Healthsouth Scandal: The Key Aspects About the Company

Subject: Company Information
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Introduction

HealthSouth Corporation is the greatest proprietor and operator of inpatient therapy hospitals in the US. The corporation runs in about 25 states and serves patients via its network of rehabilitation health centers, outpost clinics and residence health outfits. The company seeks to offer a superior height of rehabilitative care for persons recuperating from severe and chronic conditions.

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The Alabama based corporation came into existence in February 22, 1984. Its initial name was Amcare Inc. Richard Scrushy was the founder. The company changed its name in 1985, having already opened two facilities. In the following year, the company registered in the NASDAQ stock exchange. In 1988, the company finally entered in the NY stock exchange. The expansion of the company was rapid, purchasing over 50 amenities by 1990. By 1992, the company had annual revenue approaching $400 million. In 1993, it started making large acquisitions starting by the acquisition of 73 facilities from National Medical Enterprise. The company transacted in cash, and the deal was worth about $300 million. From the acquisition, the revenues doubled to $1 billion. Consequently, the company became the chief rehabilitative health provider in the US. Numerous other acquisitions occurred, which further enlarging the company.

The company acquired its current name in 1995, and in the same year, the company set out to build a novel headquarters in Birmingham. The company further diversified into surgery after acquiring Surgical Heath. Further acquisitions included NovaCare rehabilitation business, Health Care Images, Horizon/CMC and Columbia/HCA’s surgical division. Other considerable upgrading included the building of a digitalized facility at its headquarters in conjunction with oracle in 2001.

Who was scrushy?

Richard Marin Scrushy is the creator of HealthSouth Corporation. Prior to founding the company, Scrushy taught at Wallace State community college and later worked at LifeMark Corporation, a healthcare business. He quit the company due to its inability to execute a development plan he suggested. He started Amcare, Inc. From the initial stages, he led the company through the development phase to its height prior to 2003. At the time, the company employed over 50,000 personnel. He was among the best-paid CEO in the US prior to his fall.

What happened

Despite the company’s significant growth in the 1990s, ethical and fiscal queries arose in 1989. In 1989, an internal auditor said that the company fired him for calling attention on the fiscal problems that the company was experiencing then. The employee further alleged that the management coerced him into meeting certain income targets (Weld, Bergevin & Magrath, 2009). In the following years, the company was faced with allegations of defrauding Medicare. In 1998, after Medicare instituted policies to reduce exploitation in healthcare provision, the proceeds of the company fell significantly. This indicated financial woes in the company. In the same year, further accusations of fraud appeared. An insurance firm alleged that the company had improperly billed services by various unlicensed aides.

Apart from the accusations of using unlicensed personnel, Medicare accused the company of various other crimes. These included billing for services not delivered, substandard services, and lack of formal plans of treatment in providing their services. The climax of these accusations was the indictment by the SEC in 2003. The SEC alleged the company fallaciously inflated the proceeds of the company by about $2.7 billion between 1996 and 2002. The company offered to pay a compensation of about $325 million to the government to settle the case.

According to testimony during the trial, a company official told of how the management falsified the accounts. Each quarter, senior accounting personnel presented the CEO with the actual earnings of the company. When the company earnings fell short of the projected earnings, the CEO directed those in charge to fix them. Fixing involved the senior accounting personnel meeting in what referred to as family meetings (Weld, Bergevin & Magrath, 2009). The fixing occurred by diminishing contra revenue accounts and lessening expenses. This was favored over increasing the earnings directly, since they felt it would escape detection by the independent auditor. Contractual adjustment is a revenue stipend account that estimates the variance amid the sum due from patients and the amounts that the insurer will disburse for the treatment. These accounts are prone to alterations, with little evidence available, due to their estimation nature.

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The accounting personnel waited until the generation of the monthly operating reports, and keyed the falsified figures to bypass the computerized bookkeeping structure. The false records later merged into the final company reports. Since changes in assets and liabilities must convoy fluctuations in revenue and expenses, the perpetrators created false increases in assets. The overstatements were so significant that, in 2001, it was about 4,700% (Weld, Bergevin & Magrath, 2009).

The unfolding of events

The on goings in the company came into revelation in late 2002. Scrushy benefited from the disposal of shares worth $75 million before the company announced poor proceeds. This was an addition to a previous sale in shares between 1999 and 2001(Mollenkamp, 2003a). The size of these sales alarmed SEC, and they started inquiring whether the sales had any relation to the loss. If it proved to be the case, the CEO would have violated the insider operations laws. The government initiated an insider informant, the company’s CFO.

In March 2003, the SEC stopped the trading of HealthSouth in the NY stock exchange. SEC cited the inflation of the company’s earnings as the main reason for its action. Further, the company exited from the Standard and Poor’s 500 index. The board of directors fired the CEO and the CFO, together with the external auditor, E&Y. The initial counts of fraud were 85. At the trial, the other executives in the company testified against Scrushy after pleading guilty in their charges. They said that the CEO had been ordering the falsifications. After the initial trial, the judge dropped a large percent of the charges on the void-for-vagueness principle. Though Scrushy is in prison, he is serving time for other crimes unrelated to the fraud.

Impact on Stakeholders

In May 2009, Scrushy appeared back in court regarding his fraud charges. On June 2009, the judge ordered the former CEO to pay $2.87billion in damages. The judge believed that Scrushy was a hands-on manager, and was aware of the dealings in the company.

All stakeholders, in the HealthSouth business, felt the consequences of the revelation, irrespective of the people culpable of the fraudulent activities (Madden-Hallett, 2009). The stakeholders are not only the investors, but also all those who depended on the services provided by the corporation. These included the general population, partnering hospitals, and even the auditing firm, E&Y.

Patients

The general population is, tentatively, the most affected party in the fraud. As a healthcare services provider, the company had its services based on the problems facing the populace. The services included diagnostic surgery and rehabilitative services, with emphasis on severe conditions, such as stroke and cardiac problems. As noted by industry analysts, Scrushy was in the forefront of providing care for injured workers, at least for a time. He was capitalizing on the value presented by injured workers returning to their jobs after rehabilitation. This was service to the companies, to individuals and to the nation. Employees recovering faster from their injuries saved their employers money, and the government through reduced stipends issued by Medicare. It also means increased productivity through a person’s life. The work that Scrushy initiated was extremely beneficial to the nation, at least before he strayed. His straying meant that his focus was no longer on providing services to those who needed them, but squeezing proceeds from patients. His focus was to maintain a favorable look in the eye of the financial analysts, but not concerning healthcare provision. This led to the Medicare accusations of billing for services not delivered, substandard services, and lack of formal plans of treatment in providing their services. Such accusations are serious, especially, when dealing in human health (Rose, 2007).

The impact of such accusations is enormous; the effects of patients receiving substandard services or services without plans are unimaginable. It means reduced effectiveness of the services, which translates to reduced productivity for a longer time (Gonin, 2007). It is possible for patients to lose their lives and even fail to recover in cases where they could have recovered in normal circumstances. The company dishonored the trust bestowed on it by customers based on their quality services. Dubbink and Smith refer to the responsibility as political account of business accountability. This is something corporations owe to the nation (Dubbink & Smith, 2009). The CEO was always hogging media attention and displaying the company’s acquisition of new technological devices. In the same time, the company was using unregistered personnel and interns in proving its services in order to reduce the overheads and enhance proceeds. The breach of faith affected the clients, who the company denied knowledge of its shift in focus. This was on top of the disruptions of access to services due to the dismissal of workers and closing of facilities, after the revelation of the scandal.

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Employees

Another group of stakeholders affected by the scandal is the employees of the company. The company had about 50,000 personnel operating in all the States. These ranged from physicians to managers. Most of the employees had moved from other companies and their facilities via amalgamations and HealthSouth purchases. From the accounts of the employees through different forums, especially the court and the yahoo message board, shocking revelations of the effects of the fraud occurred. The effects of scandalous leadership included fear and cynicism (Pelletier & Bligh, 2007). During the period, employees either agreed to the directives of the management or experienced mistreatment. The management overlooked, during promotions in the firm, employees who questioned the accounting practices of the company. For example, the company fired Helen Schilling, a director at HealthSouth rehabilitation institute, in 2000 after working for 10 years. She alleged that the company fired her since she failed to raise her patient census to an average of 20 patients. A district court in Montgomery County awarded a reimbursement of about $1.6 million for mental agony and disciplinary damages (Mollenkamp, 2003a). This represents only one person who was able to present her case successfully.

Currently, the company has about 20,000 workers; this translates to about 30,000 losses in jobs. Like several other cases of corporate fraud, such as WorlCom, significant layoffs usually follow. The expanse of this layoff, however, was quite large. The thought and effect of 30,000 new jobless people is alarming. This means that such a high number of people found themselves with no employment, and, therefore, no source of income (Cooper, 2005). Further, the employees would get skeptical treatment, since people would question their participation in the scandal. This is, especially, true for accounting personnel, which means significantly elevated difficulty in securing future employment.

By the end of 2003, HealthSouth employee pension held a considerable 3.3 million shares in the company’s stock. After SEC stopped the trading of HealthSouth’s stock, their value reduced from above $30 to below $1in April 2003. The implication of this is explicit; apart from most of them losing their jobs, the value of their investments had reduced immensely. When they needed their money, it could not serve them any profit.

Investors

According to Judge Johnson, in a ruling, in November 2003, the loss experienced by investors was $66million. This, however, differed by the postulates expressed by the prosecutors who put the loss at about $250 million. Nevertheless, it is indubitable that the loss by the investors was immense and readily visible.

The investors in the company are divisible into two categories; these are the shareholders and creditors. The shareholders were the most prone to loss because the value of their investment depended on the value of the shares of the company. Shareholders ranged across the economic divided, from the rich with numerous shares to those who had few shares. When the scandal came into light, SEC stopped any trading in the shares of HealthSouth Corporation; consequently, their values dived to below a dollar. This signified a loss of over $30 per share, which is countable over the time shares remained low, under their normal value.

The other group of investors is the creditors. The company had grand plans of expansion, throughout the whole country and beyond. This included a modern facility, which it intended to digitize with the help of Oracle. In the period prior to the scandal, the company had achieved numerous acquisitions and mergers, some involving significant volumes of money. Some of the funds came from creditors. The financial health of the firm, though engineered, belied many investors into channeling their funds into the company. When the company appeared in the light and its shared halted from trading in the stock market, the company temporarily lost its sources of money and defaulted in some of its debts. The company had $3.3 billion in debt and the firm was defaulting on interest payments and senior bonds. Though the company’s documents indicated that it had $674 million in cash, it only had $117 million. Collaborating firms threatened to pull out, and prepared for the same.

Partner hospitals

Before the scandal, it was prestigious to collaborate with the company. The company used a number of highly acclaimed athletes in their marketing strategy. For example, the CEO highly publicized the company’s facilities when the Brazilian football star, Lucio, had surgery in one of their facilities. These celebrities featured often in the companies events. During these times, the company adopted a slogan claiming that it was the healthcare provider of the next century. Other healthcare provider started to mold their facilities in the likeness of those build by HealthSouth to emulate them. This showed the extent of influence that the company bore. Consequently, numerous firms were eager to merge and collaborate with the company.

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Such companies that had merged with HealthSouth included Horizon/CMC. After the scandal, many citizens were amazed at inhumanness exercised by the corporation, in focusing on profit rather than service provision. The negative effects concerning the operation of the company certainly transferred to the companies they did business. Though such association may not live long, it still had some effect, especially at the beginning of the cases.

E&Y

Another party that suffered from the scandal was the auditing firm of HealthSouth, E&Y. The involvement of the company in the fraud has been the debate on several forums. Analysts have argued whether the accounting company played any part in the scandal, with many arguing that it could not have failed to see the irregularities in the accounting reports of its client. The debate aside, the company suffered from the scandal. The auditing firm consented to disburse $109 million as part of payment with HealthSouth shareholders. This was because of a suit presented against the company and its client because of the fraud. Though the company never conceded to being guilty in the fraud, there are consequences to the company. The business of E&Y is upholding integrity and ensuring companies comply with GAAP. It is inconceivable that, for the time the company evaluated its client’s records, it did not notice any irregularity. The reputation of the company suffered in the process, which is an addition to the fiscal losses incurred in instituting a compensation fund for the shareholders of HealthSouth.

Outcome and fairness of punishment

After the initial trial, out of the 85 indictments, the prosecutors charged the CEO with 36 of the charges. After the trial, the jury proclaimed his virtuousness. Although Scrushy was sentenced to time in prison, the case was not related to the fraud at HealthSouth. However, in a later case, the former CEO was charged again, this time by the shareholders of the company. The Judge, in 2009, found him responsible and ordered him to pay an amercement of $2.8 billion to the ex-shareholders of the company. The two companies agreed to payment a certain amount of money to the shareholders to solve the shareholders suit against them. E&Y agreed to pay over $100 million towards that settlement.

Other fines resulting from the fraud case included the attempts, by the company, to settle their case for defrauding Medicare. The company agreed to pay Medicare a sum of $325 million to prevent indictment on criminal charges. This payment included an initial payment of $75 million with the rest paid in installments. About $170 million was to settle the allegations by Medicare and the other part for other offences.

Another payment was the settlement of the SEC case against the company. SEC had accused the company of insider trading and other stock related crimes. Towards this settlement, in June 2005, the company agreed to pay SEC $100 million over two years.

Conclusion

There was a debate regarding how much the company’s shareholder had lost in the scandal. One of the judges involved in the case cited that the loss was $66 million, while prosecutors alleged that the shareholders had lost more than $250 million. Without identifying how much money the shareholders lost it would be difficult to judge whether the fines and the charges resulting from the case were enough punishment or overrated ones. However, given the number of shares of HealthSouth, the loss was enormous. Nevertheless, the former CEO owned almost 80% of the shares. If this remained the case, the $2.8 billion award to the shareholders was adequate to settle the loss incurred by the shareholders. Additionally, this amount is comparable to the amount of inflated earnings, which the shareholders believed the company was earning.

However, the punishment against the Scrushy should have been harsher. Since the court acquitted him of all the 85 indictments, he did not face a jail term over the fraud allegations. The award of the $2.8 billion charge for the compensation of shareholders proves that the second trial found him guilty of the fraud charges. According to the Sarbanes-Oxley Act, if the court proved Scrushy guilty of all the charges, it would have incarcerated him for a maximum of 450 years (Romano, 2005). Therefore, having been guilty of almost half of the charges, there must have been a jail term, even of about 10 years. Shortly, he will be free, and though the fines may eat all of his personal wealth, he will still be a free man (Mollenkamp, 2003). However, how much has he stashed away over the years?

Analysts have argued that the board of directors may have been culpable. This is because they failed to identify the discrepancy is skills required in developing a company and those required in running an established company. They cite that the former require risk-taking, while the later requires risk-aversive managers. Nevertheless, the case highlighted a progression of unethical practices in the face of pressure. The flouting of GAAP in order to satisfy Wall Street requirements was purely unethical. A personal ego possibly fuelled such practices, trying to prove to the whole world that he could conquer. This is conceivable from his confessed dream of being the highest paid CEO in America. O’ Brien argues for moral judgment in leaders over professional competence (O’ Brien, 2008).

The case also highlights the importance of a company’s culture. Through the top-down management style of the CEO, the employees could not voice their concerns regarding the irregularity of the accounting practices. Career advancement in the company depended on an employee’s compliance to the machinations of the executives. In such an environment, exercising a person’s ethical duty becomes impossible, and its attempt is career suicide. Unfortunately, as revealed in a study, only 13% of executives think that ethics are imperative in their work (Ponnu & Tennakoon, 2009). Companies, therefore, should permeate transparency as a corporate culture. Corporations should emphasize transparency in recruitment, promotion, firing and accounting.

The HealthSouth fraud case has not been in isolation. Many have cited it as the last among the wave of mega-fraud scandals experienced in America in the close of the 20th century, which has called attention to institutional approach to pro-social outcomes (Bragues, 2008). Others include the Enron, WorldCom, Tyco and Parmalat scandals. It is a call to the corporate world to evaluate the focus of ventures and ambitions, and to choose the pursuit of fiscal gains ignoring morality, or to consider ethics in all operations (Cagle & Baucus, 2006). The proceedings of the various fraud scandals have been exemplification of the rewards of unethical behavior in business.

References

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