The SEC charged HealthSouth with inflating its earn- ings by $1.4 billion over a three-year period, with total inflated earnings of $2.5 billion over a decade. The casewas the first one brought under the new provisions of Sarbanes-Oxley for financial fraud.
In a federal district court hearing in Alabama in which former CEO Richard Scrushy asked for the re- lease of $70 million in his funds in order to pay legal fees and living expenses, the following information emerged:
- Two of the company's CFOs and its current CFO have been indicted for fraud.
- CFO William Owen recorded his conversations with Mr. Scrushy at the request of the FBI.
- Mr. Scrushy said on tape to Mr. Owen, "We just need to get those numbers where we want them to be. You're my guy. You've got the technology and the know-how."
- Mr. Scrushy sold $175 million in HealthSouth shares from the time the accounting fraud began.
- Mr. Scrushy's bookkeeper for his personal compa- nies committed suicide in September 2002. His new bookkeeper, Mary Schabacker, indicated that all of Mr. Scrushy's five corporations owe debts to each other, with no intention to repay them.
- HealthSouth stock was delisted from the NYSE in 2002. It was listed at $15 per share in 2001 and was worth pennies one year later.
- Mr. Owen's wife told him that if he kept signing "phony financial statements" that he might go to jail.
- Mr. Scrushy maintained that he knew nothing about the accounting fraud and that Mr. Owens did it all. Mr. Scrushy was acquitted later of all securities fraud charges but then convicted of bribery and sentenced to 7 years in prison.
- The acting chairman of the HealthSouth board said, "We [directors] really don't know a lot about what has been occurring at the company."
- For seven years, one director was paid a consulting contract of $250,000 per year.
- One director purchased a $395,000 resort property as a partner with Mr. Scrushy.
- One director secured a $5.6 million contract to install glass at a hospital HealthSouth was constructing.
- MedCenterDirect.com had as investors HealthSouth, Mr. Scrushy's private investment company, six of HealthSouth's directors, and the wife of one of the HealthSouth directors.
- HealthSouth directed business to MedCenterDirect.com, almost $174 million last year.
- The audit committee and compensation committee were joint committees made up of the same directors.
- HealthSouth invested $2 million in the Acacia Venture Partners, a venture capital fund founded and run by C. Sage Givens, a director of HealthSouth. When a shareholder questioned her independence as a result, HealthSouth defended her board position.
- Ernst & Young served as HealthSouth's auditor. It earned $1.2 million for financial statement audits and $2.5 million for other services.
Discuss the legal issues that each of these revela- tions raises. Be sure to cover the changes that Sarbanes- Oxley would impose. Also, refer back to Chapter 7 and determine whether criminal charges could be brought.