WSJ: Hospitals Do Business with Board Members at 6X the Rate of Other Nonprofits

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August 21, 2016; Wall Street Journal

Today’s Wall Street Journal published a report that, based on IRS data, found that nonprofit hospitals have representatives of corporations with which they do business on their boards of directors far more often than other nonprofits. In fact, in 2014, of the more than 2,300 nonprofit hospitals in the country, almost half (or 46 percent) had at least one trustee with business ties, direct or through a relative, to the hospital. This is a much higher proportion of trustees with potential conflicts of interest than in nonprofits as a whole—where the rate is seven percent.

Thus, hospitals, which number among the largest nonprofits in the country, conduct business with their board members at more than six times the rate of other nonprofits.

The practice of doing business with board members is problematic for any number of reasons and should be avoided whenever possible. There is no absolute rule against such a setup, so long as there is proper disclosure and deals are at market rate, but the article points out that the potential for violating the public trust or creating the perception that there are private interests at play makes the practice far less than ideal.

“Just because something is legal doesn’t mean that it’s appropriate,” said James Orlikoff, a hospital governance consultant.

At 270 of the hospitals reported on, the deals were worth at least $1 million each, with some occurring between hospitals and medical companies with board members in common and others involving contracts for advertising and construction.

Avera McKennan Hospital & University Health Center in Sioux Falls, S.D., had one of the largest contracts with a company that had ties to a director in 2014. The $20.9 million construction deal with the subsidiary of Avera Health, which includes a 545-bed hospital, five rural hospitals and dozens of clinics, followed years of similarly large payouts to the same company.

Between 2010 and 2014, Avera McKennan paid $91.2 million to Journey Group, the construction company where hospital trustee David Fleck is board chairman. Mr. Fleck sold his stake in Journey Group in 2012, but declined to say if the company currently pays him. Journey Group and Avera Health’s general counsel didn’t respond to questions about Mr. Fleck’s compensation.

An Avera spokeswoman declined to say whether Journey Group competitively won its contracts or offered the lowest prices. She said the hospital typically awards contracts to the lowest bidder but may consider other factors. Avera’s conflict-of-interest policies are in line with state and federal laws, and Avera hasn’t received complaints regarding Journey Group’s contracts, she added.

Mr. Fleck said hospital trustees disclose conflicts at each board meeting, and he didn’t discuss or vote on Journey Group contracts. Mr. Fleck, like most board members at nonprofits, isn’t paid for serving.

In another case, the son of the CEO of California-based Dignity Health has a multimillion-dollar marketing contract with the 39-site hospital chain. The hospital’s board reviewed the contract, and though Dignity Health said it solicited competitive bids for the job, it would not say that eLead, the company, was the lowest bidder.

This issue is one where the vagueness of IRS guidance creates too much leeway for those who find the comfort of a shared boardroom to be a great place to make deals. A self-described case in point is that of Frank Kinder, co-owner of an advertising firm, who became a board member. He says that soon after he joined, the then-CEO of SoutheastHEALTH approached him with a small project, adding, “It was just kind of a natural development of me being present in the boardroom at that time.” Eventually, the hospital became his second-largest client and paid his company, Red Letter Communications, $8.3 million between 2010 and 2014, tax records show. Kinder removed himself from marketing meetings after the hospital staff told him his presence as a board member was “intimidating.” Kinder finally stopped doing business with the hospital in favor of staying on the board when the dual role became uncomfortable.

At Licking Memorial Health Systems in Ohio, CEO Rob Montagnese says they have banned engaging in business contracts with board members so that their community can have full confidence that the board was acting in the community’s best interest. The ban has posed no problem in recruiting the most qualified board members, he says, even though the community is small.—Ruth McCambridge