HealthSouth Presented by Section 4 Group 6: 074043 Ng Man Hon 074054 Yip Ka Yu 074088 Wong Hor Yan Una HealthSouth

Content Background of HealthSouth Way of Fraud Reason of Scrushy being acquitted Ethical Issues Effects on Stakeholders Recommendation What did we learn? Conclusion

Background of HealthSouth

Found in 1984 by… Richard Scrushy – Chief Executive and Chairman Aaron Beam – Financial Controller

Background of HealthSouth 1986 Went public in NYSE 1990s Largest rehabilitation service provider In 1989, earliest fraud described 2002 Fraud exploded…

Incident… 2002 2003 Aug - CFO Weston Smith whistled the SFC about manipulation of profits Mar - FBI & SEC commenced actions against HealthSouth & CEO Richard Scrushy 1st CEO being charged under SOX Sentencing started later

2004 2005 Incident (cont’d)… 28th June Judgment Day Fraud amount: US$2.5 billion New estimated: US$4.6 billion 2004 28th June Judgment Day 2005

Incident (cont’d)… Richard Scrushy: Not Guilty and Dimissed 5 CFOs & 10 Accountant Staff: Fined & Imprisoned

How? Why? Alter contra value Falsify assets accounts Meet analyst expectation Maintain stock price

Way of Fraud

Way of fraud (1) Earnings Contra value Alter contra value As “contractual adjustment” Altering difference between gross charges to patients and the amounts insurers would reimburse afterwards Earnings Contra value

Way of fraud (2) AP Summary False journal entries Falsify Fixed Assets Accounts False supporting documents AP Summary Minimum suspicion from auditors

Break-down of figures

More of that… Fraud done since late 1980s Ex-employee

More of that… SFC gave up chasing back as evidence not available Persuasion in 1997 by Aaron Beam  Rejected by Scrushy Split Plan to hide fraud in 1999 and 2002

Reasons for Scrushy being acquitted

Reasons for Scrushy being acquitted 1. Documents Overabundance of prosecution documents but no clue to make Scrushy guilty 2.Location The juries are not like those in metropolitan areas who are more skeptical 3.Figure Scrushy was a respected figure in local perceived as local boy made good

Reasons for Scrushy being acquitted (Cont’d) focused on his religious devotion he donated one million dollars to local congregation as a white, he joined a black congregation 4.Defense strategy 5. The jury 7 blacks and 5 whites All from working class 6. Defense team Attacked the former CFOs’ credibility by treating them as liars and cheats

Ethical Issues

Ethical Issues 1. Meeting Wall Street analysts expectations Actual results vs. Expected results by Wall street analysts If shortfall, Scrushy order management to ‘fix it’ by making false entries Excuse to commit fraud Lack of legality (illegal & violated accounting standard)

Ethical Issues (Cont’d) 2. Conflicts of interest Fraud -> kept good numbers to Wall Street Stock price stay up Made millions of profit by selling stock For own interests but harmed stakeholders’ interest Public interest vs. self-interest

Ethical Issues (Cont’d) 3. Finding ways to hide the fraud, e.g. Reduced some of the money which was not there by write downs during takeovers Declared larger losses than it actually incurred in 1998 Looked for ways to reduce Wall Street expectations (no need to inflate profits as much in future) Plan of Splitting the company up & sale of assets Pushed HealthSouth deeper into fraud

Ethical Issues (Cont’d) 4. The five CFOs & Accounting executives On a slippery slope (continue the fraud) Persuade Scrushy to abandon the fraud Scrushy refused, they quitted and left HealthSouth Lack of integrity and fiduciary duty Mistakenly use of competence Should blow whistle on Scrushy and not just leave

Ethical Issues (Cont’d) 5. Mr. Scrushy (CEO) Leader of the fraud Demanded management to fix the number Refused to abandon the fraud Found ways to hide the fraud Lack of fiduciary duty and integrity When fraud broke out Claimed no knowledge of the fraud offered to give evidence in return for immunity Unethical

Ethical Issues (Cont’d) 6. Ernst and Young Auditors Failed to discover the fraud (even there were many warning signs) E.g. 1999- 2000, growth of 143% in income before taxes and minority interest , but sales increased only 3% 7. KPMG Tax Accountants Failed to discover the fraudulently claimed earnings when doing its tax returns Lack of competency and fiduciary duty Professionals must be due diligent and objective, and being alerted to special changes.

Effects on Stakeholders

Effects on Stakeholders - Directly Shareholders Capital Lost Lost Confidence Suppliers Lost of the customer Bad debts may be occurred Customers (Patients) Received improper treatment Paid overcharged price Spend time on finding new company

Effects on Stakeholders - Directly Creditors Might have bad debts Employees Dismissed Might suffer penalty and/or sentences Company Deal with the court suit Spend long time to re-build the customers’ confidence

Effects on Stakeholders - Indirectly Investors Capital Lost Lost confidence for further investment decision Government Deal with the law suit Set up more regulations Regular review Insurance Companies Deal with over-paid insurance Other Companies in the same industry Lost of revenue

Recommendation

Recommendation Securities and Future Commission (SFC) Pay attention to any abnormal movement of the shares’ price Analyze company’s annual report Require additional information if necessary Other authorization (e.g. CPA) Enhance the regulations Set up examination to test whether the members performed properly Establish workshops

Recommendation Internal Auditors External Auditors Perform regular internal audit Perform special internal audit when it is necessary Reduce weaknesses External Auditors Perform external audit analysis Additional audit analysis and testing Provide qualified opinion if client refuses to co-operate

Recommendation Company’s Accountants The Board Comply with code of ethics and other accounting principles Top management support Force employees to read Review regularly The Board Set up independent team for investigation The team members do not have relationship with suspected employee Team members change regularly

What did we learn? The Slippery Slope http://www.youtube.com/watch?v=WbhpglzmuFg&feature=related

What did we learn? How dangerous a slippery slope could be Once start a fraud -> continue -> find ways to cover the fraud Push yourself deeper into fraud Before making ethical decisions think of Consequences and impacts Public interest vs. Self-interest

Conclusion Want to sell stock at higher price  Human nature 2. Justify the value of company 3. Analyst expectation not a magic wand Honest management environment Non-selfish spiritual leader Fearless, courageous and sensible staff

“You have to stand up - or you'll be the guy that goes to prison and pays the price.”

Reference Sites: http://www.google.com.hk/images?q=aaron+beam&hl=zh-TW&rlz=1B3RNFA_enHK229HK231&um=1&ie=UTF-8&source=univ&ei=EHLATJ51hslxv4Os7gs&sa=X&oi=image_result_group&ct=title&resnum=3&ved=0CDIQsAQwAg&biw=1440&bih=707; photo of Aaron Beam searched through google and source from www.cnbc.com http://money.cnn.com/2005/06/28/news/newsmakers/scrushy_outcome/index.htm for photo of Richard Scrushy

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