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HealthSouth Spotlight Turns to Ex-Auditor

May 22, 2003 | HealthSouth never was big on second opinions.

The giant health care chain now fighting for survival preferred to take care of itself. New evidence indicates that HealthSouth doctored its own numbers and then reassured others that its accounting treatments were proper.

Trained professionals trusted HealthSouth's judgment. But critics blast those experts, including independent auditors at Ernst & Young, for ignoring dangerous warning signs that are now being uncovered in a virtual autopsy of the ailing company.

"The financial collapse of HealthSouth, and the allegations of fraud within the company over many years, raises serious concerns about the auditing practices of HealthSouth's internal and outside auditors," said W.J. "Billy" Tauzin (R., La.), chairman of the House Committee on Energy and Commerce, in a letter to E&Y's chairman. "We are interested in learning ... why Ernst & Young apparently did not uncover any accounting fraud at HealthSouth."

HealthSouth has been accused of fabricating earnings from its earliest days as a publicly traded company. So far, nearly a dozen company executives including every person who ever served as CFO have confessed to participating in a multibillion-dollar accounting scam that ranks as one of the biggest, and perhaps the most blatant, in corporate history. Government investigators and prosecutors ultimately hope to nail Richard Scrushy, HealthSouth's founder and ousted CEO, as the alleged mastermind behind the financial scheme.

Scrushy, who faces no criminal charges yet, has insisted that HealthSouth finance executives carried out the accounting scam without his knowledge. But mounting evidence, including taped conversations and other correspondence, indicates that Scrushy had plenty of input into the company's financial business.

In new excerpts from a tape-recorded conversation with former CFO William T. Owens the first whistleblower at HealthSouth Scrushy specifically warns against taking a big write-off just before the accounting scandal blew up. He instead suggests that HealthSouth find a better way to overcome its bad investment in Source Medical, another Alabama company partially owned by HealthSouth executives. By this time, HealthSouth was already reeling from a big Medicare hit now viewed as partially bogus and questionable insider sales by the CEO. Scrushy emphasized that Wall Street would not tolerate another unpleasant surprise.

We'll get killed by the Street," Scrushy said. "And we will get killed by our board when we go tell them about this."

As it turns out, HealthSouth didn't take the write-off. But HealthSouth got killed anyway. Less than a month later, federal authorities filed charges against the company for allegedly overstating earnings by as much as 4,700% and bilking innocent investors in the process. The company's stock, which had already tumbled from $15 to $3 ahead of the charges, now trades for 27 cents on the pink sheets.

Some critics hold E&Y at least partially accountable for the disaster. They say that E&Y ignored warnings more than once about HealthSouth's accounting. On Wednesday, the House committee investigating the scandal released a new memo, sent to E&Y nearly five years ago, that "provides a road map leading to possible fraud."

The unsigned memo, faxed to E&Y by a concerned HealthSouth shareholder, states in part: "How can the company carry tens of millions of dollars in accounts receivable that are well over 360 days? How can some hospitals have NO bad debt reserves? How did the E&Y auditors in Alabama miss this stuff?"

The House committee, chaired by Tauzin, collected the memo after demanding extensive access to E&Y's HealthSouth documents. In a prepared statement, E&Y attempted to explain away the memo by saying the issues raised by the shareholder "did not affect the presentation of HealthSouth's financial statements."

But government officials remain skeptical. In a joint statement with the chairman of an investigations subcommittee, Tauzin said: "We now have evidence that five years ago warnings were given to HealthSouth's corporate watchdogs their outside auditor, Ernst & Young, and perhaps even the [Securities and Exchange Commission] about the accounting shenanigans at the company. Yet, no one appears to have listened."

More recently, a former HealthSouth bookkeeper warned E&Y about potential accounting fraud at the company last summer. But the auditors apparently found no signs of wrongdoing. HealthSouth has since gone on to fire E&Y, but the company's future remains uncertain.

Donald Watkins, the local Birmingham, Ala., lawyer representing Scrushy, is reportedly organizing a group of private investors who might buy HealthSouth out. But the company itself has dismissed the buyout as far-fetched. And many believe that HealthSouth will ultimately seek Chapter 11 bankruptcy protection a strategy that may spare the company but could wipe out its shareholders in the process.

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