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The Scrushy Way

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INTRODUCTION

This paper discusses the HealthSouth Case including the activities and subsequent prosecution of its CEO, Richard Scrushy. “During the trial of former HealthSouth CEO Richard Scrushy, federal prosecutors argued that Scrushy must have known something was amiss with HealthSouth’s financial statements since there was a discrepancy between the company’s financial and nonfinancial performance.” Over a ten-year period from 1987 to 1997, HealthSouth enjoyed above–average growth at a rate of 31 percent per year. (Jennings, 2012, 2009, p. 183) This phenomenal growth was due, in part, to a series of mergers and acquisitions let by the efforts of the company’s CEO, Richard Scrushy who ran the company with an iron fist and has at least one recorded conversation directing a CFO to fix the numbers over time. The fraud lasted for seven years and totaled approximately $2.7 billion. Mr. Scrushy denied knowing anything about the fraud, claimed it was all done by the people around him and was ultimately found not guilty of the fraud at HealthSouth but was convicted on bribery and corruption charges. Mr. Scrushy was ordered to pay $2.9 billion in restitution in a civil suit. “From at least 1996 until 2002, HealthSouth senior management perpetrated a financial statement fraud primarily through the use of nonstandard journal entries.” (Carmichael, 2010, p. 64)

“Scrushy, once a high school dropout, worked as a gas station attendant and a bricklayer before retuning (sic) to school and earning his diploma. He studied at University of Alabama, Birmingham and graduated with a degree in respiration therapy in 1974. 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 decided to go on his own with a new business idea. In 1984, with help from some 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, 7/7/03). HealthSouth went public in 1986.” (Chaubey, 2006, p. 3)

“Dishonest managements have been using nonstandard journal entries as a means of perpetrating fraudulent financial reporting for decades, and auditors have generally been aware of this technique. . .the technique, however, achieved widespread prominence in 1998 when the report of the audit committee of the board of directors of Cendant Corporation became public.” (Carmichael, 2010, p. 62)

IMPACT ON STAKEHOLDERS

The prosecution of Richard Scrushy marked the first time a corporate executive had been tried under the Sarbanes-Oxley Act (SOX) “for cooking the books, altering financial returns, at the company he founded.” (Pavlo, 2012) The government spent considerable time, financial, and human resources in the prosecution of Richard Scrushy. In the research of this paper, I was unable to determine the actual financial cost to the government. “In October of 2003, the United States government indicted its first test case defendant under Sarbanes-Oxley, former HealthSouth CEO Richard M. Scrushy. In June of 2005, after 20 months rife with racial and religious posturing and propaganda, the jury rendered a not-guilty verdict on all 36 counts leveled against Scrushy, including the first ever Sarbanes-Oxley criminal charges. . .the Scrushy verdict is emblematic of key flaws in the certification requirements of Sarbanes-Oxley. Namely, that the requirements do not place ultimate responsibility on the CEO, which is a primary purpose of the Act. . .after the almost unparalleled regulatory shift and the billions of dollars spent on compliance by corporations, Sarbanes-Oxley ultimately does not fulfill one of its primary mandates. It does not hold corporate executives accountable.” (Stock, 2006, p. 1)

“Central to the investigation was the issue of what role Scrushy played in “cooking the books.” However, as the case unfolded, it highlighted many other issues such as: The role of Board of Directors in corporate governance; the role of the auditors; the effect of conflict of interest between an accounting firm and its consulting arm on auditing; whether the relationship between an investment bank and a company affects the quality of the bank’s research reports on the company; whether the executive compensation that overly relies on company’s earnings provides an incentive for committing such fraud; whether a strong leader can silence all voices of reason in an organization.” (Chaubey, 2006, p. 2)

As the trial lasted for several months, jurors had to put their lives on hold to participate in this process. Interestingly, in another apparent act of unethical behavior, “Lawyers picked a predominantly black, mostly male jury Monday for the federal fraud trial of fired HealthSouth CEO Richard Scrushy, accused in a more than $2.6 billion conspiracy that prosecutors claim financed a lavish lifestyle of mansions, cars and boats. The majority black jury is viewed as a possible advantage for Scrushy, who is white but has attended a mostly black church since coming under investigation. He and his wife also host a TV talk show that frequently features black ministers discussing the Bible, and his lead attorney is a prominent black lawyer, Donald Watkins, who has tried to become the first black owner of a major league baseball team.” ("Mostly black jury seated in fraud trial of former HealthSouth CEO," 2005) I find it quite interesting that Mr. Scrushy only started attending the predominantly African-American church, Guiding Light, only after his indictment. Guiding Light Church purchased 12 months of airtime on a local Birmingham television station for a half-hour morning program which was hosted by Mr. and Mrs. Scruchy with approximately 5,000 households tuning in.

Once a stakeholder places their funds in the hands of the receiving company, there is a “transference of some measure of trust from shareholders to executive level managers. Why in so many cases, have executives been willing to break the trust, betray shareholders, and commit fraud?” (Albrecht, Albrecht, & Albrecht, 2004, p. 110-111)

One theory that could assist in explaining the behavior of these corporate executives is the antithesis of the Stewardship theory which, in part proposes “managers are viewed as stewards of their companies, predominately desirous of acting in the best interests of the shareholders. The theory holds that as stewards, managers will choose the interests of the shareholders, perhaps psychologically identified as the best interests of “the company,” over the interests of self, regardless of personal motivations or incentives. (Sundaramrthy and Lewis, 2003)” (Albrecht et al., 2004, p. 113). Clearly, Richard Scrushy did not subscribe to the Stewardship theory as evidenced by his indifference to the plight of employees he led in perpetrating the fraud and the stockholders damaged by it.

Albrecht, et al. describe nine elements of a “perfect storm” which contributed to the proliferation of unethical behavior on the part of Richard Scrushy and other corporate executives that found themselves in similar situations:
1) “Masking of many existing problems and unethical actions by the good economy of the 1990s and early 2000s;
2) The moral decay that has been occurring in the U.S. and the world in recent years;
3) Misplaced executive incentives;
4) Often unachievable expectations of Wall Street analysts that targeted only short-term behavior;
5) The large amount of debt and leverage each of these fraudulent companies had;
6) The nature of U.S. accounting rules;
7) Opportunistic behavior of some CPA firms;
8) Greed by executives, investment banks, commercial banks, and investors;
9) Three types of educator failures:
a. Educators had not provided sufficient ethics training to students
b. Not teaching students about fraud
c. Neglect exploration of possible relationships between various theories of management behavior and fraudulent activity.” (Albrecht et al., 2004, p. 119-125)

“. . .poor corporate governance and conflict of interest also increase instances of fraudulent financial reporting. Members of the boards of directors of many Fortune 500 companies also belong to the same country clubs and serve together on the boards of many other companies. The latter creates what is referred to as interlocking directorates or board overlaps. This is a common practice and is perfectly legal. However, the problem with such practices is that it affects the quality of the board’s decision making when voting for the compensation package for another board member that serves with him or her in another company. It also creates poor corporate governance and a conflict of interest problem. The lack of independence affects the quality of the board member’s decision making process. . .The impact of fraudulent financial reporting and corporate failure are felt beyond the walls of the companies affected. The employees, the communities, the vendor, the investors, and the bankers, to name a few, are impacted by such developments.” (Enofe, 2010, p. 59)

OUTCOME

The Justice Department reached plea agreements in its criminal investigation with all five of HealthSouth’s former CFOs. Six lower-level former executives also entered into plea agreements. According to the SEC complaint, senior accountants, acting on orders from the CEO to “fix” earnings, gathered in what they called “family” meetings to falsify results when HealthSouth’s performance failed to meet Wall Street forecasts. Former CFO Weston Smith also pleaded guilty to filing a false certification statement with the SEC. . .” (Castellano & Lightle, 2005, p. 6)

“In 2003, HealthSouth investors filed several class action lawsuits against the company and certain officers and directors, including Scrushy, after HealthSouth admitted it had inaccurately reported information in its financial statements. The actions were later consolidated and in 2006, plaintiff investors reached an agreement with HealthSouth.” (Gordon, 2010/11, p. 674)

“On June 28, 2005, Richard Scrushy was acquitted on 36 counts of fraud that occurred at HealthSouth. Four months later, Scrushy was indicted on new charges of bribery and mail fraud in connection with former Alabama governor Don Siegelman. Scrushy was accused of donating $500,000 to Siegelman's campaign in exchange for a seat on a state hospital regulatory board. Both Scrushy and Siegleman were convicted on multiple charges, including bribery, mail fraud, and obstruction of justice. Both received sentences of or close to seven years in prison.” ("Richard Scrushy Biography," 2013, para. 4)

FAIRNESS OF PUNISHMENT

In this writer’s opinion, the punishments handed down were not fair at all. The fact that Richard Scrushy was found not guilty in the face of the evidence against him makes no sense. Admittedly, those that participated in the perpetration of the fraud should have been punished, but for Richard Scrushy to get away with that particular crime is unfair.

CONSLUSION

There are more questions than answers in concluding this case.
1) Even with the government regulations in place, what is to keep another HealthSouth scenario from occurring again in the future? It appears as though the sanctions imposed by SOX are not enough to deter the corporate executives involved in these scandals from continuing with their unethical activity.
2) How can corporations insulate themselves from this type of activity in the future?
3) Who will guarantee that the corporate individual ultimately responsible for accurate and complete reporting will not succumb to lapses in ethical judgment?
4) In addition to prosecuting the corporate executives in these situations, are there criminal punishments imposed on the external auditors that signed off on the financials? According to this writer’s research, it appears as though the top accounting firms involved with these corporations, are proceeding with business as usual with no adverse repercussions.
5) Is it possible to have a governmental “ethical czar? Who will monitor that individual? What is to keep that individual on the straight and narrow?

The prosecution of Richard Scrushy obviously did nothing to deter other corporate executives from taking the same path of overinflating their financials to the detriment of their employees and investors.

“. . .a great deal of the effectiveness of SOX depends on the vigor to which it's enforced. Questions remain as to whether the SEC's and Department of Justices's enforcement of SOX has been sufficient. A July 30 article in The Wall Street Journal notes that SOX's "biggest hammer - the threat of jail time for corporate executives who knowingly certify inaccurate financial reports - is going largely unused. Although SOX has been successful in increasing corporate focus on a strong ethical culture in publicly owned companies, there's room for improvement in audit firm performance as well as the PCAOB's process for assessing and reporting on it.” (Verschoor, 2012) References

Albrecht, W. S., Albrecht, C. C., & Albrecht, C. O. (2004). Fraud and Corporate Executives: Agency, Stewardship, and Broken Trust. Journal of Forensic Accounting, V(2004), 109-130. Retrieved from http://maaw.info/JournalOfForensicAccounting.htm
Carmichael, D. R. (2010, October 2010). Double-Entry, Nonstandard Entries, and Fraud. The CPA Journal, 80, 62-65. Retrieved from http://www.cpajournal.com/
Castellano, J. F., & Lightle, S. S. (2005, February 2005). Using Cultural Audits to Assess Tone at the Top. The CPA Journal, 6-11.
Chaubey, M. D. (2006, December 2006). HealthSouth Corporation: Fraud, Greed and Corporate Governance. Case for ICMC2006 International Conference on Management Cases.
Enofe, A. (2010, Summer 2010). Reaping the Fruits of Evil: How Scandals Help Reshape the Accounting Profession. International Journal of Business, Accounting, and Finance, 4, 53-69.
Gordon, A. P. (2010/11). In re HealthSouth Corp. Securities Litigation. New York Law School Law Review, 55, 671-681.
Jennings, M. M. (2012, 2009). Case 4.6. In Business Ethics Case Studies and Selected Readings (pp. 183-192). Mason, OH: South-Western Cengage Learning.
Mostly black jury seated in fraud trial of former HealthSouth CEO. (2005). Retrieved from http://www.uow.edu.au/~bmartin/dissent/documents/health/healthsouth_scr_trial.html
Pavlo, W. (2012, 1/26/2012). Former HealthSouth CEO, Richard Scrushy, Gets Prison Sentenced Reduced. Forbes. Retrieved from
Richard Scrushy Biography - Facts, Birthday, Life Story - Biography.com. (2013). Retrieved from http://www.biography.com/people/richard-scrushy-235385.
Stock, W. (2006, Fall, 2006). UNITED STATES V. SCRUSHY AND ITS IMPACT ON CRIMINAL PROSECUTIONS UNDER THE CERTIFICATION REQUIREMENTS OF SARBANES-OXLEY. Texas Wesleyan Law Review, 13 Tex. Wesleyan L. Rev. 239(), 1-39. Retrieved from http://www.texaswesleyanlawreview.org/
Verschoor, C. C. (2012). Has SOX Been Successful. Retrieved from http://www.accountingweb.com/article/has-sox-been-successful/219796

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