On October 29, 2003, Richard Scrushy, the former CEO of HealthSouth, was indicted by the federal government on 85 counts of fraud. He was released on a $10 million bond and a proposed trial date was set for August 23, 2004. The allegations against Scrushy included securities fraud and false certification of corporate financial statements. This indictment put a temporary end to the roller-coaster ride that HealthSouth, Scrushy, and the stockholders had been on for the previous 6 months. How HealthSouth got to this extreme should make even the most veteran roller-coaster rider scream.

The Birth of an Empire

Scrushy was born in the town of Selma, Alabama. He received his certification in respiratory therapy at the University of Alabama at Birmingham in 1974. After working in respiratory therapy for a brief period, Scrushy realized that Medicare was paying a large amount of money to diagnose and treat elderly patients. He saw an opportunity to open privately held clinics that could provide the same treatments with lower overhead than traditional hospitals had. In addition, he realized that as Baby Boomers aged, a higher level of sportsrelated injuries would occur. He saw this as a future growth opportunity. Scrushy decided that he wanted to develop a health care franchise that would be dedicated to physical therapy. In 1984 with $50,000 from four friends, he started AmCare, which eventually became HealthSouth.

Soon after HealthSouth went public in 1986, HealthSouth started manipulating its financial statements.

Scrushy’s primary goal was to ensure that HealthSouth always met or exceeded Wall Street’s expectations. By 1988 HealthSouth operated 21 outpatient facilities, 11 inpatient facilities, and seven rehabilitation equipment centers in 15 states, By the end of1998 the company encompassed nearly 1,900 centers in 50 states, the United Kingdom, and Australia.

In 1995, HealthSouth hired sport celebrities such as Tom Glavine and Bo Jackson to boost its corporate image. By 2001, HealthSouth had hired former Wonder Years actor Jason Hervey to head HealthSouth’s entertainment and marketing operations. Hervey was in charge of the communications department at HealthSouth that, at its peak, employed 60 employees. Scrushy’s fascination with the entertainment industry started in the late 1990s when he developed a “Go For It” road show that was supposed to present positive, healthful messages to children. An offshoot initiative of the road show was HealthSouth’s involvement in developing a girls’ group called 3rd Faze.

In Birmingham, Scrushy was given almost royal status. A parkway, a community college campus, a building, a library, and a ball field are named after him. Scrushy’s corporate helicopter was nicknamed “Bonus One” by the HealthSouth employees because it was purchased the same year that HealthSouth did not give out bonuses to the rank-and-file employees. It was estimated that the helicopter served three primary purposes: (1) take Scrushy from the corporate headquarters to the Birmingham airport, (2) take Scrushy and his family to their mansion on Lake Martin in Alabama, and (3) allow Scrushy’s wife, Leslie, to make spontaneous shopping trips to Atlanta.

According to the Security and Exchange Commission (SEC), Scrushy met with HealthSouth’s senior officers each quarter to go over the firm’s actual earnings. Scrushy then compared the actual earnings with what the market was expecting for the quarterly earnings. If the actual earnings were not as high as the expected earnings, Scrushy ordered the senior managers to “fix it.” Scrushy denied this allegation to Mike Wallace during a 60 Minutes interview. HealthSouth’s top accountants held “family meetings” in which they decided how to manipulate the financial statements. The accountants “fixed it” by “filling the gap.”

The most common method was to make adjustments in the contractual adjustment account, which is used to estimate the variance between the amount billed to a patient and the amount insurance will pay. This account was used because it could be easily manipulated without scrutiny because it was impossible to verify the amount in the account. The accountants then had to manipulate the asset accounts to rebalance the balance sheet. They did this by adjusting the fixed asset account of plant and equipment to increase the asset levels. The accountants used a series of small adjustments so they wouldn’t raise any red flags to the external auditors. In addition, the accountants had to generate false invoices to support the manipulations.

The Red Flags Fly

In 1998, HealthSouth’s auditor, Ernst & Young, received an anonymous letter identifying accounting irregularities. During a congressional House Energy and Commerce Committee hearing in 2000, James Lamphron, former engagement partner at Ernst & Young, admitted that the firm received the letter in 1998 but concluded that the issues raised in the letter did not affect HealthSouth’s financial statements.10 In the summer of 2002, Ernst & Young was notified again of accounting irregularities by a former bookkeeper, Michael Vines, at HealthSouth. Vines claimed that HealthSouth did not record certain expenses between $500 and $4,999 in order to lower the overall expense amount and, therefore, artificially increase the level of profits at HealthSouth. Vines explained that the number had to be less than $5,000 because that was the amount beyond which Ernst & Young started examining expenses.

During an audit in 2001, the Ernst & Young auditor asked about the paper trail of a specific asset that was purchased. The problem was that the asset was never purchased. As a result, Vine’s supervisor, Cathy Edwards, ordered Vines to alter an invoice from a different asset purchase. Edwards then scanned the alternative invoice and changed the information on the invoice so it matched the information on the phantom purchase. On April 3, 2003, Edwards pleaded guilty to committing securities and wire fraud. In accepting the plea bargain, Edwards admitted to the government that she altered accounting-related documents.

In 1998, a HealthSouth patient in Texas filed a complaint with Medicare that HealthSouth used “unqualified personnel” for physical therapy by using aides and trainees instead of licensed therapists. In addition, the patient claimed that HealthSouth asked for financial reimbursements for services that it did not perform. In February 2003, after an investigation of the allegations, HealthSouth offered to pay the Department of Justice (DOJ)

$150 million to settle the alleged Medicare fraud charges. The government refused, seeking more than $200 million, and would not agree to HealthSouth’s condition that it would admit no wrongdoing.....

Questions

1. Why do you think Scrushy was acquitted of all charges related to the HealthSouth fraud?

2. Identify the stakeholders in this case. Explain the impact of the fraud on each of the stakeholders.

3. Do you think it is feasible for Richard Scrushy not to have known about the fraud if all CFOs admitted to it? Explain. Is it really feasible for a CFO to commit fraud without the CEO being involved? Explain.