HealthSouth scandal

The Event The prosecution of the chief executive of an Alabama health care firm under the Sarbanes-Oxley Act for his company’s fraudulent practices

Date 2002-2005

Place Alabama

Richard Scrushy, the founder and chief executive officer of HealthSouth, was the first person to be indicted under the Sarbanes-Oxley Act of 2002, which held senior executives responsible for the accuracy and completeness of corporate financial reports. His acquittal, particularly in view of the fifteen guilty pleas by others involved in the scandal, surprised many people.

Richard Scrushy, trained as a respiratory therapist, was in management at Lifemark, a Texas hospital administrative company, before he decided to start his own business. On February 22, 1984, HealthSouth was incorporated as Amcare, with Scrushy as its CEO and major stockholder. In 1985, the company changed its name to HealthSouth. It went public in 1986 on the NASDAQ stock exchange. Before going public, firms must have an independent auditor examine their books and certify their accuracy. HealthSouth’s auditor felt the books were not reliable, so Scrushy fired the firm and found a more compliant auditor, Ernst & Young. In September, 1988, the company was listed on the New York Stock Exchange, and on January 7, 1999, it became part of the Standard and Poor’s 500 stock index.

The Rise of HealthSouth

By 1990, HealthSouth had fifty facilities throughout the United States. It then began a rapid expansion through mergers and acquisitions. In 1993, it bought twenty-eight hospitals and forty-five outpatient rehabilitation facilities from National Medical Enterprise for $300 million. In 1994, it bought ReLife for $180 million. In January, 1995, HealthSouth entered the surgery business by acquiring Surgical Health Corporation for $155 million. In February, 1995, it acquired Novacare’s rehabilitation hospital business. In 1996, it expanded into diagnostics by purchasing Health Images. These acquisitions made HealthSouth a major U.S. health care provider, with more than two hundred facilities. At its peak, it recorded $4.4 billion in revenues, employed more than fifty thousand people worldwide, and operated eighty outpatient rehabilitation services and twelve home health agencies.

Scrushy was highly rewarded for expanding HealthSouth. Between 1996 and 2002, he was paid $260 million, mostly through stock options. This provided a great incentive for accounting fraud. HealthSouth added thousands of fictitious items to its assets. Most of these were valued under $5,000, since auditors rarely checked assets with such a low value. HealthSouth also removed expenses from its annual income statements to make its profits appear larger and boost the value of its stock.

Signs of Trouble

The first sign of accounting problems arose in late 2002. Scrushy sold $75 million of HealthSouth stock several days before the company announced a large loss. This was on top of the 7.7 million shares that he had sold for $77 million between 1999 and 2001. The Securities and Exchange Commission (SEC) began to investigate whether this sale was related to the loss, which would have violated insider trading laws. HealthSouth chief financial officer William Owens became a government informant, recording his conversations with Scrushy to provide evidence for the government’s case. In one recorded conversation, Scrushy told Owens that he would “get killed” if he fixed the financial statements immediately, but that the problems could easily be dealt with over time.

On March 19, 2003, the SEC halted trading of HealthSouth on the New York Stock Exchange, charging that the company inflated its earnings by more than 10 percent and overstated its profits by nearly $2.5 billion between 1999 and 2002. The company was also removed from the Standard and Poor’s 500 index. After trading as high as $30.81 in 1998, HealthSouth fell to $3.91 per share when trading was halted. One week later, Owens pleaded guilty to doctoring the company’s financial statements.

On March 31, the board of directors fired Scrushy and Owens, as well as its auditor, Ernst & Young. They removed Scrushy’s name from the company conference center and hired the restructuring firm Alvarez & Marsal to put the company finances in order and help it avoid bankruptcy. To restore profitability, HealthSouth sold or closed its poorly performing facilities, including its surgery, outpatient, and diagnostic divisions. By late 2006, HealthSouth had completed its recovery, becoming primarily a provider of rehabilitation services, and was relisted on the New York Stock Exchange.

More Problems for Scrushy

As HealthSouth began to revive, Scrushy’s problems were just beginning. In October, 2003, he was indicted on eighty-five counts, including charges that he falsified accounts at HealthSouth, leading to a $2.7 billion fraud of investors, by reporting fictitious profits. Federal officials charged Scrushy with duping investors into believing that the company met earnings targets to boost the company stock price (which would benefit Scrushy, who owned large amounts of HealthSouth stock) and to support his extravagant lifestyle, which included ownership of a Lamborghini, a 92-foot yacht, a 360-acre farm in Alabama, seven corporate jets, and paintings by Picasso and Renoir.

At the trial (January 25-June 29, 2005), former HealthSouth executives testified that Scrushy had ordered the accounting manipulations. However, these officials had pleaded guilty and agreed to testify against Scrushy to have their sentences reduced; therefore, the possibility existed that they were lying to help themselves. The prosecutors could not produce independent evidence that tied Scrushy to the fraud. After the prosecution made its case, Judge Karen Bowdre dismissed forty-nine of the eighty-five charges against Scrushy. The jury acquitted Scrushy of all remaining counts against him.

Scrushy, however, faced further court action. In 2006, he was convicted of bribery, conspiracy, and mail fraud for his part in a bribery scheme involving Alabama governor Don Siegelman. He was sentenced in 2007 to eighty-two months in federal prison and three years of probation, and ordered to pay a $150,000 fine, $267,000 in restitution, and the costs of his incarceration.

Bibliography

Cast, William. Going South. Chicago: Dearborn, 2005.

Johnson, Gary, and Mary Johnson. “CEOs 1, SOX 0: The Case Against Richard Scrushy and HealthSouth.” Journal of Legal, Ethical and Regulatory Issues 8, no. 1 (2005): 35-41.

Markham, Jerry. A Financial History of Modern U.S. Corporate Scandals. Armonk, N.Y.: M. E. Sharpe, 2006.