advisers to AHERF's management team.

Following AHERF's bankruptcy filing, federal
and state authorities, including the Pennsylvania Attorney General's
office and the U.S. Securities and Exchange Commission (SEC), continued
their respective investigations of the AHERF cast. Eventually, several
AHERF executives and advisers faced government charges.

<blockquote><blockquote>
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<big><center>
Of the lessons taken from AHERF's demise, some
have surmised that "justice was not served," and others have
concluded that, based on the rather disproportionately modest penalties
imposed on the AHERF actors...the government's "bark is worse
than its bite."

</center></big>
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</blockquote></blockquote>

The Pennsylvania attorney general brought charges
against three of AHERF's former top corporate officers. Nearly 1,500
charges were initially brought by the Pennsylvania attorney general against
AHERF's former Chief Executive Officer (CEO), Sherif Abdelhak. In the
end, Abdelhak pleaded no contest to a single misdemeanor count of misusing
charitable funds. He was sentenced to 11-23 months in an Allegheny County
jail and was paroled about three months later. To date, Abdelhak is the
only AHERF defendant who faced trial and was incarcerated.

The Pennsylvania attorney general's office had
originally instituted similar charges against AHERF's former general
counsel, Nancy Wynstra, and against AHERF's former Chief Financial
Officer (CFO), David McConnell. All charges were dismissed against Wynstra,
and only one charge against McConnell was set for a criminal trial.
However, McConnell entered an accelerated rehabilitative disposition
program that permitted non-violent first-time offenders a chance to wipe
their records clean. McConnell did not stand trial.

In addition to the Pennsylvania attorney
general's charges, the SEC brought and simultaneously settled fraud
charges against Mr. McConnell and three AHERF finance lieutenants. Without
admitting or denying guilt, Mr. McConnell paid a $40,000 fine. Underlings
Steven Spargo and Albert Adamczak were barred from representing clients
before the SEC for three years. The third lieutenant, the former CFO of
AHERF's Philadelphia operations, agreed to pay $25,000 to settle SEC
charges and agreed to a suspension of appearing or practicing before the
SEC as an accountant for three years.

Not only were AHERF executives the subject of SEC
charges, but certain members of AHERF's professional advisory team
also faced SEC charges. In July of this year, three former auditors of
AHERF settled fraud charges. All three agreed to sanctions without
admitting or denying the SEC's allegations. Two of the former
auditors agreed to be enjoined for two years from participating as a member
of the engagement team of any independent auditing firm that issues audit
reports in connection with the financial statements of any public or
private company. The other former auditor agreed to a suspension of
appearing or practicing before the SEC as an accountant for four years and
is required to pay a civil penalty of $40,000.

Of the lessons taken from AHERF's demise, some
have surmised that "justice was not served," and others have
concluded that, based on the rather disproportionately modest penalties
imposed on the AHERF actors when compared to threatened penalties, the
government's "bark is worse than its bite." Beyond those
visceral reactions, it is interesting to compare what befell the AHERF
"cast" to the sentences of certain "characters"
associated with some of the more recent highly publicized corporate
scandals.

In the ImClone scandal, Martha Stewart was sentenced
to five months in prison, five months of home confinement and two years of
probation, plus a $30,000 fine. Though the sentence was virtually the same
as that of AHERF's former CEO, Sherif Abdelhak, Abdelhak's
wrongdoings have had much greater detrimental financial impacts. His
counterpart at ImClone, Dr. Samuel Waksal, received a much stiffer sentence
than Abdelhak. Waksal was sentenced to 87 months in prison after pleading
guilty to charges that included securities fraud. In addition, Waksal must
pay more than $4 million in fines and back taxes and was banned for life
from leading a public company.

The former CFO of WorldCom recently pleaded guilty to
fraud and faces up to 25 years in prison, though he is likely to get a
lighter sentence for his cooperation. Contrast the WorldCom CFO's
fate to AHERF's former CFO, who never had to serve any time in
prison.

Finally, consider the fallout surrounding Enron. An
accounting firm was convicted of destroying documents and later dissolved.
Enron's former treasurer, Ben Glisan, pleaded guilty to conspiracy,
was sentenced to five years in prison and was ordered to surrender
$938,000. Enron's former CFO, Andrew Fastow, pleaded guilty to fraud
and admitted to conspiracy to inflate profits in return for a 10-year
sentence, and his wife Lea, under the terms of a revised deal, pleaded
guilty to filing a false tax return and will spend no more than 12 months
in jail. Both agreed to cooperate with the government.

How can the seemingly light sentences of the AHERF
players be reconciled with the outcomes for those at the helm of the more
recent, publicized corporate scandals? One possible explanation is the
changing climate for regulatory scrutiny of corporate misdeeds. One can
only surmise that if the charges against the AHERF characters had followed
rather than preceded the latest round of corporate scandals, the outcomes
could have been very different.

One indicator of this change in climate is the
federal government's enactment of the Sarbanes-Oxley
Act in 2002. Sarbanes-Oxley was conceived in response to the aforementioned corporate
collapses resulting from accounting irregularities and perceived
irregularities in corporate ethics and internal controls; Sarbanes-Oxley was enacted in
large part to protect investors and enhance corporate oversight and
accountability. While Sarbanes-Oxley is currently applicable only to public companies, some
government officials, including the New York state attorney general, have
suggested that Sarbanes-Oxley should apply to nonprofits. In fact, some have cited AHERF as a
"poster child" of why Sarbanes-Oxley should apply to nonprofit
organizations—to protect charitable donors, tax-exempt bondholders
and the communities served by nonprofits. One can only wonder whether, in a
post-Sarbanes-Oxley corporate
environment, the AHERF defendants would have received stiffer penalties or
sentences for their misdeeds.

While the impact that Sarbanes-Oxley will have on nonprofit organizations remains
unclear, the impact on a defunct organization's "bad
actors" may be greater than ever. With the increased publicity
surrounding criminal and civil penalties placed on executives and their
advisers, the corporate insiders of a troubled organization have and will
become increasingly aware of their potential individual liability. As a
result, lawyers representing such organizations will need to consider when
management and other employees within the organization, as well as outside
professionals, may need to seek separate legal counsel to advise them on
their potential individual liability in such matters.

The world ended for AHERF, and that world ended, as
T.S. Elliot wrote, "not with a bang, but a whimper." While
AHERF did not survive its bankruptcy, the ever-evolving understanding and
lessons to be taken from AHERF's fall live on.

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<h3>Footnotes</h3>

<a name="1">1</a> Arthur L. Cobb is a partner and Herbert G. Hotchkiss is an associate with the Cleveland office of the law firm of Hahn Loeser + Parks LLP, which represented AHERF during its bankruptcy filing. <a href="#1a">Return to article</a>

Journal Authors

Arthur L. Cobb

Herbert G. Hotchkiss

Journal Date

Friday, October 1, 2004 - 12:00

Bankruptcy Rule

2004