Inside Baseball at HCA

Over the years, HCA ( HCA) insiders have shown a real knack for well-timed stock sales.

Their efforts haven't always drawn the kind of spotlight now beating down on the Nashville, Tenn., hospital chain. But then, the insiders weren't often selling just ahead of a profit warning that would send the stock into a tailspin. Nor were they usually selling alongside a member of the founding family and a high-ranking politician, Sen. Bill Frist.

The government is now investigating the well-timed sales of HCA stock by the Tennessee Republican. Frist denies wrongdoing, saying the sales were part of an effort to eliminate even the appearance of a potential conflict of interest.

But Frist's critics point out that the Senate majority leader plays a major role in shaping health-care policies that could impact the giant for-profit hospital chain that his family built. And even some who called for Frist to sell his HCA stock question why he finally decided to do so now.

"If there is a conflict now, why wasn't there a conflict when he came into office or when he became Senate majority leader?" asks Bill Allison, a spokesman for the nonpartisan government ethics watchdog group known as the Center for Public Integrity. "And with his family still involved with HCA, I don't know that selling the stock even ends the conflict of interest. ... The timing of this doesn't quite make sense."

Or, Allison goes on to suggest, maybe it does. After all, he notes, Frist decided to sell his stock at the same time that another powerful Republican senator -- Finance Chairman Chuck Grassley of Iowa -- was crafting a bill that could bring sweeping changes to the Medicare reimbursement system. Under that proposal, recommended by the Centers for Medicare and Medicaid Services (CMS), Medicare would start paying hospitals based on their costs for treating patients instead of the amount the hospitals actually charge.

UBS analyst Kenneth Weakley has warned that serious problems could lie ahead for the group.

"If CMS is successful in altering the (diagnostic-related group) system such that it achieves tight, normal distribution of profit margins across all DRG codes, then forward projections for hospital economics will likely lose ALL of their reliability," he wrote back in May. "Indeed should CMS implement this change for fiscal 2007 (which begins in October 2006), as it currently intends, it would not be unfair to say that few even in the hospital industry would be able to accurately predict the ultimate impact on hospital-by-hospital reimbursement."

CMS first recommended the change back in early March. Frist, by his own admission, sought permission to sell his HCA stock the following month. Grassley formally introduced his bill in May, and Frist executed his big transaction about six weeks later.

Moreover, Frist unloaded his stock during the biggest selling frenzy ever recorded -- for a company whose insiders who have a history of impeccable timing.

"Have they been very good at understanding when their stock is undervalued and when it is overvalued?" asks Fulcrum analyst Sheryl Skolnick. "You betcha!"

Shares of HCA, which peaked this summer at $58.60, tumbled 3.6% to $46.66 on Tuesday.

History Lesson

Market Profile Theorems, a Seattle-based investment research firm, has spent the past 17 years tracking insider transactions at big companies like HCA.

The firm's research director, Michael Painchaud, says that HCA insiders have always been regular sellers of the company's stock. However, he says, they grew even more aggressive during the summer time frame that has now come under scrutiny.

Indeed, Painchaud's data show, HCA insiders have cashed in more money on stock sales so far this year than they have during any full year in the company's history.
Ups and Downs
HCA stock over the years

Massachusetts investment strategist Peter Cohan sees a pattern in Painchaud's data.

Back in the mid-1990s, he notes, HCA insiders spent several years aggressively selling their shares -- as they rose with investor hopes -- before a sweeping Medicare fraud investigation sent the stock reeling in 1997.

The New York State public pension fund promptly sued 11 HCA leaders for alleged fraud, including some who executed stock sales when the company was being questioned about its activities by The New York Times.

HCA "was aware of the investigation by The New York Times, as well as the results, 'several months' before the expose was released to the public, during which time at least some of the insider transactions occurred," the Times quoted the lawsuit as saying back in 1997.

HCA later settled that lawsuit by agreeing to implement a strict corporate governance plan.

In the meantime, the Balanced Budge Act of 1997 had brought draconian Medicare cuts and, with them, immense pain for the entire hospital industry. By 1999, however, HCA was already betting on a turnaround that did, in fact, transpire.

"Their biggest year for insider buying was 1999," Cohan says. "And former CEO Tommy Frist was the biggest buyer, by far. That was very impressive."

Skolnick, for one, remembers that period well. She says that hospitals began to recover from the Medicare cuts in 1999 and secured some important increases in 2000.

By the following year, however, HCA insiders had started aggressively selling their stock again. They fetched high prices in both 2001 and 2002, Cohan notes, before the stock took another plunge during an industry downturn in 2003.

The trades then slowed again before picking up -- with unprecedented speed -- in 2005.

Sen. Frist's own sale came just weeks before HCA warned that the company would fall short of second-quarter expectations. However, some worry about more lasting challenges for the industry as a whole. And they believe that Frist, with his prominent role in the Senate, may see those problems surfacing earlier than most.

To be sure, Weakley is taking such threats seriously.

"Some are likely to suggest that the complexity of what is being proposed (for Medicare) is so great that the reforms suggested are never going to happen," he has written. But "with a Ph.D. economist (and a physician) in charge at CMS, pricing efficiency is perhaps a more serious focal point than ever at the federal level. The effort to improve pricing efficiency is likely to continue."

Still, Painchaud sees one reason to look on the bright side when it comes to HCA at least. Notably, he points out, company insiders have now two months without selling any stock at all.

"It's often what insiders don't do that's important," he says. "Given the history at HCA, inactivity is a great thing."

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