As I have mentioned previously, provide a new file name for the assignment you are working on using the Northcentral naming convention: Learner’s last name, first initial, course code, dash, and assignment number (DoeJXXX0000-1) EXAMPLE: John Doe, PSY300, Assignment 1 = DoeJPSY300-1.

BUSINESS ETHICS
OKECHUKWU AKANNO Sr.
NORTHCENTRAL UNIVERSITY
ASSIGNMENT#8
MGT7019-8
Dr. JENNIFFER SCOTT
September 16, 2012

Learner: OKECHUKWU AKANNO

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MGT7019-8| Dr. JENNIFFER SCOTT|
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BUSINESS ETHICS | #8|
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Faculty Use Only

TABLE OF CONTENTS PAGE
Abstract --------------------------------------------------------------------------------------4
Introduction ------------------------------------------------------------------------------5 & 6
The role of Auditors at HealthSouth ---------------------------------------- 7 & 8
SEC Investigation ----------------------------------------------------------------------------9&10
Impact on Stakeholders ---------------------------------------11, 12, 13 & 14
Outcome and Fairness In Punishment ---------------------------------------- 15, 16 & 17
Conclusion -----------------------------------------------------------------------------------------18
References-------------------------------------------------------------------------------19, 20 & 21

ABSTRACT
This paper will investigate the financial reporting scandals of the past decade at HealthSouth and the resulting U.S. legislative attempts to impose ethical behavior and control the incidence of new reporting problems via Sarbanes-Oxley legislation. This paper begins with a brief historical perspective followed by assertions of ethical consequences of legislation with discussions of key recent corporate scandals, the motives for the frauds, greed, the impact on stakeholders and the consequences of the outcome of guilty verdict.

INTRODUCTION
Richard Scrushy, once a high school dropout, worked as a gas station attendant and a bricklayer before returning to school and earning his diploma. He studied at University of Alabama, Birmingham and graduated with a degree in respiration therapy in 1994. After graduation, he became an instructor at UAB. In 1979, Scrushy left the academia and took up a position at a Texas health care management firm. The firm was sold in 1983 and Scrushy decide to go on his own with a new business idea. In 1984, with the help from some of his friends and an initial investment of $50,000, he founded HealthSouth, in Little Rock, Arkansas. In 1985, he moved the company to Birmingham, Alabama, (Heylar, 2003) . HealthSouth went public in 1986.
Richard Scrushy spotted certain trends that he incorporated in his very successful business model for HealthSouth. These trends were: Lower reimbursement for medical care, new emphasis on rehabilitation as opposed to surgery, the need to get employees back to work faster, and the absence of brand names in health care. He also wanted his rehabilitation centers to look more like upscale clubs than a hospital. He used his super sales skills, boundless energy and entrepreneurial skill in setting up clinics, making acquisitions and expanding the company. He concentrated on acquiring contracts with managed care operations and self-insured companies for workers’ compensation rehabilitation. He focused on individual facilities on specific ailments. To keep costs down, he standardized the physical layouts of his facilities and used same floor plan and furnishing for all locations (Hoover’s 2006).
By 1988, HealthSouth had expanded to nearly 40 facilities in 50 states. Scrushy expanded HealthSouth through acquisitions. The company acquired most of the rehabilitation services, business of National Medical Enterprise and became the largest provider of rehabilitation services in 1993. By 1992, HealthSouth was generating revenues to the tune of $400 million and operated 145 clinics. Scrushy formed Med Partners and entered physician practice management (PPM) field. Scrushy engineered many acquisitions and Med Partners became the largest PPM in the country. HealthSouth further expanded into inpatient rehabilitation hospitals and outpatient surgery centers (Hoover’s 2006). HealthSouth also entered the traditional hospital field in 2000 through acquisition of a hospital in Birmingham, Alabama and announced plans for a $300 million “digital hospital” near its corporate center. By 2000, the company was dominated by the rehabilitation services market and was very profitable. Eventually, HealthSouth became the largest provider of outpatient surgery, diagnostic and imaging services as well as rehabilitation services in the United States with 1,700 facilities and 51,000 employees.
As head of third largest publicly held company in Alabama, and one of the fastest growing health care companies in the country, Richard Scrushy became a celebrity in Birmingham (Alabama). As a philanthropist, he made sizable donations to charities, churches and universities. However, Scrushy was also known as an ambitious man who wanted to be the highest paid CEO in the United States. He was a strong leader, surrounded by friends and colleagues who learned to do things his way, or get out of the way. He was even called “supercilious bully” by some ex-colleagues. Scrushy was terminated from the company after the SEC sued HealthSouth for “cooking the books” in March 2003 (Heylar, 2003).
THE ROLE OF AUDITORS AT HEALTHSOUTH
HealthSouth’s auditors, Ernst and Young (E&Y) failed to uncover the $2.5 billion systematic overstatement of earnings and they allowed the company to keep on its books’ $500 million of overvalued accounts receivables owed to it by financially distressed health care technology firms without insisting on establishing adequate reserves for these receivables (Glater, 2003).
E&Y also had other non-audit business dealings with HealthSouth. In 2000-01 the accounting firm conducted a janitorial, cleanliness and physical appearance inspection of HealthSouth facilities. E&Y used a 50-point checklist designed by Scrushy. The pristine audit scores were used by HealthSouth in its marketing campaign. The accounting firm received the $2.6 million fee for the inspection as “audit related fee.” The work clearly is not audit related. This raises suspicion about the impartiality and independence of the auditors (Weil, 2003, 2003a).
HealthSouth’s former head of internal audit offered the following testimony before Congress on the HealthSouth hearings:
My name is Teresa Sanders, and I currently live in Birmingham, Alabama. I am 39 years old. In 1986, I graduated from the University of Alabama with a degree in the accounting. I received my master’s degree in accounting in 1988.
I began working with Ernst & Young, (E&Y) in August of 1998 as a staff auditor, and I was laid off in February of 1990. In March of that year (1990), I was hired by HealthSouth as the Internal Auditor. During my employment, I received three promotions, and when I left, my title became Group Vice President and Chief Auditing Officer. My immediate supervisor was Richard Scrushy, and I reported directly to him for over nine years. I left HealthSouth in November of 1999.
As part of my duties as the Chief Auditing Officer, I had to make reports to the audit committee of the Board of Directors. All the meetings that I had with the audit committee were before the full board except one time in either 1997 or 1998, when I met separately with the audit committee. However, that meeting was attended by Tony Tanner. In 1996, Richard Scrushy approached me about establishing a fifty (50) point check-list which became known as the “Pristine Audit.” After Mr. Scrushy asked me to develop the check-list, I sent him a memo expressing my opinion about the check-list. Mr. Scrushy did not appreciate my opinion on the matter and again instructed me to develop the check-list for his approval. Mr. Scrushy informed me that the Pristine Audit was to be handled by Ernst & Young.
I developed the fifty (50) point checklist which Mr. Scrushy approved. As you can see, the Pristine checklist has nothing to do with auditing the financial books of a field facility. The Pristine Audit was nothing more than a cosmetic, white glove, walk through of a facility. It was in the nature of quality control and had nothing to do with the financial viability of a particular facility.
By the time I left HealthSouth, I was having problem with Mike Martin. He turned off my computer access to the general ledgers of the field operations. If I needed access to those ledgers to do my audits, I had to manually retrieve hard copies of those ledgers, if needed, which was very time consuming. I also did not like the way HealthSouth Handled an internal sexual harassment investigation. It was my opinion that the offending employee should have been terminated. I heard that, ”they were playing with the books,” I had no knowledge that anyone was committing fraud. I ultimately left HealthSouth because I received a better job offer with Eastern Health Services Systems in the compliance department as the Compliance Officer…67

SEC INVESTIGATION
HealthSouth is perhaps the most egregious illustration of unethical and fraudulent behavior. Recent estimates indicate the accounting fraud may have manufactured $4 billion of false earnings (MSNBC, 2004). Once again, the tone at the top led to a slippery slope of unethical actions. According to the SEC indictment, senior officers would present actual results to the CEO, each quarter and if they were short of explanations, he would tell them to fix them. The accounting personnel then convened in “family Meeting” and discussed what false accounting entries to make in other to inflate earnings. The focus was on altering the contractual adjustments account (Common in Health care to recognize differences between gross billings and what health care providers will pay) to increase net revenue. The adjustment was balanced by falsifying fixed assets accounts. To further the fraud, many HealthSouth’s accounting personnel were prior employees of the auditor, Ernst and Young, and knew the adjustment they could make that would not be detected in audit procedures. If the auditors did question an entry, the HealthSouth accountant creates false documents to support it (SEC, 2003c).
The CEO, Schrushy, personally profited selling $7.7 million shares of stock when the price was artificially inflated by accounting numbers as well as bonus payments and salary payments.
HealthSouth’s ethical problems also existed at the Board level. Three directors’ had significant ties to the company, one earned $250,000 in consulting fees, one has owned expensive resort property with the CEO, and one had a $5.6 million contract to install glass at HealthSouth hospital. The same three served on the combined audit and compensation committee (Lubin and Cams, 2003). The SEC accused Former HealthSouth management of fabricating $2.74 billion in earnings and charged them with fraud, reporting violations, and internal controls violations. Fifteen financial employees pleaded guilty. Scruchy has been indicted on 85 counts and he has pleaded not-guilty (Bassing, 2003). Scrushy was the first CEO to be charged under the Sarbanes-Oxley Act for signing a false certification of financial statements. Scrushy’s attorneys have fought the charge with rebuttal that Sarbanes-Oxley Act of 2002 is unconstitutional and should be repealed (National Accounting News, 2003). Meanwhile, Scrushy has become a religious talk show host (CBSNews, 2004).
HealthSouth case, illustrate a corrupt tone at the top that emphasized making the numbers at the expense of doing the right thing. Collusion, top management pressure on employees to act unethically, personal greed and gain, audit failures and a corrupt corporate culture were common across HealthSouth Corporation. Is it possible for the legislation to prevent further unethical and fraudulent behavior in the corporation like we have witnessed in this case? The U.S. Congress has attempted to do so with the Sarbanes-Oxley legislation of 2002, however, the regulations are aimed not only at Corporate America but also at the CPA firms who perform their audits. The major international CPA firms have demonstrated similar ethical problems. “Too many CEOs are being judged today not by how effectively they manage operations, but by how they manage the street. And, too many auditors are being judged not just by how well they manage an audit, but by how well they cross-market their firm’s non-audit services” (Levitt, 2000).
IMPACT ON STAKEHOLDERS
The eighties proved to be very profitable to Amcare who formerly changed the company’s name to HealthSouth in 1985. Scrushy took the company public the following year and between the years of 1986 and 1994. With a style worthy of jealously, Scrushy built his empire to the point where they surpassed the $1 billion mark in revenues with record breaking expansions. Perhaps more importantly than general industry expansion for HealthSouth during the 1980s was Scrushy’s and his fellow managers’ unique operating strategy. When HealthSouth got started in 1984, rehabilitation were stereotyped as drab, institution-like facilities with generally, mediocre staff. Scrushy wanted to change that image. Borrowing from Health clubs, he designed his rehab centers as bright, open-spaced, mirrored rooms with trained physical therapists and sporty equipment. The centers more closely resembled high-priced health clubs than traditional hospital-styled rehab centers, and doctors became increasingly willing to send patients to a HealthSouth facility for treatment. Scrushy added a few more HealthSouth outlets and by 1985 was generating nearly $5 million in annual revenues.
HealthSouth added new rehab centers to its chain throughout the middle and late 1980s. Because of the company’s unique recipe for success, its centers became known as effective and cost-efficient, and as models for other companies in the rehab industry.
Rather than focusing on a specific rehab niche, such as head and spinal injuries, HealthSouth differed from many of its competitors in that it targeted the market for less expensive, general outpatient rehabilitation services. HealthSouth’s facilities were built around a large gymnasium, in which some patients rode exercise bikes while listening to rock music. Old and young people worked out side by side, often with the help of therapist, while others enjoyed physical, occupational, or speech therapy in private treatment rooms. Some of the machines even were hooked to computers that fed reports to doctors about how patient were responding to treatment. HealthSouth appealed to the medical community by offering a number of rehabilitation programs tailored for different ailments. At the urging of Dr. Scott Burke, a Denver spinal rehabilitations specialist, HealthSouth designed a program to treat back problems. Becoming widely used, the whole package—incorporating stretching, aerobic conditioning, anatomy education, and simulation exercises about four weeks and cost a total of only $3,700, which was much less than the patient might otherwise spend on unnecessary surgeries and hospital costs. HealthSouth also began offering special services for the lucrative sports rehabilitation market. To that end, HealthSouth eventually launched an entire sports division with separate facilities and prominent doctors. Dr. Jim Andrews, one of HealthSouth’s most renowned surgeons, treated such celebrities as Bo Jackson, Jane Fonda, and Charles Berkley, among others, (Company Histories, 2000).
HealthSouth began series of acquisitions and by 1988 they were operating 21 outpatient facilities, 11 impatient facilities and seven rehabilitation equipment centers in 15 states. Sales had spiraled upward at an average of more than 100 percent annually since 1984, peaking at $75 million in 1988, Revenues shot up to $114 million in 1989 and then to $181 million in 1990, about $13 million of which was netted as income. In fact, HealthSouth managed to post successive profits every year after 1985. Aside from increasing its customer base at existing centers, the company grew by purchasing other rehab and health care companies and restructuring them to fit into the HealthSouth organization. It was in December 1989, for example, that Scrushy jumped into the sports rehab business when he paid $21 million for a 219-bed general hospital in Birmingham that specialized in orthopedic surgery and sports medicine, (Company History, 2000). HealthSouth continued to grow and by the mid-1990s was operating 31 outpatient and 14 inpatient rehabilitation centers in 21 states making a leader in the U.S rehabilitation industry. The company continued to add new general rehabilitation centers to its chain in 1991 and 1992.
HealthSouth sustained its aggressive growth drive throughout 1995, snapping up several smaller competitors. Significantly, in October 1995 HealthSouth announced that it had agreed to purchase the rehabilitation services operations of Caremark International for $127 million in cash. The Caremark operations consisted of 123 outpatient rehabilitation facilities that were generating about $80 million in annual revenues. That gave the company a total of about 440 outpatient facilities and about 40 percent of the total rehabilitation market. HealthSouth also bought Diagnostic Health Corporation, which offered outpatient imaging services. Perhaps most notable was the early 1995 acquisition of Surgical Health Corporation, which represented HealthSouth’s diversification into an entirely new market: outpatient surgery services. The $1.1 billion acquisition, the company’s largest to date, immediately catapulted HealthSouth into the lead as the top operator of outpatient surgery centers in the nation, (HealthSouth, 2010).
HealthSouth’s steady string of acquisitions did not end as the company headed into the second half of the decade. Purchases in 1996 included Surgical Care Affiliates, Inc, which included 67 outpatient surgery centers in 24 states, for an estimated$ 1.4 billion, Advantage Health Corporation, which owned about 136 inpatient and outpatient rehabilitation centers in 11 states, for about$315 million; Professional Sport Care Management, Inc., which included 36 outpatient rehabilitation centers in New York, New Jersey, and Connecticut, for about $59 million occupational health; and Ready care , Inc which operated 37 surgical facilities in 14 states, and also acquired 34 surgery centers from Columbia/HCA Healthcare Corporation.
HealthSouth had nearly 2,000 locations in 50 states, Puerto Rico, the United Kingdom, and Australia by the end of the decade. The company had enjoyed phenomenal growth since its inception in 1984 and believed it was poised to overcome the obstacles of the rehabilitative health care, outpatient surgery, and diagnostic imaging markets. HealthSouth hoped to realize and maintain its standing as ‘the healthcare company of the 21st century, (HealthSouth, 2010).
What was actually going on behind the closed board room doors of HealthSouth some experts believe corporate America should have been able to see coming. Geoffrey Calvin, in an article written for Fortune Magazine would give his opinion regarding what was happening to HealthSouth and compare it to what happened in companies with similar make ups. Calvin writes, “With the continuing stream of juicy revelations from HealthSouth, already on the A list of business scandals, we’re in for another round of hand-wringing over the widening crisis in corporate America. But what’s most striking about the HealthSouth debacle is not what’s new but what’s familiar, how perfectly it fits the highly specific pattern already established by Enron, WorldCom, Adelphia and Tyco. While these scandals are certainly a crisis for corporate America---polls show most Americans now think CEOs are crooks until proven otherwise---the crisis seems to be in a remarkably narrow slice of it, (Calvin, 2003). “We have learned the same thing again and again: financial fraud does not start with dishonesty, your boss does not come to you and say, ‘let’s do some financial fraud’. Fraud occurs because the culture has become infected. It spreads like an unstoppable virus”, (Young, 2003). The company’s damages have led HealthSouth to lay off a lot of workers whose lives and families have been thrown into confusion, and possibly into desperation. Millions of families have had their healthcare in jeopardy as a result of the fraud at HealthSouth and the company’s later “downsizing” have taken its toll, (people’sworld.org) .
OUTCOME AND FAIRNESS IN PUNISHMENT
The Scrushy trial began in January 2005. Following jury selection, the chief federal prosecutor, Alice M. Martin, alleged that Scrushy was the mastermind behind the financial fraud at HealthSouth and that he knew about, participated in, and profited from the conspiracy. The defense contended that Scrushy was a victim of the fraud; that the fraud was conceived and perpetrated by senior accounting personnel who misled Scrushy and the outside auditors. The defense attacked the credibility of HealthSouth’s CFOs, claiming that they agreed to the plea bargain and to testify against Scrushy to gain reduced sentences.
Former CFO William T. Owens in cooperation with the Federal Bureau of Investigation wore a recorder in a meeting with Scrushy. The tape indicated that Scrushy was a hand-on CEO who exhorted his senior executives to take measures to keep profits high and prevent losses on their stock investments. On the tape, Scrushy had warned of dire financial consequences both to Owens and to the company. However, Scrushy never used the words fraud, illegal or scheme in nearly three hours of the tape, (Johnson, 2005). Owen could not point to any memo or document that would indicate Scrushy’s involvement in the fraud. Owens was later sentenced to five years in prison along with two years of probation. Owens testified that Ms. Diana Henze, a former assistant vice president of finance at the company had figured out the fraud and she took her suspicions to HealthSouth’s compliance department. She was transferred to another division and was subsequently passed over for promotion (Reeves, 2005). Ms. Henze’s testimony did not directly implicate Scrushy but it did corroborate that the financials submited by the company to the government did not reflect reality.
Kenneth Livesay, a former assistant controller at HealthSouth also testified that Scrushy was aware of the fraudulent scheme. His testimony also did not implicate Scrushy directly since the CEO was not present at any of the “family” meeting that he had attended. Livesay also listed all nine of the executives who were members of the family: Scrushy’s name was not on that list. When asked why he did not confront Scrushy on the issue, he replied that it was not a common practice to discuss the fraud openly and that Scrushy was an intimidating leader whom you would not want to cross (Shmuckler, 2005). The defense contended that Livesay and others lied to hide the fraud from Scrushy and to keep their own overpaid position in the company. Livesay was later sentenced to six months of home confinement, five years of probation, a fine of $10,000, and forfeiture of $750,000in capital gains. Former Chief financial Officer Michael Martin pleaded guilty to fraud charges. Martin testified that he oversaw the accounting fraud from 1977 to his leaving in 2000 at the behest of Scrushy. He asserted that Scrushy asked him to rework the accounts to help meet Wall Street analysts’ expectations. He gave pep talks at the “family” meetings assuring the members that they will not have to do this forever and they will figure out a way to end the fraud. The defense portrayed Martin as a hothead who made idle treats to employees. In response to defense question on why he did not leave the company, Martin replied that he did not see a way out (Morse and Shmuckler, 2005). Martin was later sentenced to six month of home detention, forfeiture of $3,375,000 in capital gains, and a fine of $50,000.
Tadd McVay, Aaron Beam and Weston Smith were the other former CFOs who testified against Scrushy. They all testified that they had discussed the fraud scheme with Scrushy. Smith was sentenced to 27 months in prison, one year probation after his release from the prison and forfeiture of $1,500,000 in assets. Beam received a reduced sentence of three months in prison, $10,000 in fine, one year probation and a forfeiture of $275,000 capital gains
Prior to his indictment, Mr. Scrushy and his wife began attending weekly services at a primarily African-American congregation in Birmingham. He preached regularly at black churches in Birmingham area. He also hosted a Christmas themed TV program on which he invited prominent African-American ministers as guests. He also made large cash donations to these churches. Scrushy made an effort to build sympathy among religious conservatives and African-Americans (Romero and Wilson, 2005). Some have questioned if Scrushy’s motivation in all of this was to influence the predominantly black jury members. After 21 days of deliberation, the jury cleared Scrushy of all 36 criminal charges. The jurors, in the post-trial interview, suggested that the CFOs who testified against Scrushy lacked credibility (Johnson, 2005a). According to the jurors, the prosecutors did not present enough evidence to show that Scrushy was guilty beyond a reasonable doubt.
CONCLUSION
This paper has documented the failures of laws, corporate internal controls, and corporate culture to deter unethical and fraudulent financial reporting. None, alone, have stood the test of time in guaranteeing appropriate corporate ethical behavior. Sarbanes-Oxley Act broadens and deepens sanctions and penalties for unethical management behavior but does not address the relationship between management behavior and rewards. Sarbanes also calls for much greater focus on internal controls by senior management. Internal systems, including IT controls, can help reduce the opportunity for fraudulent or unethical behavior but cannot eliminate it in a world where nearly 50 percent of large corporations still use spreadsheets in some aspect of financial reporting (Hacket Group, 2004). Finally, corporate ethical failures arguably appear more likely to occur in every successful company lacking a solid ethical foundation when economic conditions changes as witnessed by our case studies and the work of (Kotter and Heskett, 1992). It is the combination of a strong ethical corporate culture (beginning with the board of directors), controls, laws, rewards, and penalties that provide a context for obtaining ethical and transparent financial reporting.
We believe that the research exploring the interactions between and among corporate culture, internal controls, social controls, and rewards/sanctions will provide better answers than we have for improving corporate financial reporting.
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