Foundation hospitals may fail and put billions of pounds of public money at risk unless the Government introduces stricter assessment of NHS management, an independent watchdog warned yesterday.

The Audit Commission said the star rating system used to rank hospitals was too narrowly based and failed to pick up serious weaknesses in some trusts. Up to four of the 29 being considered for first-wave foundation status were judged to have weak management and financial arrangements, making it less likely that they could sustain high performance.

Among the 39 trusts ranked with the maximum three stars, the basic qualification for foundation status, 10 had significant managerial weaknesses.

The commission used a 16- point scale to assess management capacity, a more sophisticated method than the Government's star ratings.

The report, Achieving the NHS Plan, says progress has been made since the NHS plan was published in 2000, especially on cutting waiting times, but there are serious doubts it can be maintained.

The Commission for Health Improvement, which is taking over part of the Audit Commission's work, warned in April that ministerial pressure on the NHS to cut waiting lists was threatening overall improvements in the service.

The Audit Commission said there were too many targets, which were distorting priorities.

More than half of NHS trusts in England had resorted to one-off measures to boost performance, such as diverting money from medical equipment and maintenance to pay private-sector hospitals to do extra operations.

This left trusts facing difficulties in improving other areas, such as cancer care, and some had run up huge deficits. James Strachan, chairman of the commission, said: "We believe the vast majority of hospitals are well managed. But a significant minority are not." North Bristol NHS Trust, which ran up a £44m debt last year, illustrated the "serious problems" encountered by some trusts.

Yet the Government was planning to devolve responsibility and budgets to foundation hospitals on the basis of a star- rating system linked to measures of cleanliness and the number of booked appointments rather than to financial arrangements and management capacity. "That raises a significant risk when the Government is transferring billions of pounds to these nascent structures. I hope the Department of Health will round out its measures of performance. It needs a different system of eligibility," Mr Strachan said.

The Department of Health tried to play down the findings by suggesting it was a "snapshot report" and that "in most cases the NHS has moved on".

But Mr Strachan said it was an "extremely important" report, which was the result of two years' continuous study and was "not a snapshot".

He "totally supported" the Government's aspiration to grant the freedom of foundation status to high-performing hospitals but it had to be given to the right trusts on the right basis. "The question is how you do it and over what period."

Gill Morgan, chief executive of the NHS Confederation, which represents managers, said government targets for the NHS had helped to concentrate efforts and achieve improvements. "But we do need a new approach ... to ensure that we encourage real innovation and a focus on long-term sustainable change."