On Monday, the SEC announced a $10 million settlement with Tenet Healthcare (NYSE:THC) for the non-disclosure of its exploitation of a Medicare reimbursement loophole that enabled it to meet earnings targets from 1999 to 2002.
What did Tenet’s managers do wrong? They took advantage of a loophole in the Medicare reimbursement system for “outlier payments.” These payments compensate hospitals for taking care of the sickest Medicare patients; cynically, Tenet inflated its outlier payment revenue by raising the gross charges set by its hospitals. Tenet tripled its outlier revenue from 1999 to 2002; outlier growth during the period accounted for over 54% of its cumulative EPS growth.
The lawsuit, strangely, wasn’t over the legality of the gross charge gaming. It centered on the fact that this strategy was a material component of the company’s (unsustainable) earnings growth and investors were not informed of it. Moreover, the excess profits created by the strategy enabled the firm’s managers to squirrel away general reserves of $107 million by the end of fiscal year 2002 - which related to material misstatements in the Tenet financials between 2000 and 2004.
Physician, heal thyself.
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