RAINWATER; CRAWFORD; Want some more dots....

By BARRY MEIER
Published: February 16, 2000

The nation's largest chain of psychiatric hospitals lies in tatters. More than half of the roughly 90 hospitals and treatment centers operated by Charter Behavioral Health Systems will soon be closed and the company is expected to announce as early as today that it is seeking bankruptcy protection.
Three years ago, officials of a real estate investment trust headed by Richard E. Rainwater, the financier based in Fort Worth, announced a $400 million investment that they said would breathe new life into Charter. But rather than revitalizing the chain, the deal contributed to its collapse, according to many former Charter officials, undermining patient care in the process.
The company says that Charter's woes were caused by insurance cutbacks, not by the 1997 plan, and that patient care was not affected. The 1997 plan, though, saddled Charter Behavioral, a unit of Magellan Health Services Inc., with some $125 million in franchise fees and rapidly escalating rents. The chain's former chief executive said he warned that the costs would cause financial chaos. Those pressures, coupled with industrywide insurance cutbacks, were soon felt in psychiatric wards, former company officials said.
Hospital directors and workers, overworked and faced with repeated salary freezes, quit. Wards had too few employees, federal and state reports show. Training programs were eliminated, former company officials said. Broken chairs and walls were not repaired. ''It felt like they were strip-mining this place,'' said Dr. Hashim Hafez, the medical director at a Charter unit in Nashua, N.H., until he quit last year.
Charter Behavioral, which once had units in 27 states caring for more than 8,000 patients, many of them children, had long had a troubled past. But after 1997, patient care failed even at well-run hospitals, according to regulators and former company executives.
''Charter was never a great company,'' said Cindy Musikantow, who once ran a treatment center for adolescents that the company managed in Naperville, Ill. ''But it disintegrated to the degree that decisions were being made without regard for patients.''
The deal was a complex one that was intended to benefit both Mr. Rainwater's real estate trust, the Crescent Real Estate Equities Company, and Magellan Health. Under the plan, the trust received income from lease payments and Magellan received franchise fees.
In addition, Mr. Rainwater, as the largest shareholder in Magellan Health at the time, stood to profit because the sale of the ailing chain raised Magellan's stock price.
Magellan Health's top executive also got a large bonus, according to filings with the Securities and Exchange Commission. Additionally, the plan enabled Magellan, the nation's largest behavioral health company, to leave the hospital business for managed health care, a more lucrative field.
The deal split ownership of Charter Behavioral between Magellan Health and an affiliate of Crescent Real Estate. The psychiatric chain's buildings were sold to Crescent Real Estate, which leased them back at a healthy profit.
Both Mr. Rainwater -- a former business associate of Gov. George W. Bush Jr. of Texas -- and Mac Crawford, the chief executive of Magellan Health at the time of the deal, declined to be interviewed. In written responses, their spokesmen said that Charter Behavioral's financial woes were caused by insurance cutbacks, not by the 1997 plan. They said patient care was not affected.
''Sure, we had falling resources,'' said Dr. Gary M. Henschen, the chief medical officer of Charter Behavioral, which is based in Alpharetta, Ga. ''But we have done the best we can.''
In late 1995, Mr. Rainwater and his wife, Darla Moore, paid $69.7 million for a 12.3 percent stake in Magellan Health. The following year, he approached Mr. Crawford about a deal for Magellan to sell Charter Behavioral's buildings to Crescent. Companies that operate nursing homes had engaged in similar ''sale lease-backs'' to raise cash.
In the 1997 deal, Crescent Real Estate paid $400 million to acquire a half-stake in Charter Behavioral and buy its buildings. Because federal tax laws bar real estate investment trusts, or REIT's, from operating companies, Mr. Rainwater and his associates formed a publicly traded company, Crescent Operating Inc., to hold the half-stake.
Under the deal, Charter Behavioral was required to pay Crescent Real Estate $41.5 million in rent, a return of about 11 percent. Gerald Haddock, a Crescent executive, described the lease returns as ''exceptional.'' The rent, which took precedence over franchise fees to Magellan Health, escalated 5 percent annually.
Magellan Health, which is based in Columbia, Md., retained a 50 percent stake in Charter Behavioral, which was to pay it $78 million annually in franchise fees. Magellan, which used cash from the sale to finance managed care acquisitions, said that those payments could decline if industrywide insurance cuts continued.
At the time, most analysts applauded the plan. But John Lutzius, an analyst with Green Street Advisors in Newport Beach, Calif., said shortly after that the new payments left Charter Behavioral with little cash to weather any problems.
''Between the franchise fees and the rent, Magellan and Crescent were effectively sweeping all the cash flow from Charter,'' Mr. Lutzius said recently.
Mr. Rainwater's bet on the psychiatric industry proved to be wrong. In 1997, some within Charter Behavioral had sounded warnings about the deal's consequences for the company.
In separate interviews, two former top Charter officials said John M. DeStefanis, Charter's top executive, told Mr. Crawford of Magellan Health that the franchise fee and rent payments would financially devastate the psychiatric hospitals. Not long after the deal closed, Mr. DeStefanis resigned, those former officials said.
''John went nose to nose with them and that's why he was forced out of the company,'' said one former executive who spoke on the condition of anonymity.
Asked about that account, Mr. DeStefanis confirmed it but declined further comment, citing a confidentiality agreement. In his statement, Mr. Crawford disputed this version of events, saying that Mr. DeStefanis supported the deal. Mr. DeStefanis's departure was unrelated to the deal, he said.
Magellan officials declined to comment on discussions with Mr. DeStefanis. ''In the course of negotiating any transaction, differing viewpoints are always expressed, and, in a good organization, are even encouraged,'' the company said in a statement.
Magellan Health executives said the deal would benefit Charter Behavioral; Magellan's top official also profited. Mr. Crawford, whose salary in fiscal 1996 was $712,500, received a $2.48 million bonus for closing the deal, according to Magellan Health's 1997 proxy statement.
In his statement, Mr. Crawford described his cash payment as a ''retention bonus.'' One company director, A. D. Frazier Jr., said that he supported the payment to Mr. Crawford because the 1997 deal moved Magellan toward managed care and away from hospitals.
A month after the deal closed in June 1997, the federal government further cut hospital reimbursements. That December, Magellan told shareholders in its annual report the move would cut the $78 million due in franchise fees from Charter Behavioral in fiscal 1998 by a range of $10 million to $15 million.
Mr. DeStefanis's projections, however, proved far more accurate. Charter Behavioral managed to pay only $32 million in fees that fiscal year. In January 1998, seven months after the deal and 45 days after Magellan issued its annual report, the chain made its last franchise payment.
Charter Behavioral had had a troubled record of patient care, including settlements of government charges involving fraudulent billing. Regulators said, however, that some units provided good care.
In early 1997, for example, Dr. Ronald Davidson, a hospital consultant for the State of Illinois, declared he would not hesitate to use a company center in Brown Deer, Wis., for his own child. But by early 1998, conditions there and at other well-run units worsened as the weakening chain imposed repeated salary freezes, staff cutbacks and other cost-cutting measures, said former executives, including Ms. Musikantow, the former head of the Chicago-area unit.
At Charter's flagship hospital in Nashua, N.H., resources shrank and staff levels fell, said Dr. Philip Santora, a former associate medical director at the unit. When experienced nurses and therapists quit, they were replaced by fresh graduates, he said.
In 1998 and 1999 reports, federal and New Hampshire regulators found unsupervised children engaging in sex or hurting themselves at the Nashua unit. Wards persistently had too few employees. Suicide attempts were not recorded, and children were improperly restrained.
Dr. Santora, who quit in August, said that while insurance cutbacks played a role, the 1997 deal resulted in a pattern of neglect.
''You can chip away and chip away and sooner or later you reach a critical mass and a point of no return,'' he said.
As its hospitals veered out of control, Charter Behavioral's governing board -- which was comprised of two executives from Magellan Health and two associates of Mr. Rainwater -- had little response.
Dr. Clarissa Marques, Magellan Health's chief clinical officer, joined the board in August 1998 and found it had never received or asked for patient care reports. She said that in 1998 it did not meet until late October.
John C. Goff, one of Mr. Rainwater's closest associates, who headed the board then, declined to comment.
In mid-1998, Mr. Crawford left Magellan Health to become chief executive of Caremark Rx of Birmingham, Ala. About that time, in an S.E.C. filing, Crescent Operating -- which along with Magellan had lent some money to Charter -- acknowledged that Charter's operating losses were growing because of insurance cutbacks and the rents and fees the 1997 deal required.
In November 1998, Mr. Goff resigned from Charter Behavioral's board. A month later, the chain's accountants questioned its ability to continue, according to an S.E.C. filing.
Last April, the television news magazine ''60 Minutes II'' broadcast the results of an undercover investigation at several Charter Behavioral units. Secretly recorded footage showed ill-trained employees crudely restraining teenagers and filling in medical records for patients who apparently had not been examined.
Several company hospitals were already under government scrutiny. After the broadcast, federal officials announced a broad investigation of Charter Behavioral for Medicaid fraud and patient abuse. Magellan Health is also part of the inquiry.
That investigation involves activities both before and after the 1997 deal and is not focused on its financial aspects. (There is also a Federal investigation into billing fraud at the Columbia/HCA Corporation, a hospital chain that Mr. Rainwater helped found. Mr. Rainwater has not been accused of any wrongdoing.)
Vowing to improve patient care, Charter Behavioral hired outside consultants. Regulators shut some units and the company closed others.
By last August, Charter Behavioral could no longer make lease payments. The next month, Magellan Health transferred most of its remaining stake in Charter to Crescent Operating. Magellan and Charter agreed to indemnify each other in the face of the investigations. In December, Charter said it would reorganize and sell some 50 units.
Magellan Health officials said yesterday that the troubled chain could announce a bankruptcy filing as early as today. Michael French, Charter Behavioral's chief executive, and associates of Mr. Rainwater said they believed that following a reorganization, Charter Behavioral would be stronger.
On a recent day at the New Hampshire facility, a sign on the door instructed employees to turn in their keys during exit interviews. The keys would not work anyway. The locks had been changed. The last patient had been transferred.
''It all fell apart so fast,'' said Dr. Hafez, the former medical director. ''It was like the Kremlin. Everyone knew it was falling apart. But when it fell apart, it fell apart so quickly because there was no foundation.''