Healthsouth Corp. dismissed its chairman and chief executive, Richard M. Scrushy, and moved to replace its outside auditor, Ernst & Young LLP, as federal prosecutors made deeper inroads into the group of executives they say are responsible for massive criminal accounting fraud at the company.
The dismissals came as U.S. prosecutors announced their third guilty plea in the rapid investigation, which has centered on government allegations that Mr. Scrushy directed his lieutenants to falsify financial results for much of the company’s public history.
In a new twist, Justice Department officials appeared to suggest that potential witnesses had been threatened. Alice H. Martin, the U.S. attorney in Birmingham, Ala., said at a news conference that tampering with a witness carries a 10-year sentence. “We will punish them and we will prosecute them to the nth-degree,” she said. She declined to elaborate.
In the latest deal with prosecutors, Emery Harris, a 33-year-old HealthSouth vice president of finance and assistant controller, pleaded guilty in U.S. District Court in Birmingham to making fraudulent entries in the company’s books, at the behest of top executives, to inflate earnings and bring them in line with or exceed Wall Street expectations.
HealthSouth is one of the nation’s largest providers of outpatient surgery and rehabilitation services.
Two former chief financial officers pleaded guilty in the past two weeks to helping direct the accounting fraud. According to prosecutors and Mr. Harris, lower-level accounting employees were left with the details of how to mask the financial results.
In court, Mr. Harris told U.S. District Judge Inge Johnson that initially he was asked by senior officials to hide earnings shortfalls as a short-term “Band-Aid.” But government officials claim the fraud quickly grew.
The Securities and Exchange Commission in a civil complaint filed March 19, accused HealthSouth and Mr. Scrushy of overstating earnings by $1.4 billion since 1999, though the SEC contends that the earnings manipulation goes back to shortly after HealthSouth went public in 1986.
Monday, the SEC filed civil complaints against Mr. Harris, as well as Weston Smith and William Owens, the former finance chiefs who have reached criminal plea deals of their own.
The SEC also charged Messrs. Smith and Owens with insider trading and violating securities laws. Mr. Owens’s attorney said he hadn’t seen the complaint and declined to comment. Mr. Smith’s attorney couldn’t be reached for comment.
The insider-trading charges are the first the SEC has brought in the HealthSouth case. However, the SEC’s complaint against Mr. Scrushy notes he sold a substantial amount of stock into the market, and the agency is likely to amend its complaint to include insider-trading charges against him as well, according to people familiar with the matter. Civil and criminal investigations are continuing. HealthSouth has said it is assisting investigators.
Ms. Martin, the U.S. attorney, said that Mr. Harris has helped investigators find others involved in the alleged fraud and said that the investigation “is expanding beyond the finance department at HealthSouth.” Two senior prosecutors from the Justice Department, Richard N. Wiedis and Richard Smith, have teamed up with Ms. Martin’s office, with the goal of negotiating tough plea deals with HealthSouth executives.
Meanwhile, federal investigators said that while the government is looking into possible offshore bank accounts and side businesses run by Mr. Scrushy, those are secondary to the main investigation at HealthSouth.
Investigators are also looking into the suicide last July of William Massey, who was chief financial officer of one of Mr. Scrushy’s private companies. An FBI spokesman said, however, that investigators are focused on accounting fraud and that other areas of interest are “of low importance.”
According to Mr. Harris’ plea agreement, around the next-to-last week of each quarter, he would submit a report to senior executives showing HealthSouth’s actual results. Shortly after that, according to the plea, Mr. Harris and fellow finance employees received instructions from senior executives to inflate the company’s financial results.
Ernst & Young declined to comment on the firm’s possible dismissal by HealthSouth, but said it continues to cooperate with the government investigations.
At HealthSouth, company officials made further efforts to distance themselves from Mr. Scrushy. In a statement Monday, HealthSouth said the company’s board notified Mr. Scrushy in a letter dated March 30 that his contract was “null and void” and said his rights to severance pay and other benefits are terminated.
The company said its board can’t legally remove Mr. Scrushy as a director, but has asked him to resign.
Neither Mr. Scrushy nor his lawyers returned calls seeking comment.
The board had placed Mr. Scrushy on “administrative leave” March 19, out of concern that firing him would make him eligible for generous severance. Brian Foley, a compensation consultant in White Plains, N.Y., had estimated that under Mr. Scrushy’s 1998 contract, the executive would have been entitled to at least $15.6 million in severance pay, immediate vesting of his stock options and restricted shares.
HealthSouth said that under the Sarbanes-Oxley Act, passed last year to overhaul corporate practices after a spate of accounting scandals, Mr. Scrushy may have to forfeit bonuses or proceeds from HealthSouth stock sales if the company restates any of its financial results.
Since the company went public in 1986, Mr. Scrushy has sold $225.6 million in HealthSouth shares and sold back an additional $25.2 million of stock to the company to repay a loan, according to Thomson Financial. At the same time, he purchased $73.6 million of company shares on the open market and by exercising stock options.