The Health South Case

In 2004, Health South disclosed that a forensic audit by Pricewater house Coopers found fraudulent activities totaling between $3.8 billion and $4.6 billion. Said Bryan P. Marsal, the company’s chief restructuring officer, the fraud included:

(1) $2.5 billion in fraudulent accounting entries from 1996 to 2002,
(2) $500 million in incorrect accounting for goodwill and other items involved in acquisitions from 1994 to 1999, and
(3) $800 million to $1.6 billion in “aggressive accounting” from 1992 to March 2003.

Shareholders and bondholders sued the company and its previous auditors and investment bankers. Fraud against Medicare, the government program for the elderly and disabled, an important revenue source, was only about $6 million. If massive Medicare fraud had been found, the company might have lost its Medicare business.

HealthSouth is one of the nation’s largest healthcare services providers with a chain of rehabilitation facilities across the country. The company boasts a vast network of highly skilled physicians and clinicians, providing access to high quality healthcare including: inpatient rehabilitation, outpatient rehabilitation, long-term acute care hospitals, home health and rehabilitation technology.

Despite what prosecutors described as “persuasive evidence,” the federal government’s string of victories in corporate corruption cases ended in 2005 when former Chief Executive and Chairman of HealthSouth, Richard M. Scrushy, was acquitted on 36 counts related to the accounting fraud. The verdict came in spite of the testimony of more than six former Scrushy lieutenants who outlined his role in the fraud. Further, 15 executives, including five chief financial officers had previously pleaded guilty or been convicted of participating in the fraud. A former chief financial officer, William T. Owens even presented a secretly recorded conversation with Scrushy who discussed the illegal activity. Apparently, Scrushy enforced discipline among members of the conspiracy through threats, intimidation and payoffs and was known to have eavesdropped on employee telephone calls and email and tried to buy their silence.

Mr. Scrushy’s defense team appeared to be successful at undermining the credibility of some of the witnesses and exploit the complexity of the case, which is reflected in the length of the trial – 5 months of testimony. Maybe more important to Scrushy’s success was what Alabama radio host Paul Finebaum described as playing the “race card” and playing the “religion card.” Mr.
Scrushy had attended a predominantly white church in an affluent suburb of Birmingham, Alabama. After his legal troubles began, Mr. Scrushy joined a predominantly black church and preached at several black churches around the city. Several pastors and congregants from black churches appeared each day in court with Mr. Scrushy. Several jurists even indicated that they would buy stock in a company under his (Scrushy’s) leadership.

Some of the victims of the fraud:
• The company defaulted on roughly $350 million of convertible bonds. While at the time, the analysts valued HealthSouth at $2.4 billion, the company’s debt totaled $3.5 billion.
• The stock price, which traded as high as $15.90 a share in the 12 month period prior to the fraud becoming known, fell to less than $0.10.
• Approximately 14,000 of 51,000 employees lost their jobs.
• The company and its insurers had to pay out more than $500 million in various settlements.
• The company also paid more than $400 million for forensic audits and restatement costs.
Richard Scrushy was known for his lavish lifestyle including owning a $10 million mansion in Palm Beach, Florida, a 92 foot yacht called Chez Soiree, a Rolls Royce and paintings by Picasso, Miro and Chagall. Mr. Scrushy was also known for his philanthropy. In 2006, Scrushy was ordered to repay $47.9 million in bonuses and interest that were tied to financial performance which had been inflated as a result of the fraud.

In a bizarre turn, Richard Scrushy was eventually convicted and sentenced to 6 years and 10 months in prison. However, the conviction was not directly related to the HealthSouth accounting fraud. In this second trial, Scrushy was accused by prosecutors of paying Alabama Governor, Don Siegelman, $500,000 for a seat on the hospital regulatory board. Scrushy was convicted of bribery, conspiracy and four counts of mail fraud, while former Alabama Governor Siegelman was sentenced to 7 years and 10 months after his conviction on similar charges.
Siegelman was freed on bond while awaiting appeal; Scrushy’s bond was denied because he was considered a flight risk.

Sources:
Voreacos, David, “HealthSouth Executives Plead Guilty,” The Globe and Mail (Canada), April 4, 2003
Vicini, James, “HealthSouth’s Scrushy to Face Criminal Charges: Fraud, Money Laundering,” National Post’s Financial Post and FP Investing (Canada), November 5, 2003
Whitmire, Kyle, HealthSouth to Pay $3 Million in U.S. Accounting Fraud Case,” The New York Times, May 19, 2006
Romero, Simon and Kyle Whitmire, “Former Chief of HealthSouth Acquitted in $2.7 Billion Fraud,” The New York Times, June 29, 2005.
Davidson, Laurence Viele, “Scrushy, Ex-Governor Convicted,” The Philadelphia Inquirer, June 20, 2006
Davidson, Laurence Viele, “HealthSouth’s Scrushy Gets 6 Years in Prison,” The Washington Post, June 29, 2007.
Rappeport, Alana, “Scrushy at Home on the Ranch,” CFO.com, June 6, 2008.

Question-
In your opinion, why did prosecutors fail to win a conviction of Scrushy in the HealthSouth accounting fraud case?