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Health care companies can't seem to shake their legal headaches.

Even managed care players -- which have rallied hard for years -- are feeling some pain. On Monday, the U.S. Supreme Court upheld a lower-court ruling that could lead to huge settlement bills for some giant health management organizations. The ruling opens the door for a September trial against six HMOs accused of conspiring to violate federal law by failing to properly pay physicians. Two major HMOs,






, have already paid about $500 million each to settle their portion of the five-year-old lawsuit.

Goldman Sachs analyst Matthew Borsch warned on Tuesday that the remaining defendants --


( CVH),

Health Net







( PHS),






-- could take an even bigger hit.

"Plaintiffs are seeking billions in damages for claims paid over the past 10 to 15 years," wrote Borsch, who has a cautious view on the sector. And "settlement amounts going forward may be somewhat higher than for AET and CI, as is usually the case with this type of litigation, and because the plaintiffs have a stronger case now that the industry's appeal has been denied."

Still, Borsch portrayed the appeal as a long shot anyway and predicted that the ruling would come as no surprise to the market. Most HMO stocks barely budged on Tuesday morning.

Chronic Pain

Meanwhile, ailing hospital companies continue to suffer. And Banc of America analyst Gary Taylor on Monday cautioned investors against banking on a recovery anytime soon.

"Many investors we have talked to recently believe that hospital stocks may outperform in 2005 simply because they underperformed in 2004," wrote Taylor, who has a bearish view of the sector. "We can't agree with that line of thinking."

Taylor went on to explain that hospitals continue to suffer from weak fundamentals, especially pricing pressures from both commercial and government payers. In addition, he noted that the last time investors banked on an industry rebound -- after



blowup in 2002 -- they wound up disappointed.

Two years later, Tenet remains one of the sickest patients in the challenged hospital sector. It faces not only industry pressures -- such as bad debt from the uninsured -- but also a slew of legal problems. Most notably, the company is now embroiled in a criminal trial that could have far-reaching implications. It has been accused of violating physician kickback laws at its San Diego-based Alvarado Hospital Medical Center.

The case is considered pivotal for a number of reasons. For starters, Alvarado is just one of many Tenet-owned hospitals where the company's financial arrangements with physicians are under scrutiny. A guilty verdict would be considered a huge setback for the company and, some believe, a threat to the industry as a whole. Certainly, most agree, it would hurt the company's chances for a reasonable "global settlement" with the government.

Unfortunately for Tenet, however, the trial took a turn for the worse last week when a former Alvarado employee agreed to plead guilty and, many believe, began cooperating with the government in its case against the company. Fulcrum analyst Sheryl Skolnick viewed the development as a "likely setback" for the hospital chain.

"Tenet clearly was surprised by this and not just a little perplexed," wrote Skolnick, who has a neutral rating on the company's stock. "A trial that appeared to be going well from THC's perspective is now at best uncertain and at worst more likely to result in a conviction, at least in our view."

Tenet's stock slipped 4 cents to $10.52 halfway through Tuesday's session.

Sympathy Pains

Health Management Associates


suffered more.

The company's stock fell 1.4% to $21.99 after its rating was cut from outperform to peer perform by Thomas Weisel Partners analyst Eric Percher. Percher downgraded the entire sector, in fact, over fears that Congress' attempts to reduce the deficit will lead to government cuts in health care spending.

Percher noted that Chuck Clapton, chief health policy counsel for the Congressional Energy and Commerce Committee, recently said, "Typically when Congress has been called upon to reduce entitlement spending, one of the first places historically we've always looked has been hospitals."

And Percher is worried about more than just cuts to Medicare.

"We are extremely concerned that budget reduction efforts could lead to reductions in Medicaid funding," he wrote on Tuesday. And "reduced Medicaid funding bodes poorly for hospital profitability and bad-debt levels."

Healthier Picks?

Still, Percher did hunt down some potentially strong health care investments. He upgraded two dialysis providers --




Renal Care


-- on the belief that they will escape the brunt of any government cutbacks.

"We foresee little room for reductions in dialysis reimbursement," Percher explained when raising DaVita from peer perform to outperform on Tuesday. "The Medicare margin for dialysis providers is expected to be negative in 2005, making it difficult for regulators to cut dialysis reimbursement further at this time."

Taylor has also singled out DaVita as a favorite health care pick. But the company carries some risks. It is among many dialysis providers currently under scrutiny by the federal government. Moreover, it is acquiring a competitor that has been nailed -- at least twice -- for violating false claims laws.

In December, DaVita inked a deal to purchase Gambro shortly before Gambro agreed to pay $350 million to settle criminal and civil charges filed by the government. Gambro had ponied up $53 million to settle health care fraud charges just four years earlier.

In the most recent case, the government accused Gambro of overcharging for medical equipment through a "sham" company, billing for unnecessary tests and offering improper payments to physicians in exchange for patient referrals.

As part of the deal, a Gambro subsidiary pled guilty to criminal felony charges, admitted to executing health care fraud, paid a fine and found itself permanently excluded from the Medicare program. The government celebrated the fraud settlement as one of its largest ever.

It also sent out a warning to others.

"This investigation serves as a prime example and a constant reminder to our country's taxpayers that perpetrators executing these types of fraudulent schemes will be investigated and prosecuted vigorously," said Gary Holst, special agent in charge of the Kansas City justice office that handled the case. "Our agency will not be deterred in any manner to combat waste, fraud and abuse."

By acquiring Gambro, DaVita is poised to nearly double its patient base. Shares of the company -- which surged last month on news of the deal -- climbed 14 cents to $41.84 after Tuesday's upgrade.