Healthsouth_Corp_-_the_Enemy_Within

HealthSouth Corporation-The Enemy Within Fraud Examination Each sector of the corporate health care marketplace has come to be dominated by a small number of high growth companies. In this marketplace, companies compete to take over competitors or else are taken over themselves. The most successful have expanded dramatically by taking over or merging with competitors. Vast empires and wealth go to those who compete most successfully in this. Those unable to do so do not survive. Investors and market analysts praised this consolidation of the marketplace. This is a market where the source of legitimate income needed to fund this growth and dominance is limited by government funding and by insurers’ determination to contain costs. The companies that seemed to be successful in this field included Tenet Healthcare, Sun Healthcare, Vencor, and Integrated Health Services, as well as HealthSouth Corp and several others. However, things were not as they appeared to be. By early 1998, it became evident that most of these companies had built their dominant corporate empires in the strongly competitive healthcare marketplace by defrauding the system of payment, increasing returns by playing on the vulnerability of citizens, over-servicing and overcharging, cutting the costs of care by understaffing, under-resourcing and under servicing, or by a combination of these. Of those listed above, there was one company that seemed to be free from the deceptive practices which seemed to dominate the entire health services industry – HealthSouth Corp. Time would tell a very different tale about the health services mega giant. Background HealthSouth was founded in 1984 by Richard Scrushy, Aaron Beam, and a number of Scrushy’s close associates. It was financed with venture capital from New Enterprise Associates of Baltimore. New Enterprise’s co-founder Charles W. Newhall III, a major figure in the venture trade became a HealthSouth board member, Aaron Beam became the Chief Financial Officer and Richard Scrushy became the Chief Executive Officer. In 1986 HealthSouth went public, and started its rapid growth by buying and building rehabilitation hospitals, outpatient rehabilitation clinics and later diagnostic services and outpatient surgery centers. Over the next 12 years it would become the leader of rehabilitation and outpatient surgery. During this timeframe, Scrushy and his partners also spawned a close-knit group of interlinked and cooperating personal and public companies to exploit the opportunities provided by the health care market. It would later be claimed that their business dealings with one another were not appropriate. Scrushy and his close associates tightly controlled the companies and their directors, while conflicts of interest were simply ignored. For most of its first 19 years HealthSouth seemed the model company. It grew more rapidly than most of the other growth companies and more effectively dominated its sectors. In fact, its stock was soaring. In a recent interview, HealthSouth’s first CFO Aaron Beam indicated that the company’s bottom line “grew by 20% to 30% on a yearly basis” (Teach, 2009) throughout this period. As a result, HealthSouth became the uncontested master of rehabilitation gobbling up almost all of its corporate competitors. It bought up the majority of outpatient surgical centers in the USA. It operated in every state and its directors and investments extended into home care, nursing homes, post acute care, physician management, the pharmaceutical business and even managed care. It had established footholds in Europe, Canada and Australia. It even tried to buy the giant acute hospital group Columbia/HCA. All the while boasting that it was not tarnished by the fraud and patient care issues which characterized the healthcare market, it was a marketplace darling and appeared to be poised to dominate the global healthcare industry. Scrushy Richard Scrushy’s personal wealth soared right along with HealthSouth’s stock. By the end of the 1990s, Scrushy was worth an estimated $300 million dollars, and he was not at all quiet about the fact that he was wealthy (Grow, 2003). In addition to possessing wealth, Scrushy was incredibly charismatic, and thanks to his involvement in various philanthropic ventures, he enjoyed celebrity status in his home state of Alabama. As a result, Scrushy's name is on buildings statewide including the football stadium at Troy State University, which he gave $1 million for an expansion. Among the prized possessions he amassed with his vast wealth was a 92-foot yacht he dubbed the Chez Soiree, and a vacation home in Palm Beach that was the envy of all. Additionally, he owned two homes and land worth $4.8 million in Jefferson County, as well as two houses and land valued at $5 million at Lake Martin, a popular weekend spot in eastern Alabama. Scrushy was not just generous with his own money; he was generous with the company’s money as well. In addition to an endless stream of corporate acquisitions and mergers, he commissioned a 74-acre campus to be built, complete with a five-story building to house the company’s headquarters, an attached conference center, parking deck, museum (essentially a shrine to Schrushy), and a company store. Further, Scrushy found it necessary for the company to assemble a fleet of 11 corporate jets, which he used for both personal and business travels. There is no denying Scrushy enjoyed living the life of luxury. An argument could be made that it was precisely this insatiable desire for wealth and fine living that was the driving force behind the other side of Richard Scrushy; the dark side that only those who displeased him were privy to. When asked about his relationship with Richard Scrushy, former CFO Aaron Beam replied “you couldn’t tell Scrushy no on anything. I have seen him so mad over minor things that I actually feared for my physical safety” (Teach, 2009). Beam is not the only one who has made such comments about Scrushy. Senior employees of the HealthSouth Corporation used to dread their weekly Monday morning meetings, because Scrushy would grill his assembled subordinates about the numbers, from the performance of the company's hospitals to the details of a cellular telephone bill. Employees called these “Monday-morning beatings,” as Mr. Scrushy turned his attention to some shortcoming and publicly humiliated the person deemed responsible (Abelson, 2003). Additionally, “government officials, former employees and others say Mr. Scrushy created an elaborate facade by manipulating those around him. He surrounded himself with people who believed they owed him nearly everything. He played on their insecurities, greed and, at times, their fears, associates say” (Abelson, 2003). Investigations Due to the nature of HealthSouth’s rehabilitation business, a large percentage of its patients were Medicare recipients. As stated in the BusinessWeek article, Too Good To Be True, having a business in which a large portion of revenues were generated through federal funding “was a good place to be in the 1980s when government health-care subsidies were taking off” (Grow, 2003). By 1997, “Medicare accounted for 37% of HealthSouth’s revenues and had helped expand margins to 31%” (Grow, 2003). However, in 1997 Congress drastically cut Medicare reimbursements to hospitals, which caused HealthSouth’s operating margins and profits to nose-dive for the next two years (Grow, 2003). This is the point where the trouble began for HealthSouth During 1998 HealthSouth predicted that for the first time its profits would not meet expectations. There was a great deal of criticism, but Scrushy brushed this aside and the company recovered. Despite this recovery, cracks began to appear with criticisms and allegations of Medicare fraud and suboptimal care. In 2002 insiders sold large numbers of shares before announcing a projected massive loss and plans to split the company. It seems that the Enron and WorldCom accounting scandals, in conjunction with the new criminal legislation increasing penalties, had alarmed the company and as a result, these were both attempts to bury their own fraud. The market and shareholders were not deceived by this and an investigation got under way. Senior officials rolled over and made tape recordings of their colleagues. It seemed that from soon after it went public in 1986 the company had been carefully doctoring its accounts, and declaring profits which were not there. HealthSouth’s entire empire was built on deceit, its ability to raise money from banks and the marketplace based on its grossly inflated income stream, and the inflated reports of market analysts. From 1999 to 2003 this falsely declared income amounted to approximately $2.5 billion. Concerns about HealthSouth were not localized to its accounting practices. There were governance concerns about its controlling directors and the relationships between them, and with a group of related companies run by HealthSouth directors and doing business with HealthSouth. Of particular concern were HealthSouth’s relationships with the wider business community, auditors and bankers. These groups vetted the company’s accounts and also did lucrative business with HealthSouth. Whether any of them were complicit in the fraudulent activities or simply turned a convenient blind eye to what was happening is not clear. Certainly they benefited handsomely from business done with HealthSouth, business they would have lost if they had been picky. Accounting On March 19, 2003, the US Securities and Exchange Commission (SEC) officially charged HealthSouth and Richard Scrushy, with accounting fraud. According to the SEC, the accounting fraud may have started soon after or even before the company went public in 1986, but the allegations made public to date extend back only to 1993 and the court actions to 1997. In essence the accounting fraud resulted in a massive overstatement of profits to banks, to the SEC and to the market. The consequence was that the company appeared to have far more money and much larger assets than it actually had. According to HealthSouth’s first CFO, Aaron Beam, the fraud began in the summer of 1996, because the company could “no longer change estimates to make earnings” (Teach, 2009). Beam adds, “We thought we could make a lot of entries small enough that the auditors wouldn’t detect them. So one night during the second quarter of ’96, we credited revenue that did not exist and we debited assets that did not exist” (Teach, 2009). Accountant Harvey Kelly who was called in as an expert witness for the defense in the Scrushy trial made the argument that HealthSouth’s various subsidiaries would submit legitimate financial statements to the corporate office, where those numbers were inflated by office staff prior to the issuance of consolidated financial reports (USA Today, 2005). Most of these fabricated numbers were put into an account called “contractual adjustments,” implying that the company would be collecting more money from patients than it actually anticipated getting (USA Today, 2005). Additionally, HealthSouth recorded false income by failing to properly record the sale of technology to a related company, and fake assets were listed on the company’s books. Auditors Some of the most troubling issues surrounding HealthSouth include its dealings with its auditors Ernst and Young, its tax accountants KPMG, its loan bankers, its investment bankers and the stock analysts who advise the market. The question is whether those in these powerful and influential groups knew of the fraud. Did they choose to look past it because they did so much business with HealthSouth and associated companies' It is difficult to believe that so many large and experienced commercial groups closely studied HealthSouth's business when making decisions on behalf of their shareholders yet failed to detect a $2.5 billion empty hole in the profits. Ernst & Young became auditors for HealthSouth in 1984. It has been suggested that Scrushy fired the previous auditors because they refused to meet his requirements. Ernst and Young's role in HealthSouth's fraud must be seen in the light of the conduct of its accounting peers in ignoring fraud and sometimes actively participating in it. This is well illustrated by the complicity of auditors in the Enron fraud. In March 2009, Ernst and Young settled a securities class action lawsuit brought against them by HealthSouth investors for $109 million (Bankston, 2009). The lawsuit alleged that Ernst and Young “knew HealthSouth’s financial statements were materially overstated, failed to conduct audits of HealthSouth that were in compliance with Generally Accepted Auditing Standards, did not test a single nonstandard journal entry or HealthSouth’s general ledger, and permitted HealthSouth to impose scope limitations on its audit of the company” (Bankston, 2009). Prior to settling with investors, in January 2007, Ernst and Young settled a lawsuit with HealthSouth Corp. in the amount of $445 million. Despite paying the settlements, Ernst and Young contend that the firm was deceived by former HealthSouth executives, and consequently had no knowledge of the accounting fraud at HealthSouth Corp. Guilty or not there was definitely conflict of interest in the relationship between Ernst and Young and HealthSouth Corp. A number of HealthSouth staff, including one of the CFOs William Owens, were past employees of Ernst and Young. They would have known Ernst and Young's practices well and probably retained many friends there. They were well placed to design and implement fraudulent activity that would not too obviously trigger the auditor's alarm bells. Penalties By the time the dust settled, eighteen HealthSouth Corp. employees had been charged with fraud. Most were executives, and all but two entered guilty verdicts. Following are specifics on some of them, and the penalties they were given. All were fired from HealthSouth as a result of their involvement. In December 2003, Emery Harris, a former assistant controller at HealthSouth Corp., was sentenced to five months in prison for his role. Harris was the first person to receive a jail sentence for playing a role in the fraud. In addition to jail time, Harris was ordered to pay $106,500 in restitution, plus a $3,000 fine, six months' home detention and three years' probation immediately following prison time (Reuters). Three former vice presidents -- Angela Ayers, 34, Cathy Edwards, 34, and Rebecca Kay Morgan, 56 -- and an ex-assistant vice president, Virginia Valentine, 33, each were sentenced to four years' probation, six months' home detention and $2,000 fines. Morgan also agreed to pay $235,000 restitution out of her HealthSouth stock and options. (Reuters). In June 2004, Kenneth Livesay, previously an assistant controller and chief information officer at HealthSouth, was sentenced to five years probation, and ordered to pay a $10,000 fine, forfeit $750,000 for his part in overstating HealthSouth's earnings and assets, and spend six months under electronic monitoring(Reuters).. In addition to Livesay, Malcolm McVay, a former HealthSouth Corp. chief financial officer, was sentenced to six months home detention and five years probation, fined $10,000, and ordered to forfeit $50,000(Reuters). Former HealthSouth Corp. Chief Financial Officer Michael Martin was sentenced to five years probation, fined $50,000, and ordered to forfeit gains of $2,375,000(Reuters). In August 2005, Aaron Beam, the first chief financial officer of HealthSouth Corp., was sentenced to three months in jail, fined $10,000 and ordered to forfeit $275,000. Although Beam was facing up to 30 years in jail and fines of $1 million after pleading guilty to bank fraud, government lawyers had requested leniency because he provided investigators with information about accounting fraud at the company(Former, 2005). In Decmber 2005, William Owens, a former chief financial officer and briefly chief executive officer at HealthSouth Corp. was sentenced to five years in prison, and his marriage ended as a result of his involvement. In a bizarre twist, in June 2005, Richard Scrushy was acquitted of all 36 counts that he had been charged with. Although escaping criminal charges for his involvement in the fraud at HealthSouth Corp., Scrushy faced many lawsuits from HealthSouth, the Securities and Exchange Commission, shareholders, and whistleblowers regarding Medicare fraud among others. As settlement for one of those lawsuits, Scurshy was ordered to pay back every penny he ever received in bonuses while at HealthSouth. Scrushy would later be convicted on bribery charges for bribing the Governor of Alabama for a seat on a local hospital board, for which he received 7 years in prison. HealthSouth itself escaped criminal charges, because prosecutors decided to focus on individual executives instead. The company faced a complete restructuring of its board of directors and leadership. Additionally, HealthSouth was the subject of many lawsuits from whistleblowers, Ernst and Young, Richard Scrushy, shareholders, insurance companies, and employees. Many of which have only recently been settled. HealthSouth was also delisted from the stock market for a significant amount of time. Change Exposure of the details of the scandal and the tortuous threads between directors, companies, auditors, banks and analysts continued as the company plunged towards Chapter 11 bankruptcy. Likewise, analysts continued to speculate about a likely bankruptcy, but HealthSouth claimed it could still make it and asked its creditors to be patient. It also went looking for more capital and hired restructuring firm Alvarez & Marsal to assist in getting its finances in order. Bryan Marsal was immediately appointed Chief Restructuring Officer. By the end of 2003, the company had most of its finances back in order and was able to avoid Chapter 11 bankruptcy. Scrushy refused to resign, and due to an inability to quickly reconstruct accurate records, HealthSouth was only able to suspend Scrushy at first. In the time between his suspension and actual firing, Scrushy remained on the board, but did not attend any meetings. The company did, however immediately fire Ernst and Young the auditors who had missed the fraud. Further, it no longer used UBS as its bankers. Facilities were closed or sold off to raise funds and many staff members were fired. There were many changes in management and to the board in the years following the fraud. Some staff had already gone during the initial fallout. On May 10, 2004 Jay Grinney was chosen by the board as the company's permanent CEO. Soon after Grinney's appointment, the company moved forward with its goal of again becoming a current filer with the SEC. By doing so the company restated earnings from 2000 to 2003. The company also sold or closed many underperforming facilities including its medical center division in its effort to return to profitability (Wikipedia). On May 15, 2006 the company completed its goal of once again becoming a current filer with the SEC when it filed its first quarter 2006 financial result. It was the first time the company had filed a 10-Q since its accounting scandal began. On August 14, 2006 the company unveiled its restructuring plan which included the sell, spin-off or other disposition of its surgery, outpatient, and diagnostic divisions along with a 1-for-5 reverse stock split to coincide with its relisting on the New York Stock Exchange under the symbol HLS. The reverse stock split was approved by stock holders at a special meeting at the company's corporate headquarters on October 18, 2006. The last step in HealthSouth's recovery from its accounting scandal occurred on October 26, 2006 when it was again relisted on the New York Stock Exchange (Wikipedia). Conclusion In the end, HealthSouth ended up being guilty of defrauding the system of payment, increasing returns by playing on the vulnerability of citizens, over-servicing and overcharging, cutting the costs of care by understaffing, under-resourcing and under servicing, as well as cooking its books to overstate revenues and defraud investors to the tune of $2.7 billion. Despite boasting about their impeccable record regarding these things years before when the likes of Tenet Healthcare, Sun Healthcare, Vencor, and Integrated Health Services all underwent similar things, the far reaching arms of the fraudulent activities at HealthSouth turned out to be even more sinister. Under the leadership of Richard Scrushy, HealthSouth Corp. cultivated a corporate culture of greed and intimidation, displayed a complete lack of respect for internal controls and Generally Accepted Accounting Principles, endured excessive pressure from the market to perform, and fostered an exorbitant number of inappropriate relationships with bankers, auditors, government officials, lawyers, and stock market analysts that screamed of conflict of interest. In retrospect, it is easy to see why fraud at such a deep level took place at HealthSouth. All of the elements were in place. The astonishing part of this story is how it went on undetected for so many years with so many parties in collusion. The gnawing tragedy in this case, however, has got to be the fact that to this date no one has really significantly paid a penalty for the egregious activities that transpired. Fifteen members of HealthSouth’s staff pleaded guilty to participating in the fraud and agreed to give evidence for the prosecution. They were sentenced by different judges who held very different views about the roles they had played, the weight to be given to their cooperation, and the importance that should be given to the fact that the real culprit, Richard Scrushy, had completely evaded justice. The sentences were extremely variable, and most very lenient with only a few jail sentences. The prosecution appealed many of the sentences and some were increased. The only staff member who pleaded not guilty and attempted a defense received 8 years, the harshest sentence of all. Ultimately no one paid a price remotely commensurate with the crime committed. Much can be learned from the scandalous greed and corruption at HealthSouth, including the way cases like this should be treated in the court system going forward. Although in this case penalties were arguably not severe enough, much useful incite has been gained. Learned lessons are the only positive that can come from this tragedy that ruined so many lives. Works Cited Abelson, R., Freudenheim, M., (2003, April 20). The Scrushy Mix: Strict and So Lenient. The New York Times. Retrieved from http://www.proquest.com.proxy.msbcollege.edu:2048/pqdweb'index on June 13,2009. Accountant Describes How HealthSouth Fraud Happened. (2005, January 28). USA Today. Retrieved from http://usatoday.printthis.clickability.com/pt/cpt'action on June 9,2009. Bankston, J., (2009, March 25). Labaton Sucharow LLP Settles Securities Class Action Against Ernst & Young LLP for $109 Million. Business Wire, New York. Retrieved from http://proquest.umi.com/pqdweb'did=1667145051&Fmt=38clientId=47650&RQT=309&VName=PQD on June 9, 2009. Bergevin, P.M., Magrath, L., & Weld, L.G., (2004). Anatomy of a Financial Fraud, A Forensic Examination of HealthSouth., The CPA Journal., Retrieved from http://www.nysscpa.org/printversions/cpaj/2004/1004/p44.htm on June 9, 2009. Grow, B., (2003, April 14). Too Good To Be True. BusinessWeek. Retrieved from http://search.ebscohost.com/login.aspx'direct=true&cb=buh&AN=9454474&site=ehost-live on June 10, 2009. Teach, E., (June, 2009). “I Should Have Said No.”, CFO Magazine. Retrieved from http://www.cfo.com/article.cfm/13687644'f=most_read on June 1, 2009. Wikipedia., HealthSouth Corporation. Retrived from http://en/wikipedia.org/wiki/HealthSouth on June 13, 2009.