Ethics in the Marketplace

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Read chapter on Ethics in the Marketplace.
Analyze Healthsouth case study
Submit a three-page double spaced analysis of the case incorporating readings on ethics, and professional ethics3/26/2018 Pearson Collections
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This case was prepared by Research Assistant Jenny Mead under the supervision of Patricia H. Werhane, Ruffin
Professor of Business Ethics, and Cindy Eddins Collier, Batten Institute Fellow, Darden Graduate School of
Business Administration, and Founder and CEO, Valuations Solutions, Columbus, Ohio. It was written as a basis for
class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 
2005 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order
copies, send an e-mail to sales@dardenpublishing.com. No part of this publication may be reproduced, stored in a
retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of the Darden School Foundation. ◊
HEALTHSOUTH (B)
Although Michael Vines left HealthSouth in May 2002 to work in the accounting office
of a Birmingham country club, his concerns about the company proved correct over the next year
and a half. In the summer of 2002, the company announced that, because of changes in Medicare
regulations, it would suffer a $175 million profit shortfall. Soon afterwards, federal investigators
began scrutinizing founder and CEO Richard M. Scrushy’s sale of one-third of his HealthSouth
stock holdings earlier that year ($25 million in July, $74 million in May). As a result of these two
announcements, HealthSouth’s stock price plunged 58% over two days to $5 per share.
In early 2003, things began unraveling quickly at HealthSouth. In February, the FBI
began investigating HealthSouth stock trades. It conducted an undercover operation, having CFO
William T. Owens wear a wire during a conversation with Richard Scrushy. In the conversation,
much of which was played during an April 2003 court hearing, Owens expressed his and his
wife’s concern about “phony financial statements.” Among other remarks, Scrushy said, “I think
if there are other things that bother you about the balance sheet that you need to fix them over
time. Or…if there is a way you could fix them now but I think you’d get killed. I think that
you’ve already signed the documents.” Later in the conversation, he added, “I am convinced that
there are 8,000 companies out there right now that got s— on their balance sheet.”1 While the
recorded conversation appeared to offer no outright admission of fraud, it indicated that Scrushy
knew about the phony balance sheets and was trying to get Owens to sign the false financial
statements.
On March 19, the FBI raided HealthSouth headquarters, carting away many boxes of
documents. On that same day, the SEC filed a lawsuit charging Scrushy and HealthSouth with
faking $1.4 billion in profit, and the company suspended Scrushy. Company stock immediately
plummeted to $0.11 per share, leaving the company with a value of $50 million. On April 1,
HealthSouth fired Scrushy and two days later, the SEC accused the former CEO of unfairly
1 Carrick Mollenkamp, “Court Releases Tape of Talk Between HealthSouth Execs,” The Wall Street Journal, 12
April 2003, A-1.
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profiting from $170 million in stock sales between 1991 and 2003. Scrushy refused to answer
questions in federal court and asked to have access to $70 million of his assets.
In late April 2003, Congress began investigating the company, demanding thousands of
documents from HealthSouth and its former auditor, Ernst & Young. As the months passed,
HealthSouth executives began pleading guilty. For example, former Chief Financial Officer
Aaron Beam Jr. agreed to plead guilty to criminal charges and aid the government investigation
into Scrushy’s role in the accounting fraud, which was estimated at $2.5 billion by the end of
April. Also that month, the interim managers of HealthSouth discovered that shortly before the
scandal broke in March, several company executives, including CFO William T. Owens, had
given themselves more than $500,000 of the company’s money to pay for anticipated legal fees.
On May 1, two former company finance chiefs, Michael Martin and Tadd McVay, pleaded guilty
to charges that they fabricated profit. In a move that surprised many, on May 7, a federal judge
granted Scrushy full access to his money and property.
On June 16, Scrushy informed Congress that he was ready to testify about HealthSouth’s
financial collapse, but that he might ask for immunity from criminal charges. Shortly afterward,
on July 7, HealthSouth said that it was not going to seek bankruptcy protection. As a result, the
stock price moved up amid optimism that the company could reach an out-of-court settlement
with its creditors. In an effort to stave off bankruptcy, the company sought additional capital,
including $500 million to pay off a $345 million convertible-bond issue that had matured. The
company also hired turnaround specialist Alvarez & Marsal Inc., cut more than 300 jobs, and
sold its expensive private jets and helicopters. By that point, 11 former HealthSouth executives
had entered guilty pleas, most describing the company as a “family” in which all participants
colluded to present false financial material.
In early October 2003, Scrushy appeared on 60 Minutes and told Mike Wallace: “I’m an
innocent man. I’m not going to jail.” 2 In an October 16 congressional hearing, however, Scrushy
invoked the Fifth Amendment and refused to answer any queries about HealthSouth.
On November 4, 2003, Scrushy was indicted on 85 criminal counts, including charges of
conspiracy, securities fraud, wire fraud, mail fraud, making false statements, money laundering,
and violating the Sarbanes-Oxley (SOX) corporate crime law by providing false certifications to
securities regulators. He had earned $267 million in profits by masterminding $2.7 billion in
overstated earnings. Scrushy, who had provided the false certifications on August 14, 2002, was
the first chief executive to be charged with violating Sarbanes-Oxley, which had been signed into
law in July 2002. Scrushy pleaded innocent, claiming that his subordinates committed the fraud
without his knowledge or complicity, and was freed on $10 million bond, which was secured by
his three residences, 360 acres of plantation property, and approximately 300,000 shares in
HealthSouth stock.
2 Michael Tomberlin, “Scrushy Subpoenas 60 Minutes Reporter Wallace and Producer,” Birmingham News, 4
January 2005, 1.
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2004 Unfolds
In early January 2004, after PricewaterhouseCoopers performed a forensic audit, they
found that the accounting fraud at HealthSouth amounted to $4.6 billion. That included
“$2.5 billion in fraudulent accounting entries from 1996 to 2002, $500 million in incorrect
accounting for goodwill and other items involved in acquisitions from 1994 to 1999, and
$800 million to $1.6 billion in ‘aggressive accounting’ from 1992 to March 2003.” 3 HealthSouth
had been investigated for Medicare fraud several years earlier but the findings were
inconclusive; this time, auditors uncovered $6 million worth of Medicare fraud.
Once the $4.6 billon fraud was revealed, HealthSouth investors were left with shares of
uncertain value and without audited financial statements. HealthSouth management said that the
earliest these statements could be provided would probably be 2005. In general, the investors did
not seem to mind; in early 2004, they bid up the bonds to around par value. HealthSouth
projected $650 million in operating earnings on revenue of approximately $4 billion and
reassured investors that it had kept current on its debt payment. Meanwhile, the stock price hit
more than $6 a share in January but in early April was hovering around $4. Nonetheless, some
bondholders took the company to court in March, trying to force it to repay more quickly. They
eventually won. (See Exhibit 1 for HealthSouth timeline; Exhibit 2 for 2003–04 stock price.)
Scrushy’s attorneys fought the charges every step of the way. In the spring of 2004, they
asked the judge to throw out 78 of the 85 criminal charges, arguing that the bulk of the charges
alleged the same thing: accounting fraud. One of the lawyer’s filings stated that “An
intellectually honest approach to the government’s own allegations would have resulted in just
eight counts.” 4 Another Scrushy attorney likened it to “throwing so much spaghetti against the
wall” in the hope that “some of it will stick.” 5 In the fall of 2004, Scrushy’s defense team had
raised constitutional challenges to three of the 58 criminal counts against him, arguing that
Section 906 of Sarbanes-Oxley, which required corporate officers to sign off on the veracity of a
company’s financial statements to the SEC, was too vague and broad in scope. In an 11-page
opinion, Judge Bowdre dismissed the challenge, and remarked, “‘Hasn’t certifying a document
that is materially false been illegal all along?’” 6 In the Daily Deal, a reporter said that Scrushy
might “be better remembered as the CEO who validated the constitutionality of the SarbanesOxley
Act rather than as the disgraced founder” of HealthSouth. 7 In the meantime, Scrushy’s
trial—originally scheduled for August 2004—was postponed until early 2005.
3 Milt Freudenheim, “HealthSouth Audit Finds as Much as $4.6 Billion in Fraud,” New York Times, 21 January
2004, C2. 4 Stephen Taub, “Attorneys for Former HealthSouth CEO Richard Scrushy Maintain that Sarbanes-Oxley
Makes Criminal the Most Ordinary and Nonintentional Acts of Corporate Officials,” CFO.com, CFO Publishing
Corporation, April 7, 2004, http://www.cfo.com/article.cfm/3013081/c_3042545. Accessed 9/7/05. 5 Taub. 6 “Scrushy Trial Set to put Sarbanes-Oxley to the Test: Jury Selection Tomorrow: HealthSouth’s Former CEO
Blames Underlings for Fraud,” 4 January 2005, The America’s Intelligence Wire, Retrieved 7 September 2005 from
InfoTrac OneFile database. 7 Jaret Seiberg, “Scrushy Fails in Sarbanes Challenge,” The Daily Deal, 3 December 2004.
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In mid-December, Scrushy sued the Birmingham News for libel, claiming that the local
paper had been trying to convict Scrushy with its coverage of the HealthSouth accounting fraud.
The suit specified 12 objectionable phrases and editorial cartoons, including one that depicted a
prison with the caption, “Richard M. Scrushy Correctional Facility.” The suit asked for damages
of several million dollars as well as a public apology.
A Family Affair
Over time, the details of the HealthSouth fraud became public. Scrushy and the other
executives were accused of falsifying earnings for more than seven years. According to reports,
HealthSouth senior executives, led by Scrushy, met quarterly to analyze the company’s actual,
unreported earnings to compare against Wall Street estimates. If those numbers fell short of
predicted earnings, the officials would create false entries to boost income and corresponding
false entries in order to balance the books. One method of manipulating the financial records was
to reduce the “contractual adjustment account,” or the estimated difference between the amount
billed to the patient and the amount that insurance paid. The books were then “doctored” so that
increases in revenues or decreases in expenses matched the increases in assets or decreases in
liabilities. HealthSouth’s property, plant, and equipment (PPE) account was used to inflate the
company’s assets artificially. To throw off the auditors, who would question large PPE account
additions, HealthSouth accountants kept the false additions low and created fake documents such
as invoices to conceal the fraud. After inflating inventories, the accountants then boosted the
inventory account at the various HealthSouth facilities by different amounts so that the figures
would not look questionable.8 The HealthSouth executives allegedly involved in falsifying documents referred to this
tactic as “filling” the “holes” or “gaps” with “dirt,” and to their gatherings to alter the numbers
“family meetings.” Some participants claimed that Scrushy used intimidating tactics—threats,
surveillance, eavesdropping on emails and phone calls—as well as the rewards of lavish pay to
win the participants’ silence. Only a few had complained about the deliberate discrepancies, but
none came forward until after the scandal broke in March 2003. In the summer of 1999,
HealthSouth treasurer Leif Murphy had confronted Scrushy about the overstated profits; when
Scrushy would not take action, Murphy left the company. Former CFO Michael Martin,
unnerved by his participation in the fraud by signing off on bogus numbers, left the company in
2000.
Public Relations or Piety?
Shortly after he was indicted in November 2003, Richard Scrushy launched his own Web
site, www.richardmscrushy.com, which detailed his claims of innocence in the HealthSouth
affair. In early 2004, Scrushy made a series of moves that some observers called a “furious
8 Information taken in part from, “How Health South Cooked the Books,” Birmingham News, http://www.al.com/specialreport/birminghamnews/healthsouth/cook.jpg (accessed on 12 September 2005).
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public relations and legal blitzkrieg.” 9 He and his wife, Leslie, began attending Birmingham’s
predominantly black church, the Guiding Light Church, where services were broadcast regularly
throughout the week. Scrushy also started Viewpoints, a local television talk show, which he and
Leslie hosted, presenting “a one-of-a-kind mixture of scripture, law, and politics.” Calling the
liberal media “Satan,” Scrushy promised that his show would have no liberal bias. His first guest
was Roy S. Moore, the Alabama Supreme Court justice who had been ousted for putting up a
large granite stone with the Ten Commandments in the Alabama State Judicial Buildings.
Claiming that the FBI withheld evidence potentially supporting his claim of innocence,
Scrushy filed a formal complaint against an FBI agent, the deputy chief of the Justice
Department’s office of professional responsibility, and Alice Martin, the U.S. Attorney for the
Northern District of Alabama. Some legal experts professed confusion at this aggressive tactic,
since it often antagonizes prosecutors and judges.
HealthSouth’s Health in Late 2004
HealthSouth still persevered as a company post-Scrushy, although its employee roster
was down to 44,000 from 50,000 in its heyday and it struggled to straighten out its affairs. In late
December, the company announced that its profit would miss forecasts and that a company
turnaround might take as long as four years. Chief Financial Officer John Workman told
investors at a New York meeting that based on results through the third quarter, the company’s
profit would be about $630.4 million in 2004—not the previously forecast $650 million.
HealthSouth CEO Jay Grinney, who was hired in May 2004, told investors that the company,
based in Birmingham, Alabama, was probably six months into a three- or four-year recovery. As
an additional move to restore investor confidence, HealthSouth agreed to pay $325 million to
resolve the Medicare fraud issues that had plagued it for several years. The company would pay
$75 million immediately and the rest in quarterly payments throughout the next three years.
While the bulk of the payment would go to the government, whistle-blower James Devage (who
filed a 1996 lawsuit under the False Claims Act) would receive $8.9 million, and others who had
filed claims against the company would receive a combined $4.2 million. 10 Michael Vines
A large factor in Vines’s departure from HealthSouth was frustration with and suspicion
of the company’s accounting practices. He took steps to publicize the potential criminal activity
once he was no longer working for the company, including sending Ernst & Young an email
identifying three questionable accounts. Ernst & Young took his claims to HealthSouth President
and CEO William T. Owens, who defended the company’s accounting methods and called Vines
a “disgruntled employee.” Reassured by Owens’s explanation, Ernst & Young closed the books
9 Brian Grow, “All Scrushy, All the Time; HealthSouth’s embattled ex-CEO takes his defense directly to the
people,” BusinessWeek (April 12, 2004), 86. 10 Patti Bond, “Hospital Operator Settles Case,” Atlanta Journal-Constitution, 31 December 2004, 1F.
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on Vines’s claims, further frustrating the former HealthSouth employee. Unable to let his
suspicions go, Vines anonymously posted a notice on a Yahoo.com bulletin board in February
2003, warning others about HealthSouth. Even online, his claims were met with skepticism. By
March 20, 2003, the day after the HealthSouth executive guilty pleas started with former CFO
Weston Smith, Michael Vines’s claims were vindicated as others confirmed the fraudulent
activity that had taken place.
On April 9, 2003, shortly after HealthSouth and its alleged fraud had exploded into the
media, becoming front-page news almost daily, Michael Vines testified against his former boss
at a hearing in a federal courtroom. At that hearing, when asked by an attorney whether he would
have fired any employee who falsified accounting documents, Vines had answered yes.
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Exhibit 1
1
HealthSouth Timeline May 2002–April 2004
2002
May 14: Scrushy exercises options for 5,275,360 shares (at $3.78 per share) and sells them
the same day ($14.05 per share) for a total of $74 million.
July 31: To satisfy a debt to HealthSouth, Scrushy transfers 2.5 million common shares to
the company.
August 27: Citing changes in Medicare reimbursement for group physical therapy,
HealthSouth withdraws its earning forecasts to investors.
September 19: HealthSouth announces that the company is being investigated by the Securities
and Exchange Commission (SEC).
October 1: HealthSouth forms a committee to views its existing corporate governance
policies.
October 16: HealthSouth suspends its plan to spin off its surgery center business.
October 30: The law firm of Fulbright & Jaworski clears Scrushy of allegations of insider
trading.
December 16: HealthSouth forecasts 2003 profits to be below Wall Street estimates as it takes
into account current Medicare reimbursement policies and its 2003 budget.
2003
March 3: HealthSouth reports a fourth-quarter loss on a variety of charges totaling
$445 million.
March 19: The SEC charges HealthSouth and Richard Scrushy with civil fraud, alleging that
earnings were overstated by $1.4 billion. The FBI raids HealthSouth headquarters,
serving subpoenas on several employees. Former CFO Weston Smith is charged
with conspiracy to commit securities fraud and wire fraud and filing false
certifications with the SEC. The S&P and Moody’s cut HealthSouth’s corporate
credit rating.
1 Some information taken from Reuters News, “Chronology—HealthSouth Scandal,” November 4, 2003
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Exhibit 1 (continued)
March 20: The SEC obtains a court order to temporarily freeze most of Scrushy’s assets.
Scrushy and CFO William Owens is placed on administrative leave. Citing a
material adverse change to the business, banks block HealthSouth from drawing
down on the rest of its $1.25 billion revolving credit facility.
March 24: HealthSouth warns that its past financial statements are not reliable; many banks,
including Bank of America, give the company a “sell” rating. The company hires
turnaround specialist Alvarez & Marsal, Inc., to address liquidity concerns and to
help stabilize operations.
March 25: The New York Stock Exchange asks U.S. securities regulators to delist
HealthSouth’s stock. Trading of the stock is suspended.
March 26: CFO William T. Owens pleads guilty to fraud and conspiracy charges.
March 31: HealthSouth fires Scrushy as chairman and CEO and fires the company’s
longtime accounting firm Ernst & Young. Vice President and Assistant Controller
Emery Harris pleads guilty to conspiracy to commit wire fraud and securities
fraud.
April 3: Five more HealthSouth executives plead guilty to criminal charges.
April 4: SEC charges Scrushy with insider trading.
April 7: A group of HealthSouth employees files a lawsuit against Scrushy and the
company’s employee stock ownership program, claiming that Scrushy and other
executives breached their legal duties.
April 9: Invoking the Fifth Amendment privilege against self-incrimination, Scrushy
refuses to answer questions in court about the accounting scandal and his lavish
lifestyle. His lawyers try to unfreeze $70 million of his assets.
April 21: Treasurer and former CFO Malcolm McVay pleads guilty to fraud and conspiracy
charges.
April 24: Cofounder and former CFO Aaron Beam is charged with bank fraud and making
false representations to HealthSouth’s lender.
May 8: A federal judge in Birmingham refuses to freeze Scrushy’s assets, saying that the
government failed to make its case, giving him access to both his money and
property.
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Exhibit 1 (continued)
July 8: Vice President of Finance Jason Brown pleads guilty to conspiracy to commit
securities fraud, falsifying books and records, and wire fraud.
July 31: Two HealthSouth executives, a senior vice president for finance-tax and a vice
president of investments, are charged with conspiracy and maintaining false
books and records.
September 26: Former vice president of treasury and cash manager Catherine Fowler admits he is
guilty of conspiracy to deceive auditors and maintain false books and records.
October 16: As former HealthSouth employees accuse company management of intimidation
tactics, Scrushy again invokes the Fifth Amendment.
November 4: Scrushy is indicted on 85 criminal counts, including charges of conspiracy,
securities fraud, wire fraud, mail fraud, making false statements, money
laundering, and violating the Sarbanes-Oxley (SOX) corporate crime law by
providing false certifications to securities regulators. Scrushy is the first chief
executive to be charged with violating SOX.
2004
January: PricewaterhouseCoopers performs a forensic audit and determines that the
accounting fraud at HealthSouth totaled $4.6 billion.
March 3: A federal judge denies a request by Scrushy’s attorneys to hold a hearing on
whether tapes they claim proved his innocence (part of the undercover
conversation with Owens in March 2003) should be allowed in his August trial.
March 11: Scrushy’s attorneys accuse the Justice Department of concealing evidence of his
innocence by suppressing the tapes.
April: Fifteen former executives have pleaded guilty since March 2003.
April: Scrushy’s attorneys file court motions claiming that the Sarbanes-Oxley Act,
which Scrushy was accused of violating, was vague and unconstitutional.
April 15: The Delaware Supreme Court orders Scrushy to pay $25 million to HealthSouth,
the company that fired him the previous year, as company shareholders increase
their demands that he repay money they say was fraudulently earned.
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Exhibit 2
HealthSouth Stock Price
March 2003–April 2004 (in dollars)
Date Open High Low Close Avg. Vol. Adj Close*
Apr-04 $4.11 $4.82 $4.11 $4.55 0 $4.55
Mar-04 4.60 4.60 3.78 4.10 0 4.10
Feb-04 5.03 5.25 4.39 4.51 0 4.51
Jan-04 4.58 5.93 4.58 5.05 0 5.05
Dec-03 4.19 4.86 4.19 4.58 0 4.58
Nov-03 2.83 3.93 2.78 3.93 0 3.93
Oct-03 2.95 3.10 2.73 2.80 0 2.80
Sep-03 3.43 3.43 2.74 2.85 0 2.85
Aug-03 1.62 3.23 1.60 3.23 0 3.23
Jul-03 0.74 1.89 0.69 1.61 0 1.61
Jun-03 0.34 0.84 0.32 0.52 0 0.52
May-03 0.17 0.38 0.17 0.30 0 0.30
Apr-03 0.12 0.17 0.10 0.14 0 0.14
Mar-03 $0.09 $0.09 $0.09 $0.09 0 $0.09
* Close price adjusted for dividends and splits.

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Ethics in the Marketplace

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Read chapter on Ethics in the Marketplace.
Analyze Healthsouth case study
Submit a three-page double spaced analysis of the case incorporating readings on ethics, and professional ethics3/26/2018 Pearson Collections
https://collections.pearsoned.com/student/#print/0ac6084d-5b46-1a41-815b-67e93fff02c9/0/10 2/30
UVA-E-0274
This case was prepared by Research Assistant Jenny Mead under the supervision of Patricia H. Werhane, Ruffin
Professor of Business Ethics, and Cindy Eddins Collier, Batten Institute Fellow, Darden Graduate School of
Business Administration, and Founder and CEO, Valuations Solutions, Columbus, Ohio. It was written as a basis for
class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 
2005 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order
copies, send an e-mail to sales@dardenpublishing.com. No part of this publication may be reproduced, stored in a
retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of the Darden School Foundation. ◊
HEALTHSOUTH (B)
Although Michael Vines left HealthSouth in May 2002 to work in the accounting office
of a Birmingham country club, his concerns about the company proved correct over the next year
and a half. In the summer of 2002, the company announced that, because of changes in Medicare
regulations, it would suffer a $175 million profit shortfall. Soon afterwards, federal investigators
began scrutinizing founder and CEO Richard M. Scrushy’s sale of one-third of his HealthSouth
stock holdings earlier that year ($25 million in July, $74 million in May). As a result of these two
announcements, HealthSouth’s stock price plunged 58% over two days to $5 per share.
In early 2003, things began unraveling quickly at HealthSouth. In February, the FBI
began investigating HealthSouth stock trades. It conducted an undercover operation, having CFO
William T. Owens wear a wire during a conversation with Richard Scrushy. In the conversation,
much of which was played during an April 2003 court hearing, Owens expressed his and his
wife’s concern about “phony financial statements.” Among other remarks, Scrushy said, “I think
if there are other things that bother you about the balance sheet that you need to fix them over
time. Or…if there is a way you could fix them now but I think you’d get killed. I think that
you’ve already signed the documents.” Later in the conversation, he added, “I am convinced that
there are 8,000 companies out there right now that got s— on their balance sheet.”1 While the
recorded conversation appeared to offer no outright admission of fraud, it indicated that Scrushy
knew about the phony balance sheets and was trying to get Owens to sign the false financial
statements.
On March 19, the FBI raided HealthSouth headquarters, carting away many boxes of
documents. On that same day, the SEC filed a lawsuit charging Scrushy and HealthSouth with
faking $1.4 billion in profit, and the company suspended Scrushy. Company stock immediately
plummeted to $0.11 per share, leaving the company with a value of $50 million. On April 1,
HealthSouth fired Scrushy and two days later, the SEC accused the former CEO of unfairly
1 Carrick Mollenkamp, “Court Releases Tape of Talk Between HealthSouth Execs,” The Wall Street Journal, 12
April 2003, A-1.
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profiting from $170 million in stock sales between 1991 and 2003. Scrushy refused to answer
questions in federal court and asked to have access to $70 million of his assets.
In late April 2003, Congress began investigating the company, demanding thousands of
documents from HealthSouth and its former auditor, Ernst & Young. As the months passed,
HealthSouth executives began pleading guilty. For example, former Chief Financial Officer
Aaron Beam Jr. agreed to plead guilty to criminal charges and aid the government investigation
into Scrushy’s role in the accounting fraud, which was estimated at $2.5 billion by the end of
April. Also that month, the interim managers of HealthSouth discovered that shortly before the
scandal broke in March, several company executives, including CFO William T. Owens, had
given themselves more than $500,000 of the company’s money to pay for anticipated legal fees.
On May 1, two former company finance chiefs, Michael Martin and Tadd McVay, pleaded guilty
to charges that they fabricated profit. In a move that surprised many, on May 7, a federal judge
granted Scrushy full access to his money and property.
On June 16, Scrushy informed Congress that he was ready to testify about HealthSouth’s
financial collapse, but that he might ask for immunity from criminal charges. Shortly afterward,
on July 7, HealthSouth said that it was not going to seek bankruptcy protection. As a result, the
stock price moved up amid optimism that the company could reach an out-of-court settlement
with its creditors. In an effort to stave off bankruptcy, the company sought additional capital,
including $500 million to pay off a $345 million convertible-bond issue that had matured. The
company also hired turnaround specialist Alvarez & Marsal Inc., cut more than 300 jobs, and
sold its expensive private jets and helicopters. By that point, 11 former HealthSouth executives
had entered guilty pleas, most describing the company as a “family” in which all participants
colluded to present false financial material.
In early October 2003, Scrushy appeared on 60 Minutes and told Mike Wallace: “I’m an
innocent man. I’m not going to jail.” 2 In an October 16 congressional hearing, however, Scrushy
invoked the Fifth Amendment and refused to answer any queries about HealthSouth.
On November 4, 2003, Scrushy was indicted on 85 criminal counts, including charges of
conspiracy, securities fraud, wire fraud, mail fraud, making false statements, money laundering,
and violating the Sarbanes-Oxley (SOX) corporate crime law by providing false certifications to
securities regulators. He had earned $267 million in profits by masterminding $2.7 billion in
overstated earnings. Scrushy, who had provided the false certifications on August 14, 2002, was
the first chief executive to be charged with violating Sarbanes-Oxley, which had been signed into
law in July 2002. Scrushy pleaded innocent, claiming that his subordinates committed the fraud
without his knowledge or complicity, and was freed on $10 million bond, which was secured by
his three residences, 360 acres of plantation property, and approximately 300,000 shares in
HealthSouth stock.
2 Michael Tomberlin, “Scrushy Subpoenas 60 Minutes Reporter Wallace and Producer,” Birmingham News, 4
January 2005, 1.
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2004 Unfolds
In early January 2004, after PricewaterhouseCoopers performed a forensic audit, they
found that the accounting fraud at HealthSouth amounted to $4.6 billion. That included
“$2.5 billion in fraudulent accounting entries from 1996 to 2002, $500 million in incorrect
accounting for goodwill and other items involved in acquisitions from 1994 to 1999, and
$800 million to $1.6 billion in ‘aggressive accounting’ from 1992 to March 2003.” 3 HealthSouth
had been investigated for Medicare fraud several years earlier but the findings were
inconclusive; this time, auditors uncovered $6 million worth of Medicare fraud.
Once the $4.6 billon fraud was revealed, HealthSouth investors were left with shares of
uncertain value and without audited financial statements. HealthSouth management said that the
earliest these statements could be provided would probably be 2005. In general, the investors did
not seem to mind; in early 2004, they bid up the bonds to around par value. HealthSouth
projected $650 million in operating earnings on revenue of approximately $4 billion and
reassured investors that it had kept current on its debt payment. Meanwhile, the stock price hit
more than $6 a share in January but in early April was hovering around $4. Nonetheless, some
bondholders took the company to court in March, trying to force it to repay more quickly. They
eventually won. (See Exhibit 1 for HealthSouth timeline; Exhibit 2 for 2003–04 stock price.)
Scrushy’s attorneys fought the charges every step of the way. In the spring of 2004, they
asked the judge to throw out 78 of the 85 criminal charges, arguing that the bulk of the charges
alleged the same thing: accounting fraud. One of the lawyer’s filings stated that “An
intellectually honest approach to the government’s own allegations would have resulted in just
eight counts.” 4 Another Scrushy attorney likened it to “throwing so much spaghetti against the
wall” in the hope that “some of it will stick.” 5 In the fall of 2004, Scrushy’s defense team had
raised constitutional challenges to three of the 58 criminal counts against him, arguing that
Section 906 of Sarbanes-Oxley, which required corporate officers to sign off on the veracity of a
company’s financial statements to the SEC, was too vague and broad in scope. In an 11-page
opinion, Judge Bowdre dismissed the challenge, and remarked, “‘Hasn’t certifying a document
that is materially false been illegal all along?’” 6 In the Daily Deal, a reporter said that Scrushy
might “be better remembered as the CEO who validated the constitutionality of the SarbanesOxley
Act rather than as the disgraced founder” of HealthSouth. 7 In the meantime, Scrushy’s
trial—originally scheduled for August 2004—was postponed until early 2005.
3 Milt Freudenheim, “HealthSouth Audit Finds as Much as $4.6 Billion in Fraud,” New York Times, 21 January
2004, C2. 4 Stephen Taub, “Attorneys for Former HealthSouth CEO Richard Scrushy Maintain that Sarbanes-Oxley
Makes Criminal the Most Ordinary and Nonintentional Acts of Corporate Officials,” CFO.com, CFO Publishing
Corporation, April 7, 2004, http://www.cfo.com/article.cfm/3013081/c_3042545. Accessed 9/7/05. 5 Taub. 6 “Scrushy Trial Set to put Sarbanes-Oxley to the Test: Jury Selection Tomorrow: HealthSouth’s Former CEO
Blames Underlings for Fraud,” 4 January 2005, The America’s Intelligence Wire, Retrieved 7 September 2005 from
InfoTrac OneFile database. 7 Jaret Seiberg, “Scrushy Fails in Sarbanes Challenge,” The Daily Deal, 3 December 2004.
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In mid-December, Scrushy sued the Birmingham News for libel, claiming that the local
paper had been trying to convict Scrushy with its coverage of the HealthSouth accounting fraud.
The suit specified 12 objectionable phrases and editorial cartoons, including one that depicted a
prison with the caption, “Richard M. Scrushy Correctional Facility.” The suit asked for damages
of several million dollars as well as a public apology.
A Family Affair
Over time, the details of the HealthSouth fraud became public. Scrushy and the other
executives were accused of falsifying earnings for more than seven years. According to reports,
HealthSouth senior executives, led by Scrushy, met quarterly to analyze the company’s actual,
unreported earnings to compare against Wall Street estimates. If those numbers fell short of
predicted earnings, the officials would create false entries to boost income and corresponding
false entries in order to balance the books. One method of manipulating the financial records was
to reduce the “contractual adjustment account,” or the estimated difference between the amount
billed to the patient and the amount that insurance paid. The books were then “doctored” so that
increases in revenues or decreases in expenses matched the increases in assets or decreases in
liabilities. HealthSouth’s property, plant, and equipment (PPE) account was used to inflate the
company’s assets artificially. To throw off the auditors, who would question large PPE account
additions, HealthSouth accountants kept the false additions low and created fake documents such
as invoices to conceal the fraud. After inflating inventories, the accountants then boosted the
inventory account at the various HealthSouth facilities by different amounts so that the figures
would not look questionable.8 The HealthSouth executives allegedly involved in falsifying documents referred to this
tactic as “filling” the “holes” or “gaps” with “dirt,” and to their gatherings to alter the numbers
“family meetings.” Some participants claimed that Scrushy used intimidating tactics—threats,
surveillance, eavesdropping on emails and phone calls—as well as the rewards of lavish pay to
win the participants’ silence. Only a few had complained about the deliberate discrepancies, but
none came forward until after the scandal broke in March 2003. In the summer of 1999,
HealthSouth treasurer Leif Murphy had confronted Scrushy about the overstated profits; when
Scrushy would not take action, Murphy left the company. Former CFO Michael Martin,
unnerved by his participation in the fraud by signing off on bogus numbers, left the company in
2000.
Public Relations or Piety?
Shortly after he was indicted in November 2003, Richard Scrushy launched his own Web
site, www.richardmscrushy.com, which detailed his claims of innocence in the HealthSouth
affair. In early 2004, Scrushy made a series of moves that some observers called a “furious
8 Information taken in part from, “How Health South Cooked the Books,” Birmingham News, http://www.al.com/specialreport/birminghamnews/healthsouth/cook.jpg (accessed on 12 September 2005).
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public relations and legal blitzkrieg.” 9 He and his wife, Leslie, began attending Birmingham’s
predominantly black church, the Guiding Light Church, where services were broadcast regularly
throughout the week. Scrushy also started Viewpoints, a local television talk show, which he and
Leslie hosted, presenting “a one-of-a-kind mixture of scripture, law, and politics.” Calling the
liberal media “Satan,” Scrushy promised that his show would have no liberal bias. His first guest
was Roy S. Moore, the Alabama Supreme Court justice who had been ousted for putting up a
large granite stone with the Ten Commandments in the Alabama State Judicial Buildings.
Claiming that the FBI withheld evidence potentially supporting his claim of innocence,
Scrushy filed a formal complaint against an FBI agent, the deputy chief of the Justice
Department’s office of professional responsibility, and Alice Martin, the U.S. Attorney for the
Northern District of Alabama. Some legal experts professed confusion at this aggressive tactic,
since it often antagonizes prosecutors and judges.
HealthSouth’s Health in Late 2004
HealthSouth still persevered as a company post-Scrushy, although its employee roster
was down to 44,000 from 50,000 in its heyday and it struggled to straighten out its affairs. In late
December, the company announced that its profit would miss forecasts and that a company
turnaround might take as long as four years. Chief Financial Officer John Workman told
investors at a New York meeting that based on results through the third quarter, the company’s
profit would be about $630.4 million in 2004—not the previously forecast $650 million.
HealthSouth CEO Jay Grinney, who was hired in May 2004, told investors that the company,
based in Birmingham, Alabama, was probably six months into a three- or four-year recovery. As
an additional move to restore investor confidence, HealthSouth agreed to pay $325 million to
resolve the Medicare fraud issues that had plagued it for several years. The company would pay
$75 million immediately and the rest in quarterly payments throughout the next three years.
While the bulk of the payment would go to the government, whistle-blower James Devage (who
filed a 1996 lawsuit under the False Claims Act) would receive $8.9 million, and others who had
filed claims against the company would receive a combined $4.2 million. 10 Michael Vines
A large factor in Vines’s departure from HealthSouth was frustration with and suspicion
of the company’s accounting practices. He took steps to publicize the potential criminal activity
once he was no longer working for the company, including sending Ernst & Young an email
identifying three questionable accounts. Ernst & Young took his claims to HealthSouth President
and CEO William T. Owens, who defended the company’s accounting methods and called Vines
a “disgruntled employee.” Reassured by Owens’s explanation, Ernst & Young closed the books
9 Brian Grow, “All Scrushy, All the Time; HealthSouth’s embattled ex-CEO takes his defense directly to the
people,” BusinessWeek (April 12, 2004), 86. 10 Patti Bond, “Hospital Operator Settles Case,” Atlanta Journal-Constitution, 31 December 2004, 1F.
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on Vines’s claims, further frustrating the former HealthSouth employee. Unable to let his
suspicions go, Vines anonymously posted a notice on a Yahoo.com bulletin board in February
2003, warning others about HealthSouth. Even online, his claims were met with skepticism. By
March 20, 2003, the day after the HealthSouth executive guilty pleas started with former CFO
Weston Smith, Michael Vines’s claims were vindicated as others confirmed the fraudulent
activity that had taken place.
On April 9, 2003, shortly after HealthSouth and its alleged fraud had exploded into the
media, becoming front-page news almost daily, Michael Vines testified against his former boss
at a hearing in a federal courtroom. At that hearing, when asked by an attorney whether he would
have fired any employee who falsified accounting documents, Vines had answered yes.
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Exhibit 1
1
HealthSouth Timeline May 2002–April 2004
2002
May 14: Scrushy exercises options for 5,275,360 shares (at $3.78 per share) and sells them
the same day ($14.05 per share) for a total of $74 million.
July 31: To satisfy a debt to HealthSouth, Scrushy transfers 2.5 million common shares to
the company.
August 27: Citing changes in Medicare reimbursement for group physical therapy,
HealthSouth withdraws its earning forecasts to investors.
September 19: HealthSouth announces that the company is being investigated by the Securities
and Exchange Commission (SEC).
October 1: HealthSouth forms a committee to views its existing corporate governance
policies.
October 16: HealthSouth suspends its plan to spin off its surgery center business.
October 30: The law firm of Fulbright & Jaworski clears Scrushy of allegations of insider
trading.
December 16: HealthSouth forecasts 2003 profits to be below Wall Street estimates as it takes
into account current Medicare reimbursement policies and its 2003 budget.
2003
March 3: HealthSouth reports a fourth-quarter loss on a variety of charges totaling
$445 million.
March 19: The SEC charges HealthSouth and Richard Scrushy with civil fraud, alleging that
earnings were overstated by $1.4 billion. The FBI raids HealthSouth headquarters,
serving subpoenas on several employees. Former CFO Weston Smith is charged
with conspiracy to commit securities fraud and wire fraud and filing false
certifications with the SEC. The S&P and Moody’s cut HealthSouth’s corporate
credit rating.
1 Some information taken from Reuters News, “Chronology—HealthSouth Scandal,” November 4, 2003
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Exhibit 1 (continued)
March 20: The SEC obtains a court order to temporarily freeze most of Scrushy’s assets.
Scrushy and CFO William Owens is placed on administrative leave. Citing a
material adverse change to the business, banks block HealthSouth from drawing
down on the rest of its $1.25 billion revolving credit facility.
March 24: HealthSouth warns that its past financial statements are not reliable; many banks,
including Bank of America, give the company a “sell” rating. The company hires
turnaround specialist Alvarez & Marsal, Inc., to address liquidity concerns and to
help stabilize operations.
March 25: The New York Stock Exchange asks U.S. securities regulators to delist
HealthSouth’s stock. Trading of the stock is suspended.
March 26: CFO William T. Owens pleads guilty to fraud and conspiracy charges.
March 31: HealthSouth fires Scrushy as chairman and CEO and fires the company’s
longtime accounting firm Ernst & Young. Vice President and Assistant Controller
Emery Harris pleads guilty to conspiracy to commit wire fraud and securities
fraud.
April 3: Five more HealthSouth executives plead guilty to criminal charges.
April 4: SEC charges Scrushy with insider trading.
April 7: A group of HealthSouth employees files a lawsuit against Scrushy and the
company’s employee stock ownership program, claiming that Scrushy and other
executives breached their legal duties.
April 9: Invoking the Fifth Amendment privilege against self-incrimination, Scrushy
refuses to answer questions in court about the accounting scandal and his lavish
lifestyle. His lawyers try to unfreeze $70 million of his assets.
April 21: Treasurer and former CFO Malcolm McVay pleads guilty to fraud and conspiracy
charges.
April 24: Cofounder and former CFO Aaron Beam is charged with bank fraud and making
false representations to HealthSouth’s lender.
May 8: A federal judge in Birmingham refuses to freeze Scrushy’s assets, saying that the
government failed to make its case, giving him access to both his money and
property.
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Exhibit 1 (continued)
July 8: Vice President of Finance Jason Brown pleads guilty to conspiracy to commit
securities fraud, falsifying books and records, and wire fraud.
July 31: Two HealthSouth executives, a senior vice president for finance-tax and a vice
president of investments, are charged with conspiracy and maintaining false
books and records.
September 26: Former vice president of treasury and cash manager Catherine Fowler admits he is
guilty of conspiracy to deceive auditors and maintain false books and records.
October 16: As former HealthSouth employees accuse company management of intimidation
tactics, Scrushy again invokes the Fifth Amendment.
November 4: Scrushy is indicted on 85 criminal counts, including charges of conspiracy,
securities fraud, wire fraud, mail fraud, making false statements, money
laundering, and violating the Sarbanes-Oxley (SOX) corporate crime law by
providing false certifications to securities regulators. Scrushy is the first chief
executive to be charged with violating SOX.
2004
January: PricewaterhouseCoopers performs a forensic audit and determines that the
accounting fraud at HealthSouth totaled $4.6 billion.
March 3: A federal judge denies a request by Scrushy’s attorneys to hold a hearing on
whether tapes they claim proved his innocence (part of the undercover
conversation with Owens in March 2003) should be allowed in his August trial.
March 11: Scrushy’s attorneys accuse the Justice Department of concealing evidence of his
innocence by suppressing the tapes.
April: Fifteen former executives have pleaded guilty since March 2003.
April: Scrushy’s attorneys file court motions claiming that the Sarbanes-Oxley Act,
which Scrushy was accused of violating, was vague and unconstitutional.
April 15: The Delaware Supreme Court orders Scrushy to pay $25 million to HealthSouth,
the company that fired him the previous year, as company shareholders increase
their demands that he repay money they say was fraudulently earned.
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Exhibit 2
HealthSouth Stock Price
March 2003–April 2004 (in dollars)
Date Open High Low Close Avg. Vol. Adj Close*
Apr-04 $4.11 $4.82 $4.11 $4.55 0 $4.55
Mar-04 4.60 4.60 3.78 4.10 0 4.10
Feb-04 5.03 5.25 4.39 4.51 0 4.51
Jan-04 4.58 5.93 4.58 5.05 0 5.05
Dec-03 4.19 4.86 4.19 4.58 0 4.58
Nov-03 2.83 3.93 2.78 3.93 0 3.93
Oct-03 2.95 3.10 2.73 2.80 0 2.80
Sep-03 3.43 3.43 2.74 2.85 0 2.85
Aug-03 1.62 3.23 1.60 3.23 0 3.23
Jul-03 0.74 1.89 0.69 1.61 0 1.61
Jun-03 0.34 0.84 0.32 0.52 0 0.52
May-03 0.17 0.38 0.17 0.30 0 0.30
Apr-03 0.12 0.17 0.10 0.14 0 0.14
Mar-03 $0.09 $0.09 $0.09 $0.09 0 $0.09
* Close price adjusted for dividends and splits.

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