HEALTHSOUTH’S CORPORATE ACCOUNTING SCANDAL A CASE STUDY IN FRAUDULENT FINANCIAL REPORTING Kevin Barry Management 226: Special Topics in Advanced Accounting UCLA Anderson School of Management June 9, 2009
1. INTRODUCTION HealthSouth Corporation is a large, public healthcare company that operates 93 inpatient rehabilitation hospitals (and their 49 outpatient rehabilitation satellites), six long-term acute care hospitals, and 25 home health agencies.1 According to its website, HealthSouth is “the nation's largest provider of inpatient rehabilitation services.” 2 The Company is headquartered in Birmingham, Alabama, and its operations are spread across 26 states and Puerto Rico.3 Its mission is “to be the healthcare company of choice for patients, employees, physicians and shareholders by providing high quality care in the communities we serve.”4 HealthSouth’s stock trades on the New York Stock Exchange (NYSE) under the ticker symbol HLS, with a June 8, 2009 closing price of $12.76, giving the Company a market capitalization of approximately $1.1 billion.5 The Company’s 2008 revenue was
1
HealthSouth 2008 10-K, p. 1. http://investor.healthsouth.com/secfiling.cfm?filingID=1442643-09-12 http://investor.healthsouth.com/secfiling.cfm?filingID=1442643-09-12.. http://investor.healthsouth.com/ 3 Ibid. 4 http://www.healthsouth.com/who_we_are/mission_statement.asp 5 HealthSouth stock hit its peak on April 20, 1998, closing at at $30.56 ($152.81 split-adjusted). It hit its low point on March 28, 2003, closing at $0.40 ($0.08). The split-adjusted figures reflect the 1-for-5 reverse 2
approximately $1.8 billion and its net income was $226.4 million, for basic earnings per share (EPS) of $2.73.6 About two-thirds of HealthSouth’s revenue comes from the Medicare program.7 HealthSouth is perhaps best known for the massive accounting fraud that was discovered in 2003 and almost led to the Company’s bankruptcy. Although HealthSouth emerged from this experience and has so far had a successful recovery, the memory of this scandal is still still fresh. The events surrounding the scandal, as well as a discussion of how the fraud was perpetrated and some key lessons to be learned as a result, are the topics of this paper.
2. HISTORY AND BACKGROUND HealthSouth was founded in 1984 198 4 by respiratory therapist and businessman Richard Scrushy, and went public in 1986 with Scrushy as Chairman and Chief Executive Officer (CEO). The Company grew quickly throughout the 1980s and 1990s, mainly via acquisition. In 1997, it opened a brand-new, $50 million corporate campus on the outskirts of Birmingham. Birmingham. By the end of 1999, HealthSouth was already a $4 billion company and had expanded to 120 inpatient rehabilitation hospitals, five medical centers, 1,379 outpatient rehabilitation centers, 230 surgery centers, 129 dia gnostic centers, and 124 occupational medicine centers.8
stock split that HealthSouth completed in 2006. The collapse of the Company’s stock price in March 2003 and the 2006 reverse stock split are discussed later in the paper. Historical prices per Yahoo! Finance, available at http://finance.yahoo.com/q/hp?s=HLS&a=05&b=8&c=2009&d=05&e=8&f=2009&g=d http://finance.yahoo.com/q/hp?s=HLS&a=05&b=8&c=2009&d=05&e=8&f=2009&g=d,, http://finance.yahoo.com/q/hp?s=HLS&a=03&b=20&c=1998&d=03&e=20&f=1998&g=d,, and http://finance.yahoo.com/q/hp?s=HLS&a=03&b=20&c=1998&d=03&e=20&f=1998&g=d http://finance.yahoo.com/q/hp?s=HLS&a=02&b=28&c=2003&d=02&e=28&f=2003&g=d.. http://finance.yahoo.com/q/hp?s=HLS&a=02&b=28&c=2003&d=02&e=28&f=2003&g=d 6 Diluted EPS was $2.62. HealthSouth 2008 10-K, p. 25. 7 HealthSouth 2008 10-K, p. 3. 8 HealthSouth 1999 10-K, pp. 6-9, 24. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-00430.. At its height, 430 height, the Company had four separate divisions: inpatient rehabilitation, outpatient
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In the process of HealthSouth’s spectacular rise, Scrushy became one of the highest-paid CEOs in the country.9 From 1995-97, for example, he earned a total of $8.5 million in salary, $23 million in incentive bonuses, $4.8 million in stock option awards, and $700,000 in other compensation.10 By March of 2002, Scrushy owned approximately 20.9 million shares of HealthSouth common stock (representing 5.1% of the total shares outstanding) with a combined market value of more than $287 million.11 Problems at HealthSouth HealthSouth started to become evident in mid-2002. In May, Scrushy sold more than $75 million worth of HealthSouth stock, and in June he h e sold another $25 million back to the Company. Company. HealthSouth then disclosed in August that a change in Medicare payment pa yment policy would “significantly lower reimbursement,” causing the Company’s stock to lose more than half of o f its value and leading to shareholder shar eholder lawsuits alleging that Scrushy had acted on insider information when selling his shares. Then, in February of 2003, the Federal Bureau of Investigation (FBI) announced the opening of a criminal investigation of HealthSouth for “possible securities law violations.”12
3. ALLEGATIONS OF CORPORATE ACCOUNTING FRAUD After the close of business on March 18, 2003, the FBI used a search warrant to raid HealthSouth’s headquarters and seize the Company’s Compan y’s financial records,13 and on
rehabilitation, surgery centers, and diagnostic diagnostic centers. It has since sold off all but the inpatient rehabilitation division. 9 http://en.wikipedia.org/wiki/Richard_M._Scrushy 10 HealthSouth 1997 10-K, p. 64. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-98-290 http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-98-290.. 11 HealthSouth 2001 10-K, p. 79. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-02-448 http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-02-448.. Calculation based on March 22, 2002 share price of $13.74 per Yahoo! Finance, available at http://finance.yahoo.com/q/hp?s=HLS&a=02&b=18&c=2002&d=02&e=18&f=2002&g=d.. http://finance.yahoo.com/q/hp?s=HLS&a=02&b=18&c=2002&d=02&e=18&f=2002&g=d 12 http://www.nytimes.com/2003/02/07/business/fbi-is-investigating-healthsouth-trades.html 13 HealthSouth press release, March 19, 2009. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-613.. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-613
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March 19, the Securities and Exchange Ex change Commission (SEC) filed a civil complaint against HealthSouth for accounting fraud.14 The SEC, which had already been investigating the Company for six months, alleged that “since 1999, at the insistence of Scrushy, [HealthSouth] systematically overstated its earnings by at least $1.4 billion in order to meet or exceed Wall Street earnings expectations.”15 Although the SEC’s complaint only detailed the estimated earnings impact of the fraud between 1999 and the first half of 2002, as shown in the table below, it alleged that these practices began soon after HealthSouth went public in 1986.16
2000 Form 10-K
2001 Form 10-K
For six months ended June 30, 2002
$(191)
$194
$9
$157
Reported
230
559
434
340
Misstated Amount
421
365
425
183
220%
188%
4,722%
119%
1999 Form 10-K
Income (Loss) before Income Taxes and Minority Interests (in $ millions)
Actual
Misstated Percentage
Source: Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy , CV03-J-0615-S (N.D. Ala.). http://www.sec.gov/litigation/complaints/comphealths.htm http://www.sec.gov/litigation/complaints/comphealths.htm..
According to the complaint, before HealthSouth’s earnings were released each quarter, management would brief Scrushy Scrushy on the actual figures. If the figures figures were less than Wall Street analyst estimates, Scrushy would instruct the Company’s senior
14
SEC litigation release, March 20, 2003. http://www.sec.gov/litigation/litreleases/lr18044.htm http://www.sec.gov/litigation/litreleases/lr18044.htm.. Ibid. 16 Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy , CV-03-J0615-S (N.D. Ala.). http://www.sec.gov/litigation/complaints/comphealths.htm http://www.sec.gov/litigation/complaints/comphealths.htm.. 15
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corporate accountants to “fix it” in order to meet the Street’s expectations. 17 These accountants, known as “the family,” would then hold “family meetings” to determine how they could inflate the Company’s Compan y’s quarterly earnings and make the necessary adjustments. Based on generally accepted accounting accou nting principles (GAAP), increases in earnings must be matched by corresponding increases in net assets, so that shareholders’ equity rolls forward properly and the balance sheet balances. The SEC alleged that HealthSouth was therefore able to increase its earnings while balancing its b ooks by overstating assets and understating liabilities. This was done in a variety of ways, but certain accounts in particular were utilized most frequently in connection with the fraudulent reporting. First, on the income statement side of each fraudulent entry, the Company’s senior accountants would either reduce expenses ex penses or the “contractual adjustment” contrarevenue balance, which represented the estimated difference between gross patient billings and insurer reimbursements. (Such allowances are standard accounting for many healthcare providers and reflect proper revenue revenue recognition practices. Since revenues are earned in the same period that services are provided but reimbursements often do not occur until a subsequent period, an allowance based on the terms of the provider’s agreements with third-party payors is recorded, and later adjusted upon settlement.) Because HealthSouth only reported net revenues revenu es in its public filings, the impact of these adjustments was was easier to conceal. In addition, contractual adjustments are subject to a significant degree of management managem ent discretion, and the Company offered the public little clarity about how it determined these adjustments. adjustments. For example, in
17
Ibid.
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disclosing the Company’s accounting policy for such adjustments, HealthSouth’s 10-Q for the second quarter of 2002 stated only the following:
“We estimate contractual adjustments from non-governmental third-party payors based on historical experience and the terms of payor contracts. Our reimbursement from governmental third-party payors is based upon cost reports, Medicare and Medicaid payment regulations and other reimbursement mechanisms which require the application and interpretation of complex regulations and policies, and such reimbursement is subject to various levels of review and adjustment by fiscal intermediaries and others, which may affect the final determination of reimbursement. We estimate net realizable amounts from from governmental payors based on historical experience and interpretations of such regulations and policies. In the event that final reimbursement differs from our estimates, our actual revenues and net income, and our accounts receivable, could vary from the amounts reported.”18
Next, to make these entries balance, the accountants would need to make offsetting adjustments to to HealthSouth’s balance sheet accounts. To do this, they would frequently create fictitious fictitious fixed assets. The cumulative impact of these these fraudulent entries, according to the SEC’s complaint, resulted in an approximate $800 million overstatement to the Company’s “property, plant, and equipment” b alance by the end of third quarter of 2002,19 when the Company reported about $8 billion in total assets—$3 billion of which represented the net book boo k value of its fixed assets.20 Because HealthSouth owned hundreds of thousands of fixed assets spread across almost 2,000 facilities around the time that most of the fraud was alleged to have taken place, it was not overly difficult for the accountants to hide false assets in the Company’s facility-level fixed fixed asset sub-ledgers. So that they would not lose track track of the fictitious 18
HealthSouth Q2 2002 10-Q, p. 16. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-02973. 973. 19 Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy. 20 HealthSouth Q3 2002 10-Q, pp. 3-4. http://investor.healthsouth.com/secfiling.cfm?filingID=100515002-1280.. 02-1280
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assets, the accountants marked them as “AP Summary” on the sub-ledgers. To avoid red flags, these assets were recorded for varying amounts, and they were also intentionally recorded at amounts below the threshold that the Company’s outside auditors used in selecting which assets to test. If the auditors requested a sub-ledger with fictitious fictitious assets, the Company would change any “AP Summary” items to a description that sounded more like a real fixed asset. asset. Then, if the auditors nevertheless selected a nonexistent asset for testing, the accountants would create and provide the auditors with fictitious supporting documentation, which happened on at least one occasion.21 The SEC’s complaint alleged that the senior HealthSouth officers involved in the fraud had attempted over the years to convince Scrushy to put a stop to it, but that he consistently refused because he was concerned about ab out the possible impact that doing so would have on the value of his stock. stock. It was not until 2002 that Scrushy began to relent, when the officers were successful in convincing him to take steps to lower earnings expectations so as to remove the pressure to overstate earnings (although this too was done in a fraudulent way, wa y, by intentionally overestimating the effect of a Medicare policy change on HealthSouth’s bottom line). Then, according to the complaint, Scrushy finally agreed to stop inflating earnings in mid-2002 out of concern for the new Sarbanes-Oxley provision requiring a sworn certification by company CEOs that the financial statements contained “no untrue statement of a material fact.” 22
4. FALLOUT After the FBI raid on HealthSouth’s headquarters in March 2003, trading of the Company’s stock on the NYSE NYSE was immediately suspended. HealthSouth was also 21 22
Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy. Ibid.
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removed from the S&P 500 and its stock was delisted the following week, after which times its shares were traded on over-the-counter “pink sheets.” sheets.” (The stock price had closed at $19.55 on March 18; when trading resumed on March 25, the opening price was only $1.85, and it closed the day at just $0.60.23) J.P. Morgan Chase also froze HealthSouth’s $1.25 billion line of credit—which the Compan y needed access to in order to pay its bondholders the more than $350 $3 50 million in principal and interest due on April 1—thus raising the possibility of default and bankruptcy. 24 In addition, HealthSouth’s Board of Directors immediately placed Scrushy and Chief Financial Officer (CFO) William Owens on administrative leave.25 Both were later fired.26 Owens was just one of several HealthSouth CFOs C FOs who pled guilty to criminal charges in connection with the fraud—all four of his predecessors did as well.27 A number of other HealthSouth employees also confessed to their inv olvement in the scheme.28 Admitted and suspect participants in the fraud either resigned from the Company or were fired.29 Scrushy, however, claimed that the fraud was perpetrated pe rpetrated without his knowledge.
23
MarketWatch historical price data, available at http://www.marketwatch.com/investing/stock/hls/historical.. http://www.marketwatch.com/investing/stock/hls/historical 24 HealthSouth press release, March 27, 2003. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-668;; http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-668 http://www.nytimes.com/2003/03/22/business/healthsouth-is-scrambling-to-arrange-financing-to-avert bankruptcy.html.. bankruptcy.html 25 HealthSouth press release, March 20, 2003. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-617.. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-617 26 HealthSouth press release, March 31, 2003. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-695;; http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-695 http://www.accountingnet.com/x37629.xml.. http://www.accountingnet.com/x37629.xml 27 Report of the Special Audit Review Committee of the Board of Directors of HealthSouth Corporation (May 28, 2004), pp. 1, 37. http://investor.healthsouth.com/secfiling.cfm?filingID=950172-04-1357 http://investor.healthsouth.com/secfiling.cfm?filingID=950172-04-1357.. 28 For profiles of the five HealthSouth CFOs and ten “family members” who pled guilty to federal charges in connection with the fraud, see http://www.al.com/specialreport/birminghamnews/healthsouth/guilty.jpg http://www.al.com/specialreport/birminghamnews/healthsouth/guilty.jpg.. 29 Special Audit Review Committee Report, p. 37.
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The Board of Directors also quickly established a “Special Audit Review Committee” and engaged PricewaterhouseCoopers (PwC) to conduct a forensic audit concerning the SEC’s fraud allegations. The Board also brought in turnaround turnaround specialists Alvarez & Marsal (A&M) “to help stabilize operations, address financial and liquidit y concerns and to position the company comp any for successful restructuring as it moves forward.”30 (Although HealthSouth did default on its debt obligations, it was ultimately able to avoid being forced into bankruptcy.31) Soon thereafter, HealthSouth fired its independent auditors, Ernst & Young (E&Y),32 and notified the SEC that it would not be able to file its 2002 10-K on time. 33 The Company later replaced E&Y with PwC.34
5. FORENSIC AUDIT RESULTS The results of the PwC forensic audit were delivered delive red to HealthSouth’s Board of Directors and filed with the SEC on June 1, 2004. The forensic auditors examined possible fraudulent activity and “accounting irregularities” between 1996 and 2002, with a focus on “large or unusual accounting entries, particularly those involving round dollar amounts or adjustments after the close of a financial reporting period.” 35 The report, which adds further detail to the SEC’s SEC ’s description of how the fraud was perpetrated,
30
HealthSouth press release, March 24, 2003. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-651. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-651. 31 HealthSouth press release, August 12, 2003. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-1275.. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-1275 32 HealthSouth press release, March 31, 2003. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-695.. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-695 33 HealthSouth Notification of Late Filing, April 1, 2003. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-726.. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-726 34 HealthSouth press release, May 7, 2003. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-876.. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-876 35 Special Audit Review Committee Report, pp. 3-4.
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found that during this period the Company knowingly inflated income by more than $2.7 billion, a breakdown of which appears in the table below.36
Impact To Income Before Minority Interest And Taxes (millions of dollars)
Reduction of Contractual Allowances or Operating Expenses
$ 2,203
Acquisition Accounting
421
Bonus Accounting
52
Investment Accounting
17
Facility Contractual Accounting
19
Third-Party Transaction Accounting
29
Total
$ 2,741
Source: Report of the Special Audit Review Committee of the Board of Directors of HealthSouth Corporation (May 28, 2004), p. 8. http://investor.healthsouth.com/secfiling.cfm?filingID=950172-04-1357
Similar to the SEC’s civil complaint, the forensic audit report noted that the majority of the inflated earnings were the result of reductions to HealthSouth’s “contractual adjustment” contra-revenue contra-revenue account. According to the report, this practice began in the second quarter of 1996 and continued in every quarter through the middle of 2002. To a lesser degree, the Company also reclassified certain certain operating expenses “to make it appear as if the expenses were never incurred.”37 Instead of booking a corresponding adjustment directly to the balance sheet, however, the Company would record a series of intermediate transactions, typically through the use of corporate suspense accounts and intercompany transfers, which ultimately allocated the fictitious assets down to the facility facility level. Many of these fraudulent “management entries” were
36
The amount of inflated earnings t hat the auditors traced to the 1999-2003 period roughly approximated the SEC’s estimation from from its March 2003 complaint. Ibid., p. 8. 37 Ibid., pp. 10-11.
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externally uploaded into the Company’s accounting system s ystem and would self-reverse the following quarter.38 On the balance sheet side of the entries, the forensic audit report noted that slightly more than $1 billion of the fraudulent entries was related to nonexistent fixed assets, which, as noted, were were primarily given the designation designation “AP Summary.” The Company also overstated its cash balance by b y adding unsubstantiated amounts to the monthly reconciliations of its corporate consolidation account, which accou nted for the cash receipts and disbursements of the Company’s Compan y’s approximately 2,000 bank accounts. Although HealthSouth told analysts in early March 2003 that it had $390 million in cash at the end of 2002,39 $373 million of this was fabricated, according to the report.40 Hundreds of millions of dollars of other current and intangible assets was fu rther made up through various accounting schemes.41 HealthSouth also fabricated more than $400 million in income and assets through fraudulent acquisition accounting. One way it did this was to create artificial artificial reserves on the books of the acquired company and balance the entry by increasing goodwill. This gave the Company the opportunity op portunity to recognize income by releasing the reserves in subsequent periods. For example, with one acquisition in 1999 HealthSouth HealthSouth added a $7 million accounts receivable allowance to the acquired acq uired company’s books, which it then took down in 2000 and 2001 to increase income. Various other “cookie jar” reserves reserves were established upon acquisition and later released in similar fashion.42 Furthermore, as
38
Ibid., pp. 13-15. http://www.nytimes.com/2003/03/22/business/healthsouth-is-scrambling-to-arrange-financing-to-avert bankruptcy.html.. bankruptcy.html 40 Ibid., pp. 18-19. It is therefore unsurprising unsurprising that the Company defaulted on its debt obligations in 2003 when it lost access to its credit line. 41 Ibid., p. 12. 42 Ibid., pp. 19-22. 39
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the above table indicates, HealthSouth also created false earnings—though on a much smaller scale—through fraudulent accounting for bonuses, investments, facility-level contractual adjustments, and third-party transactions. In addition to the $2.7 billion in false earnings, the forensic audit report identified several categories of potential misstatements that “while not necessarily the result of intentional fraud, nevertheless were sufficiently aggressive or questionable to warrant discussion.”43 Examples include the improper capitalization of expenses, improper accounting for sale-leaseback transactions, and the failure to record various E&Y audit adjustments.44 The total estimated impact of such potential misstatements was $632 million. Based on these findings, the forensic audit report made a number of recommendations to prevent similar accounting and reporting problems from h appening in the future. Examples include improvements to the Company’s contractual allowance accounting, the implementation of various policies and procedures related to journal entries, stronger controls over fixed assets, and a robust internal audit department that reports directly to the Audit Committee.45 The report concluded that “the accounting fraud at HealthSouth was by any standard both enormous and complex. Its concealment over the course of nearly seven years required considerable effort and, in some cases, luck. For all its size and complexity, however, the fraud fraud shared much in common with other highly publicized earnings overstatement cases.”46
43
Ibid., p. 9. Ibid., pp. 27-33. 45 Ibid., pp. 37-42. 46 Ibid., p. 7. 44
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6. SCRUSHY In November 2003, Scrushy was indicted for his role in the HealthSouth accounting fraud. The 36-page, 85-count federal indictment47 charged him with “conspiracy, mail, wire and securities fraud, false statements, false certifications and money laundering” and sought approximately app roximately $278 million in asset forfeitures.48 For certifying financial statements that he allegedly knew to be materially false, Scrush y became the first-ever CEO to be charged with violating the the Sarbanes-Oxley Act. Scrushy steadfastly maintained his innocence.49 Scrushy’s criminal trial began in January 2005. 50 To prove Scrushy’s guilt, the government relied extensively on the testimony of several former HealthSouth executives involved in the fraud, including all five former CFOs, many of whom received lesser prison sentences in exchange for their cooperation coop eration in the investigation and testimony at the trial.51 Scrushy’s defense lawyers did not deny that fraud took place, but instead argued that it was done without his knowledge, and they attacked the th e credibility of the government’s witnesses.52 In June, after a lengthy trial and extended jury deliberations, Scrushy was acquitted on all charges. The verdict was a huge blow to the the government, 47
http://www.usdoj.gov/dag/cftf/chargingdocs/scrushyindictment.pdf . Scrushy was ultimately charged on 36 criminal counts. 48 Scrushy’s “criminally derived” property allegedly included “several residences in the state of Alabama and property in Palm Beach, Florida; Fl orida; a 92-foot Tarrab yacht called Chez Soiree, a 38-foot Intrepid Walkaround watercraft and a 42-foot Lightning boat; a 1998 Cessna Caravan 675, together with amphibious floats and other equipment, and a 2001 Cessna Citation 525 aircraft; diamond jewelry; several luxury automobiles, including a 2003 Lamborghini Murcielago, a 2000 Rolls Royce Corniche, and two 2002 Cadillac Escalades; and paintings by Pablo Picasso, Marc Chagall, Pierre-August Renoir, among others.” Department of Justice Justice press release, November 4, 2003. http://www.usdoj.gov/opa/pr/2003/November/03_crm_603.htm 49 http://www.nytimes.com/2003/11/05/business/former-healthsouth-chief-indicted-by-us.html 50 http://www.foxnews.com/story/0,2933,145392,00.html 51 Owens, for example, who became the first CFO to be convicted of Sarbanes-Oxley Act violations, received a five-year sentence for his role in the accounting scandal. http://www.washingtonpost.com/wpdyn/content/article/2005/12/09/AR2005120901890.html 52 http://www.nytimes.com/2005/02/17/business/17scrushy.html?pagewanted=all&position;; http://www.nytimes.com/2005/02/17/business/17scrushy.html?pagewanted=all&position http://www.nytimes.com/2005/05/19/business/19scrushy.html?pagewanted=2.. http://www.nytimes.com/2005/05/19/business/19scrushy.html?pagewanted=2
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which had built a careful and extensive case against him. Nonetheless, prosecutors elected not to appeal the decision.53 Despite Scrushy’s acquittal, however, his legal problems have continued. In October 2005, he was indicted on bribery and mail fraud charges in federal court for allegedly having paid former Alabama Governor Don Siegelman $500,000 in 1999 for a seat on the board of a state hospital regulatory agency (Siegelman was also indicted).54 Scrushy (along with Siegelman) was convicted in June 2006,55 and was sentenced to almost seven years in prison, which he began serving in 2007.56 His appeal request was denied in May 2009,57 and he is currently incarcerated in federal prison in Texas. Scrushy has also been charged in civil court for his role in the HealthSouth accounting scandal. In 2007, he settled settled with the SEC for $81 million.58 He is currently the defendant in a shareholder lawsuit filed on behalf of HealthSouth as a company. In May 2009, Scrushy briefly returned to Birmingham to testify in the trial, where he continued to maintain that others carried out the fraud without his knowledge.59 A ruling on the lawsuit, which seeks $2.6 billion in compensatory damages, is pending.60 In addition, Scrushy faces a class-action lawsuit from individual HealthSouth shareholders.61
53
http://articles.latimes.com/2005/jul/14/business/fi-scrushy14 http://www.nytimes.com/2005/10/29/business/29scrushy.html?_r=1 55 http://www.nytimes.com/2006/06/30/us/30verdict.html 56 http://blog.al.com/spotnews/2007/06/siegelman_gets_sevenplus_years.html 57 http://blog.al.com/spotnews/2009/05/us_appeals_court_rejects_forme.html 58 http://www.northcountrygazette.org/articles/2007/042307SECScrushy.html.. HealthSouth had http://www.northcountrygazette.org/articles/2007/042307SECScrushy.html had previously previously settled with the SEC for $100 million. http://www.nytimes.com/2005/06/09/business/09healthsouth.html http://www.nytimes.com/2005/06/09/business/09healthsouth.html.. 59 http://www.wtopnews.com/?nid=111&sid=1676144 60 http://blog.al.com/businessnews/2009/05/fate_of_richard_scrushys_perso.html 61 http://blog.al.com/businessnews/2009/05/scrushy_few_took_bigger_hit_in.html 54
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7. TURNAROUND AND RECOVERY Since the accounting scandal was first discovered in March 2003, HealthSouth has taken many steps to turn itself around and become a stronger company. It has a new senior management team, and the directors who presided over the Company when the fraud occurred have since since been replaced. HealthSouth was also able to avoid bankruptcy by selling assets and reaching various agreements with lenders to refinance its debt. Hundreds of consultants were brought in to help reconstruct the Company’s records, develop improved accounting and reporting policies, and establish a stronger, SarbanesOxley-compliant system of internal controls. 62 HealthSouth took an important step forward on June 27, 2005 when it released audited financial statements for the four years ending Decembe r 31, 2003, the first time the Company had issued financials since the third quarter of 2002.63 In December 2005, HealthSouth issued its 2004 Annual Report, 64 and in 2006, the Company reestablished itself as a current SEC filer when it issued its 2005 Annu al Report and resumed its quarterly filings. 65 HealthSouth was also relisted on the NYSE in October 2006 after shareholders approved a 1-for-5 reverse stock split. 66 As part of a corporate restructuring plan, the Company also sold its outpatient, surgery, and diagnostics divisions in 2007
62
HealthSouth came into full compliance with Section 404 of the Sarbanes-Oxley Act in 2007. HealthSouth 10-K “for the fiscal years ended December 31, 2003 and 2002, including a restatement of previously i ssued consolidated financial statements for the fiscal years ended December 31, 2001 and 2000.” http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-05-131361;; http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-05-131361 http://query.nytimes.com/gst/fullpage.html?res=9E01EFD81631F93BA15755C0A9639C8B63.. http://query.nytimes.com/gst/fullpage.html?res=9E01EFD81631F93BA15755C0A9639C8B63 64 HealthSouth 2004 10-K. http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-05-235488 http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-05-235488;; http://www.boston.com/yourlife/health/other/articles/2005/12/03/healthsouth_files_2004_results_with_sec.. http://www.boston.com/yourlife/health/other/articles/2005/12/03/healthsouth_files_2004_results_with_sec 65 HealthSouth 2005 10-K. http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-06-65473 http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-06-65473;; http://www.nytimes.com/2006/03/30/business/30health.html.. http://www.nytimes.com/2006/03/30/business/30health.html 66 http://www.secinfo.com/d18TY3.v2Pa.b.htm 63
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(primarily for cash), thus preserving only onl y its core inpatient rehabilitation business. 67 With this new structure firmly in place, HealthSouth continues to move ahead while doing its best to leave the past behind.
8. CONCLUSION The lesson of HealthSouth offers a powerful reminder that, when it comes to financial reporting, things are are not always as they seem. Whether the fraud should have been uncovered sooner is an open question.68 Regardless, analysts and investors should always be careful not to review companies’ financial financ ial statements with an uncritical eye, nor should they take management assertions about company health and various forwardlooking projections at face value: there are simply too many incentives and pressures on public companies to report favorable results and give them a positive spin—and sometimes people cross the line as a result. And although, for practical reasons, a considerable degree of reliance on independent audit opinions is absolutely necessary, the HealthSouth experience, like Enron and many others, shows that auditors do not always alwa ys do their job as well as they should. But can a fraud of this magnitude, scope, and duration still occur now that we are in the era of Sarbanes-Oxley? Will anybody even try? Only time will tell. tell.
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http://en.wikipedia.org/wiki/Healthsouth However, at least some accounting professors believe t he answer is a “qualified yes”: http://www.nysscpa.org/cpajournal/2004/1004/essentials/p44.htm.. http://www.nysscpa.org/cpajournal/2004/1004/essentials/p44.htm
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