HealthSouth Scrushy way
HealthSouth Scrushy way
Introduction
The global economic system has observed the biggest fraud, accounting manipulations and unethical behaviors in corporate history. The Enron, WorldCom, Adelphia, HealthSouth among others have been accused of fraud. The Enron, WorldCom, Health South and other fraud cases are considered the biggest economic scandal and failures since 1920s. The 20th century witnessed a growth of big international companies and certified public accounting company. The growth has not been without controversies. Corporate fraud, unethical management practices and poor financial reporting methods have surfaced severally during the 20th century. This has resulted to development of legislation to promote ethical behaviors in the market. The Enron scandal, Tyco scandal among others led to the development of the Sarbanes-Oxley (SOX) Act in 2002. The Sarbanes- Oxley Act of 2002 set new standards and improved current standards for management, public company boards and public accounting companies. The top management is supposed to certify that the financial information being provided is accurate. In addition, the Act made the penalties for fraudulent financial activities more severe than before. Further, the Act increased the autonomy of external auditors who review the correctness of financial statements. Also, the Act increased the oversight duty of the board of directors. Many companies have continued to engage in corporate fraud and unethical business practices even after the development of the SOX. South Health was the first company to be charged under the SOX after being accused of corporate fraud (Weltok, 2011). Health south provides health services to patients.
The company is one the biggest health care providers in the country with clinics across the country. The firm was successful for many years until the corporate fraud. The company overstated its earnings by more than 1.9 billion for many years. The false information increased the market values for the company and attracted investors. The company manipulated its financial statements to meet the Wall Street expectations, and this had a negative effect on the company and stakeholders. The poor leadership and corporate culture contributed to the corporate fraud. The corporate culture and leadership in an organization influences employee behaviors. A strong corporate culture promotes ethical behaviors and vice versa. Health south corporate culture affected the employee’s behaviors by encouraging unethical behaviors. The company CEO, Scrushy did not encourage ethical behaviors among the employees. He did not promote ethical business practices and accounting practices. Instead, he forced the employees to manipulate the company financial statements to give a false picture of the company’s financial position (Weltok, 2011).
Discussion
Impact on stakeholders
The health south case had a major impact on the stakeholders. The company had both internal and external stakeholders. The stakeholder included customers, employees, patients, government and society. The company should meet the needs of the stakeholders by engaging in ethical business activities. The interest of the shareholders is influenced when a company engages in unethical business practices like fraud. This was evidenced in HealthSouth case (Zimbelman, Albretcht, Albrecht & et al, 2011).
Workers and executives
The Health South fraud had an impact on employees and executives. Many employees working in senior positions and different departments participated in the fraud. Scrushy, the company CEO compelled the top executives to inflate the firm’s earning by increasing the company earnings, revenue and assets. The poor leadership and organizational culture had a negative impact on the employees as it affected their jobs. The employees engaged in poor business ad accounting practices. A large number of employees lost their jobs after the fraud case. The top executives lost their jobs after the securities and exchanges commission revealed the unethical accounting practices Health South used to increase its earning. The top executives were charged for taking part in the fraud. The Health South fraud destroyed the lives of the employees and the top executives by losing their jobs. Employees suspected of pleading guilty were sacked or suspended (Jennings, 2011).
Investors and HealthSouth stock
Health South fraud had an adverse impact on the investors and stockholders. HealthSouth did not provide accurate information to investors regarding the company financial position. Health south manipulated its financial statements so as to meet the Wall Street expectation and attract investors. Many companies considered Health South stock a buy and encouraged investors to invest in the company. USB and Citi/ Salomon considered HealthSouth stock a buy and convinced investors to buy. USB and Citi/ Salomon claimed that they were not aware of the fraud as Health South performed well financially. Health South objected the enactment of the balanced budget Act as it would have a negative impact on the company. The Act was meant to reduce Medicare spending and Health South relied on Medicare program. The passage of the Act became difficulty, and various company executives urged Health South to stop the fraud and financial falsification. Scrushy claimed that he would not stop the fraud until he sold his stock.
Scrushy and the investment banks involved in the fraud issued several public statements that Health South would not be affected by the Act. They claimed that Health South would continue to perform well financially, and its earnings will increase by 25% in the next 3 to 5 years (Bucy, 2010). Citi/ Salomon recommended the buying of Health South shares because of the strong financial position of the company (Bucy, 2010). Citi/ Salomon claimed that the company had saved the Medicare program almost $510 million and would generate $1.5 billion in the next 5 years by reducing the cost. Health South had minimized the cost because of its internal compliance programs. Citi/ Salomon claimed that the company had comprehensive internal control system that monitored accounting and accounting payable functions. This eliminated accounting irregularities. Further, Citi/ Salomon argued Health South had not been investigated like other health care operators due to reimbursement and operating procedures (Bucy, 2010).
The false financial statements and assurances by Citi/ Salomon and USB of the financial success of the company, the company share price, increased. The shares increased from $15 to $29 per share from July 1996 to July 1997. The shares remained $31 per share in April 1998. The executives unloaded their shares and pocked nearly $166 million using illegal trading procedures in the company. A total of 6.2 million shares of the company stock whose price ranged between $26 to $30 per share were unloaded. Additionally, Lorello and Mc Gahan and their investment bank sold over $1.5 in billion, in new Health South, notes through Fraud. He used SEC regulation exemptions and provided documents that contained false statements about Health South financial and business results. Citi/ Salomon earned millions after selling the securities to investors. Citi/ Salomon provided HealthSouth with cash it required to remain afloat (Bucy, 2010). In addition to that, the company sold $3.4 billion in HealthSouth notes to investors with the aid of USB, E&Y and Citi/ Salomon to get cash to continue with the scheme. The company used SEC registration exemptions to sell the notes. The investors incurred huge losses after the fraud as the company stocks and shared dropped. Also, the investors lost their investment. HealthSouth was compelled to pay investors. The company will pay the investors $215 million in cash, warrants and stock. The insurance firms will pay $230 million. The fraud affected investor’s confidence as investors stopped investing in the company (Bucy, 2010).
Customers (patients)
Moreover, HealthSouth fraud had a detrimental effect on patients and customers. Scrushy did not focus on satisfying the needs of the patients and customers. Prior Health South was the biggest public health care firm in the country. The company had 93 inpatient rehabilitation hospitals and 49 outpatient rehabilitation satellites. The company had 6 long term acute care facilities and 25 home health care agencies. The company was the main provider of rehabilitation services. The company focused on being the health care firm of choice for workers, employees, physicians and shareholders by offering quality health care services. However, the company did not meet its customers (patients) needs as it focused on profit making instead of providing quality health care services. The company did not disclose accurate information to patients and other shareholders until the fraud was discovered. The company executives and board of directors had conflicting interest. The company mission entailed providing quality care and meeting stakeholder’s needs. On the other hand, the CEO and other top executives could not engage in ethical business practices as they wanted to make profit quickly and sustain the company. The company sold the outpatient, diagnostic and surgery divisions in 2007 as part of its restructuring. It only preserved its main inpatient rehabilitation division. This affected patients relying on the company’s rehabilitation services (Moeller, 2004).
Outcome and fairness of punishment
2003 SEC civil law against the company and charges
The Securities and Exchange Commission accused HealthSouth and Scrushy of inflating the firm’s earning since 1999 by $1.9 billion. In addition, 15 former executives of the company were accused of fraud. The court found the executives guilty of engaging in a scheme to manipulate the company profit to meet the expectation of Wall Street. The executives included 5 chief financial officers, a senior vice president working in the tax department and a financial vice president. Also, the investment vice president pleaded guilty. The senior officials in the company held regular meetings to find ways to manipulate the earnings to meet the earning expectations of Wall Street. They also wanted to hide the true financial position of the company from stakeholders. Some of the executives charged argued that Scrushy directed the scam. During the trial, the executives and other parties involved claimed that the CEO used intimidation, cash payments and threats to force the top executives into committing the scam. The executives agreed to work with the government in exchange for mercy and to avoid imprisonment (Rockness & Rockness, 2005).
The security and exchange commission claimed that the HealthSouth earnings did not meet the analyst expectation of Wall Street. As a result, Scrushy directed the employees to “fix it” by inflating the earnings. The senior accounting officials held family meetings as family members to fix the earning problem. During the meeting, the officials agreed to minimize a contra revenue account or decrease expenses. In addition, the officials agreed to increase the assets and reduce liabilities. In order to balance the books, the officials matched false increases in earning and false increases in assets. The company had limited paper trial, and this made it difficult for auditors to verify the entries. The auditors could not verify the contractual adjustment accounts. The security and exchange commission indicted Scrushy on November, 2003 for 85 counts. The crimes included conspiracy, securities scam, mail fraud and laundering of money. However, Scrushy was charged with 36 counts of the crimes. The security and exchanges commission accused him of threats, intimidation and using money to force the top executives to commit fraud (Dyck, Morse & Zingales, 2006).
Inflated earnings on financial statements
The company increased its earnings between 1999 and 2000 to hide the true financial position of the company. Scrushy focused on making profit and attracting investors, and he used any method including accounting manipulation to make a profit. Scrushy made a total of $2.5 billion in profit between 1999-2002. He overstated the company’s assets by over $800 million between 1999 and 2002. This covered up the deteriorating financial situation of the company. Scrushy overstated the cash balances as at 30th June, 2002 by more than $300 million to cover the poor financial position of the company. Additionally, Scrushy managed to create a false image of the company and its financial position and influenced every person. He managed to convince investors to invest. USB rated the company stock a “strong buy” during this period. Also, Citi/ Salomon rated the stock as a “buy” many times. USB and Citi / Salomon issued glowing reports about Health solutions. They praised the management team for the good management skills that enabled the company to perform well. Also, the companies praised HealthSouth for the integrity of its financial reports and business strength. Further, they praised the management for the firm’s excellent future outlook. The company sold a large number of Health South securities to the investors. The senior accounting officials made many journal entries to the company’s income statement and balance sheet accounts. They created documents, and falsified documents to support the false accounting entries. They also doctored account ledgers for the firm’s health facilities like non existence assets.
There was no accurate and accounting justification for the entries. The company fixed asserts such as plant, equipment and property were overstated by $1 billion as at 30th, June, 2002. The total assets were increased by $1.5 billion. The Consolidated balance sheet consisted of over $300 million in cash that did not exist. The Income before income taxes and minorities interest had been increased by almost $2.7 billion (Johnson, 2005). The company reduced the contra revenue account to create the fake accounting entries. The amounts of the entries to the contra revue account were aimed at increasing earnings to meet the expectation of the Wall Street analysts that the company defendants and investment bank had created. The manipulation of the entries led to increases in company revenue, assets and earnings. The company recorded the operating expenses as assets to avoid being discovered. This reduced the operating expenses and increased profits (Johnson, 2005).
Punishment
CEO Richard Scrushy sentence
The Securities and Exchange Commission charged Scrushy of 85 counts consists of various crimes. The commission accused Scrushy of conspiracy, securities fraud, mail fraud and money laundering. However, he was charged with 36 counts. However, he was cleared of the 36 counts after 21 days. The jury cleared him of the charges after deliberating for 21 days. The jurors claimed that the chief financial officers who testified against the CEO lacked credibility. Further, the jurors argued that the prosecutor did not present adequate evidence to prove that Scrushy was guilty of the crimes accused. The top executives claimed that Scrushy knew about the corporate fraud and directed the fraud (Alvarez, CFA & Fridson, 2011). The CEO encouraged the top executives to alter the accounting records and financial statements in order to fix the company financial problems. He used threats and cash to force the top executives to fix the problem.
The Jurors claimed that Scrushy did not participate in any of the family meetings that the top executives attended to deliberate on how to alter the financial statements. The top executives could not prove whether Scrushy attended the meetings. Though the government played an important role in implementing the SOX by charging Scrushy for violating the Act, the judges hindered the government efforts. The government effectively implemented the SOX at by ensuring Scrushy got punished for violating the Act (Markham, 2006). Scrushy influenced the decision made by the judges by influencing the African American judges. Before, indictment, Scrushy and his wife started attending weekly services at an African American congregation in Birmingham. He also hosted a television program and invited black ministers as guests. Though Scrushy directed and knew about the fraud, he did not pay for the crime after the judges declared him of charges. The punishment for the crime was not equivalent to the crime committed (Johnson, 2005).
Top executives sentencing
The top executives received different sentences. The government had promised to reduce their sentences after helping in the investigation of HealthSouth fraud case. The top executives agreed to help the government in exchanged for a reduced sentence and also to avoid imprisonment. Ken Livesay was imprisoned for five months for participating in Health south accounting fraud. Others were sentenced to home confinement. Emery Harris was sentenced to 6 months of home and asked to pay $3,000 fine and $106,500 in bonuses and salary. Cathy Edwards, Kay Morgan, Virginia Valentine and Angela Ayers were put on probation for 4 years and sentenced to 6 months of home confinement. They were also fined $2,000. Other employees were also sentenced. Other employees were also sentenced. The sentences are below the sentencing stated by the federal sentencing guidelines (Johnson, 2005).
Conclusion
In conclusion, many lessons can be learned from the Health South fraud case. The Health south fraud revealed the weakness of the SEC regulations as the company managed to use the SEC regulation exemption to engage in fraudulent activities. In addition, HealthSouth managed to manipulate its accounting figures and financial statements for many years without being discovered. The company did not adhere to the accounting practices and reporting practices outlined in the SOX. The case shows the effect of organizational culture and leadership on employee behavior and organizational performance. Health South did not have a strong organizational culture and good leadership. The company CEO influenced the employee behavior and forced them to manipulate the company financial statements to give a false picture of its financial status. Though Scrushy was found guilty, he was cleared of the 36 counts later. The other executives were sentenced, fined and put on probation. The fraud had an effect on stakeholders as they did not get accurate information. Thus, investors should examine the financial status of a company before investing as the information provided in the financial statements might not be accurate.
Reference
Alvarez, F., CFA., & Fridson,M.S.(2011). Financial statement analysis. John Wiley and Sons
Bucy, P.H. (2010). Health care fraud. Law journal press
Dyck, A., Morse, A., & Zingales, L. (2006). Who blows the whistle on corporate fraud. Retrieved from on http://faculty.fuqua.duke.edu/corpfinance/papers/dyck_morse_zingales.pdf on 27/11/2012.
Jennings, M.M. (2011). Business ethics. Cengage learning. John Wiley & sons
Johnson, G.G. (2005). The case against Richard Scrushy and the HealthSouth. Journal of legal, ethical and regulatory.8 (1)
Markham, J.W. (2006). A financial history of modern us corporate scandals. M.E Sharpe
Moeller, R. (2004). Sarbanes-Oxley and the new internal auditing rules.
Rockness, H., &Rockness, J. (2005). Legislated ethics. From Enron to Sarbanes-Oxley, the impact on corporate America. Journal of business ethics.57:31-54
Weltok, J.G. (2011). Sarbanes-Oxley for dummies. John Wiley and Sons
Zimbelman, M.F., Albretcht, C.O., Albrecht, C.C., & et al. (2011). Fraud examination. Cengage Learning
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