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HealthSouth, CEO Face Charges On Earnings

Mar 19, 2003 | USA TODAY

In the first major corporate accounting scandal uncovered in the Sarbanes-Oxley era, federal authorities charged HealthSouth (HRC) and CEO Richard Scrushy with overstating its earnings by $1.4 billion since 1999.

The federal charges, filed in Birmingham, Ala., came hours after FBI agents raided HealthSouth's Birmingham offices. The Securities and Exchange Commission accused Scrushy of driving the alleged fraud. The SEC imposed a two-day suspension in trading of HealthSouth shares. Separately, the SEC secured a guilty plea from former HealthSouth CFO Weston Smith for certifying financial statements that he knew were wrong.

HealthSouth is the USA's largest provider of rehabilitation care and outpatient services. "The whole market is surprised," says Premila Peters, an analyst at KDP Investment Advisors. The stock was trading at $3.91 when trading was halted, down 75% from its 52-week high. "It really is horrific. I think people feel really violated when something like this happens in health care."

A HealthSouth spokesman insisted that the government actions would not affect its operations. Scrushy could not be reached. According to the SEC complaint filed by Richard Wessel and Richard Murphy of the agency's Atlanta office, HealthSouth inflated earnings because Scrushy wanted to meet Wall Street expectations. HealthSouth shares had plunged from $21 to $9 in late 1998 after a negative earnings report jolted investors. The complaint alleges that Scrushy responded to negative earnings information by telling his subordinates to "fix it."

Subordinates allegedly reduced the sums recorded in a "contra revenue account," which is deducted from total revenue. By decreasing revenue deductions, the SEC says, HealthSouth needed to compensate on its balance sheet by showing inflated assets.

Scrushy's subordinates allegedly inflated assets by claiming to have spent $800 million more on medical equipment and other fixed assets than was actually spent. The SEC says HealthSouth created an elaborate series of phony invoices to convince its outside auditor that the purchases were legitimate.

The SEC said subordinates tried to persuade Scrushy to halt the actions, but said Scrushy refused. He has sold almost 8 million shares of stock since 1999 and pocketed more than $15 million in pay and bonuses from 1999 to 2001, the SEC says.

In the criminal matter, Smith pleaded guilty to certifying the company's financial statements even though he knew they were false and misleading. In so doing, he became the first executive caught by the provision of last summer's Sarbanes-Oxley act. The federal law requires CEOs and top finance executives to personally vouch for the accuracy of their companies' earnings statements.

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