The Governance Paradox in Healthcare: Evaluating the Long-Term Risks of Encompass Health's Crisis

The recent collapse of Encompass Health Corporation's (EHC) stock price—a 9.95% drop on July 15, 2025, erasing $1.2 billion in market capitalization—has exposed the fragility of governance structures in the healthcare sector. While the company announced a modest dividend increase to $0.19 per share in July 2025, this gesture was overshadowed by a securities fraud investigation alleging misleading disclosures and insider trading by executives. The case of EHC is not an isolated incident but a microcosm of broader systemic vulnerabilities in healthcare investing, where regulatory shifts, opaque governance, and short-termism collide to create long-term risks.

The EHC Crisis: A Case of Misaligned Incentives

Encompass Health's troubles stem from a confluence of factors. The company's Q4 2024 and Q1 2025 earnings reports highlighted robust revenue growth (11.9% and 10.6%, respectively) while downplaying looming regulatory threats, such as CMS's site-neutral payment proposals and the phasing out of inpatient-only requirements. These policies directly undermine the business model of inpatient rehabilitation facilities, yet they were absent from public disclosures until July 2025. Meanwhile, executives including CFO Douglas Coltharp sold over $5 million in shares in April 2025, raising questions about whether they acted on non-public information.

The investigation by Shamis & Gentile P.A. suggests a pattern of selective disclosure and misaligned incentives. While management projected optimism, the company's internal data reportedly indicated declining patient mix and reimbursement rates. This disconnect between public statements and private realities has eroded investor trust, as evidenced by the stock's sharp decline.

A Sector in Turmoil: Governance Failures and Regulatory Scrutiny

The EHC saga mirrors broader governance failures across the healthcare sector. Consider Steward Health Care, which collapsed under $9 billion in liabilities after years of aggressive expansion and weak financial controls. Similarly, RxSight's stock price plummeted 70% in 2025 amid allegations of inflated product adoption metrics and insider trading by board members. These cases reveal a common thread: short-term profit maximization at the expense of long-term resilience.

Regulatory scrutiny has intensified as a result. The FTC's ongoing antitrust probe into private equity's role in healthcare, coupled with state-level legislation (e.g., California's SB 351 targeting private equity-owned hospitals), signals a shift toward stricter oversight. For instance, Massachusetts's amended False Claims Act now holds private equity investors directly liable for fraud, a development that could deter speculative investments in the sector.

The Cost of Short-Termism: Why Investors Must Reassess

Healthcare investors face a paradox: the sector's growth potential is undeniable, yet governance failures and regulatory risks create a volatile environment. The EHC case underscores three critical lessons:

1. Transparency Deficits: Companies that obscure regulatory headwinds or misrepresent financial health—like EHC and RxSight—invite legal and reputational fallout. Investors should prioritize firms with transparent governance, such as UnitedHealth Group, which has weathered crises like the Change Healthcare ransomware attack through proactive risk management.

2. Regulatory Tail Risks: CMS and state-level reforms (e.g., site-neutral payments, antitrust laws) can rapidly disrupt business models. EHC's reliance on inpatient rehab services now faces existential threats, akin to Steward Health's collapse under lease obligations. Investors must stress-test their portfolios against regulatory scenarios.

3. Insider Activity as a Red Flag: The sale of $16 million in EHC shares by executives in Q2 2025 suggests a lack of confidence in the company's long-term prospects. Historical data shows that insider trading often precedes governance scandals, making it a key metric for due diligence.

Investment Advice for a Post-EHC World

For long-term investors, the healthcare sector remains attractive but requires a more cautious approach. Here's how to navigate the risks:

• Prioritize Governance-Driven Companies: Favor firms with strong board oversight, transparent capital allocation, and alignment of executive incentives with shareholder value. Look to organizations like HCA Healthcare or Tenet Healthcare, which have demonstrated resilience through disciplined governance.

• Factor in Regulatory Contingencies: Build models that account for CMS policy shifts, antitrust risks, and state-level legislation. For example, companies with diversified revenue streams (e.g., outpatient services, telehealth) may be less vulnerable to inpatient-specific regulations.

• Monitor Insider Transactions: Use tools to track executive stock sales and trading patterns. Unusual activity, as seen with EHC and RxSight, can signal impending governance issues.

• Diversify Exposure: Avoid overconcentration in high-risk segments like for-profit hospitals or niche medical technologies. Instead, balance portfolios with stable, cash-flow-generating assets such as outpatient clinics or digital health platforms.

Conclusion: Governance as a Strategic Asset

The EHC crisis is a stark reminder that corporate governance is not merely an ethical concern but a financial imperative. In healthcare, where regulatory and operational risks are intertwined, governance failures can trigger cascading losses for investors. As the sector grapples with antitrust scrutiny, CMS reforms, and private equity's growing influence, the onus is on investors to demand transparency, accountability, and long-term value creation.

For those willing to navigate these challenges, the healthcare sector still holds promise—but only for those who recognize that governance is the bedrock of sustainable returns.