Offering new insight into how a massive accounting fraud went undetected at HealthSouth Corp., executives with its outside auditor testified Wednesday they relied on only a few people for financial data, didn’t audit some accounts and didn’t believe a whistle-blower’s e-mail last summer.
Ernst & Young got most of its financial information on the rehabilitation services giant from some of the same executives who have pleaded guilty in the scam, according to testimony by William Curtis Miller, a principal with the auditing firm.
Also, he said, Ernst & Young did not audit a contractual adjustment account the government claims was used in a scheme to overstate HealthSouth’s earnings by some $2.5 billion since 1997.
Testifying in a hearing where fired HealthSouth CEO Richard Scrushy is trying to unfreeze his assets, Miller said the firm wasn’t alerted to the fraud in part because of the use of faked invoices.
“Pretty ingenuous method, huh?” asked Scrushy attorney Tom Sjoblom.
“Yes,” replied Miller, who testified that HealthSouth paid Ernst & Young about $3 million annually.
Miller said Ernst & Young knew nothing about the fraud until the Securities and Exchange Commission filed suit last month accusing HealthSouth and Scrushy of overstating earnings by
$1.4 billion since 1999 to meet Wall Street forecasts. The amount that was allegedly overstated has increased to $2.5 billion since 1997 as the inquiry continued.
Ten former HealthSouth executives have either pleaded guilty or made deals to plead guilty. Three of those admitting their guilt came to HealthSouth after working for Ernst & Young, which the company has fired.
Scrushy has not been charged, but the government claims he directed the fraud and his attorneys have said he is the target of a criminal investigation.
A second Ernst & Young executive told the federal court that an e-mail from former HealthSouth accounting worker Michael Vines last June or July described HealthSouth expenses being misclassified as assets in three specific accounts.
James Lamphron, who managed HealthSouth audits for Ernst & Young, said auditors spoke to William Owens, the chief financial officer for HealthSouth who is now among the former executives pleading guilty to fraud. Owens said the adjustments were routine and proper and described Vines as a disgruntled former employee who had been fired, Lamphron said.
While Vines a government witness previously described the adjustments as part of the fraud, Lamphron said Ernst & Young found no problem with them. “That’s still our conclusion,” he added.
Sjoblom has tried to show in the hearing that Scrushy did not know about the complicated financial scheme and should be able to use his money, which the government wants frozen so Scrushy can pay any penalties resulting from the lawsuit.
Another witness called by Scrushy’s defense said key executives charged in the fraud met regularly behind closed doors, but Scrushy was not among them.