HEALTHSOUTH’S CORPORATE ACCOUNTING SCANDAL

A CASE STUDY IN FRAUDULENT FINANCIAL REPORTING

Kevin Barry
Management 226: Special Topics in Advanced Accounting
UCLA Anderson School of Management
June 9, 2009

1. INTRODUCTION
HealthSouth Corporation is a large, public healthcare company that operates 93

inpatient rehabilitation hospitals (and their 49 outpatient rehabilitation satellites), six

long-term acute care hospitals, and 25 home health agencies.1 According to its website,

HealthSouth is “the nation's largest provider of inpatient rehabilitation services.”2 The

Company is headquartered in Birmingham, Alabama, and its operations are spread across

26 states and Puerto Rico.3 Its mission is “to be the healthcare company of choice for

patients, employees, physicians and shareholders by providing high quality care in the

communities we serve.”4

HealthSouth’s stock trades on the New York Stock Exchange (NYSE) under the

ticker symbol HLS, with a June 8, 2009 closing price of $12.76, giving the Company a

market capitalization of approximately $1.1 billion.5 The Company’s 2008 revenue was

1
HealthSouth 2008 10-K, p. 1. http://investor.healthsouth.com/secfiling.cfm?filingID=1442643-09-12.
2
http://investor.healthsouth.com/
3
Ibid.
4
http://www.healthsouth.com/who_we_are/mission_statement.asp
5
HealthSouth stock hit its peak on April 20, 1998, closing at $30.56 ($152.81 split-adjusted). It hit its low
point on March 28, 2003, closing at $0.40 ($0.08). The split-adjusted figures reflect the 1-for-5 reverse
approximately $1.8 billion and its net income was $226.4 million, for basic earnings per

share (EPS) of $2.73.6 About two-thirds of HealthSouth’s revenue comes from the

Medicare program.7

HealthSouth is perhaps best known for the massive accounting fraud that was

discovered in 2003 and almost led to the Company’s bankruptcy. Although HealthSouth

emerged from this experience and has so far had a successful recovery, the memory of

this scandal is still fresh. The events surrounding the scandal, as well as a discussion of

how the fraud was perpetrated and some key lessons to be learned as a result, are the

topics of this paper.

2. HISTORY AND BACKGROUND

HealthSouth was founded in 1984 by respiratory therapist and businessman

Richard Scrushy, and went public in 1986 with Scrushy as Chairman and Chief Executive

Officer (CEO). The Company grew quickly throughout the 1980s and 1990s, mainly via

acquisition. In 1997, it opened a brand-new, $50 million corporate campus on the

outskirts of Birmingham. By the end of 1999, HealthSouth was already a $4 billion

company and had expanded to 120 inpatient rehabilitation hospitals, five medical centers,

1,379 outpatient rehabilitation centers, 230 surgery centers, 129 diagnostic centers, and

124 occupational medicine centers.8

stock split that HealthSouth completed in 2006. The collapse of the Company’s stock price in March 2003
and the 2006 reverse stock split are discussed later in the paper. Historical prices per Yahoo! Finance,
available at http://finance.yahoo.com/q/hp?s=HLS&a=05&b=8&c=2009&d=05&e=8&f=2009&g=d,
http://finance.yahoo.com/q/hp?s=HLS&a=03&b=20&c=1998&d=03&e=20&f=1998&g=d, and
http://finance.yahoo.com/q/hp?s=HLS&a=02&b=28&c=2003&d=02&e=28&f=2003&g=d.
6
Diluted EPS was $2.62. HealthSouth 2008 10-K, p. 25.
7
HealthSouth 2008 10-K, p. 3.
8
HealthSouth 1999 10-K, pp. 6-9, 24. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-00-
430. At its height, the Company had four separate divisions: inpatient rehabilitation, outpatient

2
 In the process of HealthSouth’s spectacular rise, Scrushy became one of the

highest-paid CEOs in the country.9 From 1995-97, for example, he earned a total of $8.5

million in salary, $23 million in incentive bonuses, $4.8 million in stock option awards,

and $700,000 in other compensation.10 By March of 2002, Scrushy owned

approximately 20.9 million shares of HealthSouth common stock (representing 5.1% of

the total shares outstanding) with a combined market value of more than $287 million.11

Problems at HealthSouth started to become evident in mid-2002. In May,

Scrushy sold more than $75 million worth of HealthSouth stock, and in June he sold

another $25 million back to the Company. HealthSouth then disclosed in August that a

change in Medicare payment policy would “significantly lower reimbursement,” causing

the Company’s stock to lose more than half of its value and leading to shareholder

lawsuits alleging that Scrushy had acted on insider information when selling his shares.

Then, in February of 2003, the Federal Bureau of Investigation (FBI) announced the

opening of a criminal investigation of HealthSouth for “possible securities law

violations.”12

3. ALLEGATIONS OF CORPORATE ACCOUNTING FRAUD

After the close of business on March 18, 2003, the FBI used a search warrant to

raid HealthSouth’s headquarters and seize the Company’s financial records,13 and on

rehabilitation, surgery centers, and diagnostic centers. It has since sold off all but the inpatient
rehabilitation division.
9
http://en.wikipedia.org/wiki/Richard_M._Scrushy
10
HealthSouth 1997 10-K, p. 64. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-98-290.
11
HealthSouth 2001 10-K, p. 79. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-02-448.
Calculation based on March 22, 2002 share price of $13.74 per Yahoo! Finance, available at
http://finance.yahoo.com/q/hp?s=HLS&a=02&b=18&c=2002&d=02&e=18&f=2002&g=d.
12
http://www.nytimes.com/2003/02/07/business/fbi-is-investigating-healthsouth-trades.html
13
HealthSouth press release, March 19, 2009.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-613.

3
March 19, the Securities and Exchange Commission (SEC) filed a civil complaint against

HealthSouth for accounting fraud.14 The SEC, which had already been investigating the

Company for six months, alleged that “since 1999, at the insistence of Scrushy,

[HealthSouth] systematically overstated its earnings by at least $1.4 billion in order to

meet or exceed Wall Street earnings expectations.”15 Although the SEC’s complaint only

detailed the estimated earnings impact of the fraud between 1999 and the first half of

2002, as shown in the table below, it alleged that these practices began soon after

HealthSouth went public in 1986.16

For six
1999 2000 2001 months
Income (Loss) before Income Taxes and
Form Form Form ended
Minority Interests (in $ millions)
10-K 10-K 10-K 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%

Source: Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy, CV-
03-J-0615-S (N.D. Ala.). http://www.sec.gov/litigation/complaints/comphealths.htm.

According to the complaint, before HealthSouth’s earnings were released each

quarter, management would brief Scrushy on the actual figures. If the figures were less

than Wall Street analyst estimates, Scrushy would instruct the Company’s senior

14
SEC litigation release, March 20, 2003. http://www.sec.gov/litigation/litreleases/lr18044.htm.
15
Ibid.
16
Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy, CV-03-J-
0615-S (N.D. Ala.). http://www.sec.gov/litigation/complaints/comphealths.htm.

4
corporate accountants to “fix it” in order to meet the Street’s expectations.17 These

accountants, known as “the family,” would then hold “family meetings” to determine

how they could inflate the Company’s quarterly earnings and make the necessary

adjustments.

Based on generally accepted accounting principles (GAAP), increases in earnings

must be matched by corresponding increases in net assets, so that shareholders’ equity

rolls forward properly and the balance sheet balances. The SEC alleged that HealthSouth

was therefore able to increase its earnings while balancing its books by overstating assets

and understating liabilities. This was done in a variety of ways, but certain accounts in

particular were utilized most frequently in connection with the fraudulent reporting.

First, on the income statement side of each fraudulent entry, the Company’s

senior accountants would either reduce expenses or the “contractual adjustment” contra-

revenue balance, which represented the estimated difference between gross patient

billings and insurer reimbursements. (Such allowances are standard accounting for many

healthcare providers and reflect proper revenue recognition practices. Since revenues are

earned in the same period that services are provided but reimbursements often do not

occur until a subsequent period, an allowance based on the terms of the provider’s

agreements with third-party payors is recorded, and later adjusted upon settlement.)

Because HealthSouth only reported net revenues in its public filings, the impact

of these adjustments was easier to conceal. In addition, contractual adjustments are

subject to a significant degree of management discretion, and the Company offered the

public little clarity about how it determined these adjustments. For example, in

17
Ibid.

5
disclosing the Company’s accounting policy for such adjustments, HealthSouth’s 10-Q

for the second quarter of 2002 stated only the following:

“We estimate contractual adjustments from non-governmental third-party

payors based on historical experience and the terms of payor contracts.
Our reimbursement from governmental third-party payors is based upon
cost reports, Medicare and Medicaid payment regulations and other
reimbursement mechanisms which require the application and
interpretation of complex regulations and policies, and such
reimbursement is subject to various levels of review and adjustment by
fiscal intermediaries and others, which may affect the final determination
of reimbursement. We estimate net realizable amounts from governmental
payors based on historical experience and interpretations of such
regulations and policies. In the event that final reimbursement differs
from our estimates, our actual revenues and net income, and our accounts
receivable, could vary from the amounts reported.”18

Next, to make these entries balance, the accountants would need to make

offsetting adjustments to HealthSouth’s balance sheet accounts. To do this, they would

frequently create fictitious fixed assets. The cumulative impact of these fraudulent

entries, according to the SEC’s complaint, resulted in an approximate $800 million

overstatement to the Company’s “property, plant, and equipment” balance by the end of

third quarter of 2002,19 when the Company reported about $8 billion in total assets—$3

billion of which represented the net book value of its fixed assets.20

Because HealthSouth owned hundreds of thousands of fixed assets spread across

almost 2,000 facilities around the time that most of the fraud was alleged to have taken

place, it was not overly difficult for the accountants to hide false assets in the Company’s

facility-level fixed asset sub-ledgers. So that they would not lose track of the fictitious

18
HealthSouth Q2 2002 10-Q, p. 16. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-02-
973.
19
Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy.
20
HealthSouth Q3 2002 10-Q, pp. 3-4. http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-
02-1280.

6
assets, the accountants marked them as “AP Summary” on the sub-ledgers. To avoid red

flags, these assets were recorded for varying amounts, and they were also intentionally

recorded at amounts below the threshold that the Company’s outside auditors used in

selecting which assets to test. If the auditors requested a sub-ledger with fictitious assets,

the Company would change any “AP Summary” items to a description that sounded more

like a real fixed asset. Then, if the auditors nevertheless selected a nonexistent asset for

testing, the accountants would create and provide the auditors with fictitious supporting

documentation, which happened on at least one occasion.21

The SEC’s complaint alleged that the senior HealthSouth officers involved in the

fraud had attempted over the years to convince Scrushy to put a stop to it, but that he

consistently refused because he was concerned about the possible impact that doing so

would have on the value of his stock. It was not until 2002 that Scrushy began to relent,

when the officers were successful in convincing him to take steps to lower earnings

expectations so as to remove the pressure to overstate earnings (although this too was

done in a fraudulent way, by intentionally overestimating the effect of a Medicare policy

change on HealthSouth’s bottom line). Then, according to the complaint, Scrushy finally

agreed to stop inflating earnings in mid-2002 out of concern for the new Sarbanes-Oxley

provision requiring a sworn certification by company CEOs that the financial statements

contained “no untrue statement of a material fact.”22

4. FALLOUT
After the FBI raid on HealthSouth’s headquarters in March 2003, trading of the

Company’s stock on the NYSE was immediately suspended. HealthSouth was also
21
Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy.
22
Ibid.

7
removed from the S&P 500 and its stock was delisted the following week, after which

times its shares were traded on over-the-counter “pink sheets.” (The stock price had

closed at $19.55 on March 18; when trading resumed on March 25, the opening price was

only $1.85, and it closed the day at just $0.60.23) J.P. Morgan Chase also froze

HealthSouth’s $1.25 billion line of credit—which the Company needed access to in order

to pay its bondholders the more than $350 million in principal and interest due on April

1—thus raising the possibility of default and bankruptcy.24

In addition, HealthSouth’s Board of Directors immediately placed Scrushy and

Chief Financial Officer (CFO) William Owens on administrative leave.25 Both were later

fired.26 Owens was just one of several HealthSouth CFOs who pled guilty to criminal

charges in connection with the fraud—all four of his predecessors did as well.27 A

number of other HealthSouth employees also confessed to their involvement in the

scheme.28 Admitted and suspect participants in the fraud either resigned from the

Company or were fired.29 Scrushy, however, claimed that the fraud was perpetrated

without his knowledge.

23
MarketWatch historical price data, available at
http://www.marketwatch.com/investing/stock/hls/historical.
24
HealthSouth press release, March 27, 2003.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-668;
http://www.nytimes.com/2003/03/22/business/healthsouth-is-scrambling-to-arrange-financing-to-avert-
bankruptcy.html.
25
HealthSouth press release, March 20, 2003.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-617.
26
HealthSouth press release, March 31, 2003.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-695;
http://www.accountingnet.com/x37629.xml.
27
Report of the Special Audit Review Committee of the Board of Directors of HealthSouth Corporation
(May 28, 2004), pp. 1, 37. http://investor.healthsouth.com/secfiling.cfm?filingID=950172-04-1357.
28
For profiles of the five HealthSouth CFOs and ten “family members” who pled guilty to federal charges
in connection with the fraud, see http://www.al.com/specialreport/birminghamnews/healthsouth/guilty.jpg.
29
Special Audit Review Committee Report, p. 37.

8
 The Board of Directors also quickly established a “Special Audit Review

Committee” and engaged PricewaterhouseCoopers (PwC) to conduct a forensic audit

concerning the SEC’s fraud allegations. The Board also brought in turnaround specialists

Alvarez & Marsal (A&M) “to help stabilize operations, address financial and liquidity

concerns and to position the company for successful restructuring as it moves forward.”30

(Although HealthSouth did default on its debt obligations, it was ultimately able to avoid

being forced into bankruptcy.31) Soon thereafter, HealthSouth fired its independent

auditors, Ernst & Young (E&Y),32 and notified the SEC that it would not be able to file

its 2002 10-K on time.33 The Company later replaced E&Y with PwC.34

5. FORENSIC AUDIT RESULTS

The results of the PwC forensic audit were delivered to HealthSouth’s Board of

Directors and filed with the SEC on June 1, 2004. The forensic auditors examined

possible fraudulent activity and “accounting irregularities” between 1996 and 2002, with

a focus on “large or unusual accounting entries, particularly those involving round dollar

amounts or adjustments after the close of a financial reporting period.”35 The report,

which adds further detail to the SEC’s description of how the fraud was perpetrated,

30
HealthSouth press release, March 24, 2003.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-651.
31
HealthSouth press release, August 12, 2003.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-1275.
32
HealthSouth press release, March 31, 2003.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-695.
33
HealthSouth Notification of Late Filing, April 1, 2003.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-726.
34
HealthSouth press release, May 7, 2003.
http://investor.healthsouth.com/secfiling.cfm?filingID=1005150-03-876.
35
Special Audit Review Committee Report, pp. 3-4.

9
found that during this period the Company knowingly inflated income by more than $2.7

billion, a breakdown of which appears in the table below.36

Impact To Income Before Minority Interest And Taxes (millions of dollars)

Reduction of Contractual Allowances or Operating Expenses $ 2,203
Acquisition Accounting 421
Bonus Accounting 52
Investment Accounting 17
Facility Contractual Accounting 19
Third-Party Transaction Accounting 29
Total $ 2,741

Source: Report of the Special Audit Review Committee of the Board of Directors of HealthSouth
Corporation (May 28, 2004), p. 8. http://investor.healthsouth.com/secfiling.cfm?filingID=950172-04-1357

Similar to the SEC’s civil complaint, the forensic audit report noted that the

majority of the inflated earnings were the result of reductions to HealthSouth’s

“contractual adjustment” contra-revenue account. According to the report, this practice

began in the second quarter of 1996 and continued in every quarter through the middle of

2002. To a lesser degree, the Company also reclassified certain operating expenses “to

make it appear as if the expenses were never incurred.”37 Instead of booking a

corresponding adjustment directly to the balance sheet, however, the Company would

record a series of intermediate transactions, typically through the use of corporate

suspense accounts and intercompany transfers, which ultimately allocated the fictitious

assets down to the facility level. Many of these fraudulent “management entries” were

36
The amount of inflated earnings that the auditors traced to the 1999-2003 period roughly approximated
the SEC’s estimation from its March 2003 complaint. Ibid., p. 8.
37
Ibid., pp. 10-11.

10
externally uploaded into the Company’s accounting system and would self-reverse the

following quarter.38

On the balance sheet side of the entries, the forensic audit report noted that

slightly more than $1 billion of the fraudulent entries was related to nonexistent fixed

assets, which, as noted, were primarily given the designation “AP Summary.” The

Company also overstated its cash balance by adding unsubstantiated amounts to the

monthly reconciliations of its corporate consolidation account, which accounted for the

cash receipts and disbursements of the Company’s approximately 2,000 bank accounts.

Although HealthSouth told analysts in early March 2003 that it had $390 million in cash

at the end of 2002,39 $373 million of this was fabricated, according to the report.40

Hundreds of millions of dollars of other current and intangible assets was further made up

through various accounting schemes.41

HealthSouth also fabricated more than $400 million in income and assets through

fraudulent acquisition accounting. One way it did this was to create artificial reserves on

the books of the acquired company and balance the entry by increasing goodwill. This

gave the Company the opportunity to recognize income by releasing the reserves in

subsequent periods. For example, with one acquisition in 1999 HealthSouth added a $7

million accounts receivable allowance to the acquired company’s books, which it then

took down in 2000 and 2001 to increase income. Various other “cookie jar” reserves

were established upon acquisition and later released in similar fashion.42 Furthermore, as

38
Ibid., pp. 13-15.
39
http://www.nytimes.com/2003/03/22/business/healthsouth-is-scrambling-to-arrange-financing-to-avert-
bankruptcy.html.
40
Ibid., pp. 18-19. It is therefore unsurprising that the Company defaulted on its debt obligations in 2003
when it lost access to its credit line.
41
Ibid., p. 12.
42
Ibid., pp. 19-22.

11
the above table indicates, HealthSouth also created false earnings—though on a much

smaller scale—through fraudulent accounting for bonuses, investments, facility-level

contractual adjustments, and third-party transactions.

In addition to the $2.7 billion in false earnings, the forensic audit report identified

several categories of potential misstatements that “while not necessarily the result of

intentional fraud, nevertheless were sufficiently aggressive or questionable to warrant

discussion.”43 Examples include the improper capitalization of expenses, improper

accounting for sale-leaseback transactions, and the failure to record various E&Y audit

adjustments.44 The total estimated impact of such potential misstatements was $632

million.

Based on these findings, the forensic audit report made a number of

recommendations to prevent similar accounting and reporting problems from happening

in the future. Examples include improvements to the Company’s contractual allowance

accounting, the implementation of various policies and procedures related to journal

entries, stronger controls over fixed assets, and a robust internal audit department that

reports directly to the Audit Committee.45 The report concluded that “the accounting

fraud at HealthSouth was by any standard both enormous and complex. Its concealment

over the course of nearly seven years required considerable effort and, in some cases,

luck. For all its size and complexity, however, the fraud shared much in common with

other highly publicized earnings overstatement cases.”46

43
Ibid., p. 9.
44
Ibid., pp. 27-33.
45
Ibid., pp. 37-42.
46
Ibid., p. 7.

12
6. SCRUSHY

In November 2003, Scrushy was indicted for his role in the HealthSouth

accounting fraud. The 36-page, 85-count federal indictment47 charged him with

“conspiracy, mail, wire and securities fraud, false statements, false certifications and

money laundering” and sought approximately $278 million in asset forfeitures.48 For

certifying financial statements that he allegedly knew to be materially false, Scrushy

became the first-ever CEO to be charged with violating the Sarbanes-Oxley Act. Scrushy

steadfastly maintained his innocence.49

Scrushy’s criminal trial began in January 2005.50 To prove Scrushy’s guilt, the

government relied extensively on the testimony of several former HealthSouth executives

involved in the fraud, including all five former CFOs, many of whom received lesser

prison sentences in exchange for their cooperation in the investigation and testimony at

the trial.51 Scrushy’s defense lawyers did not deny that fraud took place, but instead

argued that it was done without his knowledge, and they attacked the credibility of the

government’s witnesses.52 In June, after a lengthy trial and extended jury deliberations,

Scrushy was acquitted on all charges. The verdict was a huge blow to the government,

47
http://www.usdoj.gov/dag/cftf/chargingdocs/scrushyindictment.pdf. Scrushy was ultimately charged on
36 criminal counts.
48
Scrushy’s “criminally derived” property allegedly included “several residences in the state of Alabama
and property in Palm Beach, Florida; a 92-foot Tarrab yacht called Chez Soiree, a 38-foot Intrepid
Walkaround watercraft and a 42-foot Lightning boat; a 1998 Cessna Caravan 675, together with
amphibious floats and other equipment, and a 2001 Cessna Citation 525 aircraft; diamond jewelry; several
luxury automobiles, including a 2003 Lamborghini Murcielago, a 2000 Rolls Royce Corniche, and two
2002 Cadillac Escalades; and paintings by Pablo Picasso, Marc Chagall, Pierre-August Renoir, among
others.” Department of Justice press release, November 4, 2003.
http://www.usdoj.gov/opa/pr/2003/November/03_crm_603.htm
49
http://www.nytimes.com/2003/11/05/business/former-healthsouth-chief-indicted-by-us.html
50
http://www.foxnews.com/story/0,2933,145392,00.html
51
Owens, for example, who became the first CFO to be convicted of Sarbanes-Oxley Act violations,
received a five-year sentence for his role in the accounting scandal. http://www.washingtonpost.com/wp-
dyn/content/article/2005/12/09/AR2005120901890.html
52
http://www.nytimes.com/2005/02/17/business/17scrushy.html?pagewanted=all&position;
http://www.nytimes.com/2005/05/19/business/19scrushy.html?pagewanted=2.

13
which had built a careful and extensive case against him. Nonetheless, prosecutors

elected not to appeal the decision.53

Despite Scrushy’s acquittal, however, his legal problems have continued. In

October 2005, he was indicted on bribery and mail fraud charges in federal court for

allegedly having paid former Alabama Governor Don Siegelman $500,000 in 1999 for a

seat on the board of a state hospital regulatory agency (Siegelman was also indicted).54

Scrushy (along with Siegelman) was convicted in June 2006,55 and was sentenced to

almost seven years in prison, which he began serving in 2007.56 His appeal request was

denied in May 2009,57 and he is currently incarcerated in federal prison in Texas.

Scrushy has also been charged in civil court for his role in the HealthSouth

accounting scandal. In 2007, he settled with the SEC for $81 million.58 He is currently

the defendant in a shareholder lawsuit filed on behalf of HealthSouth as a company. In

May 2009, Scrushy briefly returned to Birmingham to testify in the trial, where he

continued to maintain that others carried out the fraud without his knowledge.59 A ruling

on the lawsuit, which seeks $2.6 billion in compensatory damages, is pending.60 In

addition, Scrushy faces a class-action lawsuit from individual HealthSouth

shareholders.61

53
http://articles.latimes.com/2005/jul/14/business/fi-scrushy14
54
http://www.nytimes.com/2005/10/29/business/29scrushy.html?_r=1
55
http://www.nytimes.com/2006/06/30/us/30verdict.html
56
http://blog.al.com/spotnews/2007/06/siegelman_gets_sevenplus_years.html
57
http://blog.al.com/spotnews/2009/05/us_appeals_court_rejects_forme.html
58
http://www.northcountrygazette.org/articles/2007/042307SECScrushy.html. HealthSouth had previously
settled with the SEC for $100 million. http://www.nytimes.com/2005/06/09/business/09healthsouth.html.
59
http://www.wtopnews.com/?nid=111&sid=1676144
60
http://blog.al.com/businessnews/2009/05/fate_of_richard_scrushys_perso.html
61
http://blog.al.com/businessnews/2009/05/scrushy_few_took_bigger_hit_in.html

14
7. TURNAROUND AND RECOVERY
Since the accounting scandal was first discovered in March 2003, HealthSouth

has taken many steps to turn itself around and become a stronger company. It has a new

senior management team, and the directors who presided over the Company when the

fraud occurred have since been replaced. HealthSouth was also able to avoid bankruptcy

by selling assets and reaching various agreements with lenders to refinance its debt.

Hundreds of consultants were brought in to help reconstruct the Company’s records,

develop improved accounting and reporting policies, and establish a stronger, Sarbanes-

Oxley-compliant system of internal controls.62

HealthSouth took an important step forward on June 27, 2005 when it released

audited financial statements for the four years ending December 31, 2003, the first time

the Company had issued financials since the third quarter of 2002.63 In December 2005,

HealthSouth issued its 2004 Annual Report,64 and in 2006, the Company reestablished

itself as a current SEC filer when it issued its 2005 Annual Report and resumed its

quarterly filings.65 HealthSouth was also relisted on the NYSE in October 2006 after

shareholders approved a 1-for-5 reverse stock split.66 As part of a corporate restructuring

plan, the Company also sold its outpatient, surgery, and diagnostics divisions in 2007

62
HealthSouth came into full compliance with Section 404 of the Sarbanes-Oxley Act in 2007.
63
HealthSouth 10-K “for the fiscal years ended December 31, 2003 and 2002,
including a restatement of previously issued consolidated financial statements
for the fiscal years ended December 31, 2001 and 2000.”
http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-05-131361;
http://query.nytimes.com/gst/fullpage.html?res=9E01EFD81631F93BA15755C0A9639C8B63.
64
HealthSouth 2004 10-K. http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-05-235488;
http://www.boston.com/yourlife/health/other/articles/2005/12/03/healthsouth_files_2004_results_with_sec.
65
HealthSouth 2005 10-K. http://investor.healthsouth.com/secfiling.cfm?filingID=1193125-06-65473;
http://www.nytimes.com/2006/03/30/business/30health.html.
66
http://www.secinfo.com/d18TY3.v2Pa.b.htm

15
(primarily for cash), thus preserving only its core inpatient rehabilitation business.67

With this new structure firmly in place, HealthSouth continues to move ahead while

doing its best to leave the past behind.

8. CONCLUSION
The lesson of HealthSouth offers a powerful reminder that, when it comes to

financial reporting, things are not always as they seem. Whether the fraud should have

been uncovered sooner is an open question.68 Regardless, analysts and investors should

always be careful not to review companies’ financial statements with an uncritical eye,

nor should they take management assertions about company health and various forward-

looking projections at face value: there are simply too many incentives and pressures on

public companies to report favorable results and give them a positive spin—and

sometimes people cross the line as a result. And although, for practical reasons, a

considerable degree of reliance on independent audit opinions is absolutely necessary, the

HealthSouth experience, like Enron and many others, shows that auditors do not always

do their job as well as they should. But can a fraud of this magnitude, scope, and

duration still occur now that we are in the era of Sarbanes-Oxley? Will anybody even

try? Only time will tell.

67
http://en.wikipedia.org/wiki/Healthsouth
68
However, at least some accounting professors believe the answer is a “qualified yes”:
http://www.nysscpa.org/cpajournal/2004/1004/essentials/p44.htm.

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