Question
Quandary at National Health Company N. Ahadiat, & D. Rice Abstract National Health Company (NHC) became one of the natio ns leading providers of healthcare
Quandary at National Health Company
N. Ahadiat, & D. Rice
Abstract
National Health Company (NHC) became one of the natio
ns leading providers of
healthcare during the early 2000s, through aggressive m
ergers and acquisitions. The
company provides both in and out patient care such a
s convalescent care, rehabilitation,
physical therapy, outpatient surgical centers, ultras
ounds, mammograms, MRIs, CT
scans, and other medical services. The companys rap
id expansion initially resulted in a
substantial amount of profit and success in the heal
thcare market. However it became
increasingly difficult to maintain the growth and e
xpansion in light of the economic
climate, continued pressure from Medicare, the insu
rance companies to cut costs, com-
petition from other health field carriers and the c
oncern over potential government
funded health care programs. As the NHCs managemen
t failed to sustain the expected
growth, its management resorted to other strategies
that not only maintained the expec-
tation of its shareholders, but would also allow man
agement to keep their extravagant
life style.
In this case, we will follow the struggles and angu
ish faced by Karen Larson, NHCs
Chief Financial Officer, as she battles her way throug
h making the right financial and
corporate governance decisions and not to allow hers
elf to be allured, by fancy titles,
avarice and greed as well as upper management pressur
e placed before her. We will
present not only the decisions she has to make but
also the outcome of her decisions.
Background
National Health Company (NHC) is one of
the nations largest providers of
healthcare. It is ranked in the top ten na-
tionally in terms of size and revenue. The
company reached its ranking by expand-
ing rapidly through aggressive mergers
and acquisitions throughout the late 1990s
through the 2006. The company had 50 fa-
cilities across the nation in 1990. By 2006
the company had purchased another 28
hospitals and 45 outpatient rehabilitation
facilities from National Health Enterprise.
In 2003, NHC purchased ReLive, a major
healthcare chain. In 2005, NHC acquired
Medical Surgical Corporation, Novacare,
Health Imaging, Horizon and several oth-
er healthcare providers, with acquisition
costs totaling approximately $2.5 billion.
The buying binge positioned the company
as one of the major players in the
healthcare industry.
As the expansions continued, the NHCs
stockholders became accustomed to a pe-
riod during which they enjoyed double
digit growth rate in their investments.
Yet, once this growth began to truly slow
down, management and Karen Larson,
NHCs Chief Financial Officer (Karen)
did not pay any heed but instead took var-
ious steps to ensure that the price of the
stock would continue to soar.
102
In December 2008, Karen was celebrating a
triumphant moment in her career. She
had been made the CFO in a company she
loved. For Karen, this moment did not
come soon enough. For 20 years, she had
set her sight on this position. She had
toiled in the trenches, putting in long
hours and sacrificing even her vacation
time in hopes of attaining her dream job.
Achieving this position was a fitting cul-
mination of her years of dedication. It was
a richly deserved reward that she cher-
ished and relished. Now Karen was too
pre-occupied with her thoughts. As she
sat huddled in the corner of her dark pris-
on cell, surrounded by belligerent, mental-
ly unstable inmates, Karen Larsons mind
could not help but revisit the fateful day
when her plunge from the lofty perch in a
major corporation to the bowels of prison
began. Painfully, it was time for her to
trace back her steps to what had brought
her here.
The Plan
No sooner had Karen settled on her new
position, when her troubles started. Ap-
proximately nine months into her new job,
Karen Larson was lying awake, sleepless
and listless on her bed. Her thoughts
wandering around the meeting she had
earlier in the day with several other mem-
bers in upper-level management. George
Dawson (George), the CEO of the com-
pany had gathered all the members of up-
per-level management with direct rela-
tions to the finance and treasury
departments. George had started the
meeting with a speech about how proud
he was to be working with such trustwor-
thy and loyal associates, and how he was
very fond of everyone and how they were
all like family to him. After Georges wel-
coming introduction, the real topic of the
meeting came into play. George stated
that, Im sure youre all aware of our cur-
rent financial position as a company. Ka-
ren and everyone there nodded with the
understanding of his statement. He con-
tinued, This recent quarter has been very
bleak, the bleakest one this company has
ever seen in its history. Everyone contin-
ued to nod in agreement with his words.
George went on, However, I believe our
company can pull through this stumble.
All I ask is a small favor in order to bring
the company to new heights. A deep si-
lence swept across the room in the antici-
pation of his next words. All I ask is that
we hide the stumble we had this quarter
from the public. Not everyone in the pub-
lic might agree with our strengths and
abilities. And if word got out that we the
giant in the healthcare industry was falter-
ing, it would hurt the company as a whole.
And we wouldnt want that now would
we? Whispers started out among every-
one all at once, at the notion of what was
being asked of them. George, the CEO of
the company, the one that she had looked
up to, was asking her and everyone else in
the room to commit fraud and falsify the
accounting books and records. George
started to silence the whispers, as he con-
tinued, I will hold personal responsibility
in this act and request. All Im asking for
is to make this one quarter look positive to
the eyes of the public. And next quarter,
Ill ensure the company truly has a posi-
tive quarter. Ill let you all think it over for
103
a few days, and well continue this meet-
ing then.
Over the next several days Karen agonized
over the decisions that she was going to
have to make, yet there were so many un-
answered questions. These questions con-
tinued to spin in her mind. Was she really
a part of the play to deceive the public?
And if she wasnt, should she tell someone
about the companys wrongdoings and the
CEO? She thought about the sincerity of
George Dawson when he stated that he
would bring the company into positive
cash flow over the next quarter, in line
with the financial markets expectations.
Then she thought about all her fellow as-
sociates, all of her friends and all of the
people who worked under her. She had
been working for NHC for over 20 years,
she had worked hard and diligently to
gain her last position as Chief Financial
Officer. She had also worked hard to gain
the trust and loyalty of her fellow associ-
ates. However, what the members of top
management had asked her to do against
the oath she had sworn when she became
a CPA, and her fiduciary duties as one of
the officers in the company. It also went
against the very morals and fibers of her
upbringings and had left her in utter tur-
moil. She continued to ponder. What
would have been the outcomes if the com-
pany had reported a loss? What would
have been the outcomes if she and those
involved did not get caught in the fraud
they were about to commit? What was
she going to do?
The Afterthought
A debate raged in Karens head. She
thought if she agreed to commit fraud
then the company would have no reason
to lay off any of their workers. All of the
jobs would be saved. But then what if the
jobs were saved but the investors lost their
money? She shook the thoughts out of her
head. It was only going to be this one
quarter, as far as she could tell and dared
to believe and hope for. She convinced
herself then that agreeing to commit to the
act would be the best course, especially if
everyone else in the meeting agreed to it.
She didnt want to be the outcast, nor did
she want to disappoint everyone. She
didnt want to constantly have to look
over her back with all the ridicules about
why she didnt go along with the decision.
And she definitely wasnt going to tell an-
yone for fear of losing her own position in
the company; the position that she had
worked so hard to achieve. Karen had fi-
nally decided that she was going to accept
the CEOs plea.
The next meeting took place around Octo-
ber of 2009. The meeting room was quiet.
All her fellow upper management associ-
ates looked tired, as if they too didnt get
very much sleep the last few days. But
they also all had a stern look; she could tell
that everyone else probably went through
a similar ordeal to her own. She could al-
so see in their eyes, as they waited for
George, that they were all going to agree
with what George had proposed a few
days earlier.
As George walked through the doors of
the meeting room, he was quick to notice
104
the deadly silence, and was quick to break
it and get down to business. He asked,
So has everyone come to a decision?
They all nodded their heads. What is it
then? George asked, Are you with or
against me? A short silence fell over eve-
ryone, as no one seemed willing to be the
first to admit to conspiring to the devious
plan. Then Patricia Kim the corporations
in-house counsel stood up and gave her
answer, I agree to your idea George and
stand behind you and your decision all the
way. At that moment, everyone else was
quick to chime in with similar affirma-
tions.
The rest of the meeting went into a discus-
sion of how they were going to hide this
from the public and cover their tracks to
make it difficult for an auditor to find the
deception, if one ever came to investigate.
The plan that they came up with was to
decrease a contra asset account as well as
the expense accounts, either of which
would increase earnings and correspond-
ingly the assets. In addition, they were go-
ing to create fictitious journal entries to
correspond with the generally accepted
accounting principles. Furthermore they
were going to create false documents to
support the bogus accounting entries.
After the meeting adjourned, George came
into Karens office and said we are going
to be reporting all of this additional in-
come and with the capital gain NHC had
from the sale of an asset this year, I am
concerned about the inability from a cash
flow standpoint for NHC to pay its corpo-
rate income tax. We need to find a way to
offset the companys potential tax liability,
which in part was due to a large capital
gain from the sale of an asset and I would
like you to consider some of the tax shel-
ters out there. Karen wanting to help out
George came across a tax shelter, called
Son of Boss,
11
which was designed to re-
duce capital gains. The transaction is a
listed transaction with the IRS. Howev-
er, George had made it clear that it was
necessary to defer any immediate issues
with their taxes with the Securities and
Exchange Commission (SEC) or the Inter-
nal Revenue Service (IRS) and requested
that Karen not file the listed transactions
form with the IRS. Karen complied with
this request in order to please her boss.
The Aftermath
The plan went off without a hitch. Every-
thing had gone according to plan. How-
ever, the next quarter rolled by and passed
rather quickly and still George didnt or
couldnt hold up his end of the bargain.
They all held another similar meeting, and
George asked to continue the plan for an-
other quarter. One quarter after another
came and passed with no end to the ac-
counting and financial subterfuges insight.
Then one day, rather unexpectedly and
11
Son of Boss tax shelters were designed to re-
duce federal income tax obligations from the sale of
a business or other appreciated assets. Assume
that the statute of limitations was not an issue, as in
the Supreme Court case of
U.S. vs. Home Concete &
Supply, LLC, 566 U.S.___(2012)
. Assume that our
clients executive offices are located in Texas in
which is a 5
th
Circuit case,
Klamath Strategic Inv. V.
U.S.
568 F.3d 537 (5
th
Cir. 2009), held that the
transaction lacked any economic substance and
was nothing more than a sham.
105
without discussing it with anyone, George
sold his stocks of NHC.
Even though NHCs business was suppos-
edly booming, the first of National Heath
Company's accounting problems started to
surface in late 2010 after George sold $85
million in stocks several days before the
company posted a large loss, the first in
the companys history. The SEC started to
investigate whether or not Georges deci-
sion to sell his stocks was related to the
posting of a large loss. NHC hired an out-
side law firm to review Georges stock sale
in order to try to postpone the SECs in-
vestigation. The outside law firm con-
cluded that the sale and profit loss were
not related. This however did not ease the
SEC's suspicions. The SEC not only
looked into the stock sale but began exam-
ining the books and records of the compa-
ny along with the FBI. As the investiga-
tions progressed, various employees were
interviewed, including Karen. The FBI
and the Department of Justice met with
Karen and offered her a reduced sentence
if she would come clean with what she
knew. On the evening of June 13, 2012,
FBI agents executed search warrants at the
company's headquarters after the compa-
ny's CFO Karen agreed to wear a wire, in
which she was able to get George to talk
about the fraud.
A number of months thereafter, the Feder-
al Grand Jury issued indictments against
all upper management, including Karen
for committing fraud, for falsifying NHCs
books and records, and for aiding and
abetting to defraud shareholders. Now,
less than a year later, Karen agreed to a
plea deal in which she would be sentenced
to 18 months in prison and a fine of
$500,000 in return for her cooperating with
the government. Had she not cooperated
with the government she could have re-
ceived 10 years.
As Karen Larson sat outside the court-
room waiting to testify for the government
against George, the governments first de-
fendant, she began to recollect her
thoughts on her misguided actions and the
ordeals she would now have to go
through. She no longer was a CFO, she no
longer had a job, she lost her CPA license,
she lost her right to practice before the IRS,
she was facing 18 months in prison and
when she get out of prison, she could look
forward to repaying $500,000 in restitu-
tion.
What could she have done to avoid these
problems, especially of the devastating pit-
fall of languishing in prison for 18
months? How she could be so foolish, Ka-
ren muttered to herself in retrospection.
What was she thinking? How could she
possibly believe that the fraud would only
last a quarter? George was a human, not a
god. Karen sighed deeply. She had al-
lowed herself to be deceived. She had
been myopic to think that she could save
her own skin and her colleagues jobs
through fraud. Perhaps now, Karen
thought bitterly, she would be able to
clearly discern her misguided actions to
ensure that she never acts in that manner
again. With at least another year of her
life devoted to testifying on behalf of the
government against other defendants with
respect to the fraud committed by NHC
106
and its officers and directors and 18
months of prison time yet to serve, Karen
will certainly have sufficient time to dwell
on all her missteps.
Questions for Discussion
1. What are the laws governing the proper
practice of accounting and finance?
2. What are the protections afforded to a
whistle blower?
3. What are Karen Larsons fiduciary du-
ties toward the company as vice presi-
dent to the CFO?
4. Aside from participating in the scheme,
what are Karen Larsons other options
in face of the dilemma?
5. What are the pros and cons of each of
her options?
6. May the IRS impose a tax preparer pen-
alty under IRC 6694?
7. Has the Corporation violated any of the
tax laws where the IRS could impose a
penalty? If so, under what sections of
the Internal Revenue Code?
8. What ethical duties were violated by
Karen under the AICPA Statements on
Standards for Tax Services as well as
those set forth under Circular 230?
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