Sutter's Giant Sucking Sound

Sutter Health, which owns one of California's largest hospital empires, is a nonprofit, tax-exempt charity. Critics wonder why Sutter dispenses so little charity, and vacuums so much profit, from the hospitals it acquires.

"We are pledging the revenues of Mills-Peninsula to pay off incredible debt for other parts of this corporation," says Glenn Mendleson, chairman of the Peninsula Health District Board in San Mateo. "I'm concerned about being tied to such a heavy debt. I'm more concerned about the divided we fall than the united we stand."

Several of the people who sit on the boards of directors of the nonprofit, tax-exempt side of Sutter Health also have ties to Sutter-related for-profit entities. These types of connections worry Sutter's critics, who wonder whether Sutter is being run to maximize community health care -- or to maximize the money Sutter directors and executives can squeeze out of the "nonprofit" health conglomerate.

Sutter does not have to disclose details of the business dealings of its for-profit subsidiaries. There are, however, plenty of apparently incestuous transactions between the nonprofit and its for-profit siblings.

Take, for example, retired Sacramento doctor Harold Ray, who was a paid member of the Sutter Health board for years until he resigned in December. During his tenure, Ray was also paid as much as $40,000 a year as a consultant. Then again, Ray is a senior medical consultant for Dallas-based the Pace Group, one of Sutter Health's largest contractors. Tax records show that Sutter paid the Pace Group $609,000 in 1995 alone.

Meanwhile, Ray was chairman of Omni Healthcare Inc., a for-profit health maintenance organization majority-owned by Sutter.

The same type of multidipping arrangement can be found throughout the Sutter network. For instance, Gould/Sutter Medical Foundation is a nonprofit medical clinic that serves Modesto and surrounding areas. Three of its board members -- including Board Chairman Thomas Ustach -- are doctors who practice as members of the Gould Medical Group. Tax records show that in 1996, the clinic paid that medical group more than $26 million for services. A fourth Gould/Sutter board member, Dr. Robert Wright, practices as a member of the Sutter North Medical Group. The clinic paid the Sutter North Medical Group about $12 million in 1996. The clinic also leases property from a partnership that includes Wright as one of its owners.

The Internal Revenue Service doesn't prohibit this kind of board intermingling and cross-entity contracting, so long as the nonprofit is not paying more than market rate for goods or services to its for-profit cousins. But the interlocking boards alone are enough to raise questions, since those board members are in a position to pass out contracts that directly affect their livelihood.

Sutter money flows in and out of its subsidiaries in a variety of other ways that raise a variety of questions.

According to Sutter tax filings, the nonprofit invested $8.8 million in Derjjan Associates Inc., a management company that owns the assets of Santa Cruz Medical Center, and another $1.6 million in Turlock Medical Clinic in 1996. Both businesses are Sutter-owned, for-profit subsidiaries attached to the nonprofit's officers or directors in some way.

Once capital from Sutter, the nonprofit, flows into a for-profit business, it disappears from public view. Those for-profit companies do not have to disclose their business transactions, or what they are paying their employees and directors.

In short, Sutter "investments" in for-profit entities raise questions about whether they are indeed investments -- or the siphoning of nonprofit assets into private pockets.

"It's all about making the doctors happy, and making money," says one source close to Sutter.

With control of nonprofit and for-profit businesses on all sides of the health care transaction -- by owning hospitals, doctor groups, and a managed care provider -- Sutter is in a position to determine where the patients, and therefore the money, goes. And there has been an awfully lot of money going in a lot of strange directions.

For a charitable health care organization, Sutter Health has ventured into some curious business dealings. Chief among them are lending money to a for-profit public company that quickly went bankrupt, and maintaining an insurance business in the Cayman Islands, the world leader in bank and corporate secrecy.

Back in the early 1980s, a group of doctors started a commercial laboratory in Sacramento -- appropriately called Physician's Clinical Laboratory Inc. (PCL) -- to provide quick laboratory work, primarily to local doctors' offices.

The doctors sold the business in 1986 to a partnership of Sutter Health and two other nonprofit hospitals, and the company went public in 1992. For its part, Sutter, through a subsidiary, invested about $2 million in the venture.

Physician's Clinical Lab gobbled up smaller labs until it became the second-largest commercial laboratory in California, with net annual revenues of $111 million. And then, somehow, the bottom fell out. Bill collectors were at the door. Banks were getting nervous.

And for some reason the nonprofit, tax-exempt Sutter Health became an even bigger benefactor of this public, for-profit company.

In May 1995, Sutter guaranteed a $3.5 million Wells Fargo Bank loan to Physician's Clinical Lab, ostensibly to keep the doors open until the company could be sold. At the time of the loan, Sutter owned about 23 percent of the company. The board of directors of Physician's Clinical Lab included two members of Sutter Health's board, and one member of a Sutter affiliate's board. Two of the cross-directors held stock warrants for a total of nearly 10,000 shares in the company, whose value was plummeting. The company, then more than $114 million in debt, filed a petition for Chapter 11 bankruptcy reorganization in November 1996.

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