LOCAL VOICES: A Conversation With James Sherlock

2021-05-26

James Sherlock is a retired U.S. Navy captain living in Hampton Roads, Virginia. He writes for the blog Bacon’s Rebellion, where he examines, among other subjects, Sentara Healthcare and its lock on the local health care market. We asked him how he views the company and its practices. Sherlock responded by email. As part of our reporting, we have spoken to a variety of Hampton Roads residents about Sentara and how its actions are affecting the community. We’re sharing them in an occasional series called “Local Voices.”

C&BP: As a longtime observer of Sentara who lives in Virginia Beach, do you believe the hospital giant is properly serving the people of Hampton Roads?

Sherlock: I am going to offer a bifurcated answer to that question.

While I find the physicians and nurses at Sentara to be very professional, I do not profess any expertise in medicine, and have no comment on the overall merits of the practice of medicine at Sentara.

As for the business of healthcare, Sentara has proven to be serially unethical.

I am not an attorney, but the extent of Sentara’s state-granted and state-protected monopoly in South Hampton Roads and the ways they employ it as a sword and a shield seem to be per se violations of state and federal antitrust law. But the partnership of Sentara with the Virginia Department of Health (VDH) in the COPN process constitutes state action and has made prosecution under federal antitrust law very difficult. And no attorney general or Commonwealth’s attorney has seen fit to bring a complaint under the Virginia Antitrust Act. Such suits would also be complicated by the state actions of COPN.

Regardless of the legalities, Sentara’s predatory business operations do not properly serve the people of Hampton Roads.

In close partnership with VDH, which is officially Sentara’s regulator, it denies us choice and the value of competition in healthcare delivery. Norfolk’s Bon Secours DePaul Hospital just closed after decades of assault by Sentara. The scandal of the secret plot of Sentara with others to offload its support to Eastern Virginia Medical School (EVMS) to the state and take over the medical practices of EVMS physicians is fresh in the minds of people here.

Sentara’s control of healthcare delivery also gives it control over the healthcare labor market, reducing choice and market power for doctors, nurses and technicians.

Again in partnership with the Virginia Department of Health and the COPN process, Sentara has:

gained control over the vast majority of the diagnostic imagery systems in Hampton Roads, placing them primarily in hospitals rather than freestanding imagery centers, doubling the costs of each procedure.
fought off competition from physician-owned ambulatory surgical centers – there is only one in South Hampton Roads – again denying choice and driving up costs.

So, the best interests of the people of Hampton Roads have been ravaged by Sentara’s business practices.

C&BP: Sentara is supposed to be a nonprofit, but its corporate structure doesn’t resemble other nonprofit health care companies. What are the differences and why does it matter?

Sherlock: Sentara is a tax-exempt non-profit because it claims status as a public charity and neither the federal IRS nor the state tax authorities have challenged it. It is hardly unique in that status, but it has for decades stretched the rules for such an exemption without consequence.

The organizational deficiencies at Sentara are the result of incredibly complex corporate structures and weak and ineffective governance. The corporate executives run the show.

By contrast Inova, the powerful hospital monopoly in Northern Virginia, has a strong parent board. It has created a corporate structure of three major components. Each of those three component corporations is overseen by an independent board. That system controls the executives rather than vice versa and has kept Inova out of the ethical muck that has characterized Sentara for decades.

Board oversight of major nonprofit corporations is not a game. From the IRS:

“The Internal Revenue Service encourages an active and engaged board believing that it is important to the success of a charity and to its compliance with applicable tax law requirements. Governing boards should be composed of persons who are informed and active in overseeing a charity’s operations and finances.”

The way the public can be assured of the careful consideration of nonprofit corporate decisions is by independent directors exercising oversight of the executives.

Sometimes fast-growing corporations like Sentara that focus on growth, especially through mergers and acquisitions, grow faster than the acquisitions can be smoothly integrated. From the evidence, that appears to be part of the issue with Sentara.

The Sentara Healthcare system reported total assets of $8.4 billion in its June 30, 2019, consolidated financials. Inova, mentioned earlier, is in the same asset class.

Based on the information in its IRS Form 990s, Sentara corporate governance is stretched far too thin. Both the enterprise structure and the boards of individual companies controlled by the parent company seem unsuited for their scale, the mission and their individual purposes.

Most apparently, Sentara is astonishingly complex.

The system itself in 2018 was composed of 63 companies including 20 non-for-profit, untaxed organizations, 21 taxable partnerships and 22 taxable C corporations. Each filed its own federal and state returns.

Sentara can and does make money because of its Hampton Roads monopoly and the way it flexes the muscles of the vertical and horizontal components of that monopoly.

But the charitable mission for years took a back seat to profits and expansion. It even reported to the IRS for a few years that its CEO was incentivized to improve revenue and margins — profit — and win quality awards. I read nothing in that same explanation of his compensation about him being incentivized to improve the health of the poor.

Yet the health of the poorest among the population of Hampton Roads, officially a core concern of the parent company, is among the worst in the state.

The biggest public sign of trouble is that Sentara keeps getting caught in disreputable actions that a competent board with accurate, complete and timely information would correct before they happen. However, the scale and structure of Sentara really begs the question of how likely it is that those information requirements can be regularly fulfilled.

Oversight of controlled entities

For people that don’t follow non-profits, independent board members are generally unpaid except for per diem. The Sentara Healthcare board has 17 unpaid independent members, largely local businesspeople and a leader of the local Urban League joined on the board by the CEO. The members have the right mix of skills but not experience at the scale of Sentara.

It is their span of control that is in question.

Parent company Sentara Healthcare is affiliated with its subsidiaries through the legal relationship of sole “member” or sole “stockholder.” From an article “Sole Member Nonprofits Complicate Directors’ Fiduciary Duties” by Jeremy T. Coffey:

“there are unique risks to structures where a tax-exempt entity’s board is effectively controlled by other entities or individuals. … A nonprofit sole member structure puts directors of the subsidiary in a challenging position because their fiduciary duties to the nonprofit can sometimes put them at odds with the interests and direction of the sole member.”

The meaning of the sole member structure is that the 18-member board of Sentara Healthcare must oversee the charitable mission, the operations, finances, employee compensation and ethics of the entire enterprise. In an optimally designed sole member nonprofit structure,

“Potential pitfalls can be mitigated by embedding certain structural safeguards to protect the controlled nonprofit’s independence.”

In other words, it can be set up so that a light touch by the parent board will suffice.

Yet the boards of most of Sentara’s non-profit companies, including the two largest after the parent, don’t seem to meet reasonable standards for effective oversight of the large non-profits they each control.

Only three Sentara non-profits, including the parent company, have boards with any significant number of independent directors:

The Sentara Healthcare board also directly oversees Princess Anne Hospital.
Potomac Hospital Corporation of Prince William has directors split evenly between Sentara executives and independent members.

The parent company in 2018 held nearly $5 billion assets and had $456 million gross receipts.

The nine largest of 21 nonprofit organizations (separate EINs, separate Form 990 filings, separate governance structures) controlled by the parent company are:

Sentara Hospitals, an operating company that managed seven of the eight Sentara hospitals in Hampton Roads and Elizabeth City, seven Ambulatory Surgical Centers (ASCs) and 121 other non-hospital healthcare facilities. It had $1.8 billion assets; $2.85 billion gross receipts. It is one of the most complex of the organizations in the Sentara orbit, yet has only three voting members of the governing body, all of whom are Sentara executives.
Optima Health Plan, a captive HMO, the largest Medicaid HMO in Virginia and another 501c3, had 2018 assets of $711 million and gross revenue $2.86 billion. The Optima board has ten voting members, only two of which are independent. It was Optima that got into the hot water at a cost to both the corporate public reputation and its relationship with the State Corporation Commission over the massive hikes to ACA individual market rates in 2018. It is hard to know if the board of Optima’s parent company knew of that strategy ahead of time.
Sentara Princess Anne Hospital. $330 million assets. $317 million gross receipts. Directly overseen by the Sentara Healthcare board.
Mpb Inc. $310 million assets; $44 million gross receipts. The Mob board has three voting members, all of whom are Sentara executives
Sentara RMH Medical Center. Assets $257 million. Gross receipts $477 million. – Board has three voting members, all of whom are Sentara executives.
Martha Jefferson Hospital. Assets $233 million. Gross receipts $342 million. Board has three voting members, all of whom are Sentara executives
Potomac Hospital Corporation of Prince William. Assets $200 million. Gross receipts $252 million. Board has eight voting members, four of whom are independent.
Sentara Medical Group (SMG). Assets $101 million. Gross receipts $276 million. Board has 20 voting members, all Sentara executives and other employees.
Sentara Enterprises. $44 million in assets and $131 million gross receipts. Board has five voting members, all employees.

That partial list of nonprofits of course doesn’t take into account the 43 for-profit companies controlled by Sentara.

So absent reliable and independent boards of component companies, the only strategy would seem to be for the parent company board to maintain tight control. The issue is that strategy is not viable with Sentara’s corporate structure.

Board members cannot reasonably be expected to closely control the structure they are charged to oversee.

Money transfers

It may be a sign of an attempt at tight control that the parent company reported nearly $2 billion changing hands in 56 financial transfers of eleven types with 24 subordinate organizations in 2018, netting $444 million for the parent company in 2018. More than $77 million of that net to the parent was from for-profit companies.

But it is hard for any outsider to know how much control the board of Sentara Healthcare and the boards of the subordinate companies had over the moving of that much money in so many different transactions.

Transfers that are other than for the actual value of goods or services rendered also can present management challenges to the subordinate companies as can being forced to send much of their earnings to the parent. For example, Optima transferred $60 million to its parent in a transaction classified as “Other transfer of cash or property from related organization(s)”.

Finally, the financial transfers make it hard to value a company if it is spun off or sold because a buyer cannot know either whether the financial transfers for goods and services were at fair market value or how that company would have developed with more independence and control over its money.

Bottom Line on Sentara

IRS guidelines say is important that each charity be thoughtful about the governance practices that are most appropriate for that charity in assuring sound operations.

I have every expectation that the independent members of the Sentara Healthcare board of directors are good people and skilled at their jobs on the board.

I find it unlikely, however, that a volunteer, unpaid board such as Sentara’s can meet four times a year — the IRS is told in the Form 990 that each independent board member works one hour per week — and provide the tight oversight required in an organization of the size and structural complexity of the 63 separate companies of Sentara.

Thus, the evidence from Sentara’s own IRS reporting appears to suggest that the oversight and management issues at Sentara may be systemic.

My assessment is that the controversies are going to keep coming and Sentara’s business practices will remain periodically in question until the Sentara Healthcare board both makes major structural changes to the organization of the whole enterprise and improves the governance of its major components.

I hope they will do it. Maybe they are already working on changes because of the pending merger discussed next. If so, I hope these inputs help.

C&BP: What first brought your attention to Virginia’s Certificate of Public Need process and how is it being abused by Sentara?

Sherlock: I first became interested in Sentara’s business practices when I experienced them firsthand. It was a relatively small thing in Sentara’s world, but had negative effects on many who Sentara executives would never meet.

In about 2008, Sentara bought an independent rehabilitation practice in Virginia Beach and nearly immediately closed it and fired the employees. I knew some of the patients at that business personally. They were thrown out with the employees and forced to find other providers. Some could not find another provider that worked for them with their limited mobility, assistance arrangements and budgets. Those mostly elderly people had not only formed friendships there, but therapy visits were for many of them the only times of the week they got out of their residences. It was not just their therapy; it was their entire social lives.

I started to investigate whether the state might regulate such a transaction. It turned out that it did not and still does not.

But I did find out about COPN. About the same time Sentara closed Bayside Hospital, where my wife’s doctor practiced.

That was a COPN transaction. Sentara closed Bayside, its only hospital serving a majority minority population in Virginia Beach, and “moved” the beds to the new Sentara Princess Anne to satisfy the COPN requirement that Princess Anne not increase the number of hospital beds in South Hampton Roads. As noted later with the closing of DePaul, VDH regulates the maximum number of hospital beds, but has no control of the minimum number.

I have been on the case of COPN and VDH ever since.

C&BP: Which agencies do you believe need to investigate Sentara’s activities?

Sherlock: VDH is officially the regulator, but it has been so thoroughly captured by the incumbent hospitals that it is just really at their beck and call.

The Attorney General or Commonwealth Attorneys could sue over many of the very public Sentara transgressions such as the secret cabal to transfer EVMS to state funding, but they have not done so. They could also sue in state or federal court for antitrust violations, but have not done that. The only exception to AG inaction of which I am aware is the threatened action by AG Bob McDonnell to go to federal court to stop expansion of Inova in 2007 I believe.

C&BP: What developments give you hope that the system will change?

Sherlock: The only hope for system change currently in play is the complaint filed in state court by Chesapeake Regional Medical Center against Sentara for tortious interference with its business. The underlying charges, if proven, are evidence of antitrust violations even though CRMC’s attorneys did not file under that law. If CRMC is successful, I would expect to see other similar suits against Sentara and perhaps other regional monopolies.

The other hope is the Antitrust Division of the Department of Justice. Sentara and other regional monopolies that own regionally powerful health insurers have been brought under additional scrutiny since the law that exempted insurers from antitrust law changed January 1st. Sentara is now as vulnerable for its use of Optima as a weapon as it is for its use of its healthcare provider monopoly. It is thus a tempting target for DOJ.