The New York Stock Exchange Suspended Trading

Published Date: 02 Nov 2017

Scrushy faced numerous legal battles as a result of the accounting fraud at HealthSouth. First, as mentioned before, the Securities and Exchange Commission indicted Scrushy - and HealthSouth - for various civil charges relating to the fraud. Furthermore, Scrushy was indicted by the Department of Justice on eighty-five criminal counts for the fraud, including money laundering and mail, wire, and securities fraud. Notably, the SEC and DOJ alleged in the indictments that Scrushy violated the Sarbanes-Oxley Act of 2002 by making false certifications and filing false financial statements. Scrushy was the first executive charged with violating the new law. The government alleged that the fraud overstated income by $2.7 billion from 1996 to 2003. Various HealthSouth shareholders also filed civil suits against Scrushy on behalf of the company to recover compensation and other benefits he received while the fraud was being perpetrated.

The high-profile criminal trial began on January 25, 2005 in Birmingham, Alabama. Central to the case was the degree to which Scrushy was aware of or involved in the fraud. HealthSouth’s five Chief Financial Officers, all of whom had already plead guilty, testified on behalf of the government that Scrushy was intimately involved in the fraud. Another prominent witness was Leif Murphy, a former HealthSouth Treasurer who, unlike the other executives who testified, was never incriminated or charged with any involvement in the fraud. Mr. Murphy produced records containing an analysis which led him to believe that earnings were being manipulated. When the analysis was purportedly shown to Scrushy, he supposedly became irate and defensive.

Unlike other executives charged for violating Sarbanes-Oxley, such as former WorldCom CEO Bernard Ebbers, Scrushy did not use the so called "aw shucks" or "deaf, dumb, and blind" defense. Instead, the credibility of the prosecution’s witnesses was vigorously attacked. The validity of the recorded conversations with Owens were also attacked. Scrushy’s attorneys argued that the conversations were incomplete and out of context. The defense alleged that the fraud was perpetrated by other executives and expertly concealed from Scrushy. His defense attorneys also pointed out that no concrete evidence, or "smoking gun", had been produced by the prosecution that displayed Scrushy’s alleged participation in the fraud.

After twenty-one days of deliberations, the jury, which had previously reported that it was deadlocked, acquitted Scrushy of all charges on June 28, 2005. Jurors said, in a statement released by the Court, "The reason behind our verdict was the lack of substantial evidence and witnesses’ credibility". Many explanations have been proffered to explain why the jury acquitted Scrushy despite the strong case against him. Some point to the prosecutions decision to prosecute Scrushy in Birmingham, where HealthSouth is headquartered, rather than another location. Some point to Scrushy’s religious activities: he became a televangelist and donated large sums of money to various churches in Birmingham. Regardless, the acquittal was a powerful blow to the government in its first attempt to enforce Sarbanes-Oxley.

The SEC’s civil case against Scrushy was postponed until the criminal prosecution was completed. Rather than go to trial, Scrushy reached a settlement with the SEC in April 2007 under which Scrushy agreed to pay $81 million. The amount represented $3.5 million in fines and $77.5 million in forfeiture of profits Scrushy received from his involvement in the fraud. Scrushy received a credit of $71.5 million credit relating to settlements and judgments in other civil cases. As a result of the settlement, Scrushy could not serve as an officer or director of a public company for five years.

Scrushy also faced a class-action lawsuit brought by various current and former investors in HealthSouth, which later went to trial. A similar defense was employed during the trial by Scrushy as he alleged, once again, that the fraud was orchestrated and hid from him by other executives at the company. However, unlike the criminal case, Scrushy took the stand and testified that he had no knowledge or involvement in the accounting shenanigans. In June 2009, Judge Allwin E. Horn concluded that Scrushy was highly aware of and heavily participated in the fraud and ruled that Scrushy must pay $2.9 billion dollars to the company’s shareholders.

Scrushy also had legal woes unrelated to the accounting fraud. He was indicted on October 26, 2005 for various criminal charges which alleged that he paid $500,000 in bribes to Don Siegelman, a former Governor of Alabama, in exchange for a seat on a state regulator overseeing hospitals and healthcare companies. Unlike the previous criminal trial, the jury convicted Scrushy on all counts. Scrushy was sentenced to 82 months in jail and three years’ probation. In addition, he was also ordered to pay a $150,000 fine and $267,000 in restitution to the United Way of Alabama. The prison sentence was later reduced to 70 months due to a Supreme Court ruling that affected a law under which Scrushy was convicted. Scrushy completed his prison sentence on July 25, 2012 and began three years of supervised release. During this time, he is required to perform 500 hours of community service.

In all, fifteen former HealthSouth Executives plead guilty to participating in the fraud and cooperated with the government, including the five aforementioned CFOs. Most of these individuals received relatively short prison sentences or avoided prison completely. However, William Owens, a former CFO, was sentenced to five years of prison and two years’ probation. Also, Weston Smith, another former CFO, received a prison sentence of twenty-seven months. In addition, Hannibal Crumpler, a former HealthSouth Controller, was convicted for his involvement in the fraud. Notably, Crumpler is the only HealthSouth executive successfully prosecuted by the government and convicted by jurors for participating in the fraud. Crumpler was sentenced to eight years in prison and ordered to pay $1.4 million supposedly received from his involvement in the fraud.

HealthSouth also faced various legal problems as a result of the fraud. HealthSouth, as mentioned earlier, was indicted alongside Scrushy by the SEC. Rather than litigate the matter in court, HealthSouth reached a settlement for $100 million. HealthSouth did not admit wrongdoing as part of the settlement. The amount was to be paid in five installments over two years to the SEC. HealthSouth agreed to hire various consultants and advisers to review and monitor new policies instituted by the company. In addition, HealthSouth pledged to cooperate with the SEC and DOJ in their investigations and prosecutions related to the fraud.

HealthSouth was never indicted by the DOJ for the accounting fraud. Rather, the company reached an agreement to avoid prosecution. Per the agreement, HealthSouth agreed to pay $3 million to the United States Postal Inspection Service’s consumer fraud division. In addition, the company was required to implement more rigorous and strict controls and avoid any illegal acts for three years. Alice H. Martin, United States Attorney in Birmingham, Alabama stated "prosecution would likely have pushed this company into bankruptcy. By taking this approach, jobs of thousands have been saved, and the company has an opportunity to rebuild shareholder value".

HealthSouth also faced various lawsuits filed by its investors. These lawsuits were settled in 2006 by the company for $445 million as a result of court-ordered mediation. Approximately $230 million of the amount was to be borne by various insurers with the remainder satisfied by HealthSouth stock and warrants. The company admitted no wrongdoing in the settlement and agreed that twenty-five percent of any future judgments recovered from Richard Scrushy, Ernst and Young, or UBS, the company’s former investment bank, would be paid to the shareholders.

Ernst and Young was never indicted by the SEC or DOJ for its role in the fraud. Interestingly, Ernst and Young actually sued HealthSouth, alleging that the fraud harmed the firms’ reputation and opened the firm to litigation from the fraud. HealthSouth quickly countersued, accusing the accounting firm of being negligent in its role as an auditor. In 2010, a judge ordered the parties to arbitrate the claims. In late 2012, the arbitration panel concluded that HealthSouth did not have any basis to sue Ernst and Young for negligence and dismissed the case because former executives at the company admitted to committing and concealing the fraud. The arbitration stemming from Ernst and Young’s claims against HealthSouth appears to still be in arbitration.

Ernst and Young, along with HealthSouth’s investment banker, UBS, was sued by various investors in the same class-action suit as Scrushy. The lawsuit alleged that Ernst and Young was aware of the fraud as far back as 1994. Additionally, a UBS banker purportedly discussed the fraud with a HealthSouth executive from 1999 to 2002. Ernst and Young and UBS reached a settlement with the investors. UBS agreed to pay, in a partial settlement, $100 million to shareholders in 2008, $117 million to shareholders in 2010, and $100 million to the company’s bondholders in 2010. Ernst and Young settled with HealthSouth’s shareholders in 2009 and agreed to pay $109 million. Also, the firm agreed to pay $33.5 million to bondholders. UBS and Ernst and Young have continued to deny any culpability for the fraud.

In its first audited financial report since 2002, HealthSouth issued a restatement of its 2000 and 2001 financial statements. Produced by the work of at least five outside firms, the restatement wrote down the value of various assets carried on the company’s books. The adjustments reduced stockholders’ equity at the end of 2001 by $3.9 billion. More than $250 million was spent to complete the restatement. According to HealthSouth, 1.4 million accounts were examined, 92 percent of which were eventually amended.

As can be expected, HealthSouth faced bankruptcy concerns after the fraud became public. The company found itself low on cash and facing principal and interest on debt coming due. At one point, J. P. Morgan Chase, one of the company’s creditors, declared HealthSouth to be in default on an essential line of credit. However, the company was able to work with its creditors, restructure its debt, and avoid filing bankruptcy.

HealthSouth, unlike other companies that committed fraud, is an independent, successful company, largely as a result of Jay Grinney. Grinney was hired as HealthSouth’s CEO in May 2004 and made a number of changes to the company. Grinney sold off numerous assets and businesses that traced back to the Scrushy regime and refocused the company’s strategy on inpatient rehab. He was responsible for the aforementioned debt restructuring. Under Grinney, the company’s heavy debt burden was reduced over time. Also, thirty-eight senior executives who served under Scrushy, and still worked for HealthSouth, were replaced. Under Grinney, the company issued its first current quarterly financial report since the fraud in April 2006 and was relisted on the New York Stock Exchange later that year. According to the company’s website, in terms of revenue, number of hospitals, and number of patients treated and discharged, HealthSouth is the largest owner and operator of inpatient rehabilitation hospitals in the United States today. The company operates in twenty-seven states and Puerto Rico.