2nd UPDATE: Tenet Claims Community Health Overbilled Medicare

Tenet Healthcare Corp. (THC) dramatically stepped up its defense against Community Health Systems Inc.'s (CYH) hostile bid with a federal lawsuit Monday accusing the rival hospital operator of boosting its financial performance for years by unnecessarily converting emergency-room visits into more lucrative inpatient admissions.

News of the suit sent shares of both hospital companies plunging, especially Community Health, shares of which kept tripping the single-stock circuit breaker Monday morning on their way down. Community Health's stock fell as much as 45% to $22.32, its lowest point in nearly two years.

Tenet, based in Dallas, has been fighting Community Health's unsolicited $6 a share, $3.3 billion cash and stock offer since late last year, calling the bid opportunistic and inadequate. Filing a federal lawsuit accusing Community Health of overbilling Medicare seems to go beyond the standard takeover defense and has weakened shares of the whole industry.

As a result of Community Health's "improper admissions practice," Medicare and likely state Medicaid programs, private insurers and other payers have paid the company "untold hundreds of millions--if not billions--of dollars for unnecessary hospital admissions," Tenet said in the lawsuit, filed in U.S. District Court in Dallas.

"We filed this complaint because our due diligence revealed that Community Health has been systematically overbilling Medicare and likely other payers by causing patients to be admitted to its hospitals when industry practice is to treat them in outpatient observation status," a Tenet spokesman said.

"We believe this unsustainable strategy has resulted in Community Health overstating its inpatient admissions, revenues and profits and has created substantial financial and legal liability. We are seeking to provide Tenet stockholders with the information they need to make an informed decision by asking the court to compel Community Health to correct its false and misleading statements and omissions," the company said.

Under federal securities laws, takeover target companies and their shareholders are entitled to bring such claims, according to a person familiar with the case.

Community Health representatives didn't immediately respond to requests for comment. Community Health shares recently fell nearly 30% to $28.20.

Tenet shares also fell on the news, down 13.5% to $6.53, removing some of the gains in the stock's price following Community Health's announcement of the offer in December.

Other hospital operators also fell Monday. HCA Holdings Inc. (HCA) dropped 4.2%, while Health Management Associates Inc. (HMA) lost almost 5%.

Tenet said that because of Community's billing practices, its stock--which is part of the offer--is worth less than stated, and its ability to finance the cash portion of the bid may be impaired.

Tenet wants the court to force Community to disclose "its unique and non-industry standard patient admissions criteria and billing practices and the financial and legal implications arising from them," Tenet said. Tenet alleges Community Health's admissions and billing practices have resulted in "materially misleading financial reports and statements."

Community Health disclosed in February that the Texas attorney general's office had opened a civil probe involving its hospitals in the state, focusing on emergency-department procedures and billing. The agency months earlier had issued civil investigative demands saying it was probing "misrepresentations and/or unlawful acts" related to practices of health-care providers treating Medicaid recipients.

Tenet said consultants it hired found Community Health's observation rate to be "significantly lower than the industry and its peer companies," or less than half of the national average. Community expanded admissions by dramatically reducing observation status at hospitals it acquired, especially in the case of Triad Hospitals, acquired in 2007, according to the lawsuit.

While Community "trumpets the synergies it created" through the Triad acquisition, it doesn't disclose that it achieved them by admitting would-be observation patients, "generating far greater revenue for the hospital," and violating Medicare rules and industry standards, the lawsuit said.

Community Health's potential liability, including damages, is well in excess of $1 billion for the years between 2006 and 2009 for the Medicare fee-for-service portion of its business alone, Tenet alleged.

"Tenet's shareholders are at risk of being harmed by false and misleading statements and omissions by CHS, a company whose financial performance has, for many years, been driven by the improper and undisclosed practice of systematically admitting into CHS hospitals despite no clinical need," the lawsuit said.

The lawsuit is the latest move to fend off Community, which is based in Franklin, Tenn. Tenet previously delayed its 2011 shareholder meeting by some six months and adopted a shareholder-rights plan, or poison pill, that could dilute the holdings of a major acquirer of its stock.

Community, meanwhile, announced a full slate of 10 director nominees to Tenet's board.

-By Dinah Wisenberg Brin, Dow Jones Newswires, 215-982-5582; dinah.brin@dowjones.com

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