PRICING NURSING HOME GOODS & SERVICES: MISINFORMATION, FRAUD, & THE ROLE OF SHADOW BANKING
Slide # 1: Cover Slide
Introduction to Presentation
This set of slides presents an overview of capital flows and the justification for costs presented to state regulators by owners of and investors in nursing homes. They accompany a discussion of the extractive nature of the Medicaid and Medicare funded long-term care and skilled nursing component of American healthcare. Extractive in this context describes financial engineering in the pursuit of shareholder interests at the expense of stakeholders’ interests.
Extraction of funds without investment in the future growth of the business, development of a stable, loyal, competent workforce and improvement in the quality of services is a major facet of what is known as financialization, i.e., immediate maximization of financial returns at the expense of patients and employees and the future growth of enterprises in the industry. An analogy, example so to speak, in a manufacturing setting would be a corporation loading up on debt, buying back stock, and paying dividends without investing in a better product (innovation), increasing productivity, and enhancing employee pay and benefits.
The oft touted private equity form of business financial structure is a key piece of the nursing home extraction puzzle but is often overstated and has too often become the sole focus in discussion of unsavory business practices. Real estate investment trusts (REITs, limited liability companies (LLCs), sole proprietorships, Limited Liability Partnerships (LLPs), family and individual trusts, and other forms of legal, financial structures which vary from state to state in terms of taxes, liabilities, and opaqueness can be found in different combinations in the ownership of U.S. facilities.
The complicated and secretive financial techniques utilized by business entities obscure and obfuscate fraud. Indeed, separating fraud from legal but unethical conduct is a challenge – especially in an under sourced and weak regulatory process.
Slide # 2
Identifiable Patterns & Practices in a Chaotic System
If you’ve seen one nursing home, you’ve seen one nursing home. If you’ve seen one nursing home chain, you’ve seen one nursing home chain. If you’ve seen one state Medicaid program, you’ve seen one state Medicaid program.
The average number of beds in New York licensed nursing homes is 120 whereas nursing homes average 60 beds in Kansas. Ownership legal and financial structures are different from facility to facility. The role of place is a major factor in workforce and quality of care. Facilities are nested within chains. Chains are nested within local areas. Local areas are nested in states. And states are nested in regions.
Ownership patterns exhibit an unlimited number of permutations and combinations of sole proprietors, REITs, LLCs, private equity, family and individual trusts, and wealthy individuals and their family offices. Each facility has a unique combination of ancillary businesses and related party payments to home offices, parent corporation real estate, insurance, and other ancillary businesses formed as LLCs.
Expensing related parties on cost reports submitted to regulators varies from facility to facility cost report. Nevertheless, general patterns and practices such as low operating income (net income or operating margin) are typically a little below to a little above zero – either a very low or negative net operating income. Also, cost reports typically note earnings before interest, taxes, depreciation, and amortization (EBITDA) as the same or nearly the same as net operating income. This nonsensical but unquestioned by state auditors.
With rare exception, nursing home corporations are closely held. The flow of funds from government sources through a labyrinth of LLCs are hidden from view. Therefore, the public has little opportunity to see how cash flows from Medicaid, Medicare, and other sources into owners’ accounts.
These patterns and practices are pervasive and systemic. They reveal order in a seemingly chaotic system. Secrecy and lack of public accessibility to pricing of goods and services by related parties are conducive to the industry’s claims of hardship and underpayment through Medicaid. Therefore, a well-organized and well-funded propaganda campaign is used by industry lobbyists to justify low wages and poor quality of care.
Slide # 3
2000 & the Dawn of a New Nursing Home Financial Era
At the turn of the century, the ground shifted under the feet of nursing home regulators, advocates, and scholars. By 2000, macroeconomic trends and government policy opened the door to the flow of unregulated capital from pension, college endowment, insurance, sovereign wealth, and family offices funds and other pools of capital. Managers of the vast accumulation of capital in these funds were looking for higher returns and saw opportunities in private equity and real estate. Nursing homes were an inviting target for financiers seeking higher returns.
Although private equity had been somewhat moribund between the end of a takeover craze of the 1980s (until circa early 1990s) and the availability of a massive amount of capital in the early 2000s. Private equity resurged and undertook leveraged buyouts of the few large publicly traded nursing home chains that had developed in the first 50 years of the contemporary nursing home industry. Indeed, private equity played a role along with other legal and financial structures in transforming the industry in the first two decades of the 21st Century (more about those other types of businesses in a bit).
The Carlyle Group undertook a $6.1 billion leveraged buyout of HCR ManorCare, Filmore Capital bought out Beverly Enterprises, and Formation Capital targeted Genesis Healthcare. Apollo and other PE firms bought out a large number of closely held smaller chains. All of the corporations targeted in these major buyouts slid into bankruptcy due to typical patterns and practices, such as sale of assets, borrowing and loading the target company with debt,
Along with the entry of PE into the nursing home space, the limited liability company rapidly spread as a vehicle for secretive cash flows, avoidance of taxes, and escape from liability. Every type of company whether PE firm, C Corporation, partnership, or other legal financial configuration utilized LLCs as shell companies for the purpose of secrecy. This innovation increased challenges for regulatory agencies and public oversight.
PE firms have received deserved attention from legislators, journalists, and advocates. However, other equally important financial legal developments have had, still have, and will continue to have a significant amount of influence over the character of the nursing home industry. Most, if not all, of the innovations in nursing home finance and ownership arrangements involve the tax codes. Real estate investment trusts (REITs), limited liability companies (LLCs), family and individual trusts, have all been inducive to tax arbitrage, secrecy, and avoidance of liability. Financial decisions about networking various financial entities such as REITs, LLCs, PE, and other forms of ownership such as family dynasty trusts, irrevocable individual trusts, and family offices are driven by tax avoidance, opaqueness of capital flows, and the limitation of liability for neglect and abuse.
Commercial real estate is a primary revenue stream in the nursing home business. Real Estate Investment Trusts (REITs) entered the asset intensive skilled nursing/long-term care sector of healthcare and served as a market for large sales of property by PE firms. The Carlyle Group sold HCR ManorCare property for over $6 billion to Health Care REIT (now Welltower).
Slide # 4
Fundamentals of Corporate Finance in Financialized Corporations
“Financialization” of U.S. corporations on a wide scale has occurred in the past several decades and is continuing unabated. The term “financialized” connotes corporations that have elevated financial engineering for the benefit of shareholders and executives at the expense of customers/patients, employees, communities, and the long-term interests of the business. Cash flow – optimal extraction of cash as opposed to R&D and reinvestment – is the most important metric of financial success in a financialized business.
Companies that are undergoing financialization often take on debt for the purpose of increasing cash flow, paying dividends, stock buybacks and excessive executive compensation. Revenue that could be invested in employees, development of a better service or product, or retained on the balance sheet is often dedicated to servicing loans. Bankruptcy often results from this business model, but executives and shareholders have already been rewarded to an extent beyond their initial investment. These practices are most common in the private equity business, which undertakes leveraged buyouts and disassembles companies by selling them off in piecies.
In the nursing home business, financialization is denoted by separation of the licensed facility from real estate, buying services from subsidiaries owned by the parent/holding company, and engaging in transfer pricing, i.e., paying higher than market rates for products and services from related parties.
The long-term care, skilled nursing business has an interest in high labor turnover caused by suppressing employee pay and purchasing contract labor. Therefore, labor costs are kept lower than would be the case with a stable well-trained workforce that could demand better pay and working conditions. Furthermore, subsidiaries selling labor to their parent/holding company nursing home LLC increases revenue and return on investment while lowering payroll costs.
The nursing home business is asset intensive, which indicates that it has a major stake in real estate in the form of buildings and land. Therefore, separating the real estate from the licensed nursing home operation increases revenue through triple net leasing (leasee pays insurance, maintenance, and taxes). The practice also opens the door to transfer pricing through higher than market lease prices.
In the financialized nursing home system, patients are commoditized bodies for which corporations are remunerated on a per diem basis. However, value can be added to those bodies through higher than market costs remitted back to the parent for related parties’ services such as leasing, physical therapy, nursing, leases, medical transport, and all they other conceivable means of extraction. This value added diverted to investors results in less funding from care and therefore to lower quality of life for inmates of long-term care and skilled nursing institutions.
Slide # 5
The LLC is a Unifying Legal/Financial Structure
As will be reiterated throughout this presentation, private equity is a deleterious and serious problem for the American people and the American economy, but it is not THE problem. It is one despicable component in a network of practices and business models that has led U.S. businesses into a dark age of capitalism. Financialization is THE problem. However, an attitude of disrespect – distain shall we say – toward stakeholders such as patients, customers, employees, people in communities, and so forth is a necessary condition for an extractive business model at the expense of everyone but executives and shareholders.
There is no manner in which this attitude can be better expressed than through the limited liability company (LLC). These are not corporations. Rather, they are businesses set up under the organizing rules of individual states. States have different requirements and rules regarding taxes, secrecy, and liability. Some states allow for more secrecy, lower taxes, and less liability than other states. The state of Nevada has become a haven for hiding money, avoiding taxes, and escaping liability. The laws of the state have attracted large numbers of companies to the state to set up companies as LLCs.
LLCs are easy to organize. Some fees and simple forms and you are in business. The first LLC legislation was passed in Montana in the 1970s but it wasn’t until the late 1990s when the IRS greenlighted them as pass through entities for tax purposes that they caught on and became widespread. Consequently, they have become popular for criminal and unethical business activities. One might say that LLCs are a tool for hiding ownership and the flow of capital.
Slide # 6
LLC “Shell Company:” What Is It?
Shell companies are business entities – almost always LLCs – without employees and a physical place of business. They are set up in accordance with the laws of the state in which they are formed. They are not corporations. However, they are referred to as “foreign corporations” in states other than the one in which they are set up and in which they have an address (which could be a P.O. box). Statutes regarding the formation of an LLC vary from state to state. For instance, Kansas statutes requires public listing of all beneficial owners of LLCs formed in that state – beneficial owner is defined as any individual or entity owning 5% or more of the entity.
Foreign corporations are not required under Kansas law to list beneficial owners. The secretaries of state in all states maintain a “business entity” database that includes documents filed by LLCs in accordance with the laws of the state. Typically, those documents do not reveal beneficial ownership. In some cases, forensic research through tracing names and addresses on documents can lead to determination of entities and individuals with an ownership in a facility, piece of property, labor contracting firm, and other related parties.
Hiding money and ownership is a primary purpose of shell companies. Indeed “The U.S. has become a leading ‘safe haven’ jurisdiction for those seeking anonymity of ownership” (The Harvard Law School Forum on Corporate Governance | The leading online blog in the fields of corporate governance and financial regulation).
Slide # 7
Nursing Home Financialization: Examples
The impact of financialization of the nursing home industry on the quality of care, labor conditions, and communities – the stakeholders – has been transformational. Financial performance and shareholder value are primary values driving management philosophy. Known as “agency theory of management,” whereby owners, investors, and managers operate in accordance with their purported fiduciary responsibility for protection and enhancement of shareholder value. Patient health and safety, hours, wages, and working conditions, community interests, and families’ satisfaction are secondary to return on investment and extraction of free cash flow.
Cash flow is enhanced through adding value to reimbursement revenue. Reimbursement is tied entirely to human bodies in beds. Expenses for serving patients (bodies) are deducted from revenue. Expenses primarily include lease payments, direct care labor (nursing and therapy), maintenance, insurance, taxes, utilities and so forth.
Value is added to revenue through financial maneuvers such as: (1) separation of property from facility ownership into a subsidiary of the parent/holding company, (2) formation of separate subsidiaries for the supply of pharmaceuticals, food, insurance, medical transport, labor, and other goods and services. The subsidiaries are typically LLCs. Hence, the pricing of goods and services flowing from related parties are not transparent. The problem of transfer pricing (as opposed to market pricing) increases costs and payouts to owners that could be otherwise invested in care and a stable, adequately paid workforce.
Financialization has also been partially responsible for an effective and misleading but industry narrative that their pervasive abuse and neglect of patients is unavoidable given their low net income. Because the lay public is understandably not schooled in corporate finance, net income is conflated in the minds of most people with profitability. As will be explained as this course proceeds, net income is absolutely not an indicator of profitability and ROI.
Large amounts of costs expensed on the income statement are noncash expenses such as depreciation and interest. Furthermore, facility cost reports and the income statements included in them are facility specific. A large portion of their revenue flows out as expenses to and through related parties or directly to parent/holding companies. As much as 14 to 20 percent of revenue is paid to subsidiaries and parent/holding companies but expensed on facility income statements.
Given the financialized nature of the industry, draining as much cash from care – which includes labor – is the primary ethic of management. Suppression of wages, poor working conditions, and the neglect and abuse of patients are morally and ethically secondary to the needs of shareholders/owners/investors.
Slide # 8
Forensics: Finding Fraud in a Financialized Nursing Home Corporation
Although cost reports are required by statutes which specify information that must be submitted, erroneous and misleading facility submittals are common. The statutes require a desk audit of the reports. Nevertheless, auditing is, for the most part, sloppy and shallow. Even reports that raise major concerns regarding third-party charges and other information or lack of information are not raising concerns among state agencies.
Investigators will find a fertile ground for ferreting out by looking at statutorily required cost reports. Each facility has an obligation to report legally required financial information. Adherence to the legal requirements is pervasively ignored with few to no consequences. Desk auditing is a responsibility of state agencies. However, the resources and competence for carrying out this function are lacking. Therefore, cheating and knowingly filing false information is a “low risk-high return” form of criminality.
As this set of slides advances, the financial and statutory details related to cost reports will be explained with examples of forms such as the income, related parties, labor, and other important CR documents. The important points are: (1) what can we learn from the forms as submitted? (2) what can we learn from what they don’t say, (3) what can we learn from what they do say? And (4) what other avenues can we take to achieve a picture of honesty versus cheating? For instance, if the real estate owner doesn’t appear as a related party, how do we nail down property ownership?
Slide # 9
Drowning Us in Information & Starving Us for Knowledge
It is important to note that regulators and investigators are confronted with an overwhelming amount of information that in and of itself does not answers our questions about whether the industry is pervasively cheating and lying about the amount of profit they (free cash flow) they are extracting. The industry lobby has devised and sold a narrative of low returns based on the facility CR income statement. This is nonsensical. The income statement expenses depreciation, interest, taxes, and a host of payments to home offices and related parties for rent, labor, insurance, dietary supplies, and so forth.
The circumstantial evidence suggests that the industry is a high return, stable, business. However, most of the chains in the business are closely held and not required to disclose their consolidated financial statements, e.g. parent/holding company income statement, balance sheet, and cash flow statement. Furthermore, a considerable amount of ownership and capital flow information is often secreted through a tunnel of shell companies.
Slide # 10
Genesis Ownership: Absurd & Misleading
Genesis Health Corporation is a former publicly listed (on the NASDAQ) corporation and one of the biggest operators of nursing homes in the United States. The company was taken over by Formation Capital in a leveraged buyout in 2015. The property was sold off to a real estate investment trust (REIT) and leased back to Genesis which had become a management firm in the business of operating but not owning facilities. Arnold Whitman and Steven Fishman, principles in the Formation Capital buyout, are owners of the business.
The 15 beneficial owners listed on slide 10 are primarily owned by Whitman and Fishman. This network of LLCs and other business entities are so obscure and riddled with shell companies, that it would take a judge’s order for them to produce documents detailing how the cash flows through the organization. It is practically impossible to know how much Whitman and Fishman are pocketing at the expense of patients.
This ownership list did not appear on the cost reports. It was taken from the CMS Nursing Home Compare website, which is an important source of information for nursing home investigations.
Slide # 11
Income Statement: A Misleading Metric
The income statement indicates that the Genesis facility located in Bowling Green, Kentucky noted net inpatient revenue of $4,774,709 and operating expenses of $6,068,281 for a net operating income (loss) of -$1,293,572 They are noting a small nonpatient revenue of $7,567 for an overall net income (loss) of -$1,286,005.
These numbers have nothing to do with profitability or return on investment. Expenses deducted from net patient revenue include depreciation, interest, home office allocations, and other related parties expenditures. Furthermore, nonpatient revenue is typically COVID relief. It would be highly unusual if a facility in the Genesis chain of 300+ facilities did not take full advantage of PPP loans, the employee retention tax credit, and a host of other incentives and supports during 2020, 2021, 2022, and 2023. PPP loans are customarily forgiven and should appear as income.
Slide # 12
Colonial Center Related Parties/Home Office Allocations
The HBR Colonial facility related parties form Part I appears on Slide 12. Note in column 5 that the facility is claiming related parties expenditures – payments to parent corporation subsidiaries – in the amount of $1,799,986. When depreciation of $58,888 alone is added back, corporate income can be increased to $1,858,874. Income becomes +$28,888 without other tax write downs. So, the facility actually has a net positive income. But we do not know if the pricing of goods and services from related parties was above market prices and boosted parent companies cash flow above a reasonable level given the quality of service.
Slide # 13
Home Office/Related Parties Expenditures Adjusted
Slide 13 lists the facility expenditures for related party charges. These are charges actually paid – listed in column 5 on the form in Slide # 12. Column 4 is the amount authorized by state reimbursement policy (the state of Kentucky).
Slide # 14
Red Flag: Contract Labor Bonanza
Forensic accounting, auditing, and investigation requires knowledge of industry-wide patterns and practices. For instance, statistical analysis suggests that approximately 5% of facility labor is, on average, contract labor. Typically, facilities contract for labor to fill in for a few hard to fill nursing positions. That is not the case with the Colonial Center – a facility owned in most part by Formation Capital, a private equity firm. Sixty-three percent of the facility’s labor costs are paid to a subsidiary also owned primarily by Formation Capital. As part of a statistical analysis of the industry, this facility and probably most other Formation Capital owned facilities would jump off the page. Furthermore, referral back to slide 13, which displays the home office allocations and payments to related parties, indicates that the owners of the facility also own the company providing contract labor. This arrangement benefits the parent/holding company entity. In a labor market in which pay is low and working conditions are substandard, the industry mantra of labor shortages works to the advantage of a company using the situation for enrichment.
The company can claim that it is necessary to hire contract labor due to a labor shortage. However, that claim is belied by the overall industry pattern of contract labor as a minor part of overall labor throughout the industry. Objective data analytics suggest that a small part of the overall nursing workforce is hired from labor contracting firms.
Genesis Healthcare Corporation is a “related party management entity” – an LLC owned by Formation Capital. Prior to takeover by Formation, Genesis was a publicly listed C corporation listed on the NASDAQ. Formation understood a leveraged buyout of Genesis in 2012. At that time Genesis was considered the largest U.S. nursing home chain with between 300 and 400 facilities at any one time. As Formation disassembled Genesis, the former C Corp. became a facility management subsidiary set up as an LLC.
This process of financialization became exceedingly elaborate with important functions and components of the company split off as wholly owned subsidiaries designed to charge facilities for services and goods. Auditors in states where Formation/Genesis operates, do not have the resources to measure “free cash flow” or what renowned investor Warren Buffet calls “owners’ earnings.” Labor, real estate, and management services are earning considerable cash flow from facilities into Formation. This is a hidden capital flow. Hence, the public has no access to knowledge about the money paid to Genesis in comparison to th
Slide # 15
Colonial Related Parties Form Part II
CMS requires submittal of a “Statement of Costs of Services from Related Organizations and Home Office Costs.” Part I of the form requires the cost center (Column 2), which typically includes home office allocations, and specific payments to related parties such as real estate, labor, insurance, dietary, pharmaceutical, and other services from parent/holding company subsidiaries.
Part II of the form is designed to clarify ownership of the related entities providing services to the facility. It is notable that Column 2 is left blank. This is a violation of law as issued by CMS. By leaving the column blank, the individuals and or businesses with a financial interest in the related party business remains unknown.
Slide # 16
Exposing the Cabal: New York Attorney General Petition Against Comprehensive at Orleans LLC d/b/a Health & Rehab Center
Attorneys General can obtain records not generally accessible to the public – including scholars. Therefore, the patterns and practices that are contrary to the public interest are likely to only become public when an AG takes action against a facility or chain of facilities. Indeed, the action by the AG of New York regarding a cabal seen in nursing homes in various states, is an example of how capital and ill-gotten gains flow from government sources through a thicket of LLCs into a variety of entities with an ownership stake in a targeted facility.
The legal and financial arrangement of the facility targeted by the NY AG is not a pure private equity arrangement, rather, it is the typical investor or group of investors who raise funds from associates by offering them a stake in the business/facility. The organizing principles are based on the laws of the state in which the LLC is formed.
The schematic below is an excellent illustration of the type of legal/financial arrangement pervasive in the nursing home industry. This illustration was included in Supreme Court of the State of New York County of Orleans, People of the State of New York (Petitioner) Against Comprehensive of Orleans
Figure 1
The limited liability company is one of the most significant financial innovations in the economic history of the United States. Because these entities have been in existence since the 1970s but generally accepted only a quarter of century, the public is unaware of how recently they have been part of the legal/financial landscape.
As Figure 1 indicates, an individual nursing home business can be set up as a network of interrelated LLCs.
What is Private Equity
“Private Equity” is one of the most misunderstood and misused terms in discussion of corporations and legal/financial structures. Although a PE firm, to be called private equity, must meet specific necessary and sufficient conditions. Many groups of investors organized into networks of LLCs, partnerships, and limited partnerships are often called PE but they are not PE.
The necessary conditions and sufficient conditions for a business to be considered a PE firm are:
• General partners who own and/or manage the PE company.
• Limited partners who invest in a fund set up by the general partners.
• The general partners manage the fund, which buys portfolio companies through leveraged buyouts, for a 2% management fee and 20% of net earnings – this is called the “2 and 20” or “carried interest” on which the managers/general partners pay long-term capital gains taxes rather than income taxes.
• In addition to selling assets, general partners have sole management responsibility and authority.
• A fund is typically set up for 5 to 10 years.
• It is not uncommon for PE firms to saddle target companies with debt through a lending institution or by issuing corporate bonds – often junk bonds.
• Managers often load the target company with debt for the purpose of increasing payouts to limited partners and an increase in management fees (dividend recapitalization).
• Investors and managers often bail out of a portfolio company with high returns or management fees in spite of bankruptcy.
The carried interest issue. What is carried interest? It is considered the return a fund manager receives based on the 2 and 20 rule. Holding period of 3 years to qualify for long-capital gains. Deferred taxes – unrealized gains
PE firms are operating in the nursing home industry, but this type of business is often considered “the problem” instead of one of the many privatized financial/legal organizations presenting problems in the contemporary NH system. They fit nicely into the network of PE firms, REITs, LLCs, LLPs, and other legal/financial structures. For instance, the Carlyle Group’s leveraged buyout of HCR ManorCare for $6.1 billion included all of the real estate, i.e. the land and buildings. The real property was subsequently sold by the Carlyle Group to a REIT for approximately the same amount as the total buyout of over $6 billion. Therefore, the PE firm recouped its entire investment in the takeover by selling off assets.
PE firms sell valuable assets which could be real estate alone, could be a part of the entire business alone (like a factory or subsidiary), or both.
Cost Reports & Other Financial Information:
The industry claims that the nursing home business is an overregulated and low return business. However, given that it is a business with responsibility for extremely fragile patients needing around the clock care, it is far too lightly regulated.
SLIDE NARATIVE FOR NURSING HOME FINANCE
SLIDE NARRATIVES
PRICING NURSING HOME GOODS & SERVICES: MISINFORMATION, FRAUD, & THE ROLE OF SHADOW BANKING
Slide # 1: Cover Slide
Introduction to Presentation
This set of slides presents an overview of capital flows and the justification for costs presented to state regulators by owners of and investors in nursing homes. They accompany a discussion of the extractive nature of the Medicaid and Medicare funded long-term care and skilled nursing component of American healthcare. Extractive in this context describes financial engineering in the pursuit of shareholder interests at the expense of stakeholders’ interests.
Extraction of funds without investment in the future growth of the business, development of a stable, loyal, competent workforce and improvement in the quality of services is a major facet of what is known as financialization, i.e., immediate maximization of financial returns at the expense of patients and employees and the future growth of enterprises in the industry. An analogy, example so to speak, in a manufacturing setting would be a corporation loading up on debt, buying back stock, and paying dividends without investing in a better product (innovation), increasing productivity, and enhancing employee pay and benefits.
The oft touted private equity form of business financial structure is a key piece of the nursing home extraction puzzle but is often overstated and has too often become the sole focus in discussion of unsavory business practices. Real estate investment trusts (REITs, limited liability companies (LLCs), sole proprietorships, Limited Liability Partnerships (LLPs), family and individual trusts, and other forms of legal, financial structures which vary from state to state in terms of taxes, liabilities, and opaqueness can be found in different combinations in the ownership of U.S. facilities.
The complicated and secretive financial techniques utilized by business entities obscure and obfuscate fraud. Indeed, separating fraud from legal but unethical conduct is a challenge – especially in an under sourced and weak regulatory process.
Slide # 2
Identifiable Patterns & Practices in a Chaotic System
If you’ve seen one nursing home, you’ve seen one nursing home. If you’ve seen one nursing home chain, you’ve seen one nursing home chain. If you’ve seen one state Medicaid program, you’ve seen one state Medicaid program.
The average number of beds in New York licensed nursing homes is 120 whereas nursing homes average 60 beds in Kansas. Ownership legal and financial structures are different from facility to facility. The role of place is a major factor in workforce and quality of care. Facilities are nested within chains. Chains are nested within local areas. Local areas are nested in states. And states are nested in regions.
Ownership patterns exhibit an unlimited number of permutations and combinations of sole proprietors, REITs, LLCs, private equity, family and individual trusts, and wealthy individuals and their family offices. Each facility has a unique combination of ancillary businesses and related party payments to home offices, parent corporation real estate, insurance, and other ancillary businesses formed as LLCs.
Expensing related parties on cost reports submitted to regulators varies from facility to facility cost report. Nevertheless, general patterns and practices such as low operating income (net income or operating margin) are typically a little below to a little above zero – either a very low or negative net operating income. Also, cost reports typically note earnings before interest, taxes, depreciation, and amortization (EBITDA) as the same or nearly the same as net operating income. This nonsensical but unquestioned by state auditors.
With rare exception, nursing home corporations are closely held. The flow of funds from government sources through a labyrinth of LLCs are hidden from view. Therefore, the public has little opportunity to see how cash flows from Medicaid, Medicare, and other sources into owners’ accounts.
These patterns and practices are pervasive and systemic. They reveal order in a seemingly chaotic system. Secrecy and lack of public accessibility to pricing of goods and services by related parties are conducive to the industry’s claims of hardship and underpayment through Medicaid. Therefore, a well-organized and well-funded propaganda campaign is used by industry lobbyists to justify low wages and poor quality of care.
Slide # 3
2000 & the Dawn of a New Nursing Home Financial Era
At the turn of the century, the ground shifted under the feet of nursing home regulators, advocates, and scholars. By 2000, macroeconomic trends and government policy opened the door to the flow of unregulated capital from pension, college endowment, insurance, sovereign wealth, and family offices funds and other pools of capital. Managers of the vast accumulation of capital in these funds were looking for higher returns and saw opportunities in private equity and real estate. Nursing homes were an inviting target for financiers seeking higher returns.
Although private equity had been somewhat moribund between the end of a takeover craze of the 1980s (until circa early 1990s) and the availability of a massive amount of capital in the early 2000s. Private equity resurged and undertook leveraged buyouts of the few large publicly traded nursing home chains that had developed in the first 50 years of the contemporary nursing home industry. Indeed, private equity played a role along with other legal and financial structures in transforming the industry in the first two decades of the 21st Century (more about those other types of businesses in a bit).
The Carlyle Group undertook a $6.1 billion leveraged buyout of HCR ManorCare, Filmore Capital bought out Beverly Enterprises, and Formation Capital targeted Genesis Healthcare. Apollo and other PE firms bought out a large number of closely held smaller chains. All of the corporations targeted in these major buyouts slid into bankruptcy due to typical patterns and practices, such as sale of assets, borrowing and loading the target company with debt,
Along with the entry of PE into the nursing home space, the limited liability company rapidly spread as a vehicle for secretive cash flows, avoidance of taxes, and escape from liability. Every type of company whether PE firm, C Corporation, partnership, or other legal financial configuration utilized LLCs as shell companies for the purpose of secrecy. This innovation increased challenges for regulatory agencies and public oversight.
PE firms have received deserved attention from legislators, journalists, and advocates. However, other equally important financial legal developments have had, still have, and will continue to have a significant amount of influence over the character of the nursing home industry. Most, if not all, of the innovations in nursing home finance and ownership arrangements involve the tax codes. Real estate investment trusts (REITs), limited liability companies (LLCs), family and individual trusts, have all been inducive to tax arbitrage, secrecy, and avoidance of liability. Financial decisions about networking various financial entities such as REITs, LLCs, PE, and other forms of ownership such as family dynasty trusts, irrevocable individual trusts, and family offices are driven by tax avoidance, opaqueness of capital flows, and the limitation of liability for neglect and abuse.
Commercial real estate is a primary revenue stream in the nursing home business. Real Estate Investment Trusts (REITs) entered the asset intensive skilled nursing/long-term care sector of healthcare and served as a market for large sales of property by PE firms. The Carlyle Group sold HCR ManorCare property for over $6 billion to Health Care REIT (now Welltower).
Slide # 4
Fundamentals of Corporate Finance in Financialized Corporations
“Financialization” of U.S. corporations on a wide scale has occurred in the past several decades and is continuing unabated. The term “financialized” connotes corporations that have elevated financial engineering for the benefit of shareholders and executives at the expense of customers/patients, employees, communities, and the long-term interests of the business. Cash flow – optimal extraction of cash as opposed to R&D and reinvestment – is the most important metric of financial success in a financialized business.
Companies that are undergoing financialization often take on debt for the purpose of increasing cash flow, paying dividends, stock buybacks and excessive executive compensation. Revenue that could be invested in employees, development of a better service or product, or retained on the balance sheet is often dedicated to servicing loans. Bankruptcy often results from this business model, but executives and shareholders have already been rewarded to an extent beyond their initial investment. These practices are most common in the private equity business, which undertakes leveraged buyouts and disassembles companies by selling them off in piecies.
In the nursing home business, financialization is denoted by separation of the licensed facility from real estate, buying services from subsidiaries owned by the parent/holding company, and engaging in transfer pricing, i.e., paying higher than market rates for products and services from related parties.
The long-term care, skilled nursing business has an interest in high labor turnover caused by suppressing employee pay and purchasing contract labor. Therefore, labor costs are kept lower than would be the case with a stable well-trained workforce that could demand better pay and working conditions. Furthermore, subsidiaries selling labor to their parent/holding company nursing home LLC increases revenue and return on investment while lowering payroll costs.
The nursing home business is asset intensive, which indicates that it has a major stake in real estate in the form of buildings and land. Therefore, separating the real estate from the licensed nursing home operation increases revenue through triple net leasing (leasee pays insurance, maintenance, and taxes). The practice also opens the door to transfer pricing through higher than market lease prices.
In the financialized nursing home system, patients are commoditized bodies for which corporations are remunerated on a per diem basis. However, value can be added to those bodies through higher than market costs remitted back to the parent for related parties’ services such as leasing, physical therapy, nursing, leases, medical transport, and all they other conceivable means of extraction. This value added diverted to investors results in less funding from care and therefore to lower quality of life for inmates of long-term care and skilled nursing institutions.
Slide # 5
The LLC is a Unifying Legal/Financial Structure
As will be reiterated throughout this presentation, private equity is a deleterious and serious problem for the American people and the American economy, but it is not THE problem. It is one despicable component in a network of practices and business models that has led U.S. businesses into a dark age of capitalism. Financialization is THE problem. However, an attitude of disrespect – distain shall we say – toward stakeholders such as patients, customers, employees, people in communities, and so forth is a necessary condition for an extractive business model at the expense of everyone but executives and shareholders.
There is no manner in which this attitude can be better expressed than through the limited liability company (LLC). These are not corporations. Rather, they are businesses set up under the organizing rules of individual states. States have different requirements and rules regarding taxes, secrecy, and liability. Some states allow for more secrecy, lower taxes, and less liability than other states. The state of Nevada has become a haven for hiding money, avoiding taxes, and escaping liability. The laws of the state have attracted large numbers of companies to the state to set up companies as LLCs.
LLCs are easy to organize. Some fees and simple forms and you are in business. The first LLC legislation was passed in Montana in the 1970s but it wasn’t until the late 1990s when the IRS greenlighted them as pass through entities for tax purposes that they caught on and became widespread. Consequently, they have become popular for criminal and unethical business activities. One might say that LLCs are a tool for hiding ownership and the flow of capital.
Slide # 6
LLC “Shell Company:” What Is It?
Shell companies are business entities – almost always LLCs – without employees and a physical place of business. They are set up in accordance with the laws of the state in which they are formed. They are not corporations. However, they are referred to as “foreign corporations” in states other than the one in which they are set up and in which they have an address (which could be a P.O. box). Statutes regarding the formation of an LLC vary from state to state. For instance, Kansas statutes requires public listing of all beneficial owners of LLCs formed in that state – beneficial owner is defined as any individual or entity owning 5% or more of the entity.
Foreign corporations are not required under Kansas law to list beneficial owners. The secretaries of state in all states maintain a “business entity” database that includes documents filed by LLCs in accordance with the laws of the state. Typically, those documents do not reveal beneficial ownership. In some cases, forensic research through tracing names and addresses on documents can lead to determination of entities and individuals with an ownership in a facility, piece of property, labor contracting firm, and other related parties.
Hiding money and ownership is a primary purpose of shell companies. Indeed “The U.S. has become a leading ‘safe haven’ jurisdiction for those seeking anonymity of ownership” (The Harvard Law School Forum on Corporate Governance | The leading online blog in the fields of corporate governance and financial regulation).
Slide # 7
Nursing Home Financialization: Examples
The impact of financialization of the nursing home industry on the quality of care, labor conditions, and communities – the stakeholders – has been transformational. Financial performance and shareholder value are primary values driving management philosophy. Known as “agency theory of management,” whereby owners, investors, and managers operate in accordance with their purported fiduciary responsibility for protection and enhancement of shareholder value. Patient health and safety, hours, wages, and working conditions, community interests, and families’ satisfaction are secondary to return on investment and extraction of free cash flow.
Cash flow is enhanced through adding value to reimbursement revenue. Reimbursement is tied entirely to human bodies in beds. Expenses for serving patients (bodies) are deducted from revenue. Expenses primarily include lease payments, direct care labor (nursing and therapy), maintenance, insurance, taxes, utilities and so forth.
Value is added to revenue through financial maneuvers such as: (1) separation of property from facility ownership into a subsidiary of the parent/holding company, (2) formation of separate subsidiaries for the supply of pharmaceuticals, food, insurance, medical transport, labor, and other goods and services. The subsidiaries are typically LLCs. Hence, the pricing of goods and services flowing from related parties are not transparent. The problem of transfer pricing (as opposed to market pricing) increases costs and payouts to owners that could be otherwise invested in care and a stable, adequately paid workforce.
Financialization has also been partially responsible for an effective and misleading but industry narrative that their pervasive abuse and neglect of patients is unavoidable given their low net income. Because the lay public is understandably not schooled in corporate finance, net income is conflated in the minds of most people with profitability. As will be explained as this course proceeds, net income is absolutely not an indicator of profitability and ROI.
Large amounts of costs expensed on the income statement are noncash expenses such as depreciation and interest. Furthermore, facility cost reports and the income statements included in them are facility specific. A large portion of their revenue flows out as expenses to and through related parties or directly to parent/holding companies. As much as 14 to 20 percent of revenue is paid to subsidiaries and parent/holding companies but expensed on facility income statements.
Given the financialized nature of the industry, draining as much cash from care – which includes labor – is the primary ethic of management. Suppression of wages, poor working conditions, and the neglect and abuse of patients are morally and ethically secondary to the needs of shareholders/owners/investors.
Slide # 8
Forensics: Finding Fraud in a Financialized Nursing Home Corporation
Although cost reports are required by statutes which specify information that must be submitted, erroneous and misleading facility submittals are common. The statutes require a desk audit of the reports. Nevertheless, auditing is, for the most part, sloppy and shallow. Even reports that raise major concerns regarding third-party charges and other information or lack of information are not raising concerns among state agencies.
Investigators will find a fertile ground for ferreting out by looking at statutorily required cost reports. Each facility has an obligation to report legally required financial information. Adherence to the legal requirements is pervasively ignored with few to no consequences. Desk auditing is a responsibility of state agencies. However, the resources and competence for carrying out this function are lacking. Therefore, cheating and knowingly filing false information is a “low risk-high return” form of criminality.
As this set of slides advances, the financial and statutory details related to cost reports will be explained with examples of forms such as the income, related parties, labor, and other important CR documents. The important points are: (1) what can we learn from the forms as submitted? (2) what can we learn from what they don’t say, (3) what can we learn from what they do say? And (4) what other avenues can we take to achieve a picture of honesty versus cheating? For instance, if the real estate owner doesn’t appear as a related party, how do we nail down property ownership?
Slide # 9
Drowning Us in Information & Starving Us for Knowledge
It is important to note that regulators and investigators are confronted with an overwhelming amount of information that in and of itself does not answers our questions about whether the industry is pervasively cheating and lying about the amount of profit they (free cash flow) they are extracting. The industry lobby has devised and sold a narrative of low returns based on the facility CR income statement. This is nonsensical. The income statement expenses depreciation, interest, taxes, and a host of payments to home offices and related parties for rent, labor, insurance, dietary supplies, and so forth.
The circumstantial evidence suggests that the industry is a high return, stable, business. However, most of the chains in the business are closely held and not required to disclose their consolidated financial statements, e.g. parent/holding company income statement, balance sheet, and cash flow statement. Furthermore, a considerable amount of ownership and capital flow information is often secreted through a tunnel of shell companies.
Slide # 10
Genesis Ownership: Absurd & Misleading
Genesis Health Corporation is a former publicly listed (on the NASDAQ) corporation and one of the biggest operators of nursing homes in the United States. The company was taken over by Formation Capital in a leveraged buyout in 2015. The property was sold off to a real estate investment trust (REIT) and leased back to Genesis which had become a management firm in the business of operating but not owning facilities. Arnold Whitman and Steven Fishman, principles in the Formation Capital buyout, are owners of the business.
The 15 beneficial owners listed on slide 10 are primarily owned by Whitman and Fishman. This network of LLCs and other business entities are so obscure and riddled with shell companies, that it would take a judge’s order for them to produce documents detailing how the cash flows through the organization. It is practically impossible to know how much Whitman and Fishman are pocketing at the expense of patients.
This ownership list did not appear on the cost reports. It was taken from the CMS Nursing Home Compare website, which is an important source of information for nursing home investigations.
Slide # 11
Income Statement: A Misleading Metric
The income statement indicates that the Genesis facility located in Bowling Green, Kentucky noted net inpatient revenue of $4,774,709 and operating expenses of $6,068,281 for a net operating income (loss) of -$1,293,572 They are noting a small nonpatient revenue of $7,567 for an overall net income (loss) of -$1,286,005.
These numbers have nothing to do with profitability or return on investment. Expenses deducted from net patient revenue include depreciation, interest, home office allocations, and other related parties expenditures. Furthermore, nonpatient revenue is typically COVID relief. It would be highly unusual if a facility in the Genesis chain of 300+ facilities did not take full advantage of PPP loans, the employee retention tax credit, and a host of other incentives and supports during 2020, 2021, 2022, and 2023. PPP loans are customarily forgiven and should appear as income.
Slide # 12
Colonial Center Related Parties/Home Office Allocations
The HBR Colonial facility related parties form Part I appears on Slide 12. Note in column 5 that the facility is claiming related parties expenditures – payments to parent corporation subsidiaries – in the amount of $1,799,986. When depreciation of $58,888 alone is added back, corporate income can be increased to $1,858,874. Income becomes +$28,888 without other tax write downs. So, the facility actually has a net positive income. But we do not know if the pricing of goods and services from related parties was above market prices and boosted parent companies cash flow above a reasonable level given the quality of service.
Slide # 13
Home Office/Related Parties Expenditures Adjusted
Slide 13 lists the facility expenditures for related party charges. These are charges actually paid – listed in column 5 on the form in Slide # 12. Column 4 is the amount authorized by state reimbursement policy (the state of Kentucky).
Slide # 14
Red Flag: Contract Labor Bonanza
Forensic accounting, auditing, and investigation requires knowledge of industry-wide patterns and practices. For instance, statistical analysis suggests that approximately 5% of facility labor is, on average, contract labor. Typically, facilities contract for labor to fill in for a few hard to fill nursing positions. That is not the case with the Colonial Center – a facility owned in most part by Formation Capital, a private equity firm. Sixty-three percent of the facility’s labor costs are paid to a subsidiary also owned primarily by Formation Capital. As part of a statistical analysis of the industry, this facility and probably most other Formation Capital owned facilities would jump off the page. Furthermore, referral back to slide 13, which displays the home office allocations and payments to related parties, indicates that the owners of the facility also own the company providing contract labor. This arrangement benefits the parent/holding company entity. In a labor market in which pay is low and working conditions are substandard, the industry mantra of labor shortages works to the advantage of a company using the situation for enrichment.
The company can claim that it is necessary to hire contract labor due to a labor shortage. However, that claim is belied by the overall industry pattern of contract labor as a minor part of overall labor throughout the industry. Objective data analytics suggest that a small part of the overall nursing workforce is hired from labor contracting firms.
Genesis Healthcare Corporation is a “related party management entity” – an LLC owned by Formation Capital. Prior to takeover by Formation, Genesis was a publicly listed C corporation listed on the NASDAQ. Formation understood a leveraged buyout of Genesis in 2012. At that time Genesis was considered the largest U.S. nursing home chain with between 300 and 400 facilities at any one time. As Formation disassembled Genesis, the former C Corp. became a facility management subsidiary set up as an LLC.
This process of financialization became exceedingly elaborate with important functions and components of the company split off as wholly owned subsidiaries designed to charge facilities for services and goods. Auditors in states where Formation/Genesis operates, do not have the resources to measure “free cash flow” or what renowned investor Warren Buffet calls “owners’ earnings.” Labor, real estate, and management services are earning considerable cash flow from facilities into Formation. This is a hidden capital flow. Hence, the public has no access to knowledge about the money paid to Genesis in comparison to th
Slide # 15
Colonial Related Parties Form Part II
CMS requires submittal of a “Statement of Costs of Services from Related Organizations and Home Office Costs.” Part I of the form requires the cost center (Column 2), which typically includes home office allocations, and specific payments to related parties such as real estate, labor, insurance, dietary, pharmaceutical, and other services from parent/holding company subsidiaries.
Part II of the form is designed to clarify ownership of the related entities providing services to the facility. It is notable that Column 2 is left blank. This is a violation of law as issued by CMS. By leaving the column blank, the individuals and or businesses with a financial interest in the related party business remains unknown.
Slide # 16
Exposing the Cabal: New York Attorney General Petition Against Comprehensive at Orleans LLC d/b/a Health & Rehab Center
Attorneys General can obtain records not generally accessible to the public – including scholars. Therefore, the patterns and practices that are contrary to the public interest are likely to only become public when an AG takes action against a facility or chain of facilities. Indeed, the action by the AG of New York regarding a cabal seen in nursing homes in various states, is an example of how capital and ill-gotten gains flow from government sources through a thicket of LLCs into a variety of entities with an ownership stake in a targeted facility.
The legal and financial arrangement of the facility targeted by the NY AG is not a pure private equity arrangement, rather, it is the typical investor or group of investors who raise funds from associates by offering them a stake in the business/facility. The organizing principles are based on the laws of the state in which the LLC is formed.
The schematic below is an excellent illustration of the type of legal/financial arrangement pervasive in the nursing home industry. This illustration was included in Supreme Court of the State of New York County of Orleans, People of the State of New York (Petitioner) Against Comprehensive of Orleans
Figure 1
The limited liability company is one of the most significant financial innovations in the economic history of the United States. Because these entities have been in existence since the 1970s but generally accepted only a quarter of century, the public is unaware of how recently they have been part of the legal/financial landscape.
As Figure 1 indicates, an individual nursing home business can be set up as a network of interrelated LLCs.
What is Private Equity
“Private Equity” is one of the most misunderstood and misused terms in discussion of corporations and legal/financial structures. Although a PE firm, to be called private equity, must meet specific necessary and sufficient conditions. Many groups of investors organized into networks of LLCs, partnerships, and limited partnerships are often called PE but they are not PE.
The necessary conditions and sufficient conditions for a business to be considered a PE firm are:
• General partners who own and/or manage the PE company.
• Limited partners who invest in a fund set up by the general partners.
• The general partners manage the fund, which buys portfolio companies through leveraged buyouts, for a 2% management fee and 20% of net earnings – this is called the “2 and 20” or “carried interest” on which the managers/general partners pay long-term capital gains taxes rather than income taxes.
• In addition to selling assets, general partners have sole management responsibility and authority.
• A fund is typically set up for 5 to 10 years.
• It is not uncommon for PE firms to saddle target companies with debt through a lending institution or by issuing corporate bonds – often junk bonds.
• Managers often load the target company with debt for the purpose of increasing payouts to limited partners and an increase in management fees (dividend recapitalization).
• Investors and managers often bail out of a portfolio company with high returns or management fees in spite of bankruptcy.
The carried interest issue. What is carried interest? It is considered the return a fund manager receives based on the 2 and 20 rule. Holding period of 3 years to qualify for long-capital gains. Deferred taxes – unrealized gains
PE firms are operating in the nursing home industry, but this type of business is often considered “the problem” instead of one of the many privatized financial/legal organizations presenting problems in the contemporary NH system. They fit nicely into the network of PE firms, REITs, LLCs, LLPs, and other legal/financial structures. For instance, the Carlyle Group’s leveraged buyout of HCR ManorCare for $6.1 billion included all of the real estate, i.e. the land and buildings. The real property was subsequently sold by the Carlyle Group to a REIT for approximately the same amount as the total buyout of over $6 billion. Therefore, the PE firm recouped its entire investment in the takeover by selling off assets.
PE firms sell valuable assets which could be real estate alone, could be a part of the entire business alone (like a factory or subsidiary), or both.
Cost Reports & Other Financial Information:
The industry claims that the nursing home business is an overregulated and low return business. However, given that it is a business with responsibility for extremely fragile patients needing around the clock care, it is far too lightly regulated.