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HealthSouth CEO, Finance Chief Suspended Amid Fraud Charges

Mar 21, 2003 | Wall Street Journal

HealthSouth Corp. put its top two executives on leave and handed the helm over to two board members, who will have to navigate through allegations of massive accounting fraud and a resulting cash crunch.

The Birmingham, Ala., company, which provides outpatient surgery and rehabilitation services, named Robert P. May, a former executive at FedEx Corp. and Cablevision Systems Corp., as acting chief executive. Mr. May, 53 years old, joined the HealthSouth board in October when the company was trying to recruit more independent directors.

Joel C. Gordon was named as acting chairman. Mr. Gordon, 74, has been a board member since 1996, when he sold his company, Surgical Care Affiliates Inc., to HealthSouth.

HealthSouth said Chairman and Chief Executive Richard Scrushy and Chief Financial Officer William T. Owens were placed on administrative leave, a day after the Securities and Exchange Commission, in a civil complaint, accused both the company and Mr. Scrushy of overstating earnings by $1.4 billion since 1999.

Thursday, a federal court in Birmingham agreed to an SEC request to temporarily freeze "substantially all" of Mr. Scrushy's assets. The SEC asked for the freeze so it can collect any "ill-gotten gains" that Mr. Scrushy received. The court also ordered HealthSouth to place in escrow all extraordinary payments, such as bonuses, to its directors, officers, employees and others.

HealthSouth Thursday went to its lenders, looking for a new loan commitment in place of a credit line for $1.25 billion that has been frozen, people familiar with the talks said. The new commitment would be secured. But there are concerns over whether the banks can get an accurate picture of HealthSouth's financial condition as the government's investigation unfolds.

The company's former chief financial officer, Weston L. Smith, is cooperating with investigators and pleaded guilty to conspiracy to commit wire fraud and securities fraud in connection with what the government said was a longstanding scheme to artificially inflate the company's financial results.

Mr. Smith, in his plea agreement with the U.S. Attorney's Office in Birmingham, said that Mr. Scrushy and an unnamed senior executive at the company participated in the accounting scheme and that they referred to themselves as "family" members. Individuals close to the situation said Mr. Owens is the other senior executive.

Frederick Helmsing, a lawyer for Mr. Owens, said his client "is cooperating with all the government agencies in their investigation." Mr. Owens, through his lawyer, declined to comment further. Investigators have said the criminal and regulatory investigations continue and more charges are likely in the coming weeks.

Mr. Scrushy said through his lawyers late Wednesday that he was shocked at the government's action and that he asked the company to put him on administrative leave so that he can concentrate on responding to the allegations.

One of the initial challenges for Mr. May as acting CEO will be finding a way to repay an estimated $345 million in convertible securities due April 1.

HealthSouth's availability of cash is unclear, given the allegations of accounting fraud. According to a person familiar with HealthSouth's financial situation, the company will be able to meet its payroll, but there are concerns over whether it can avoid filing for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code.

J.P. Morgan Chase & Co. and Wachovia Corp. were among the lead banks in arranging the $1.25 billion loan commitment, according to research firm Loan Pricing Corp. Another two dozen or so banks, including Bank of America Corp., Deutsche Bank and FleetBoston Financial also participated in providing the credit line, according to a person familiar with the loan commitment and Loan Pricing.

HealthSouth had about $3.3 billion of debt as of Dec. 31 and annual revenue of $4.31 billion. Standard & Poor's Ratings Services cut HealthSouth's credit rating to triple C minus Thursday and warned of a "near-term credit default." A spokesman for HealthSouth declined to comment on the company's financial statements and negotiations with its lenders.

Thursday, Mr. May was flying to the company's headquarters after cutting short a cruise and couldn't be reached for immediate comment. Mr. Gordon couldn't be reached for comment.

Certain HealthSouth directors favored firing Mr. Scrushy immediately rather than putting him on leave, one person familiar with the situation said. But unless the board fired him for cause, he would have been eligible for a generous severance.

Under Mr. Scrushy's 1998 contract, he can be fired for cause only if he is found guilty of a felony or a fraud with "a material adverse impact" on HealthSouth and he has exhausted his appeals. That definition of cause "is outrageously narrow," said Brian Foley, an executive-pay consultant in White Plains, N.Y.

If the board terminates him without cause, Mr. Foley said, the CEO would get at least $15.6 million in severance pay, immediate vesting of his stock options and restricted shares plus perks.

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