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The recent collapse of public companies such as Enron and WorldCom has brought new public and regulatory attention to corporate governance issues, exemplified by the passage of the Sarbanes-Oxley Act of 2002 and new corporate governance rules adopted by the New York Stock Exchange. Although publicly traded health care companies, such as for-profit hospital chains and health plans, will be directly affected by measures such as the Sarbanes-Oxley Act, virtually every health care enterprise, whether public or private, for-profit or nonprofit, should evaluate its governance practices in light of these new standards. The California health care industry continues to be under intense financial pressure and many hospitals and other nonprofit health care entities are struggling to survive. Inattention to corporate governance issues, such as conflicts of interest and self-dealing transactions, if discovered during an acquirer’s due diligence, could pose a stumbling block to the sale of a nonprofit hospital. Moreover, if a nonprofit hospital files for bankruptcy or closes, regulators, the California attorney general, the media and the public are likely to apply a heightened level of scrutiny to the hospital board’s conduct. The nonprofit, tax-exempt hospital remains arguably the prototypical health care provider in the California marketplace. These are the steps they should take to remain in step with the post-Enron regulatory environment. THE SARBANES-OXLEY ACT The Sarbanes-Oxley Act, enacted in July 2002, adopts civil and criminal standards for corporate governance of public companies. The standards include personal certification by chief executive officers and chief financial officers that periodic reports filed with the Securities and Exchange Commission fully comply with the reporting requirements of federal securities laws, and that the information in the reports fairly presents, in all material respects, the public company’s financial conditions and operating results. Criminal penalties apply to any person who certifies any statement knowing that it does not comply with all relevant requirements. Most significantly for nonprofit health care organizations, the act also establishes restrictions on perceived abuses in corporate governance, requiring expedited disclosure of transactions involving management and principal stockholders. The act also requires that the SEC issue rules to require a public company to disclose whether or not it has adopted a code of ethics for its senior financial officers, applicable to the principal financial officer, comptroller and similar persons. THE NYSE RULE In August 2002, the New York Stock Exchange adopted new corporate governance measures for public companies. The NYSE rule requires that a majority of directors be independent. The board must affirmatively determine that the director is “independent,” meaning that the director has no material relationship with the company (directly or as a partner, shareholder or officer of an organization that has a relationship with the company). Similar to the Sarbanes-Oxley Act’s requirement of a financial code of ethics, the NYSE rule requires public companies to adopt and disclose a set of corporate governance guidelines. These guidelines must address director qualification standards, director responsibilities, director access to management and independent advisers, director compensation, director orientation and continuing education, management succession, and provide for annual performance evaluation of the board of directors. The NYSE rule also requires the adoption of a code of business ethics, which should address conflicts of interest, corporate opportunities, confidentiality, fair dealing, protection and proper use of company assets, compliance with laws and the reporting of illegal or unethical behavior. Some large companies have created the new position of Chief Ethics Officer to better comply with the new responsibilities under the NYSE rule and the Sarbanes-Oxley Act. PRACTICAL CONSIDERATIONS FOR HEALTH CARE NONPROFITS Perform a legal checkup. While the Sarbanes-Oxley Act and the NYSE rule provide valuable guidance regarding emerging corporate governance standards, the first priority for the board of directors of a nonprofit health care organization is to confirm compliance with applicable laws. The directors of a California nonprofit corporation are held to a standard of conduct defined in terms of fiduciary duties owed to the corporation: the duty of loyalty and the duty of care. A nonprofit board should periodically perform a “legal checkup” to confirm ongoing compliance with provisions of the California nonprofit corporations law governing self-dealing transactions (Corporations Code �5233), interlocking directorships (Corporations Code �5234), and limitations on board membership by “interested persons” (Corporations Code �5227). In addition, the nonprofit board should ensure that measures are in place to guard against “excess benefit transactions” that might subject board members to “intermediate sanctions” by the Internal Revenue Service pursuant to �4958 of the Internal Revenue Code. Conflict of interest policy. Nonprofit corporations should review their conflict of interest policy to ensure that it provides an effective tool for the board in complying with the requirements of California nonprofit corporation law (discussed above), as well as “best practices” that can be drawn from the Sarbanes-Oxley Act and the NYSE rule. For example, does the conflict of interest policy establish a procedure for determining whether a conflict exists and, if so, how it will be addressed by the board? Does the policy require annual disclosure of conflicts by board members? Determination of independence. Taking a cue from the NYSE rule, a nonprofit health care organization should make an annual determination as to which directors may be considered independent with regard to board actions. In the case of a nonprofit hospital corporation, for example, a board member who is a hospital-based physician should be considered an “insider” or non-independent. Executive sessions. It is a sound corporate governance practice to convene executive sessions of the board comprised of only independent directors at least twice a year. Interested directors and management should not participate in or attend these executive sessions. Board training and education. Orientation sessions should be conducted for new board members, including detailed review of the conflict of interest policy and rules governing interested directors and self-dealing transactions. Similar education sessions should also be conducted for current board members, particularly in conjunction with revisions to corporate governance policies. Board performance and compliance with corporate governance standards should be evaluated annually. Time Commitment and Scheduling. For boards with a majority of out-of-town directors, board meetings are typically compressed into a half-day schedule where much time is also devoted to committee meetings. Consider whether the current board meeting schedule affords sufficient time for the directors to thoroughly discharge their obligations with respect to the agenda items. Scheduling committee meetings for the day before the board meeting may reduce the time pressures on board deliberations. Committees. Consider whether board committees, such as nominating, audit or compensation committees, should be composed exclusively of independent directors. Code of ethics. All nonprofit organizations should have a conflict of interest policy, but many do not have a code of ethics. Consider the advisability of adopting a code of ethics to address issues such as acceptance of gifts from vendors to the corporation and whether the organization should appoint an ethics officer. IMPACT ON U.S. SENTENCING GUIDELINES The Sarbanes-Oxley Act may also have a significant direct impact on health care organizations in the form of impending changes to the U.S. Sentencing Guidelines. In response to the complex framework of laws and regulations governing the healthcare industry, corporate compliance programs are commonplace for hospitals and other health care organizations. The adoption of corporate compliance programs has been repeatedly encouraged by the U.S. Department of Health and Human Services’ Office of Inspector General. The Sentencing Guidelines set forth criteria for an effective corporate compliance program that may mitigate the imposition of criminal sanctions against a health care organization and its management. The U.S. Sentencing Commission appointed a 16-member advisory panel in January 2002 to assess criteria for corporate compliance plans and then submit suggested changes for public comment. The advisory panel process was designed to continue through 2003. However, that time frame appears to have been accelerated with the passage of the Sarbanes-Oxley in July 2002. The act directed the Sentencing Commission to review organizational sentencing guidelines and make changes to reflect requirements in the act, specifically those dealing with obstruction of justice. Congressional findings related to the act stated that the current sentencing guidelines are outdated and insufficient with respect to corporate compliance programs. Congress further indicated that changes to the sentencing guidelines should be completed by January 2003. Partly in response to the act, the advisory group is considering changes to the sentencing guidelines that relate to management accountability, corporate governance, administration and implementation of compliance programs, confidentiality for internal reporting and whistle-blowing, cooperation with government investigators, and issues about waivers of legal privileges in investigations. If changes to the Sentencing Guidelines are issued in early 2003, as anticipated, many health care organizations will be reevaluating their existing corporate compliance programs, providing a good opportunity to revisit corporate governance issues.

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