As Healthcare Focuses on False Claims Liability, Industry Should Mind the GAAP

February 2017

Concern around fraud in healthcare is nothing new, especially since the Affordable Care Act was enacted, unleashing a revolution in the way care is reimbursed. The Department of Justice intensified that concern this past June when it netted 301 individuals for $900 million in false billing.

But when it comes to addressing the risk for fraud in healthcare—an industry under growing pressure and one ripe for fraudulent activity—organizations should pay attention to a risk increasingly on the minds of regulators: non-GAAP (Generally Accepted Accounting Principles) reporting measures.

The consistent use of an agreed-upon set of principles applied to the preparation of financial statements is key to objectively comparing companies or analyzing their results over time. In most jurisdictions around the world, these rules are known as the GAAP. For organizations concerned with sustaining investor interest and confidence, reporting non-GAAP financial measures, like Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA), can be useful to presenting a different context to the GAAP financial statements.

In fact, this is a growing approach.

For 18 out of 20 Dow Jones Industry companies that reported non-GAAP earnings per share (EPS) alongside GAAP figures in 2015, the non-GAAP figures were higher—on average by 30.7 percent, one report showed. In fiscal year 2014, the comparable difference between the two was just 11.8 percent.

And perhaps more strikingly, in 2015, just 5.7 percent of companies in the S&P 500 Index closed their books exclusively using GAAP measures, compared to 25 percent in 2006.

Healthcare is one of the industries (along with the IT, materials and utilities sectors) where non-GAAP reporting is most common. And not surprisingly, as the diversity of both healthcare constituents and reporting requirements often makes it hard to use comparable GAAP terms to gauge the performance of organization A versus organization B. While permissible in their own right, there is subjectivity in the way non-GAAP measures are presented, and so there can be inconsistencies even though the components used to compute non-GAAP measures may have been obtained from audited financial statements. It’s when these measures start taking a turn toward misleading—like by presenting a non-GAAP measure inconsistently between reporting periods, or providing undue prominence to non-GAAP measures or selective editing of data—that they run the risk of violating securities laws.

Industry Shifts Can Make an Industry Look Shifty

Consolidation, restructuring and new business collaborations between non-traditional stakeholders are rampant in healthcare, impacting the very definitions of “core” business elements, and increasing the complexity of accounting.

Non-cash expenses and non-recurring charges: The consolidation environment in the healthcare industry is full of non-cash and one-time charges. Healthcare companies commonly exclude restructuring charges from non-GAAP measures, with about 65 percent of non-GAAP reporting entities in the industry doing so. This is an area of increasing concern as the industry continues to see unprecedented M&A and companies reorganize to remain profitable under new models.

According to GAAP, all costs associated with a business combination must be expensed by the acquirer. These include one-time charges like legal diligence fees, investment banker fees, financial diligence fees and commissions. While they don’t technically recur, their impact can continue to weigh significantly on a business even after the reporting period; thus, their absence can be particularly misleading.

As an example, the acquisition of a not-for-profit hospital by a for-profit one dependent upon the assumption of the pay-down of a defined benefit pension plan liability that is slowly bleeding the acquiree to death is a perfect scenario for a healthcare organization to try to treat those costs as one-time restructuring or nonrecurring charges.

Finally, in the area of non-cash charges, organizations often exclude impairment charges, such as those resulting from writing off goodwill from past acquisitions, from their non-GAAP metrics.

Defining core business elements: In the healthcare world, “core business” has become an expansive term. In a broader healthcare sense, “core” may no longer be limited to hospitals or provider services, but may also encompass payer responsibilities, as providers increasingly collaborate with insurers and take on capitated risk. Additionally, “core” may no longer be limited to acute care but also include post-acute care–potentially even including telehealth services. Healthcare companies must carefully define what does and does not fall into their core businesses as they face accounting scrutiny.

Use of pro formas in acquisitions: Because for-profit companies and nonprofits construct their income statements differently, the acquisition of the latter by the former can raise problems of an interpretive nature when presenting non-GAAP metrics.

Value-based reimbursement adjustments: Under value-based reimbursements, Medicare rewards providers with bonuses when they meet the target cost of care for particular services, but penalizes them with fines when they fail to meet the same target. This presents the potential for missteps if healthcare organizations use non-GAAP reporting to exclude these potential adjustments, even though they should be disclosed as operational costs. Further, as providers are held to outcome standards, the industry faces a potential demand for the development of “customized” metrics to show the financial impact of value-based care, especially since considerable questions remain over how to define and measure quality.

Other examples of misleading reporting practices include (1) publishing non-GAAP measures more prominently than audited GAAP figures, running the risk that readers will mistakenly assign a higher level of credibility to the former; (2) leaving out a clear description of how a non-GAAP measure is calculated, along with the necessary reconciliation; and (3) using unreliable (and unaudited) non-GAAP reconciling items to calculate non-GAAP measures, like “underlying” net income and “from recurring operations.”

The issue of non-GAAP measures has been on the minds of regulators for years, and in March 2016 the Securities and Exchange Commission (SEC) signaled broad change—and potential regulation—coming down the pike.

“It’s something that we are really looking at–whether we need to rein that in a bit even by regulation,” SEC Chair Mary Jo White said, as reported by The Wall Street Journal. “We have a lot of concern in that space.” In May 2016, the SEC went a step further, releasing new guidance on the use of such measures.

Because of the diverse types of companies and reporting in healthcare, it’s often difficult to use comparable GAAP measures to gauge the performance of one type of healthcare entity (e.g. a hospital) versus another type (e.g. an insurer). Hence, there are legitimate reasons for including non-GAAP measures in healthcare reporting, particularly to provide additional insight into an organization’s operations beyond what is included in the audited financial statements. But healthcare entities should do so cautiously—ensuring consistency with SEC guidance and rules—given the new regulatory focus on such measurements. Otherwise, they risk being liable under the anti-fraud provisions of securities laws and could find themselves the target of shareholder litigation.


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