As state regulators consider whether to approve Health Net management's proposal to buy the giant HMO, the controversial deal now faces the threat of a big tax bite if it goes through.
The threat looms because of legislation being considered by Rep. Pete Stark (D-Oakland) in response to public criticism that Health Net's plan would enable management to gain control of the tax-exempt health maintenance organization for a cheap price, thus cheating the public.
His bill would levy a major excise tax on such HMOs and certain other tax-exempt organizations that convert from nonprofit to for-profit status and are bought by management at prices well below their actual market value.
In Health Net's case, Stark's tax could be a stunning $148 million if his idea were approved. "If we have a tax bill this year, I will do everything I can to see it amended" with the proposed change, Stark said in an interview.
Legislators, of course, routinely propose bills that never become law. But there also are indications that the Internal Revenue Service is just offstage in Health Net's case and could come into play.
The IRS recently revoked the nonprofit status of an unrelated hospital--thus making it liable for corporate income tax--after finding that its management had bought the hospital for an undervalued price and then resold it for a huge profit just two years later.
"I'd be very surprised if the IRS wouldn't look into this case," Stark said of Health Net. "There's some question about whether" the HMO's executives "are entitled to benefit as they so obviously would." Stark is a 19-year Congress veteran who is a senior member of the House Ways and Means Committee and chairs its health subcommittee.
Health Net said it is too soon to comment specifically on Stark's idea or the IRS' involvement because both are conjecture. But the company asserted in a statement that "we expect no unusual tax impacts" because both Stark's idea and the IRS ruling assume that the properties are sold for undervalued prices.
Health Net says that won't happen in its case because the HMO can't convert until the state Department of Corporations agrees that the price is fair and approves management's plan. Health Net is the state's second-largest HMO, with 840,000 members and 1990 revenue of $886 million.
The Department of Corporations' commissioner, Thomas Sayles, said he's under no deadline but expects to decide the Health Net matter in four to six weeks.
"We're taking a hard look at the entire conversion process," he said. "My job is to make sure fair value is contributed to the success of charity." Sayles also said the Stark proposal "doesn't bear on my decision."
The management of Health Net, led by Chairman Roger F. Greaves, proposes to convert the Woodland Hills-based HMO to for-profit by donating $127 million--its supposed "fair market value" as determined by an outside accounting firm--to a public charity as state law requires.
Nearly all of the cash would come from Health Net's operations. Simultaneously, Greaves and 30 other Health Net employees would buy the equity ownership of the HMO for a mere $1.5 million.
Consumer groups and several outside suitors that have made higher bids for Health Net claim that the $127 million is way below the HMO's actual value. They claim that if the deal is approved, the public--which effectively supported the HMO by allowing it to grow under tax-exempt status--would be shortchanged.
Health Net's management, meanwhile, would stand to earn millions of dollars on its $1.5-million investment if Health Net is later sold or goes public via a stock offering.
Last week, Consumers Union--the nonprofit publisher of Consumer Reports--formally asked Sayles to block the plan and urged him to adopt new rules for HMO conversions that would stop the "looting" of HMOs by "self-dealing" executives.
The new rules should "provide standardized procedures with appropriate public scrutiny and participation" and "protect against the raiding of public assets," Consumers Union said in its petition to Sayles.
The criticisms caught the attention of Stark. His tax law idea envisions a $148-million tax against Health Net, taking the difference between management's buyout price ($127 million) and the average of the two highest rival offers ($300 million and $250 million) that Health Net has received from outside bidders.
So far, Health Net's board--dominated by members of the same management group that wants to buy the HMO--has not welcomed any of the outside offers.
In a recent letter to IRS Commissioner Fred T. Goldberg, Stark said that the Health Net case appeared to be "a terrible abuse of tax-exempt status" and that his proposed tax "would prevent violations of the public trust in cases such as this."