Michael LaNue, Michael

Tancredo, Dina Mamarbashi,

Jordan Nguyen (Section 1)

Executive Summary
HealthSouth Accounting Fraud
Intro
HealthSouth Corporation a company whose headquarters is in Birmingham,
Alabama, operates inpatient rehabilitation hospital as their line of business. The
company while being headquartered in Birmingham, Alabama, has been able to
proliferate throughout the United States through aggressive acquisition. Currently
the company trades on the New York Stock Exchange under the symbol HLS.
However, HealthSouth almost lost this privilege in 2003 when government officials
unearthed the companys involvement is a massive accounting scandal that nearly
led to the companys financial devastation. This executive summary will give a brief
overview of the chronological timeline of the HealthSouth Case, particularly of the
events which transpired as well as how the accounting fraud was committed

History
Founded 1984 by respiratory therapist Richard Scrushy, the company became an
overnight success. After only two years the company went public with Scrushy
leading the charge as its Chief Executive Officer (CEO). After its initial public offering
the company used its cash to acquire numerous hospitals and health-care
companies to artificially growa growth that continued throughout the 1980s and
1990s. Throughout this period of growth Scrushy cemented his position as one of
the top paid executives in the country with a vested interest in HealthSouth that
was worth approximately 300 million.

Immergence of Scandal
Problems started to arise in 2002, however, when HealthSouth asserted that
alterations to Medicare payment policy would impact their bottom line and would
result in the company losing half of its market value. This drop in value starts to be
investigated especially since two months prior, Scrushy had sold his shares of
Health South stock totaling 100 million dollars. In March 18 th the Federal Bureau of
Investigation (FBI), using a search warrant, raided the HealthSouth headquarters
with the intent of confiscating the companys financial records. The next day after
being raided, the Securities and Exchange Commission (SEC) elucidated to the fact
that HealthSouth had already been under investigation for over 6 months.
Furthermore, they also enlightened that HealthSouths earnings had been
overstated by 1.5 billion dollars. This was done, according to the SEC on the
instructions of Richard Scrushy. Before each quarter Richard would instruct senior
accountants to alter the numbers if they were less than Wall Streets estimates. The
numbers were then inflated though a series of meetings known as family
meetings.

Method of Fraud
To increase earnings senior accountants will falsify journal entries by adjusting the
contra-revenue account. This account lowers revenue for health-care providers
because for many cases, the gross billings to customers and insurer
reimbursements are different. As the reimbursements occur in a later period, the

Michael LaNue, Michael

Tancredo, Dina Mamarbashi,
Jordan Nguyen (Section 1)

contra-revenue account is standard. HealthSouth executives continually made

adjustments to this account in order to increase their earnings. To balance out the
accounting equation, HealthSouth senior accountants would also make journal
entries to record fake assets under $5000, knowing that the external auditors would
not examine them because the amount is immaterial. With an average journal entry
of $2500 there were over a million separate entries that had to have been created
to perpetrate this fraud.

Aftermath
After the raid of HealthSouths headquarters by the FBI, the company was
immediately suspended on the market before being delisted the following week.
When trading did resume the stock price fell from almost $20 a share to being only
worth 60 cents. Their credit line was also frozen by retail banking institutions such
as JP Morgan Chaseleading to the possibility of bankruptcy. Along with
repercussions by external entities, HealthSouths board of directors placed both
Richard Scrushy and William Owens, who was the current Chief Executive Officer
(CFO) at the time, on administrative leave. Following the aftermath, HealthSouth
executives were indicted; while Owens and other former HealthSouth CFO pleaded
guilty to in order to lessen the lengths of their criminal sentences, Scrushy
adamantly repudiated his involvement and heavily emphasized his lack of
knowledgerefusing to be the first CEO to be charged with violating the recentlypassed Sarbanes-Oxley Act of 2002.

Forensic Audit and Results

PricewaterhouseCoopers (PwC) was then hired by the audit committee to conduct a
forensic audit.
The forensic results were startling. In June of 2004, PwC, through a report of their
findings, illuminated the degree of fraud that encompassed HealthSouth during its
years of operations, particularly between 1996 and 2002. Below is a table that
delineates the different accounting rules employed by HealthSouth executives in
order to overstate their earnings.
Impact to income Before Taxes
Reduction of Contractual Allowances
Acquisition Accounting
Bonus Accounting
Investment Accounting
Facility Contractual Accounting
Third-party Transaction Accounting
Total

Scrushys Litigation

(In Millions)
2,203
421
52
17
19
29
2,714

Scrushy went to trial in January 2005. Using numerous testimonies from former
HealthSouth executives as ammunition, the U.S. government sought to put Scrushy
away for a very long time. Unfortunately, Scrushys lawyers were very proficient at
their jobs. Arguing that the fraud was done without Scrushys knowledge and
attacking both the credibility and character of the witnesses, Scrushy was
exonerated from blame. Yet despite the success of his trial, Scrushy was still not
liberated from the courtroom. Months later he was again indicted on charges of

Michael LaNue, Michael

Tancredo, Dina Mamarbashi,
Jordan Nguyen (Section 1)

bribery with the former Alabama governor. He was convicted and sentenced in 2006
for 7 years in prison. Since June 2012, he has been released from custody but still
faces a class-action lawsuit from HealthSouth shareholders seeking 2.6 billion
dollars in compensation.

Current HealthSouth

After the chaos of the accounting scandal, HealthSouth had been able to avoid
bankruptcy by selling off assets and refinancing its debts. It also brought in
consultants to implement internal controls in order to avoid fraud from reoccurring.
Keeping only its core inpatient rehabilitation centers, HealthSouth now operates
within 26 states and is currently trading at $35.34 per share. It has emerged from
the rubble to become a stronger company and that has learned a very important
lesson, one that we believe will help it continue to grow even further while still
being ethical to its stakeholders.