Offering new insight into how a massive accounting fraud went undetected for years at HealthSouth Corp., an executive with its longtime outside auditor testified Wednesday his firm relied on a few people for information about the rehabilitation giant and didn’t check some accounts.
Ernst & Young got most of its financial data on HealthSouth 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 probe 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 probe.
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 who have been charged in the fraud met regularly behind closed doors, but Scrushy was not among them.
Dawn Richey-Fowler, an accounting manager who has worked at HealthSouth since 1987, said the corporation officials, previously identified by federal prosecutors as members of the “family” who posted fraudulent earnings for HealthSouth, met several times a week in offices near her office.
When the federal investigation began bearing down on HealthSouth in February, she said, the closed meetings “increased to daily or several times daily.”
Before audits, Richey-Fowler said, HealthSouth accounting employees were told “not to have any loud discussions regarding numbers” and not to leave any documents about company finances lying around.
Also, she said, workers were told to give any documents requested by Ernst & Young to either Emery Harris or Kay Morgan, two of the HealthSouth executives who have pleaded guilty. Miller identified Harris and Morgan as two of the people who auditors were told to approach when in need of information.
U.S. District Judge Inge Johnson expressed surprise that a leading auditing firm would agree to such restrictions and not dig deeper when reviewing a company’s books.
“Have you never learned that you don’t go just through the authorized channels?” she asked, referring to Miller’s accounting courses in college.
“That education was 20-some years ago. I don’t recall specifically addressing that,” he said. He testified that Ernst & Young believed HealthSouth had adequate internal financial controls.
But Richey-Fowler said she learned of one HealthSouth bank account only after the SEC filed suit, and she recalled Morgan making odd accounting entries involving $5 million to $10 million a quarter.
“I did not know a logical reason for that to happen,” she said.
She testified that she once asked Morgan about the entries and was told “not to worry about it.”
HealthSouth is the largest U.S. provider of diagnostic imaging, outpatient surgery and rehabilitation services. The company has nearly 1,700 locations in all 50 states and abroad.