SUBMITTED TO : SIR. JAVAID ZAFAR

Submitted by : Sana Munir

MBO - II

CORPORATECORPORATE GOVERNANCE : GOVERNANCE :

ACCOUNTING SCANDAL

COMSATS INSTITUTE OF INFORMATION TECHNOLOGY

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TABLE OF CONTENTS1 COMPANY INTRODUCTION AND HISTORY....................................22 CORPORATE BUSINESS ACTIVITIES.............................................4

2.1 Rehabilitation Hospitals...............................................................4

2.2 Outpatient Therapy Services........................................................4

2.3 Long Term Acute Care Hospital.....................................................4

2.4 Home Health...............................................................................4

2.5 Rehabilitation Technology............................................................43 ACCOUNTING SCANDAL.............................................................5

3.1 To Meet Wall Street’s Expectation................................................5

3.2 Insider Trading............................................................................6

3.3 Personal Profit.............................................................................7

3.4 Hiding the Fraud: To Restructure..................................................74 DETECTION OF ACCOUNTING FRAUD..........................................8

4.1 Red Flags....................................................................................85 PENALTIES FOR FRAUD.............................................................9

5.1 Richard Scrushy...........................................................................9

5.2 Chief Financial Officers Charges...................................................96 AUDITORS ROLE IN FRAUD.......................................................11

6.1 Ernst and Young Auditors...........................................................11

6.2 FEES paid to E&Y for services.....................................................12

6.3 Charges or penalties for E&Y......................................................127 BOARD OF DIRECTORS............................................................13

7.1 Healthsouth Board Viewed As Beholden To Scrushy.....................13

7.2 Doubts Created..........................................................................13

7.3 New Members In Board Of Director.............................................148 CORPORATE SOCIAL RESPONSIBILITY.......................................159 CONCLUSION..........................................................................16

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1 COMPANY INTRODUCTION AND HISTORY

Healthsouth Corporation is the leading provider of medical rehabilitation health care and outpatient surgery services in the United States. With more than 1,900 locations in the United States, the United Kingdom, and Australia, Healthsouth provides physical and other therapy in its rehabilitation facilities, offers imaging services through its diagnostic centers, and provides nonemergency surgical services at its outpatient surgery centers. The company also has occupational medicine clinics that deal exclusively with patients suffering from work-related health conditions. Healthsouth has contracts with managed care plans, insurance companies, and major corporations, including Wal-Mart and Goodyear. Healthsouth also has alliances with professional sports associations and schools to supply rehabilitative and sports medicine services.

A New Twist on Rehabilitation Services: 1980s

Healthsouth was being established by the idea of Richard Scrushy. Before the establishment of the Healthsouth, the previous rehabilitation companies were proceeding with stereotype functions. But Healthsouth added new rehab centers to its chain throughout the middle and late 1980s. Because of the company's unique concept for rehabilitation services, the company was successful and became model for other companies in the rehab industry. Rather than focusing on a specific rehab niche, Healthsouth appealed to the medical community by offering a number of rehabilitation programs tailored for different sicknesses.

By 1988 Healthsouth was operating a network of 21 outpatient facilities, 11 inpatient facilities, and seven rehabilitation equipment centers in 15 states, making it a leader in the U.S. rehabilitation industry. 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.

Rapid Growth through Acquisitions in the Early 1990s

By the mid-1990s, Healthsouth was operating 14 inpatient and 31 freestanding outpatient rehabilitation centers in 21 states. The company continued to add new general rehabilitation centers to its chain in 1991 and 1992. Meanwhile, its specialized sports business flourished and it

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enjoyed success with its new orthopedic hospitals that featured leading surgeons. By 1992 Healthsouth had established itself as one of two leaders in the U.S. rehabilitation industry.

Healthsouth's revenues for 1993 surged impressively to $575 million and the company assumed the industry lead. Healthsouth stepped up its acquisition program in 1994 and 1995 by absorbing a number of new companies. Two major purchases included the September 1994 acquisition of ReLife Inc. and the February 1995 buyout of NovaCare, Inc.'s inpatient rehabilitation hospital division. Significantly, in October 1995 Healthsouth announced that it had agreed to purchase the rehabilitation services operations of Caremark International for $127 million in cash. Healthsouth also bought Diagnostic Health Corporation, which offered outpatient imaging 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.

Continued Diversification and New Challenges in the Late 1990s

Healthsouth's steady string of acquisitions did not end as the company headed into the second half of the decade. In the year 1996, Healthsouth acquired Health Images. The most significant acquisition, however, was the purchase of Horizon/CMS Healthcare, the largest provider of specialty health care services in the United States. In 1998 Healthsouth made two major acquisitions. The firm purchased National Surgery Centers, Inc., and also acquired 34 surgery centers from Columbia/HCA Healthcare Corporation.

Healthsouth face difficulties in 1999. In June the company announced plans to divide its inpatient and outpatient operations by spinning off the inpatient services into a new company, to be called Healthsouth Hospital Corporation. For the third quarter of 1999 Healthsouth reported revenues of $993.3 million, down from $1.05 billion during the comparable period of 1998. The overall picture was not necessarily bleak, however, and for the nine months ended September 30, 1999, Healthsouth's revenues were $3.07 billion, up from $2.97 billion in the same period of 1999

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2 CORPORATE BUSINESS ACTIVITIES

2.1 Rehabilitation Hospitals

At Healthsouth inpatient rehabilitation hospitals, Healthsouth’s network of highly skilled physicians, nurses and therapists utilize the latest in equipment and techniques to return patients to home and work. Healthsouth’s hospitals offer specialized rehabilitative care across a wide array of diagnoses and deliver comprehensive patient care services in a manner that sets us apart from other post-acute healthcare providers. Healthsouth hospitals provide a more intense regimen and higher level of care such as greater physician involvement and therapy time, as well as increased availability of pharmacy and laboratory services.

2.2 Outpatient Therapy Services

Healthsouth's inpatient rehabilitation hospitals provide a smooth transition from inpatient rehabilitation to outpatient therapy. All of Healthsouth’s hospitals offer outpatient therapy with services available at the hospital or at a nearby freestanding clinic. Healthsouth's outpatient rehabilitation centers treat people of all ages and offer specialized rehabilitation programs for pediatric, adolescent, adult and geriatric populations.

2.3 Long Term Acute Care Hospital

Healthsouth's long-term acute care hospitals (LTCH) specialize in managing the complex medical care and rehabilitation of patients with multiple acute healthcare needs. Programs are designed to medically stabilize and strengthen patients so they can return to their highest level of function. A patient's average length of stay is between 25 and 30 days.

2.4 Home Health

Healthsouth's home health programs provide skilled nursing and therapeutic services, such as physical, occupational or speech therapy, medical social services, and other home medical arrangements.

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2.5 Rehabilitation Technology

Healthsouth is the industry leader in providing the most advanced rehabilitation technology to its patients. These new modalities, when combined with traditional therapy, can greatly enhance overall outcomes and improve a patient's quality of life.

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3 ACCOUNTING SCANDAL

There were various ways through which Healthsouth Corporation was notified by the Authorities about committing the fraud. The fraud started soon after its initial public offering in 1986, through various activities.

3.1 To Meet Wall Street’s Expectation

In 1986, the Healthsouth corporation went public, and offered its initial public offering, and at the instruction of Scrushy, the company began to artificially inflate its earnings in order to match the Wall Street analysts' expectations and maintain the market price for Healthsouth corporation’s stock.

The company implemented the practice for couple of times.

3.1.1 Fix the earnings

SEC said that, If the Healthsouth corporation’s actual results fell short of wall street’s expectations, Scrushy would tell Healthsouth corporation’s management to "fix it" by recording false earnings on Healthsouth corporation’s accounting records to make up the shortfall.

Healthsouth corporation’s senior accounting personnel then organized a meeting to "fix" the earnings shortfall. By 1997, the attendees referred to these meetings as "family meetings" and referred themselves as "family members."

At the meetings, they discussed the ways by which members of the accounting staff would falsify Healthsouth's books to fill the "gap" or "hole" and meet desired earnings. The fraudulent postings used to fill the "hole" were referred to as the "dirt."

3.1.2 Overstated Earnings

Between 1999 and the second quarter of 2002, HRC intentionally overstated its earnings, identified as "Income Before Income Taxes And Minority Interests," by at least $1.4 billion in reports filed with the Commission.

The approximate amounts of overstated "Income Before Income Taxes And Minority Interests" since 1999 in Forms 10-K and 10-Q are as follows:

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Income (Loss) before Income Taxes and Minority Interests (in $ millions)

1999Form 10-K

2000Form 10-K

2001Form 10-K

For six monthsended June 30, 2002

Actual $(191) $194 $9 $157

Reported 230 559 434 340

Misstated Amount 421 365 425 183

Misstated Percentage 220% 188% 4,722% 119%

3.2 Insider Trading

SEC while investigations concluded that Richard Scrushy was the heading towards insider trading, resulting in loss to the shareholders. In 1997, Richard Scrushy the CEO, asked Owens CFO to continue falsifying Healthsouth’s books and records because he was planning to sell the stock, and also he wanted to maintain the stock’s current level.

While the scheme made by Scrushy was going on, Healthsouth’s senior officers and accounting personnel periodically discussed with Scrushy regarding periodically increasing false financial statements, and also tried to persuade him to abandon the scheme. Scrushy insisted that the scheme continue because he did not want Healthsouth’s stock price to suffer. Indeed, when Healthsouth Corporation’s accounting personnel advised Scrushy to abandon the earnings manipulation scheme, Scrushy refused, stating in substance, "not until I sell my stock."

But on Sept. 30, 1998, after Mr. Scrushy and other senior executives had sold millions of dollars in Healthsouth stock, the company made a startling announcement: it was likely to miss the analysts' estimates for 1998 and 1999. The stock lost more than half of its value in less than a month, dropping to $7.69 from $18.38 a few days before the announcement. Ms. Landry a former employee of Healthsouth was the evidence of the insider trading regarding the executives attitude, she listened them laughing at shareholders in 1998 after the stock's drop. 

Richard M. Scrushy, the chairman and chief executive of Healthsouth, was accused for using insider information advantage and selling about 5.2 million shares for $14.05 each May 14 and about 2.5 million more shares back to Healthsouth at $10.06 a share on July 2003 in the weeks before the company made an announcement was about the new payment policy of Medicare which caused its stock price to drop for more then 50% sharply.

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3.3 Personal Profit

Scrushy had personally profited from the scheme to artificially inflate earnings. He has sold at least 7,782,130 shares of Healthsouth’s stock since 1999, when Heathsouth Corporation’s share price was affected by Heathsouth Corporation’s artificially inflated earnings. Moreover, according to Heathsouth Corporation’s 2001, Scrushy received at least $6.5 million from Healthsouth during 2001 in "Bonus/Annual Incentive Awards." This bonus payment was based on Heathsouth Corporation’s artificially inflated earnings. Further, Healthsouth from 1999 through 2001, paid Scrushy $9.2 million in salary. Approximately $5.3 million of this salary was based on Healthsouth’s achievement of certain budget targets. HRC attained these budget targets through its scheme to artificially inflate earnings.

According to Alabama special reprts, another estimate abouth scrushy pay, bonuses and Stock sales is given below:

3.4H

iding the Fraud: To Restructure

One former employee concluded while investigation that "Splitting up the company would make it more difficult to trace the earnings fraud."

3.4.1 In 1992

Scrushy declared that Healthsouth had grown enormously since it had gone public and proposed that it was "absolutely necessary" to restructure. So Healthsouth mapped out a plan to divide the Healthsouth into three pieces each with its own president and CFO through an informal division that left the parent company intact. But was not succeeded.

3.4.2 In 1999

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Healthsouth sketched out a second restructuring plan, this plan was an official spinoff intended to split inpatient and outpatient services and blur the old fire beneath Healthsouth's stock. But at various times staff at the Healthsouth became alarmed and attempted to pressure Scrushy into abandoning the fraud.

3.4.3 In 2002

The previous decayed plans for division of the company was recomposed in 2002 with a plan to split the company into in-patient rehabilitation and a more profitable outpatient surgery and rehabilitation group.

One employee suggested that Scrushy would become chairman of the latter, and Owen of the former. The in-patient company would become a private company in which the fraud could be hidden. The market refused to go along with these strategies and Healthsouth was forced tabandon them once again. Moreover, Shareholders met and put the issues forcefully to Scrushy.

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4 DETECTION OF ACCOUNTING FRAUD

The fraud was massive in nature and could not stay hidden for longer period of time. The company was on the radar of SEC from 1992.

4.1 Red Flags

In 1998, A dissatisfied shareholder of Healthsouth, ”FLEECED SHAREHOLDER” alerted the company’s auditor E&Y chairman, the American institute of certified public accountants, health care financing administration, business week, Morgan Stanley-an investment bank, Milberg Wiess-a law firm specializing in securities fraud and investors rights, and the SEC division of enforcement. Unlike other average investors, this fleeced shareholder had great knowledge of accounting. The shareholder challenged the propriety of some of the Healthsouth’s accounting practices.

A former CFO of Healthsouth, Weston Smith, whistle blowed about the fraud was taken place at the Healthsouth. He approached prosecutors 2003 and offered to make audiotapes of his colleagues, to form the solid evidence. The CFO took the step to disclose the farud because of Sarbanes Oxley Act, prolonging the prison time for white collar crime as well as the fine amounts. Smith pleaded guilty to fraud charges, was sent to prison for 27 months and was also ordered to forfeit $1.5 million in ill-gotten gains and will spend one year on probation after his release.

An employee of Healthsouth had written a letter to the E&Y audit team in June 2002 disclosing that in three specific areas of the accounts there could be problem. E&Y had checked out the allegations, but E&Y determined that there had been no wrongdoings in the accounts of the Healthsouth.

An other employee after leaving the organization in 2002, tried to spread the facts about the questionable practices were taken place in department, but his efforts resulted in nothing. He also sent an email to Healthsouth's auditor, Ernst & Young, about a particular area involved in fraud. But E&Y concluded that the accounting was legitimate. He tried to make his case online, but yahoo forum readers dismissed his claims as typical internet blather.

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5 PENALTIES FOR FRAUD

On March 19, 2003, the Securities and Exchange Commission (SEC) charged Healthsouth, the nation's largest provider of outpatient surgery, diagnostic and rehabilitative healthcare services and formerly a major player in the occupational medicine market, and its Chief Executive Officer and Chairman Richard M. Scrushy with a massive accounting fraud.

The participation of Weston Smith, William Owens, Michael Martin, Aaron Beam and Jason Brown in the fraud is described there as is their assistance to investigators and their guilty pleas. Other personnel pleaded to be guilty were Malcolm McVay, Kenneth Livesay, Emery Harris, Angela Ayers, Cathy Edwards, Rebecca Kay Morgan and Virginia Valentine.

5.1 Richard Scrushy

Richard Scrushy, the former CEO and the Chairman of Healthsouth was not found to be guilty over the manipulation of the accounting practices. And still he is struggling to prove himself innocent from the fraud occurred.

Healthsouth Corp. head Richard Scrushy has been indicted on 85 counts in a massive federal fraud case that already has seen 15 former executives of the rehabilitating services giant plead guilty.

The indictment charges that Mr. Scrushy used threats, bribes, surveillance and eavesdropping to intimidate his executives into participating in an effort to inflate the company's profits by $2.7 billion from 1996 to 2002. Healthsouth executives talked of "filling the hole" or "filling the gap" when they made false entries in the company's books. Government's court filed outlines six "crimes, acts or wrongs" that were not the part of the 85-count against Scrushy that alleges he falsified financial results by $2.7 billion since 1996.

Scrushy collected $279 million in unethical gains from fraud, including salary, bonuses and stock options that were based on the company's performance.

5.2 Chief Financial Officers Charges1. Malcolm McVay, a former Healthsouth Corp. chief financial officer, was sentenced to

six months home detention and five years probation after the tenure, also fined McVay $10,000 and ordered him to forfeit $50,000.

2. Healthsouth Corp. Chief Financial Officer Michael Martin to five years probation for his role in the company's massive accounting scandal also fined Martin $50,000 and ordered him to forfeit gains of $2,375,000.

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3. Aaron Beam, the first chief financial officer Healthsouth Corp., was sentenced to three months in jail today by a U.S. District judge in Birmingham. Beam was also fined $10,000 and ordered to forfeit $275,000.

4. Healthsouth Corp. finance chief Weston Smith, who blew the whistle on the accounting scandal that stunned the company, was given 27 months in prison and was also ordered to forfeit $1.5 million in ill-gotten gains and will spend one year on probation after his release.

5. William Owens, a former chief financial officer and briefly chief executive officer at Healthsouth Corp., Birmingham, Alabama, was sentenced to five years in prison for his role in massive accounting fraud at the company. Owens is contesting the government's request that he forfeit $12 million in assets, and a hearing likely will be scheduled for late January, a court clerk said.

The accounting fraud opened the door to a flood of lawsuits including separate fraud and bribery suits against Scrushy, prison sentences and fines for the staff involved and a myriad lawsuits involving Healthsouth itself. Healthsouth faced almost certain bankruptcy but somehow survived.

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6 AUDITOR’S ROLE IN FRAUD

Most of the troubling issues surrounding HEALTHSOUTH include its dealings with its

Auditors Ernst and Young, Its tax accountants KPMG,

Its loan bankers,

Its investment bankers

The stock analysts who advise the market.

6.1 Ernst and Young Auditors

Healthsouth had a US $2.5 billion empty hole in the profits, which was not being detected by the powerful and influential groups while making decisions. The list of these commercial groups also includes its auditors Ernst and Young.

Healthsouth’s profits increased over the period of time. By 1994 the company’s revenues had topped the billion-dollar mark, and Healthsouth was the acknowledged industry leader for rehabilitative health care services. Ernst & Young became auditors for Healthsouth in 1984. It has been suggested that Scrushy fired the previous auditors because they refused to meet his requirements. As Healthsouth’s independent auditor throughout this period Ernst n Young always gave the company a clean bill of financial health. Despite the audit firm’s vote of confidence in its clients financial statements, documents exist that prove that the auditor’s client was committing fraud early as 1993. It has been believed that failure of detection of fraud by E&Y at early stages enabled the Healthsouth Corporation to continue fraud, eventually costing investors at least 2.7 billion.

6.1.1 Scrushy Schemes

Scrushy himself was undoubtedly charismatic, extremely plausible, persuasive and expert at getting what he wanted, in one sense the ultimate con man. He recruited staff, which were young and fresh in the organizations and from those he did businesses in Birmingham Alabama. These young and fresh employees had the extensive knowledge of the company they worked in and also had personal contacts and some understandings in these organizations.

Scrushy was to create a company in which it was legitimate for senior staff to exploit their knowledge and the vulnerability of the previous organizations from which they were recruited. It is clear that some of these previous employees were induced to participate in

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the fraud. Such activities were carried with the collaboration of their friends and previous colleagues. So same is with the case in Ernst and Young.

Ernst and Young's role in Healthsouth's fraud must be seen in the light of the conduct of its accounting peers in ignoring fraud and sometimes actively participating in it.

6.1.2 Recruitment Scheme

A number of Healthsouth staff, including the most recent CFO, William Owens who has been pleaded guilty was past employees of Ernst and Young. They would have known Ernst and Young's practices well and probably retained many friends there. Their recruitment was aimed to design and implement a fraud that would not too obviously trigger the auditor's alarm bells.

6.1.3 Overlooking the accounts

It was being analyzed that either these employees cooked up for malpractices or Ernst and Young had a blind eye by simply trustingly accepted the accounts from their mates without closely looking at their contents, which was not known.

6.1.4 Why to be Picky

Ernst and Young did very profitable business with Healthsouth and its interconnected companies. The employees of the firm received incentive payments, based on performance. They made a large amount of money with their dealings with Healthsouth – sometimes billions of dollars. They would have lost all incentives program if they chose to be PICKY about the large discrepancies created US$2.5 billion empty whole in accounts.

6.2 FEES paid to E&Y for services

Ernst & Young $1.16m (pounds 700,000) in audit fees and $2.39m in "audit- related fees" in 2001. The "audit-related fees" covered payments to the firm for so- called "pristine audits", which included checking magazines in waiting rooms and making sure toilets were clean. The company has been accused by the SEC of inflating its profits by $1.4bn since 1999.

6.3 Charges or penalties for E&Y

E&Y even though having a blind eye over the mal accounting practices of the Healthsouth Corporation, still had not been charged with criminal conduct in the fraud. But the accounting firm still in 2007 was subjected to multiple lawsuits by shareholders and by the Healthsouth itself.

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7 BOARD OF DIRECTORS

The Board of Directors at Healthsouth Corporation were not independent of the management. Richard Scrushy founded Healthsouth corporation in 1984, with some his associates and became, CEO, chairman of board of directors. In 1985 another venture capitalist C. Sage Givens put up the capital. The company maintained a close knit between the associates, even when the company went public in 1986.

The major cause of Healthsouth downfall was the absence of independent Board of directors to safeguard the interest of shareholders. But the tradition of the board of directors was firm enough to be broken by any strong entity. This tradition was accelerating due to having powers to perform misconduct.

7.1 Healthsouth Board Viewed As Beholden To ScrushyThe board of Healthsouth was being controlled by the Scrushy himself, and his associates who formed the basis for organization. These fellows were providing Scrushy lavishly, and did not inquire much about the activities being conducted in the corporation. Scrushy led the board with his own management style and it was being criticized that the board was the personal fief of Mr. Scrushy (New York Times 2004).

7.2 Doubts Created

7.2.1 Board Members

The other board members also existed on the board of directors. Most of these board members were the executives of the firms were being acquired by the Richard Scrushy. These board members often inquired Scrushy about the financial crisis inside the organizations. But there was no valid reply in exchange.

7.2.2 Shareholders

In 1998 when there was increase in the fall of the stock price of the Healthsouth corp. I could not be ignored. Investors and shareholders appeared to investigate. They submitted the proposal to separate the ownership of control by having independent directors. they suggested the board to be independent of management. But the board of directors opposed the proposal of shareholders and in counterargument they blamed the recent drop in stock price to be the basis of industry wide decline of earnings.

7.2.3 Dismissed the concept at First

Richard Scrushy did not want to separate the board from the management, he fear the affiliation of the board members would be formed and act would against Scrushy’s will. Moreover the independent directors might cut short the gratuitous compensation for the

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Richard Scrushy. Scrushy neglected the concept also because, he had a long withstanding ties with his associates and refused to approve a plan to add independent members who might form a majority. According to the employees of the Healthsouth the associates having close relationship with one another included three investors, George H. Strong, C. Sage Givens, Charles W. Newhall III and Larry D. Striplin Jr. a friend of Mr. Scrushy.

7.3 New Members In Board Of Director

In 2002 when the companies activities remained undone, the struggle was being carried down by to recruit the outside investor. The reason of continuously interviewing the outside directors to be recruited was to build a safety plans covering the fraud. The recent Sarbanes Oxley act stated regarding white collar crime that the executives involved in the mal practices would be penalized and the prison tenure will be increased.

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8 CORPORATE SOCIAL RESPONSIBILITY

The company for providing rehabilitative services for profit. It was facilitating the patients with various services. But there has been no Corporate citizenship being provided by Healthsouth Corporation.

On the other hand, the Richard Scrushy is an philanthropist. He personally had been performing charitable doings, and was providing philanthropy to various institutes and the needy people.

The Richard M. Scrushy Charitable Foundation distributed to churches and religious groups most of the $716,000 in donations in 2005

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9 CONCLUSION

The Healthsouth Corporation had done a successful business by its creation and expanded enormously. But the self interest of the executives led the company suffered losses which were not disclosed. The theme to deceive the shareholders with various malpractices took place. The shareholder activism existed but, it took a lot of time to get notice practically.

Healthsouth executives were charges with penalties but on the other hander, investors and shareholders faced great loss. It was the responsibility of the Board of directors to safeguard the rights of shareholders.

Each Company is responsible for performing with ethics and promoting the corporate governance in the organization to become a role model and aside the self interest of position being given. Its also important to maintain independent