How “SOX-Like” Compliance Can Benefit the Healthcare Industry

Feature How “SOX-Like” Compliance Can Beneﬁ t the Healthcare Industry By Mark B. Zajac, CICA held directly or indirectly equity (or Executive Summary debt) stakes in these companies. The Sarbanes-Oxley Act of 2002 (SOX) is no longer limited only to public But what type of capital-at-stake does organizations that fi le fi nancial statements with the Securities and Exchange the healthcare industry hold? Most Commission (SEC). SOX has been undertaken successfully by many private healthcare providers do not have stocks organizations, including hospitals and not-for-profi ts. Over the years, this or bonds issued to the public, and most unprecedented corporate governance legislation has been adapted, to some extent, cannot be purchased for your 401k (or in its applicability as a best-in-class corporate governance methodology. Fully 403b) plan at work. Therefore, healthcare implemented SOX addresses many aspects of corporate governance that are not providers do not satisfy the defi nition applicable to the private sector such as analyst confl icts of interest and, to some of “too big to fail” and thus are not extent, auditor independence. There are, however, signifi cant portions of the considered to be “at risk.” Keeping the legislation that apply on a one-for-one basis to healthcare providers. The healthcare aforementioned in mind, why should industry should look to these portions to serve as a corporate governance best healthcare providers voluntarily comply practice. with Sarbanes-Oxley? Easy. It’s what This article will evaluate the applicability of SOX in the healthcare industry and your stakeholders would want you to provide the reader with a historical foundation of the law and best practices that can do, it is the right thing to do, and there applied within a provider setting. are many benefi ts to following the best practices guidelines set forth within SOX. Introduction from fi nancial executives and Board What Went Wrong members to auditors and shareholders It’s hard to believe it was over eight of public companies in the U.S. When Before I get into the details of SOX, or any years ago, on July 30, 2002, when the I fi rst heard of SOX, my initial reaction of its applications to healthcare, a high- most sweeping corporate responsibility was that it was going to be expensive level analysis of the auditing profession and fi nancial reporting legislation since and companies were going to fi nd prior to SOX seems appropriate. the Great Depression was signed into creative ways to not do it, or do it the law by President Bush. Senator Paul The more I have talked to people about way they wanted. Well, I was 50% right. Sarbanes and Representative Michael what events have led to SOX legislation, Companies did fully comply with it, and Oxley crafted the Act and Congress the more I am convinced that my initial it was incredibly expensive. Although the delivered it to American business in an list below is correct. While many events new rules were strict, enforceable, and, unprecedented timeframe in the wake of were considered to be infl uential in one not to mention, expensive, no one will the Enron scandal. form or another, the ones below are can be argue that SOX did not help corporate considered the main trigger points. The primary objective of SOX was to reign America achieve a level of accountability, in corporate irresponsibility and restore transparency, and independence that was • Loss of Auditor Independence—Audit investor confi dence in big business. It so desperately needed. fi rms, by their nature, have always had also provided investors with a level of an incentive to sell additional services Although the original law specifi cally transparency never before imagined. In to their clients. Ever since audit catered to larger-sized public companies short, the days of using creative accounting fi rms began branching out into the known as “accelerated fi lers,” its techniques to misrepresent corporate consulting arena many years ago they applications and “spirit” to the private profi tability and fi nancial position were knew it was going to be a cash cow. sector can no longer be discounted. Public over. Corporate America was introduced But, when fi rms found clients willing companies with large amounts of public to an entirely new set of ideas which to pay top dollar for consulting advice, capital at stake were the primary audience included accountability, transparency, and they did not think twice. It is supply of SOX. As the thinking goes, these were independence. and demand in its perfect form. the organizations that had the most For the uninitiated, SOX was a far-reaching profound effect on the American public Basically, why not sell ABC Company corporate legislation that affected everyone (voting public that is) since the public an external fi nancial statement September 2010 Association of Healthcare Internal Auditors New Perspectives 55 audit along with a financial systems This marketing technique may sound reviewed, a simple slap on the wrist implementation or an internal audit familiar to you. Your local grocery occurred. The rule-breaker promised outsourcing arrangement? Just package store uses bread and milk as loss to fix it and everybody got on with them together and show the client leaders to get you to buy products business. Nothing was ever published; how much value is provided through that have a “fatter margin” like no firm made the news headlines, efficient use of economies of scale. premium ice cream, deli meats, etc. there was nothing in place to prevent Another added benefit to clients was It is the same thing. As you can see repeated violations of professional the perception of having a “one-stop in the graph, it was not until after standards from occurring. Simply shop” of available financial advice. the SOX legislation passed that you put, the process did not work. Now, could begin to observe a correction the peer review process has been Take for example, Arthur Andersen in audit fees, as percent of total fees, replaced by the PCAOB whose and Enron. During 2000, Enron paid collected. responsibility it is to set audit Andersen $25 million in audit fees. To standards and enforce compliance. the average person, that would seem For non-PCAOB firms, a modified like a large number. But, Andersen peer review program administered was accepting a lot of risk for There are two by the American Institute of Certified those fees, so they were, in a sense, basic components Public Accountants (AICPA) has been justifiable. Also, in 2000, Enron paid developed since the passage of the Andersen an additional $27 million in of SOX applicable SOX legislation. tax and consulting fees. Rather than to all organizations • Loss of Auditor Skepticism—Prior to generating $25 million in fees from SOX, auditor’s no longer thought it Enron, Andersen generated a total regardless of was necessary to ask basic questions of $52 million for that year. Not bad. legal form. as part of their audit engagements. If Andersen took a financial statement auditor’s programs told them not to audit product line and cross-sold audit a certain area on the financial millions of dollars more in tax and • Self-Regulated Accounting Industry— statements, they did not. In addition, consulting fees. Peer reviews were the main check and as I have elaborated above (Auditor The same story is true for another balance audit firms used to make sure Independence), the imbalance between one of Andersen’s clients. Again, $4.4 they had no “quality control” issues. audit and consulting fees was the million in audit fees, $7.6 million for Prior to the establishment of the Public primary driver for auditor’s failure to taxes, and $4.8 million for ‘other fees’. Company Accounting Oversight ask the simple, basic questions. There The name of this client was Worldcom. Board (PCAOB), audit firms regulated was just no incentive to ask the tough themselves through a series of what questions. In both examples, Andersen made the industry called “peer reviews.” more money providing higher • Pressures to Keep Audit Fees Low— Once every couple of years, a Big Five margin consulting services than Audit firms were constantly pressured firm would “audit” another Big Five. lower margin attestation services. to find ways to keep fees low, but Some of what they would look at Andersen was using the financial concomitantly expand their services. during these reviews was workpaper statement audit as a loss leader in Much is the same today. However, the quality, compliance with independence favor of charging the client fatter difference between today and back rules, client risk management, and margin services from the consulting then is that audit firms would agree professional conduct. area. However, in the process they to the lower fees knowing they could lost sight of their professional When another audit firm found make up for it with higher margin skepticism during the financial audit. something material in what was being consulting fees. Today, audit firms no longer have the “consulting option” to fall back on and thus are more apt to keep fees higher, or to say “no” to clients more often. • Focus on Cost Efficiencies—The birth of risk-based and quantitative auditing was supposed to increase audit efficiency and quality. No firm wanted to capitalize on this trend more than Arthur Andersen did. Andersen was generations ahead of the other Big Five firms when it came to risk-based auditing methodologies and quantitative auditing techniques. For Andersen, it ended up being a monumental disaster. Computer or “black box” models would quantify all the risks that were inherent with an audit client 56 New Perspectives Association of Healthcare Internal Auditors September 2010 and produce reports telling the Exhibit A—Highest Profile Fraud Cases Publicly Reported—Pre-Sarbanes-Oxley engagement team where they needed to spend the majority of their Company Auditor Year Fraud Technique time.

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