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HealthSouth Corporation: Fraud, Greed and Corporate Governance

Manmohan D. Chaubey, Ph.D. The Pennsylvania State University One College Place Du Bois, PA 15801 (USA) Tel: 814-375-4846 Fax: 814-375-4784 Email: mdc13@psu.edu

Case for ICMC2006 International Conference on Management Cases 4-5 December 2006 IMT Ghaziabad, India

HealthSouth Corporation: Fraud, Greed and Corporate Governance
During the 1990s, Richard M. Scrushy, the former CEO of HealthSouth Corporation, engineered many acquisitions of rehabilitation clinics, outpatient surgical care operators, nursing homes and other health care companies. In 2003, the Securities and Exchange Commission (SEC) accused the company and Scrushy of inflating earnings to the tune of $1.4 billion since 1999. In November 2003, a federal grand jury indicted Scrushy on 85 counts including conspiracy, securities fraud, money laundering and charges related to overstating HealthSouth’s earnings by nearly $3.0 billion. According to federal investigators, the company overstated earnings to meet analysts’ earning estimates, while hiding the accounting fraud from the auditors. However, questions were raised whether the auditors failed to find or simply overlooked the fraud at HealthSouth. Central to the investigation was the issue of what role Scrushy played in “cooking the books.” However, as the case unfolded, it highlighted many other issues such as: The role of Board of Directors in corporate governance; the role of the auditors; the effect of conflict of interest between an accounting firm and its consulting arm on auditing; whether the relationship between an investment bank and a company affects the quality of the bank’s research reports on the company; whether the executive compensation that overly relies on company’s earnings provides an incentive for committing such fraud; whether a strong leader can silence all voices of reason in an organization.

Background
Scrushy, once a high school dropout, worked as a gas



References: Frieswick, Kris (2003). “How Audits Must Change”. CFO. Boston: Jul 1, 2003. Glater, Jonathan D. (2003) “HealthSouth Looks Deeper Into Its Books.” New York Times. (Late Edition, East Coast). New York, N.Y.: Jul 12, 2003. p. C.1 Helyar, John (2003). “The Insatiable King Richard He Started As A Nobody. He Became A Hotshot CEO. He Tried To Be A Country Star. Then It All Came Crashing Down. The Bizarre Rise and Fall of Healthsouth 's Richard Scrushy.” Fortune Magazine, July 7, 2003. Hoover’s Inc. (2006). http://premium.hoovers.com. HealthSouth Corporation-Profile, Accessed on (August 10, 2006) Johnson, Carrie (2005). “Credibility Of Ex-CFO Questioned; Owens Opportunistic, Scrushy Lawyers Say”, The Washington Post. (Final Edition). Washington, D.C.: Feb 12, 2005. pg. E.01 Johnson, Carrie (2005a). “Jury Acquits HealthSouth Founder of All Charges”. The Washington Post. (Final edition), Washington, D.C.: Jun 29, 2005. p. A.01 Lublin, Joann S. (2003). “Boardrooms Under Renovation; Independence Of Directors Is Elusive Goal”. Wall Street Journal, (Eastern edition). New York, N.Y.: Jul 22, 2003. p. B1 Morse, Dan & Evelina Shmukler (2005). “Executives on Trial: HealthSouth CFO 's Testimony May Bolster Case for Defense; Prosecution Witness Says He Punched a CoWorker, Wanted to Kill Some Others”. Wall Street Journal. (Eastern edition). New York, N.Y.: Mar 9, 2005. pg. C.4 Romero, Simon & Glynn Wilson (2005). “Race, Religion and the HealthSouth Founder 's Trial”. New York Times. (Late Edition, East Coast). New York, N.Y.: Feb 17, 2005. pg. C.1 Securities and Exchange Commission (2003). “Complaint: HealthSouth Corporation and Richard M. Scrushy”. http://www.sec.gov/litigation/complaints/comphealths.htm. Accessed on August 10, 2006. Shmukler, Evelina (2005). “Executives on Trial: Witness Says Scrushy Skipped HealthSouth 'Family ' Meetings”. Wall Street Journal. (Eastern edition). New York, N.Y.: Feb 28, 2005. pg. C.4 Weil, Jonathan (2003). “HealthSouth - Proxy Document Says Company Performed Janitorial Inspections Misclassified as Audit-Related.”. Wall Street Journal. (Eastern edition). New York, N.Y.: Jun 11, 2003. pg. C.1 Weil, Jonathan (2003a). “HealthSouth and Ernst Renew Flap Over Fee Disclosures.” Wall Street Journal. (Eastern edition). New York, N.Y.: Jul 1, 2003. pg. C1 Wilke, John R., Chad Terhune & Carrick Mollenkamp (2003). “HealthSouth Ex-Chairman Faces Charges He Took Part In Big Accounting Fraud”. Wall Street Journal. (Eastern edition). New York, N.Y.: Nov 4, 2003. p. A.3. Teaching Notes HealthSouth Corporation: Fraud, Greed and Corporate Governance Case Summary During the 1990s, Richard M. Scrushy, the former CEO of HealthSouth Corporation, engineered many acquisitions of rehabilitation clinics, outpatient surgical care operators, nursing homes and other health care companies. Mr. Scrushy had been a respiratory therapist who spotted a niche in the health care market and utilized his entrepreneurial talents, marketing skills, and super salesmanship to set up and run what became the third largest publicly held company in Alabama. Eventually, HealthSouth became the largest provider of ambulatory surgery and rehabilitative health care services in the United States with 1,700 facilities and 51,000 employees. In 2003, the Securities and Exchange Commission (SEC) accused the company and Mr. Scrushy of inflating earnings to the tune of $1.4 billion since 1999. In November 2003, a federal grand jury indicted Mr. Scrushy on 85 counts including conspiracy, securities fraud, money laundering and charges related to overstating HealthSouth’s earnings by nearly $3.0 billion. According to federal investigators, the company overstated earnings to meet analysts’ earning estimates, while hiding the accounting fraud from the auditors. However, questions were raised whether the auditors failed to find or simply overlooked the fraud at HealthSouth. Central to the investigation was the issue of what role Mr. Scrushy played in “cooking the books.” However, as the case unfolded, it highlighted many other issues such as: The role of Board of Directors in corporate governance; the role of the auditors; the effect of conflict of interest between an accounting firm and its consulting arm on auditing; whether the relationship between an investment bank and a company affects the quality of the bank’s research reports on the company; whether the executive compensation that overly relies on company’s earnings provides an incentive for committing such fraud; whether a strong leader can silence all voices of reason in an organization. This case can be used for teaching corporate governance, business ethics, corporate fraud, and corporate social responsibilities. It highlights the pitfalls in corporate management when the various actors—directors, auditors, investment bankers, company executives— work solely in the interest of a few and ignore the interests of other stakeholders. 1. What is the role of the company’s Board of Directors in: Providing oversight of company’s CEO’s performance? Protecting the long-term interest of the shareholders? Providing oversight of company’s financial performance through its audit committee? 2. A portion of executive compensation is based upon company’s performance? How can we ensure that the Executives do not use the company to their own benefit? 3. What is the role of company auditors? How do we ensure auditor’s impartiality and independence? 4. Why is the role of ethics in management? What are the consequences of unethical behavior? 5. What is corporate social responsibility? Is committing fraud not only illegal, but also unethical and socially irresponsible? 6. Are there limits to the powers of a chief executive? How can this power be controlled? 7. What is the role of other senior executives? Can you visualize senior level executives conspiring to cook the book without the knowledge of the CEO? Under what conditions that could happen? What can prevent such a situation?

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