In Such a Regulated Industry, Why So Much Fraud and Financial Impropriety?

The health care industry is one of the most regulated industries with extensive federal and state governmental oversight. For instance, the industry is largely financed by monies paid under the Medicaid and Medicare programs, which require health care facilities receiving these monies to submit cost reports to federal and state governments that substantiate the monies received. The agencies regulating these facilities also have the ability to audit the facilities’ cost reports and obtain, as part of that audit, additional detailed financial information from the health care facilities—thus, the facilities’ finances are monitored and can be extensively reviewed. Moreover, state health departments are to survey and carefully monitor health care facilities to ensure that quality care is being provided, and those facilities can be fined or even lose their licenses for serious patient-care issues. Finally, as most health care facilities are licensed by state health departments, an extensive investigation is typically required when the license is first granted or on any subsequent transfer, merger or the like. Again, this is a situation where the state government is supposed to be reviewing the facilities’ operations. With all this oversight, one would expect health care facilities to be well-run, transparent businesses.

Over the years, health care facilities have received significant press for alleged fraudulent conduct or other illegal actions. A quick Google search reveals several instances of alleged fraudulent conduct or financial impropriety by health care institutions. For example, Rural Health Plans Initiative, which offered self-funded insurance for companies with 50 or fewer employees, filed for bankruptcy and indicated that it had no money to pay claims. [2] Regulators informed the victims that this company fell through the legal cracks because each plan was allegedly self-funded and therefore, the state and federal regulating agencies had no oversight jurisdiction. [3]

The home health industry is also prone to fraud. Every month, more than 150,000 New Yorkers receive some form of Medicaid-funded home health services. [4] (In 2010, Medicaid spent $4.3 billion on home health care in New York alone.) One of these Medicaid recipients was sentenced to 45 days in jail followed by five years of probation, and was ordered to pay $15,000 in restitution for colluding with her own home health aides to steal from the Medicaid program. The Medicaid recipient filed false time sheets for her aides to inflate the hours worked and increase the reimbursement. Then, the recipient and her home health workers split the additional money received from Medicaid on account of the inflated hours. Unfortunately, there are countless qui tam cases filed against various health care facilities based on alleged fraudulent billing practices, kickbacks, illegal referrals and other violations. The health care facility’s alleged improper actions often involve activities that are outside of the government’s oversight. The bankruptcy process can, at times, be used to investigate and expose any alleged improprieties through the use of examiners or trustees.

Section 1104 of the Bankruptcy Code: Appointment of Trustee or Examiner
When there are allegations of fraud, dishonesty, incompetence, misconduct or mismanagement by a debtor in a chapter 11 case, § 1104 of the Bankruptcy Code allows for the appointment of a trustee or an examiner upon the motion of a party in interest at any time after the commencement of a case and before the confirmation of a plan of reorganization. The appointment of an examiner, who has more limited powers than a trustee, is done pursuant to § 1104(c). To make such an appointment, the court must find that appointing the examiner is in the best interests of the debtor’s creditors and estate, or that the debtor’s unsecured debts exceed $5 million. If warranted, the court will direct the U.S. Trustee to make the appointment. An examiner’s responsibilities are defined by the court order authorizing the appointment and vary depending on the particular circumstances of each case. An examiner will typically conduct an in-depth investigation of the debtor’s financial affairs to determine if there has been fraud, dishonesty, incompetence, misconduct or mismanagement. During the investigation, the debtor’s pre-petition management team continues to manage the debtor’s estate. [5]
           
Alternatively, a chapter 11 trustee is appointed pursuant to § 1104(a), which provides that a trustee shall be appointed for “cause” or where it is in the best interests of the debtor’s creditors and estate. Under the Code, “cause” includes “fraud, dishonesty, incompetence or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case.” The trustee is appointed by the U.S. Trustee, after consulting with parties in interest. Pursuant to § 1104(b), a chapter 11 trustee may be elected rather than appointed if a party in interest requests the election within 30 days after the court orders the appointment of the trustee. In that case, the U.S. Trustee convenes a meeting of creditors for the purpose of electing a person to serve as trustee in the case. Upon appointment or election, the chapter 11 trustee takes over management of the property of the estate and the operation of the debtor’s business.

North General Bankruptcy
The North General Hospital case [6] illustrates the use of both a bankruptcy examiner and a chapter 11 trustee. On Jan. 4, 2011, the U.S. Trustee for the Southern District of New York moved for the appointment of an examiner to conduct an investigation concerning alleged “unauthorized payments [made by the debtors] to insiders, employees, creditors and professionals.” The U.S. Trustee cited a report prepared by the financial adviser to the official committee of unsecured creditors that found that the debtors had made unauthorized payments, which, in the aggregate, totaled more than $1.5 million. The U.S. Trustee argued that the appointment of an examiner was mandated because the unsecured debts of the debtors totaled more than $5 million. Because not all courts have agreed that appointing an examiner is mandatory when the unsecured debt threshold is met, the U.S. Trustee also argued that appointing an examiner was in the best interests of the estates’ creditors. Judge Chapman agreed with the U.S. Trustee and entered an order directing the appointment of an examiner on Jan. 6, 2011 (examiner order). [7]
           
The examiner order directed the examiner to conduct an investigation and to submit a report detailing the allegedly unauthorized payments. The order specifically asked for the report to include, among other things, details on any post-petition payments made on account of pre-petition obligations, a determination on whether any unauthorized payments were recoverable and an analysis on whether there were any violations of fiduciary obligations on behalf of the debtors, the debtors’ management or the debtors’ professionals. Richard Stern was appointed as examiner on Jan. 10, 2011.
           
Stern submitted the examiner’s report 21 days later. The 30-page report detailed numerous categories of unauthorized post-petition payments made by North General’s executive vice president and chief financial officer (CFO). The unauthorized payments included payments to vendors on account of pre-petition claims and payments to employees for pre-petition vacation benefits and expense reimbursements. The examiner concluded that the unauthorized payments were largely attributable to a lack of communication between North General’s executive vice president and CFO and North General’s bankruptcy counsel. He asserted that had counsel reviewed the weekly cash flow reports provided by the debtors, the unauthorized payments would have been apparent.
           
Stern recommended that a representative of the estate commence litigation against the recipients of the unauthorized transfers to recover payments for the benefit of the estates and their creditors. He also determined that North General’s bankruptcy counsel breached its fiduciary obligations to the debtors by failing to provide them with adequate legal advice regarding the payments. Accordingly, he recommended that counsel be required to disgorge some of the $1.3 million in fees that it had received and/or that the court disallow certain future fees to counsel.
           
Additionally, in a move that reflected how seriously the allegations in the report were taken, on March 24, 2011, the U.S. Trustee filed a motion for an order directing the appointment of a chapter 11 trustee. [8] The North General Hospital debtors initially objected to the U.S. Trustee’s motion, but ultimately withdrew their objection and an order was entered on March 28, 2011, directing the appointment of a chapter 11 trustee. [9] Management of the debtors’ estates is now vested with the chapter 11 trustee.

Conclusion
With such a regulated industry, the amount of fraud or other improprieties that occur within the health care industry is somewhat surprising. While the agencies charged with overseeing and/or funding the healthcare industry, including the Medicare or Medicaid program, the Department of Health, the Department of Insurance or another agency of the state or federal governments, likely have the tools and jurisdiction to uncover the fraudulent conduct and other improprieties, this conduct is sometimes difficult to uncover. Unfortunately, this industry is not immune from such improprieties. For those health care businesses in bankruptcy, courts, creditors and other parties in interest have the additional tools of the appointment of an examiner or trustee if there are concerns about any improper conduct.