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The HealthSouth Scandal

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on 25 April 2014

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Transcript of The HealthSouth Scandal

HealthSouth Scandal
What was the scandal and how did they do it?
The first of HealthSouth's accounting problems surfaced in late 2002 after CEO Richard M. Scrushy sold $100 million in stock several days before the company posted a large loss.

They were accused of falsely inflating their earnings by $1.4 billion.

In certain fiscal years, the company's income was overstated by as much as 4700%.

Scrushy allegedly instructed the company's senior officers and accountants to falsify company earnings reports.
Why, who, and when did they do it?
WHY?
To overstate the company’s earnings in order to meet investor expectations and control the price of the company’s stocks.

WHO?
Fifteen HealthSouth employees which includes all five former chief financial officers (CFO) Tadd McVay, Aaron Beam, Michael Martin, William Owens and Weston Smith
Former CEO Richard M. Scrushy

WHEN?
It started in 1996 when Scrushy instructed the company's senior officers and accountants to falsify company earnings reports and the fraud continued for 7 years.
GAAP's cont'd...
Lessons Learned
The HealthSouth Scandal
By: Jessica and Samantha
Dollar value of the scandal
A forensic audit by PricewaterhouseCoopers found additional fraudulent entries to raise the total to a range of $3.8 billion to $4.6 billion.

The fraud included $2.5 billion in fraudulent accounting entries from 1996 to 2002, $500 million in incorrect accounting for goodwill and other items involved in acquisitions from 1994 to 1999, and $800 million to $1.6 billion in ''aggressive accounting'' from 1992 to March 2003.
Stock price and stock activity: Before, During, and After
Who are the stakeholders and the impact of this violation on them?
The employees and the company: it impacts the lives of the employees and their families for being laid of work and the company itself is going to have a bad reputation.

The shareholders: they were poised to go after Scrushy’s assets, but it's doubtful they will ever squeeze anything close to $2.9 billion from him. He sold his shares and was estimated to have $275 million in assets in 2005.

The customers and patients: it impacts millions of families that have had their healthcare disrupted or threatened as a result of the corruption at HealthSouth and the company’s subsequent “downsizing.”
About HealthSouth
One of the nation’s largest healthcare providers specializing in rehabilitation.

Operates in 28 states across America and in Puerto Rico.

Serves patients through their network of inpatient rehabilitation hospitals, outpatient rehabilitation satellite clinics and home health agencies.

Their hospitals provide a higher level of rehabilitative care to patients who are recovering from different conditions.
Full Disclosure and
What happened after
After the scandal took place, HealthSouth fully disclosed the fraud in their notes.

No longer used UBS as its bankers.

Suspended Scrushy and fired Ernst and Young, the auditors who had missed the fraud.

Facilities were closed or sold off to raise funds and staff were fired.

HealthSouth ordered Scrushy to repay his company $2.9 billion.
GAAP's cont'd....
GAAP's Violated
Conservatism
– Prudence is a degree of caution in making judgments such that assets or income are not overstated and liabilities and expanses are not understated.

HealthSouth greatly overstated their assets. In certain fiscal years, the company's income was overstated by as much as 4700%. This is a huge violation of conservatism.


Full Disclosure
- To be reliable, financial information must be complete, as an omission can cause information to be false and misleading.

In 1998, HealthSouth was accused of violation of the Securities Exchange Act by failing to disclose negative trends and misrepresenting company's financial information. Since they failed to disclose the negative trends at HealthSouth, the Full Disclosure principle was violated.

Objectivity –
To be reliable, the information contained with the financial statements must be neutral, that is, free from bias.

Since Scrushy instructed the company's senior officers and accountants to falsify company earnings reports, the accounting was done with the bias of what Scrushy instructed them to do.

Matching Principle
– Increases in earnings must be matched by corresponding increases in net assets, so that shareholders’ equity rolls forward properly and the balance sheet balances.

HealthSouth was able to increase its earnings while balancing its books by overstating assets and understating liabilities to follow the matching principle.

How were the financial statements affected?
Assets were overstated and liabilities were understated.
An approximate $800 million overstatement to the Company’s property, plant, and equipment.
On the income statement side of each fraudulent entry, the expenses were reduced.
The company reported about $8 billion in total assets—$3 billion of which represented the net book value of its fixed assets.
The auditor involvement
Ernst & Young was HealthSouth’s auditor from 1996 to 2002.

E&Y missed the fraud and said it was deceived by a criminal conspiracy.

E&Y took no action when an internal auditor at HealthSouth told the accounting firm she couldn't get full access to the company books.

E&Y claimed that the scandal exposed it to lawsuits and damaged its reputation and sued HealthSouth.
Charges
1998
- HealthSouth was accused of violation of the Securities Exchange Act by failing to disclose negative trends and misrepresenting company's financial information.

2003
- HealthSouth's CEO Richard M. Scrushy was charged with the accounting fraud .

2005
- Scrushy was acquitted on all 36 of the accounting fraud counts against him, most notably one count in violation of the Sarbanes-Oxley Act.

However, four years later, he was sued for fraud by HealthSouth investors and ordered to repay his company $2.9 billion.

Fifteen HealthSouth employees, including all five former chief financial officers, pleaded guilty to criminal charges.
Things are not always as they seem especially when it is reported by just financial reports.

Reports can easily be spoofed and changed by top management.

Analysts and investors must pay attention to the ethical side when they are reviewing the companies’ financial statements. For example, the bonuses and salaries paid to the top executives and whether it actually matches what they do or not
HealthSouth CFO on Scandal
Full transcript