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Official Committee of Unsecured Creditors of Allegheny Health, Education and Research Foundation v. Pricewaterhouse Coopers

January 17, 2007

THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS OF ALLEGHENY HEALTH, EDUCATION AND RESEARCH FOUNDATION, PLAINTIFF,
v.
PRICEWATERHOUSE COOPERS, LLP, DEFENDANT.



The opinion of the court was delivered by: Judge David Stewart Cercone

Electronic Filing

Phase III

MEMORANDUM OPINION

I. INTRODUCTION

In July of 1998, the Allegheny Health, Education & Research Foundation ("AHERF") and certain of its affiliates filed for bankruptcy. AHERF was a nonprofit Pennsylvania corporation which was one of the largest nonprofit, integrated healthcare systems in the country. Prior to the bankruptcy, Coopers & Lybrand, L.L.P.("CL") audited the financial statements of AHERF and its affiliates or their predecessors. PricewaterhouseCoopers, L.L.P. ("PwC"), the successor to CL, was formed in July of 1998 from the merger of Price Waterhouse L.L.P. and CL.

Plaintiff, the Official Committee of Unsecured Creditors of AHERF (the "Committee") filed this action on behalf of the AHERF estates against PwC alleging professional negligence, breach of contract, and aiding and abetting breaches of fiduciary duty committed by certain members of AHERF's management. These claims by the Committee are based upon CL's audits of AHERF's financial statements for the fiscal years 1996 and 1997*fn1 . PwC has filed a motion for summary judgment, the Committee has responded and, after argument in open court, the motion is now before the Court.

II. STATEMENT OF THE CASE

PwC is a limited liability partnership that provides accounting and auditing services. PwC's Statement of Undisputed Material Facts ("PwC's SUMF") ¶ 1. PwC has an office in Pittsburgh. Id. AHERF was a nonprofit Pennsylvania corporation, which, prior to filing bankruptcy, operated as the parent company for a number of affiliates in the greater Pittsburgh and Philadelphia areas. PwC's SUMF ¶¶ 3 & 4.

On July 21, 1998, AHERF filed for bankruptcy under Chapter 11 of the Bankruptcy Code. PwC's SUMF ¶ 5. On that same day, the following AHERF affiliates also filed for bankruptcy: (1) Allegheny University Hospitals, East ("AUH-East")*fn2 ; (2) Allegheny University Medical Practices ("AUMP")*fn3 ; (3) Allegheny Hospitals, Centennial ("AH-Centennial")*fn4 ; and (4) Allegheny University of the Health Sciences ("AUHS")*fn5 (collectively, including AHERF, "Debtors"). Id. AHERF affiliates that did not file bankruptcy include: (1) Allegheny General Hospital ("AGH"); (2) Allegheny University Medical Centers ("AUMC")*fn6 ; and (3) Allegheny Hospitals, New Jersey("AH-NJ")(collectively the "Non-Debtor Affiliates"). PwC's SUMF ¶ 11. The Committee was appointed to represent the creditors of the Debtor and is comprised of: MBIA Insurance Co.; PNC Bank; the Bank of New York, as trustee for the Centennial bondholders; Aetna U. S. Healthcare, Inc.; and Coventry Corporation. PwC's SUMF ¶ 6.

Certain AHERF affiliates were members of obligated groups, on whose behalf state and local authorities issued municipal bonds. PwC's SUMF ¶ 18. As of June 30, 1996, AHERF had two obligated groups, the Allegheny General Hospital Obligated Group ("AGHOG") and the Delaware Valley Obligated Group ("DVOG"). PwC's SUMF ¶ 19. The DVOG included Debtors AUH-East and AUHS. PwC's SUMF ¶ 20. The DVOG bonds were issued in June of 1996, and all the bonds were either insured by MBIA, Inc., or secured by a stand-by letter of credit from PNC Bank. Id.

As of June 30, 1997, AHERF had five obligated groups: AGHOG; DVOG; the AUMC Obligated Group; the AG-Centennial Obligated Group; and AH-NJ Obligated Group. PwC's SUMF ¶ 21. The AUMC, the AG-Centennial, and AH-NJ Obligated Groups comprised affiliates that joined the AHERF system in the 1997 fiscal year and remained liable on bonds issued prior to their affiliation with AHERF. Id. All the bonds for the AHERF obligated groups were issued prior to June 30, 1996. PwC's SUMF ¶ 22.

Sherif S. Abdelhak ("Abdelhak") was AHERF's President and Chief Executive Officer ("CEO") from 1986 until June 5, 1998. PwC's SUMF ¶ 23. As CEO, Abdelhak had overall executive responsibility for AHERF and its affiliates. Id. Abdelhak was also a member of the Boards of Trustees of AHERF, AUHS, AUH-East, AH-Centennial, AUMP, AGH and AUMC. Id. David W. McConnell ("McConnell") served as Executive Vice President and Chief Financial Officer ("CFO") of AHERF from November of 1991 until June of 1998. PwC's SUMF ¶ 24. McConnell also served as the Treasurer of AUHS, AH-Centennial and AUMC, and as Assistant Treasurer of AUH-East and AGH. Id. McConnell reported to Abdelhak. PwC's SUMF ¶ 32.

The Committee contends that in the late 1980's, Abdelhak, McConnell and others among the AHERF System's senior management ("senior management"), acting in concert with AHERF's Trustees, adopted the view that in order to prosper in a changing market for healthcare institutions, AHERF must grow by acquisition of hospitals, educational institutions, research facilities and medical practices. Amended Complaint ¶ 15. The theory underlying such growth was in part that healthcare providers needed to achieve economies of scale and an assured supply of patient revenue through the acquisition of geographically-proximate hospitals and physician practices. Id. The Committee avers that AHERF pursued this "economies of scale" strategy though a series of ill-advised and unjustifiable acquisitions, beginning in 1988 and continuing through the decade of the 1990's. Id. Further, AHERF never took the steps necessary to implement its "synergistic" strategy, as it failed to perform the proper due diligence, cut overhead costs or develop and employ the operational infrastructure essential to achieving the promised "economies of scale." Id.

The Committee directs this Court to various examples of AHERF's failed business strategies during the above-mentioned time period. In 1988, AHERF acquired MPC, which operated a medical school and associated hospital in Philadelphia. Amended Complaint ¶ 16. At the time of the acquisition, the Committee contends that MCP was in serious financial distress, and agreed to the acquisition only after AHERF pledged a capital infusion of $40-60 million into MCP over a five year period. Id.

Through the 1990's, senior management acting with the knowledge of and in concert with certain AHERF Trustees, continued to pursue similar acquisitions of failing institutions. Amended Complaint ¶ 18. In 1991, AHERF acquired the United Health System ("United"), which operated St. Christopher's Hospital for Children in Philadelphia and three suburban hospitals. Amended Complaint ¶ 19. At that time, the Committee contends that the three hospitals were struggling financially, and United was headed for bankruptcy. Id. AHERF's Board approved the acquisition of the four hospitals. Amended Complaint ¶ 20. In so doing, AHERF assumed the hospitals' $137 million in long term debt. Id. Two years later, AHERF acquired Hahnemann University Medical School and its associated medical center, Hahnemann University Hospital. Amended Complaint ¶ 21.

In 1996, despite "already straining under the load of its debt-ridden and failing acquisitions," AHERF negotiated a plan to acquire six more hospitals in the Philadelphia area that were owned by the Graduate Health System ("GHS"). Amended Complaint ¶ 22. The Committee contends that the GHS hospitals were already losing millions of dollars every month. Amended Complaint ¶ 23. While pursuing the GHS hospitals, AHERF also acquired five hospitals in the Greater Pittsburgh market including four hospitals that made up the Forbes Health System and Allegheny Valley Hospital. Amended Complaint ¶ 26. The acquisition of the GHS and Pittsburgh area hospitals added $282 million of under-secured bond debt to the AHERF System's consolidated balance sheet. Amended Complaint ¶¶ 25 & 26. The Committee also avers that AHERF, in the latter half of the 1990's, purchased the practices of hundreds of primary care physicians practicing in the Philadelphia and Pittsburgh markets which produced "staggering losses" to the AHERF System. Amended Complaint ¶ 21.

CL was retained by AHERF to audit AHERF's consolidated financial statement for the fiscal year 1996, and to audit the separate financial statements of AGHOG, DVOG and the Allegheny Integrated Health Group. PwC's SUMF ¶ 64. CL was also retained by AHERF to audit AHERF's consolidated financial statement for the fiscal year 1997, but not the separate financial statements of the obligated group affiliates. Id. CL was required to conduct the audits in accordance with generally accepted accounting standards ("GAAS") and other professional standards. Comm's SUMF ¶ 63.

The 1996 and 1997 engagement letters executed by CL and AHERF with regard to the audits provided, inter alia:

REPRESENTATION FROM MANAGEMENT

At the conclusion of the audits, AHERF management will provide to [CL] a representation letter for each respective report that . . . will confirm management's responsibility for the preparation of the financial statements in conformity with generally accepted accounting principles, the availability of financial records and related data, the completeness and availability of all minutes of the Board and committee meetings, management's responsibility for the entity's compliance with laws and regulations, the identification and disclosure to the auditor of all laws and regulations that have a direct and material effect on the determination of financial statement amounts and, to the best of their knowledge and belief, the absence of irregularities involving management or those employees who have significant roles in the control structure.

PwC's SUMF ¶ 66; PwC's Appendix at Tabs 51 & 52.

The Committee contends that CL violated numerous core auditing standards which caused AHERF's statements of operations and balance sheets for fiscal years 1996 and 1997 to be materially misstated. Comm's SUMF ¶¶ 256 & 257. Specifically, the Committee claims that AHERF's audited statement of operations overstated net income by more than $90 million in 1996 and by more than $150 million in 1997, turning positive net income into losses of approximately $80 million in 1996 and $130 million in 1997. Comm's SUMF ¶ 257. Further, AHERF's balance sheet overstated unrestricted net assets by more than $80 million in 1996 and more than $240 million in 1997. Id.

PwC, however, contends that AHERF management knowingly misstated AHERF's financial statements in both 1996 and 1997, alleging that McConnell directed the improper accounting entries, and Abdelhak was aware of the misstatements. PwC's SUMF ¶¶ 31-35. Moreover, the Committee admits that the financial statements of AHERF and its affiliates for the fiscal years 1996 and 1997 were "materially misstated." Amended Complaint ¶ 36. It is further alleged that AHERF maintained internal schedules that showed two (2) sets of financial results, side by side: one side with the results provided to CL and reported externally; and the other side showing the actual financial results. PwC's SUMF ¶ 113. These internal schedules showing different sets of financial results were provided to McConnell and Abdelhak by the AHERF financial department. PwC's SUMF ¶ 114. Members of AHERF management who were certified public accountants were required by AICPA standards to be candid and forthcoming with CL. PwC's SUMF ¶ 68. Members of AHERF's management who were CPAs included: Stephen Spargo*fn7 ...


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