Lance K. Poulsen exuded confidence during the panel discussion atthe Atlantis Paradise Island resort in the Bahamas one afternoon lastOctober as he trumpeted the virtues of National Century FinancialEnterprises Inc., the health care financier he had built into anindustry leader over the past decade.
Listening closely were executives from Credit Suisse First BostonCorp. and Moody's Investors Service, Wall Street firms that suppliedthe funds and the positive credit ratings that helped propel hiscompany from a small-time lender into a multibillion-dollar giant.The meeting was called 'Healthcare Securitization: Checking the VitalSigns,' and the prognosis that balmy day was as upbeat as Poulsen'smarketing brochures.
Just three weeks later, National Century was engulfed in scandal.
The FBI raided the company's Ohio headquarters as investorsalleged that National Century misappropriated more than $3 billionraised through bond sales. Poulsen and his partners resigned, even asthey denied wrongdoing. Their privately held company quickly filedfor Chapter 11 bankruptcy protection. Its collapse sent more than adozen health-industry clients around the country into financialchaos, including nursing homes, home health care providers, andGreater Southeast Community and Hadley Memorial hospitals in theDistrict, whose parent company declared bankruptcy. Also hurt weremany bondholders, from large mutual funds to small cities in Arizona,which stand to lose millions.
After publicly traded corporations such as Enron Corp. andWorldCom Inc. blew up, Congress tightened regulations and prosecutorspursued wrongdoers. But the National Century story highlights anotherimportant failure in the system of checks and balances in U.S.capitalism: the lack of oversight for companies that are privatelyowned but still absorb billions of dollars in investments fromoutsiders.
Public and private documents, and interviews with participants,show that bond raters, underwriters and accountants -- theinstitutions that burnished National Century's credibility during itsquick rise -- missed, downplayed or ignored warning signs untilshortly before the company's collapse.
National Century 's annual audits were sometimes late. The companychanged outside accountants three times in recent years, often a redflag to securities experts. One credit-rating company stopped ratingNational Century bonds entirely in 1995. Another received,investigated and discounted anonymous letters that offered specificexamples of what they called the company's fraudulent conduct.Meantime, Poulsen and his partners were making personal investmentsin some of their clients, including several that were publiclytraded.
Through it all, some of the biggest blue chips in the financialworld continued to work closely with National Century, collectingsubstantial fees. Moody's and Fitch Ratings Ltd. rated the company'sbonds in increasingly large deals, grading them AAA until weeksbefore the bankruptcy filing. Accounting firms PricewaterhouseCoopersand Deloitte & Touche audited the company's books. Credit Suisse anda few other Wall Street banks acted as underwriters, essentiallyguaranteeing that all the bonds would be sold. And J.P. Morgan Chase& Co. and Bank One Corp., as trustees, maintained bank accounts forNational Century, its clients and the bondholders.
All the players in the National Century case disclaimresponsibility for not noticing the red flags, each interpreting itsoversight role narrowly. Moody's, for example, said it relied oninformation from National Century and on the work performed by CreditSuisse and other underwriters. Credit Suisse, in turn, blamed Moody'sand the banks for not being vigilant. The banks said it wasn't theirrole to investigate the company's financial underpinnings.
Mark Sargent, a securities law specialist and dean of theVillanova University School of Law, said National Century's fallshows that the financial system imposes little real responsibility onthe dealmakers and bond raters to perform due diligence on behalf ofinvestors.
Because there are few consequences under securities regulationsfor failing to detect signs of fraud, Sargent noted, there's noincentive to take action against questionable companies and forgo thefees. 'It's another systematic failure of the gatekeepers,' he said.'It's arranged in such a way that it provides no mechanism forbringing fraud or conflict of interest to the surface.'
Poulsen, a former brewery marketer and insurance salesman, startedNational Century in Ohio in early 1991. The basic business idea wasto provide struggling hospitals, nursing homes and other health careoperations with quick cash infusions, in exchange for control of thereceivables, or bills due, from insurers. Then bonds were sold byWall Street on behalf of National Century, with the agreement thatthe cash flow from the receivables would be used to pay off the debt.In all, the company floated about $19 billion in bonds, according topromotional material and the bond agreements.
Unlike companies that sell shares of their stock to the public,National Century was not obligated to register its bond offeringswith the Securities and Exchange Commission, a way investors canmonitor the terms of such deals. Instead, National Century wasallowed to claim an exemption from registration because Wall Streetwas selling the bonds to large institutional investors, such asbanks, pension funds or insurance companies, which are supposed to bemore financially sophisticated.
Even if a bond sale is not subject to registration and disclosurerequirements, 'companies are not allowed to lie in their offeringdocuments,' said Paula Dubberly, chief counsel of the SEC's corporatefinance division. Dubberly said her office 'doesn't have the staff orresources' to review every registered offering, much less everyunregistered one.
When any bond offering is made, the interest rate paid to thebuyers is determined, in part, by the perceived risk of thetransaction and the letter grade assigned by one of the three majorcredit agencies recognized by the SEC.
National Century received its first AAA rating for a bond issue in1992, from Standard & Poor's, not long after Poulsen started thecompany. Three years later, however, S&P stopped rating NationalCentury bonds altogether. Ted Berbage, a managing director of therating agency's structured-finance group, said analysts had adifficult time assessing which receivables were valid. 'We just feltover the course of that time we weren't completely satisfied with theaccuracy of their reporting,' Berbage said.
The other two companies that dominate the credit-rating industry,Moody's and Fitch, continued to rate National Century bonds.Officials said they were comfortable with the performance of thebonds and the financial reports issued by the company.
Signs of trouble cropped up again in 1995, when National Century'saccountant at the time, Hausser & Taylor LLP of Columbus, Ohio, wasmonths late in issuing its audit for the previous year. The auditorand National Century were wrangling over the auditor's conclusionthat the company was violating its agreements with bondholders,according to participants. National Century had provided funding tosome borrowers with only the promise of future -- not actual --billings as collateral. Eventually the auditors issued two reports, adraft Poulsen requested that blessed the company's bookkeeping and afinal report that said National Century wasn't in compliance withbond agreements.
There were other warning signs in the mid-1990s. One of NationalCentury's largest customers was Rx Medical Services Corp. of Florida.The publicly traded company filed papers with the SEC in 1995 sayingits auditors questioned whether it was a viable company. The auditorsalso warned it was too dependent on National Century for funding. Buta short time later, National Century gave Rx Medical still more moneyto acquire another health care provider -- money that, if it camefrom bondholders, may have been used inappropriately.
Over the next few years, Poulsen expanded his business rapidly,increasing the size of its bond offerings and its profits.
In 1999, an anonymous writer warned in two letters to Fitch bondraters that National Century was a fraud, estimating that half thecompany's portfolio of receivables 'is either worthless ornonexistent.' In March 2000, a third anonymous letter to Fitch, alsosent to a trade journal and published, gave even more explicitsuggestions about where to look, including the names of a clienthospital with a questionable financial history.
Fitch officials acknowledged receiving the letters, and in July2000, after getting 'extensive information' from the company, it saidthat 'no rating actions were warranted.'
Current and former National Century employees say Fitch executivesdid little to check on the allegations in the letters. They visitedheadquarters, spoke at length with Poulsen and 'kicked the tires,'they said, and did not aggressively investigate the company's complexfinances.
Kevin Duignan, a managing director at Fitch, said his firm didtake the allegations seriously and found Poulsen's explanationsconvincing. 'It's fair to say that either more detailed or morereliable information should have been provided to Fitch by either thecompany or its agents,' he added.
It was also in 2000 that National Century terminatedPricewaterhouseCoopers, the national auditing firm that had replacedHausser & Taylor four years earlier. Securities industry specialistssay firing an outside accounting firm is a classic sign of trouble. Apublicly traded firm would have had to explain the reason to the SEC;Poulsen had to explain nothing.
Last year, the National Century audit was late again. The auditfirm this time, Deloitte & Touche, wouldn't sign off. People withaccess to the company's books now are looking closely, sources said,at the PricewaterhouseCoopers and Deloitte audits and asking why theaccountants didn't draw more attention to questionable businesspractices.
PricewaterhouseCoopers was fired, one knowledgeable source said,because it wanted National Century to change some of its methods, butit declined. Deloitte declined to discuss its work.
Wall Street players began asking harder questions. Last July,Fitch lowered the ratings on one set of the company's bonds, sayingit was not receiving enough financial information.
Poulsen offered no hints at the Paradise Island conference on Oct.3 that his company was ready to implode. 'All Lance Poulsen did onthe panel was smile and try to charm everybody,' said a fellowpanelist, John W. Everets, who heads HPSC Inc., a large Boston healthcare financing firm.
Another panelist, Moody's Senior Vice President Jay Eisbruck, saidPoulsen only discussed 'basic information' about his company. But afew weeks later, Poulsen called another senior Moody's executive withsome ominous news: National Century had begun dipping into specialreserve accounts set up to ensure that bondholders would get paid inthe event of a lapse by health insurers.
On Oct. 28, some large note-holders, including Daniel Ivascyn, ofPacific Investment Management Co., which manages bond funds, traveledto Poulsen's headquarters to demand an explanation. But instead ofmeeting as promised, Poulsen kept them waiting for two hours and thenushered them out of the building, Ivascyn said in a sworn statementfiled in an Ohio court.
The next day, court papers say, Poulsen acknowledged to Ivascynand other bondholders that National Century had moved money betweentwo reserve accounts, a violation of bond agreements, and that he andhis partners had advanced millions to companies in which they held apersonal interest. Investigators have since determined that thetransfer of money between reserve accounts to cover a lack of cashhad been going on for years, sources familiar with the matter said.
After the fact, National Century's financial backers and overseerspointed fingers at one another.
When asked about the role Moody's played, Eisbruck said hiscompany typically conducts only a narrow 'operational review' thatincludes an examination of the legal and financial structure of thebond pools. Moody's also assesses the creditworthiness of theinsurers paying the bills, or receivables, he said.
But Moody's does not conduct 'due diligence' in the commonlyaccepted sense, Eisbruck said. It also relies on companies likeNational Century 'to provide us with relevant information,' Eisbrucksaid. He said the bonds were backed by the cash flow of receivablesfrom hundreds of National Century clients, and 'we certainly don'thave the resources to research all of them.'
If a company 'goes to great lengths to violate' bond agreements,Eisbruck said, 'it's very difficult to try to pick these things up.'
Eisbruck said it was up to underwriters, such as Credit Suisse,their lawyers and their accountants to dig deeply into NationalCentury's activity.
Officials at Credit Suisse blamed Moody's and the other players.They said the companies that rate the bonds and the banks that managethe bond accounts are crucial to ensuring the validity and safety ofthe transactions.
Credit Suisse said in a statement that it 'conducted allappropriate due diligence for a placement agent for this type oftransaction and relied on the company and its officials, theaccountants, the ratings agencies and the trustees.' Credit Suissehas already written off $214 million worth of National Century bondsthat it owned, saying it 'suffered losses as a result of what appearsto be massive fraud' at National Century.
Officials at Bank One and J.P. Morgan Chase who oversaw specificbond pools as trustees said they're obligated to do only what thebond agreements require -- in effect, to follow National Century'sdirection. 'Our role here is administerial,' said an official at onebank who asked not to be named.
In one recent lawsuit, a National Century customer named MedDiversified Inc. took aim at the trustees, saying Bank One and J.P.Morgan 'knew or should have known' that National Century'sinstructions to move reserve funds around was 'a radical and riskydeparture from the structure of those funds and would result in theloss of significant investor security.'
Bank One, of Chicago, helped precipitate the fall of NationalCentury when it told Moody's about the manipulation of the reserveaccounts, the rating agency said. But the bank did not raise thosequestions with Moody's until hundreds of millions of dollars inreserves apparently had disappeared.
Poulsen, at home in Florida, denies doing anything deceptive orillegal, according to his attorney Albert Lucas.
Lucas also indicated it would be hard for his client's Wall Streetpartners to argue that they were unfamiliar with the details of thebusiness. 'There were lots of people looking at this every day,' hesaid.
