Running header: HEALTHSOUTH: THE SCRUSHY WAY 1

Business Ethics
HealthSouth: The Scrushy way—Activity 8
Melinda S. Whitman
Dr. Jennifer Scott
Northcentral University
May 19, 2013

HEALTHSOUTH: THE SCRUSHY WAY 2
Table of Contents
Introduction…………………………………………………………………………….. 3
Richard Scrushy Represented the American Dream…………………………………… 3
The Sarbanes-Oxley Act was enacted in 2002…………………………………………. 4 What caused the demise of HealthSouth?...……………………………………. 5
Characteristics of Unethical CEOs……………………………………………………… 6
Was Richard Scrushy narcissistic?.……………………………………………………. 7
Impact on Stakeholders………………………………………………………………… 8
Outcome and Fairness of Punishment…………………………………………………. 9
Conclusion……………………………………………………………………………... 10
References……………………………………………………………………………… 12

HEALTHSOUTH: THE SCRUSHY WAY 3 Introduction For at least 20 years, HealthSouth represented a new concept in health care. Its founder, Richard Scrushy was the embodiment of the American dream. His rise was meteoric, yet ultimately the empire he created collapsed due to fraud of his creation. Richard Scrushy Represented the American Dream Richard Scrushy came from humble beginnings. He was born in Selma, Alabama, dropped out of high school, married, and fathered two children. He worked in manual labor jobs, even managing a gas station, until he enrolled in the University of Alabama and completed a degree in respiratory technology (Solomon, Carrns & Terhune, 2003, March 20). After he worked as a respiratory technician for several years he began a company of small hospitals and clinics and created a hospital model which he believed would revolutionize the future of health care (Jennings, 2012) and HealthSouth was born. HealthSouth went public in 1986 with an initial public offering (IPO) of one dollar per share (Jennings, 2012). He courted celebrity endorsements and the trappings of success (Jennings, 2012). In less than two years, HealthSouth’s stock rose to $31 per share and continued to rise thirty-one percent per year over the next decade (Jennings, 2012). Scrushy boasted to industry analysts that HealthSouth had exceeded earnings estimates for 47 quarters in a row and through business acquisitions it became a billion dollar company (Jennings, 2012). HealthSouth became the largest provider of inpatient rehabilitative facilities by creating a network of inpatient and outpatient facilities, outpatient surgery centers, and other healthcare facilities that provided medical services at lower cost than traditional inpatient hospital facilities (Carlson, Coulter & Vogel, 2009). By 2001, HealthSouth operated 1,900 facilities worldwide (Carlson, et al., 2009).

HEALTHSOUTH: THE SCRUSHY WAY 4 As the corporate executive officer and founder, Scrushy personally benefited from the success of HealthSouth. He owned nineteen cars, and art including original works by Renoir and Picasso (Robertson, 2011, March 20). One of the highest paid CEOs at the time, Scrushy earned a salary of $4 million and received a $6.5 million bonus in 2001 alone. The Sarbanes-Oxley Act was enacted in 2002. To address concerns about corporate accountability and accounting practices, Congress passed the Sarbanes-Oxley Act (SOX) in 2002. The country had already experienced a market crisis as many technology companies formulated in the 1990s started to lose value precipitously (Carlson, et al., 2009). In addition, in the previous year a number of significant corporate frauds had been discovered, from Enron to Worldcom and others (Carlson, et al., 2009). To comply with SOX requirements that all financial statements be certified, Richard Scrushy, as HealthSouth’s corporate executive officer (CEO) and its corporate financial officer (CFO) William Owens certified to the accuracy of HealthSouth’s 2001 financial statements which were filed with the Securities and Exchange Commission (SEC) in 2002 (Carlson, et al., 2009). Within a matter of months, questions about the accuracy of the financial stability of HealthSouth surfaced and by February of 2003, the SEC had begun a formal investigation into HealthSouth’s accounting practices (Carlson, et al., 2009). In March 2003, HealthSouth became the first corporation accused of accounting fraud under the SOX law (Carlson, et al., 2009). Several corporate executives freely admitted to authorities that they knew the financial statements were a sham but that they had been directed by Scrushy to make the numbers match Wall Street expectations of HealthSouth’s performance (Solomon, Carrns, & Terhune, 2003, March 20). Additionally, the SEC alleged that on a quarterly basis HealthSouth, with the participation of Scrushy and other senior executives would pick a desired number to represent earnings per share, and then would manipulate the number in such a way so as to arrive at that figure (Solomon, et al., 2003, March 20). The SEC also alleged

HEALTHSOUTH: THE SCRUSHY WAY 5 that HealthSouth reflected inflated earnings by decreased operating expenses, showed some expenses as capital assets, and simply manufactured more than $800 million of non-existent assets, among other things (Solomon, et al., 2003, March 20). Although HealthSouth showed a profit of $230 million in 1999 because of the manipulated financial statements, in reality, the company had a loss of $191 million during that time frame (Solomon, et al., 2003, March 20). The SEC further alleged that HealthSouth’s accountants had perpetrated the fraud by creating false entries that it knew would go undetected by its auditor, Ernst and Young (Solomon, et al., 2003, March 20). HealthSouth insiders who were alleged to have cooperated with the SEC stated that in 1997 they had asked Scrushy to stop the financial manipulation but that Scrushy would not do so before selling his stock (Solomon, et al., 2003, March 20). Ultimately, investigations revealed that HealthSouth’s revenues had been reported 2500 percent higher than actual earning in the five year period from 1997 to 2001, a figure which reached $2.1 billion (Jennings, 2012). Once the SEC revealed its findings, the stock traded on pink sheets at $0.16 per share from a high of $31 in 1998 (Jennings, 2012). What caused the demise of HealthSouth? Certainly, there is no single factor which caused so many at HealthSouth to act unethically. However, in retrospect it is clear that the culture of fraud at HealthSouth was orchestrated by Richard Scrushy. He saw himself in total control of the company and someone who surrounded himself with those he could easily manipulate (Jennings, 2012). He was said to rule with intimidation and fear, veiled threats, and was not willing to accept less than favorable reports of HealthSouth’s financial condition. When the numbers did not reflect his expectations, subordinates were told to get the numbers where they needed to be by going back in time to make subtle changes to each quarterly report so as not to draw suspicion (Jennings, 2012). HEALTHSOUTH: THE SCRUSHY WAY 6 Beginning in the mid-1990s, there was high turnover in older members of the executive team as Scrushy preferred having younger officers, many of them still in their twenties, and none with advanced degrees (Jennings, 2012). During Congressional hearings after HealthSouth practices came to light, employees testified that they voiced concern over what they perceived to be fraud, they were refused a promotion or required to transfer elsewhere in the company (Jennings, 2012). Scrushy was described as flamboyant, and would have celebrities accompany him to HealthSouth events and let politicians and athletes use the corporate jet (Jennings, 2012). He fancied himself as a rock musician who created and performed in his own rock band, used it as entertainment at HealthSouth events and used corporate assets to further the band’s interests (Jennings, 2012). He owned multiple homes, yachts, and created a number of businesses that had contracts with HealthSouth from which he also benefitted (Jennings, 2012). Yet, he was also seen by many as magnanimous because he gave generously to civic causes (Jennings, 2012). Characteristics of Unethical CEOs In their study of corporate fraud and managers’ behaviors as described in the press, Cohen, Ding, Lesage, and Stolowy illustrated that many of those later charged for corporate misdeeds (e.g., managers at Tyco, Enron, HealthSouth, Qwest, Worldcom, among others), managed in the following ways (2011): * They operated in a competitive field; * They felt pressure to be profitable and meet investment expectations; * Their compensation was dependent on reaching financial targets; * They typically dominated management; * The board of directors (BOD) and/or auditing process was ineffectual; * They gave unrealistic financial projections to third parties. HEALTHSOUTH: THE SCRUSHY WAY 7 Additionally, Cohen et al., also found that these managers shared a number of personal characteristics: * It was important that they maintain a high standard of living; * Their personal reputation was tied to the success of the corporation; * They had significant influence on others to carry out the fraud; * They were often tyrannical, narcissistic, demanded compliance, personally ambitious, or a combination of these attributes; * They exhibited a moral obligation by making generous charitable contributions often with corporate assets (2011). Was Richard Scrushy narcissistic? In their article which concerned observations of narcissism in organizations, Blair, Hoffman, and Helland, referenced the collective conclusion of researchers that narcissism was found to be the consistent manager personality trait linked to unethical behavior (2008). According to the American Psychiatric Association (APA), narcissistic people have an exaggerated sense of importance, seek positions of power, lack empathy, need admiration, evidence an attitude of entitlement, and typically exploit others (as cited in Blair, et al., 2008). Additionally, Kernis and Sun found that narcissists discounted negative information (as cited in Blair, et al., 2008), and they based most decisions on their personal needs rather than those of the organization (Blair, et al., 2008). As such, these leaders lacked integrity which McCall and Lombardo demonstrated was shown as a factor in examples of poor leadership (as cited in Blair, et al., 2008). Finally, in his study on narcissistic leadership in organizations, Gérard Ouimet referenced a study by Padilla, Hogan and Kaiser that narcissistic leaders are able to function in organizations which have a lack of structural mechanisms designed to provide oversight of their behavior thus enabling them to essentially be omnipotent, acting with an expanded sphere of influence and acting out fantasies of their exaggerated importance (2010).
HEALTHSOUTH: THE SCRUSHY WAY 8 Hochwarter and Thompson noted that Maccoby found that narcissistic leaders may be perceived as visionaries because of their boldness and risk-taking (as cited in Hochwarter and Thompson, 2012), and further, they tended to respond to ego-threats by aggression and other counterproductive behaviors (Jones & Paulus, 2010, as cited in Hochwarter & Thompson, 2012). Finally, Penney and Spector found that subordinates who provided the narcissistic leader with negative information tended to be punished (as cited in Hochwater & Thompson, 2012). Other researchers identified malevolent leadership behavior (Hochwarter & Thompson, 2012) as a precursor to workplace hostility (Trzesniewski, et al., 2008, as cited in Hochwarter & Thompson, 2012); counterproductive work behavior (Tepper, et al., 2011, as cited in Hochwarter & Thompson, 2012); corporate scandals (Lerner & Tetlock, 1999, as cited in Hochwarter & Thompson, 2012); and lapses in decision-making (Paul, et al., 2002, as cited in Hochwarter & Thompson, 2012). Richard Scrushy came from humble means; he did not possess the Ivy-league business education expected of many in control of a billion dollar enterprise. He saw himself as creating a medical model that would transform the hospital industry. Quite telling is that he intentionally surrounded himself with young, lesser experienced and educated directors to whom he could feel superior. He used intimidation as a means to control subordinates. He also insulated himself with a type of ignorance about the financial picture of HealthSouth, telling financial executives to simply get the numbers where we want them to be (Jennings, 2012, p. 184). He needed to feel important and to surround himself with the trappings of success. Richard Scrushy completed the picture of his narcissistic personality with comments he made concerning his future endeavors, which will be discussed later in this paper. Impact on Stakeholders The fallout from the implosion of HealthSouth is no different from that of those which went before or which have gone since: people lost jobs, investors lost money, workers lost benefits, and leaders lost reputation and sometimes their freedom. When the dust settled and the HEALTHSOUTH: THE SCRUSHY WAY 9 experts performed a postmortem on HealthSouth, obvious lapses surfaced. Those who studied HealthSouth’s governance found its board to be particularly ignorant about how the company functioned, the actions of Scrushy, and the financial stability of the business. In 2003, board member Joel C. Gordon admitted that the board really did not know what happened at the company (Jennings, 2012). Some corporate governance experts have called the board’s lack of action to be gross negligence (Jennings, 2012, p. 189). Dr. Philip Watkins, a board member hand-picked by Scrushy posited that if there were checks and balances in place, they must not have been because if the board was made aware improprieties it would have acted swiftly (Jennings, 2012). Outcome and Fairness of Punishment The government filed criminal charges against sixteen HealthSouth executives. All but Richard Scrushy pled guilty. Scrushy was charged with thirty-six counts of fraud, including one count under SOX for falsely certifying the 2001 financial statement with the SEC (Carlson, Coulter, & Vogel, 2009). In fact, the prosecution of Scrushy for the financial statement fraud was the first prosecution under the SOX Act (Carlson, et al., 2009). Ever the manipulator, Scrushy joined a church prior to the trial and gave to it generously. The church’s pastors attended the trial each day and Scrushy became a televangelist of sorts by appearing on his son’s television show (at a television station owned by the elder Scrushy) (Jennings, 2012). While Scrushy did not testify in his own defense, his attorneys argued that it was the other executives (who had pled guilty) who had committed this fraud without Scrushy’s knowledge (Crawford, 2005, June 28). To the dismay of many, Scrushy was acquitted of all charges in 2005, yet ever the narcissist, Scrushy believed it was the truth which had prevailed (Jennings, 2012). Further, he described the two year prosecution as torture (for him) and he was quick to point out that he considered himself to be the victim of overzealous prosecutors (Crawford, 2005, June 28). HEALTHSOUTH: THE SCRUSHY WAY 10 Scrushy’s entanglement with HealthSouth did not end with his unsuccessful prosecution. HealthSouth shareholders brought suit against Scrushy and alleged that he had actively participated in the fraudulent reporting of HealthSouth’s financial picture. At this civil trial, Scrushy testified and denied receiving millions from the company or playing any part in creating financial fraud. He recycled the defense that had worked so well for him in his criminal prosecution: the Sergeant Schultz defense—I know nothing (Crawford, 2005, June 28). He further disputed that he had inappropriately benefitted from HealthSouth in any way: the fact that HealthShouth purchased land next to his Birmingham, Alabama estate for $1.9 million then gave it to him became a bonus he received one year; his personal profit of $12 million by making an $82 investment in a company which had purchased property from HealthSouth at a steep discount became the way it works in America (ABCnews.com, 2009, June 19). In his testimony, Scrushy disputed the numbers which reflected that he was paid compensation of $226 million at a time the corporation was losing $1.8 billion (ABCnews.com, 2009, June 19). In 2009, the presiding judge found Scrushy’s personal net worth to be $300 million in 2003, that plaintiffs had met their burden of proof and he was ordered to repay $2.7 billion to HealthSouth (Robertson, 2011, March 27). Of interest no doubt to those who were victims of HealthSouth was the fact that Scrushy was actually in custody at the time of his civil trial as he was convicted in 2006 of bribery and honest services fraud for having bought a seat on a hospital regulatory board by making a $500,000 contribution to the gubernatorial campaign of Don Seligman in 1999 (Robertson, 2011, March 27). He served a six year sentence and was paroled in 2012. Now released after having completed his sentence, Scrushy is still pursuing an appeal of that conviction (Faulk, K., 2013, May 10). Despite the fact that he was not convicted of the charges brought by the government, the SEC pursued a civil action against Scrushy to which he entered into a consent judgment in which HEALTHSOUTH: THE SCRUSHY WAY 11 he paid an $81 million judgment and agreed to never serve as an officer or director of a company that markets certain types of securities (Faulk, K., 2013, May 10). The settlement provided that Scrushy could seek removal of the ban after five years which prompted his efforts in 2012 to do so (Faulk, K., 2013, May 10). Toward that end, he has filed an affidavit in federal court in Birmingham to ask that the ban be removed and asserted in support that he has potential investors who want to help him start a company to take advantage of opportunities created by Obamacare legislation (Faulk, K., 2013, May 10). At its most basic, Scrushy is in denial, which is a type of psychological defense mechanism which has enabled him to ignore reality (“Denial,” 2013) and deny the role he played in so many acts of fraud. Conclusion These actions leave no doubt that Richard Scrushy is narcissistic, without remorse, and in denial about his past actions. We can only hope that the Federal Judge in Birmingham comes to the same conclusion and denies Scrushy’s request to lift the ban on him serving as an officer in other corporations.

HEALTHSOUTH: THE SCRUSHY WAY 12
References
Blair, C. A., Hoffman, B. J., & Helland, K. R. (2008). Narcissism in organizations: A multisource appraisal reflects different perspectives. Human Performance (21), 254-276. doi: 10.1080/08959280802137705
Carlson, R. L., Coulter, J. M., & Vogel, T. J. (2009). HealthSouth corp.: The first test of Sarbanes-Oxley. Journal of Forensic and Investigative Accounting (1)2, 1-27. Retrieved from http://www.bus.lsu.edu/accounting/faculty/lcrumbley/jfia/Articles/v1n2.htm

Cohen, J., Ding, Y., Lesage, C. & Stolowy, H. (2010). Corporate fraud and managers’ behavior: Evidence from the press. Journal of Business Ethics (95), 271-315. doi: 10.1007 /s10551-011-0857-2

Crawford, K. (2005, June 28). Ex-HealthSouth ceo Scrushy walks. CNNMoney. Retrieved May 17, 2013 from http://money.cnn.com/2005/06/28/news/newsmakers/scrushy_outcome/

Denial. (2013). In Merriam-Webster’s online dictionary (11th ed.). Retrieved from http://www.m-w.com/dictionary/denial Ex-ceo Scrushy ordered to pay HealthSouth shareholders $3b. (2009, June 19). ABCNews. Retrieved May 18, 2013 from http://abcnews.go.com Faulk, K. (2013, May 10). Former HealthSouth ceo Richard Scrushy seeks to form new healthcare business with opportunities opened by obamacare [Blog post]. Retrieved from http://blog.al.com/spotnews/2013/05/former_healthsouth_ceo_richard_2.html Hochwarter, W. A. & Thompson, K. W. (2012). Mirror, mirror on my boss’s wall: Engaged enactment’s moderating role on the relationship between perceived narcissistic supervision and work outcomes. Human Relations (65)3, 335-366. doi: 10.1177/ 0018711430003 Jennings, M. M. (2012). Business ethics: Case studies and selected readings. Mason, OH: Cengage. Ouimet, G. (2010). Dynamics of narcissistic leadership in organizations. Journal of Managerial Psychology (25)7, 713-726. doi: 10.110802683941011075265 Robertson, C. (2011, March 27). Hunting for bargains after a titan’s fall: Everything must go. The New York Times. Retrieved from http://www.nytimes.com Solomon, D., Carrns, A., & Terhune, C. (2003, March 20). SEC alleges HealthSouth faked $1.4 billion in profits. The Wall Street Journal. Retrieved from http://online.wsj.com