SowdersDMGT7019-8-8

Learner: Daniel Edward Sowders

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Ethics in Business 8

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The HealthSouth Scandal’s Negative Ramifications and Unreasonable

Punishments

Introduction

The HealthSouth scandal caught media attention in late 2002 as HealthSouth

engaged in a massive accounting fraud scheme lasting over several years that allowed

HealthSouth to overstated profits by more than $4.6 billion. Accounting ‘‘fraud,’’ as

defined in SAS No. 99 is “… an intentional act that results in a material misstatement in

financial statements that are the subject of an audit” (AICPA, 2002, Para. 5).

HealthSouth accomplished this unbelievable accounting fraud through small and simple

accounting entries, nothing terribly sophisticated. However, the corporation's internal

and external auditors apparently, and unreasonably, never detected the errors.

HealthSouth, in order to meet Wall Street analysts’ expectations, managed to make

large amounts of little mistakes to appear to remain a strong performing stock.

HealthSouth executives went as far as to monitor these transactions to ensure that they

did not exceed the automatic dollar threshold that Ernst & Young (external auditing

company) used to check year-to-year variations (Kaplan, 2004). However, by 2003, the

United States government had caught on, and through guilty pleas and convictions,

over eighteen executives and officers would be formally charged and punished

(Johnson and Johnson, 2005). The fallout was quick, decisive, and negatively affected a

myriad of stakeholders from innocent and guilty employees to the philanthropic

community. Moreover, as the case came to an end, the general populace became

outraged at what appeared to be nothing more than “slaps on the wrists” punishments

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of these unethical executives. Though the HealthSouth scandal illuminated unethical

accounting practices, the stakeholders truly got the raw deal in the end.

All Stakeholders Receive Negative Ramifications

The HealthSouth scandal affected more than just the CEO and executives. The

unethical actions conducted by HealthSouth employees surpassed unethical and

breached irrational behavior. More than just those eighteen convicted executives felt

negative repercussions. The employees, owners, and those executives may have seen

the harshest consequences from the HealthSouth falling out, but the accounting and

health care industries, stockholders, and the philanthropic community accrued negative

ramifications as well. The deceitful accounting that existed within HealthSouth, paired

with a volatile work environment should have been interdicted by the United States

government in order to protect all stakeholders and prevent an economic meltdown

within the healthcare industry. However, since that governmental interdiction failed to

come to fruition, HealthSouth remained unethical, and thus became a catalyst an

example for future ethical and unethical accounting practices, and remains a textbook

example of poor business.

Marianne Jennings reports that the corporate atmosphere was far beyond

kosher. Jennings goes as far as to refer to the Monday morning briefings as “Monday-

Morning Beatings” (Jennings, 2012). Employees literally feared for their job if numbers

and quotas were not met. This corporate culture is severely regulated by the

government, infringing on what is known as a hostile work environment. The hostile

work environment law is a bit misleading, misunderstood, and vague. UCLA law

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professor Eugene Volokh believes that the government's uses an overly broad

interpretation of Title VII, a federal anti-bias law (Carelli, 1997). Title VII exists in order

to protect employees, and foster a beneficial work environment, the government created

this law to protect against such things as “Monday-Morning Beatings”. However, just

because higher managers are demanding profits does not mean that employees must

make this happen through any means possible. The executives, auditors, and

accountants are the true villains of HealthSouth, but many employees paid a price.

Noteworthy, during the initial unethical accounting, quotas were being met, and as

profits increased, so did the jobs provided by HealthSouth, but these jobs were a mere

mirage of long-term stability. In addition, Rossbacher writes in the Journal of Financial

Crime that the “ordinary” employees were not blame free, that it “’takes a village’ to

mount such a criminal enterprise”, with employees continuing to employ obviously

unethical practices without whistle blowing and all the while remaining to sleep at night

(Rossbacher, 2006). However, some positive consequences resulted from the

HealthSouth scandal. Sims, writing on how to rebuild reputation after a scandal, noted

that the HealthSouth debacle caused an industry wide evolution, stating that the

HealthSouth scandal allowed corporate culture to move from a CEO centric atmosphere

to an employee centric atmosphere. The martyred employees of HealthSouth pioneered

a new corporate culture that will increase reputation and service (Sims, 2009). This

employee centric view allows a business to survive a scandal; HealthSouth manages to

operate openly to this day, but without the assistance of indicted executives and

suspicious owners.

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Though Richard Scrushy was not found guilty of any federal offenses in the

HealthSouth case, his actions impacted his direct associates, employees, and future

endeavors. Many people were astounded to discover that Scrushy had not been found

guilty of any of the 36 charged federal counts, not limited to just fraud and conspiracy.

Even as the Sarbanes-Oxley Act specifically designated Scrushy’s actions as criminal,

the jury expected an irrational amount of evidence of proof to indict. In addition, most of

this type of evidence would not even have existed in HealthSouth’s fraudulent

accounting scheme (Jennings, 2005). Surprisingly, the federal government knew

HealthSouth had committed crimes and attempted to catch Scrushy, who was

eventually caught on tape implying enormous amounts of unethical actions. At one point

a close associate of Scrushy wore a wire and recorded Scrushy remarking that:

“[If you] fixed [financial statements] immediately, you'll get killed. But if you fix it

over time, if you go quarter to quarter, you can fix it ....Engineer your way out of

what you engineered your way into ....I don't know what to say. You need to do

what you need to do." (New York Times, 2003)

However, Scrushy would be eventually fined and penalized for the false certification of

records, but he did remain out of jail. His impact is far reaching, and Scrushy’s actions

have spurred a revolution of auditing practices and have been the content for numerous

business ethics courses. Even with a recorded statement, Scrushy walked, but his

actions and comments were the mere wake before the Tsunami, which engulfed

eighteen of the highest executives at HealthSouth.

The HealthSouth scandal was one of the first incidents where a plethora of

executives received judicial punishment for unethical accounting actions. As of 2005,

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Johnson and Johnson reports that 18 HealthSouth executives have been brought on

federal charges, with eighteen already pleaded guilty to some charges (Johnson and

Johnson, 2005). This is great news to justify the government’s criminalization of

fraudulent accounting, but the punishments were not equivalent to the crimes. The

Delaware Journal of Corporate Law remarks that some of these executives saw jail

time, nearly all executives were fined and penalized, and few are active in the corporate

world as of today (Casey, 2010). To demonstrate the level of unfairness in the

HealthSouth case, Roy Smith in the Independent Review notes that WorldCom’s

Ebbers, who conducted nearly the same type of fraud, and also had similar executives

testimony against him, received a life sentence in jail, where as Scrushy was acquitted

(Smith, 2006). However, these personal consequences not only changed the futures of

these executives, but the actions conducted antagonized the United States government

to further increase and enforce unethical accounting.

The accounting industry has remained in constant flux since 1999 due to

scandals and debacles. Big business after big business is caught conducting unethical

accounting that leads the government to criminalize further these actions to protect

other stakeholders. Within the Journal of corporate Law, author Christine Hurt

reprimands and explicates on fraudulent accounting and its enforcement. Hurt states

that within any environment where rampant under-enforcement of laws exists, local

members will eventually begin to act more criminal due to a sense of survival or a sense

that “the law is meaningless”. However, as soon as an arrest is made, the penalty will

be disproportionate in order to send a message to the under-policed area (Hurt, 2008).

Therefore, the corporate accounting industry can be seen as an under-policed arena.

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Hurt hypothesizes that corporate law has been deliberately under-enforced in the

criminal arena because of the sense that the civil arena is better suited to discipline

corporate misconduct. (Hurt, 2008). Regardless, as soon as a major scandal breaks,

new laws are enacted, either to protect the general populace or to placate to the general

populace’s need for vindication. Major federal laws such as the Sarbanes-Oxley Act of

2002 and the new “law of 702” exist specifically due to large corporations finding new

ways to conduct fraudulent accounting (Paulo, 2009). However, there is no argument

that laws must be put in place to protect the stockholders and economic dependents of

large corporations, which hold a large market footprint. These types of measures are

often needed, but to over-criminalize unethical accounting practices may not be the

answer. This again is the governments way to deter future illegal behavior by “making a

case” out of any, and all violators. Since a stockholder can only be told information, they

cannot do their own personal auditing, and stockholders rely on ethical accounting, thus

the government must enact rules and regulations to deter unethical behavior that can

severely detriment the United States economy and defraud taxpaying citizens.

Stockholders are often left on the outside of a scandal looking back and

wondering how it happened. As long as business has been around, so have unethical

business practices. However, recently, cheating has moved from deceiving the

customer to deceiving the stockholder. The HealthSouth scandal was more than

crooked executives, but brought to the forefront an evolving issue, the corruption of the

audit process itself. Illuminated by the $5 billion HealthSouth fraud accumulated over

years of false accounting, there were no large, singularly obvious actions, but

thousands of tiny and unnoticeable actions (Kaplan, 2004). As mentioned before, there

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was executive pressure from above to maintain the profitable status quo, but the end

game client, the stockholders, ended up being the entities holding the bill. Economically,

as presented by Bonini and Boraschi in the Journal of Business Ethics, the falsified

financial records inflates the capital structure presented by the company, inflating

confidence and creating an illusion of long term stability. Only to see the largely inflated

stock prices drop drastically after the scandal reached the media. Thus, post-scandal

actions left nearly all stockholders upside down on stocks and fiscal divisions (Bonini

and Boraschi, 2010). According to Investopedia, due to federal implications, the

Scrushy sale of over $75 million in shares, and a poorly performing quarter, the

HealthSouth stock dropped from $20 a share to $.45 cents in one trading day

(Investopedia, 2011). Stockholders were left baffled, economically destroyed, and

beyond angry over the consequences that they could not have seen coming. These

investors lost much more than just money in a stock portfolio, but confidence and trust

into the economy, which directly contributes to economic recession felt years later in the

United States. However, it was not just stockholders that carried a personal burden, but

the HealthSouth beneficiaries undeservingly carried their share of heartaches into the

philanthropic community.

Though Richard Scrushy obviously lacked ethical judgment at times, he

remained a community figure of high moral value. As far as charities are concerned,

Scrushy appeared to have a vast diameter of giving. According to RichardScrushy.com,

Scrushy contributed personal time and substantial monetary donations to charities such

as United Cerebral Palsy, the Arthritis Foundation, Big Oak Ranch, the March of Dimes,

and many others (RichardScrushy.com, 2012). Furthermore, he served time on

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numerous boards and chairs for many colleges and even the Alabama Sports Hall of

Fame. Scrushy did serve his community, and his financial stress will be felt in the

Alabama philanthropic community. One example of charity was the $1.35 million he

gave to churches in his local community in just one year (Tomberlin, 2005). Therefore,

his unethical actions not only harmed himself and his family, but also stretched to the

needy families that may have relied on his generosity, or his donations. Though

philanthropy was not his reason d’être, undeniably, people were helped by his

generosity. However, though he was not put in jail for the HealthSouth scandal, bribery

charges were brought up against Scrushy in 2005 for which he was found guilty and

sentenced to prison for an 85-month term (Brickey, 2008). During this time, he went

bankrupt, lost financial stability, and spent no time helping the less fortunate. It is these

second and third order effects that impacted an entire community from the unethical

actions of fraudulent accounting, which put HealthSouth behind the rest of the industry.

Nevertheless, the outcomes and consequences from the HealthSouth scandal painted a

picture of poorly orchestrated prosecution and seemingly guilty executives walking.

Lastly, HealthSouth the corporation felt an impact from the scandal. The health

care system and industry has been under continual scrutiny from politicians and

activists for some time. The HealthSouth scandal illuminates an issue that had been

brought up before, but not under these conditions. In the case of HealthSouth, the

negative impact from the scandal could have been far worse. However, the stock prices

did take an initial hit in the stock market, only years later to have the stock recover to

pre-scandal levels. HealthSouth continues to receive health care contracts, and even

against all odds of reputation rebuilding, has managed to stay in the forefront (Sims,

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2009). Sims believes that recovering reputation is hard, but due to the circumstances

surrounding the plea bargains, executives did appear to fight for the remaining

employees and HealthSouth the corporation. James Bennet, former HealthSouth

president remarked that "if you want to save a company for the benefit of the

shareholders and the employees, you have little choice but to cooperate.” He further

stated that “… [We made] as many arguments as we could that no legitimate purpose

would be served in indicting the company. The company has not been forced into

bankruptcy." (Mokhiber & Weissman, 2003). Thanks to this company saving attitude by

the convicted executives, HealthSouth survived one of the biggest scandal of the early

2000’s and remains in business today.

Confessions and Convictions Ruin Reputation

Since the HealthSouth scandal went to court, new arrests and convictions for

unrelated matters have occurred such as the Richard Scrushy bribery case in Alabama

(Brickey, 2008). However, many arrests, confessions, and convictions scarred the

reputation of executives, HealthSouth, and the health care industry. Though the

HealthSouth case has not been totally closed due to continuing arbitrations and

prosecutions, at this time more than eighteen executives and officers have been

officially charged with federal offenses, with all of the executives and officers except

Scrushy agreeing to plea bargains (Mackey, 2003). The Securities and Exchange

Commission continues to battle for convictions against HealthSouth for “overstating

earnings by $1.4 billion” from 1999 up to 2003 (Terhune and Mollenkamp, 2003). The

actions of HealthSouth and the confessions and cooperation has led to hundreds of

thousands of dollars in penalties and fines as well as at least four executives serving

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prison terms as long as 60 months (Mackey, 2003). However, though these numbers

appear to be a win for the government with solid convictions and confessions, the

punishments lacked fairness in many stakeholders’ eyes.

Guilty pleas are the underlying effect of why it appeared so many executives

were unfairly under-punished. Statistically, as long as an alleged criminal fully

cooperates with law enforcement, they receive far les punishments, and as far as plea

bargains go, white-collar crimes often receive a perceived “slap on the wrist”. Kathleen

Brickley points out in the Journal of Criminal Law & Criminology that guilty pleas are

critical to the government's successful pursuit of corporate fraud cases. In a study of

prosecutions completed between March 2002 and July 2004, charges against eighty-

seven alleged white-collar criminals were resolved. However, “…while more than ninety

percent of the outcomes were convictions, only about ten percent of the convictions

were products of jury verdicts” (Brickley, 2006). Basically, white-collar crimes are

overwhelmingly resolved through guilty pleas, which evoke a lesser penalty. This

common knowledge of the ineffectiveness of guilty pleas on fuels the fire of the

populace’s perceived unfairness. Even those executives that were fined, penalized, and

jailed did not receive the actual maximum amount of penalties set in place by the laws

they broke. The Sarbanes-Oxley Act has a maximum sentence of as much as 25 years

and complete forfeiture of assets to a person found guilty, which in the HealthSouth

case was over fourteen people (Mackay, 2003). Jennings writes that even as Scrushy

left the court room with a full acquittal, protestors stood by holding signs that stated “Still

guilty in God’s eyes” (Jennings, 2012). Obviously if a perceived unethical villain such as

Scrushy receives no punishment for an obvious crime, obviously justice was not served.

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However, the penalties and punishments accrued by the other executives did not even

come close to the actual amount they could have received. As stated before, in an

industry under-enforced, crimes caught must be punished to the fullest extent in order to

deter future behavior. It appears in the HealthSouth case that not only was under-

enforcement rampant, but also justified and full punishments were under-enforced (Hurt,

2008).

Conclusion

The HealthSouth scandal is a textbook example of how to manipulate the

auditing and accounting system without justified repercussions. The United States

government had an ideal situation in which over eighteen executive pleaded guilty to

unethical practices. These practices in which they knowingly knew were illegal and

caused far-reaching consequences to innocent stakeholders. However, the government

did not take the opportunity to make an example out of unethical accounting; instead,

the United States government gave unjustifiable punishments to people who deserved

so much more. The fines and insignificant amount of jail time could not justify the

negative ramifications of the HealthSouth employees. Furthermore, for HealthSouth to

remain in business with no long term effects shows that the current system is not just

inefficient but ineffective in controlling big business. Something must be done in the

future to mitigate future unethical actions as it has been proved that corporations will

only continue to work outside the spirit of the law. In addition, until a real, harsh, and

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impending consequence is associated with this kind of practice there will be no

significant decrease in unethical accounting and auditing in the future.

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References

AICPA ( 2002) Statement on Auditing Standards (SAS) No. 99: Consideration of Fraud in a Financial Statement Audit (American Institute of Certified Public Accountants, Durham). Retrieved from http://search.proquest.com.proxy1.ncu.edu/docview/871185808/134AB8162C1726DEE78/7?accountid=28180#

Bonini, S., & Boraschi, D. (2010). Corporate scandals and capital structure. Journal of Business Ethics, 95(01674544), 241-269. doi:10.1007/s10551-011-0856-3

Brickey, K. F. (2008). From boardroom to courtroom to newsroom: The media and the corporate governance scandals. Journal of Corporation Law, 33(3), 625-663. Retrieved from http://search.proquest.com/docview/220804464?accountid=28180

Carelli, R. (1997). Is policing harassment arresting free speech? Broad interpretation of anti-bias law allows strong words to legally define a hostile work environment. (1997, Sep 16). Journal Record, pp. 1-1. Retrieved from http://search.proquest.com/docview/259364870?accountid=28180

Casey, L. L. (2010). Twenty-eight words: Enforcing corporate fiduciary duties through criminal prosecution of honest services fraud. Delaware Journal of Corporate Law, 35(1), 1-96. Retrieved from http://search.proquest.com/docview/210684300?accountid=28180

Hurt, C. (2008). The Undercivilization of Corporate Law. Journal of Corporation Law, 33(2) 361-445

Investopedia, 2011. The Biggest Stock Scams of All Time. Retrieved from http://www.investopedia.com/articles/00/100900.asp#axzz1lr3S2rzc

Jennings, M. (2009). Business Ethics: Case Studies and selected Readings. United States: South-Western College

Jennings, M. (2003). The ethics Lessons of HealthSouth. Corporate Finance Review, 8(1) 44 http://search.proquest.com.proxy1.ncu.edu/docview/198764075/134AB8162C1726DEE78/1?accountid=28180

Jennings, M. M. (2005). The legal vs. ethical distinction and why we care. Corporate Finance Review, 10(2), 42-47. Retrieved from http://search.proquest.com/docview/198776643?accountid=28180

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Johnson, G. G., & Johnson, M. V. M. (2005). CEOs 1, Sox O: The Case against Richard Scrushy And HealthSouth. Journal of Legal, Ethical and Regulatory Issues, 8(1), 35-41. Retrieved from http://search.proquest.com/docview/216236868?accountid=28180

Kaplan, R. (2004). The Mother of All Conflicts: Auditors and Their Clients. Journal of Corporation Law, 29(2) 363-383

Mackay, S. (2003). HealthSouth investigation nets 14th guilty plea. Birmingham Business Journal, 20(36), 9-9. Retrieved from http://search.proquest.com/docview/220934859?accountid=28180

Mokhiber, R., & Weissman, R. (2003). Multiple Corporate Personality Disorder: The 10 Worst Corporations of 2003. Multinational Monitor, 24(12) 9-20

Paulo, S. (2009). Fisherian analysis, the Sarbanes-Oxley Act of 2002, and the new rule 702 of the federal rules of evidence of 2000. International Journal of Law and Management, 51(6), 389-400. doi:10.1108/17542430911005927

RichardScruchy.com (2012). In Richard Scrushy’s personal webpage. Retrieved from http://www.richardscrushy.com/

Rossbacher, H. H. (2006). The business of corruption, or is the business of business corruption? Journal of Financial Crime, 13(2), 202-213. Retrieved from http://search.proquest.com/docview/235991696?accountid=28180

"Secret Recording Is Played at a HealthSouth Hearing," The New York Times (Apr. 11, 2003): C2. Retrieved from http://search.proquest.com.proxy1.ncu.edu/docview/198764075/134AB8162C1726DEE78/1?accountid=28180

Sims, R. (2009). Toward a Better Understanding of Organizational Efforts to Rebuild Reputation Following an Ethical Standard. Journal of Business Ethics, 90(4) 453-472. Doi:10.1007/s10551-009-0058-4

Smith, R. C., & Walter, I. (2006). Four years after Enron: Assessing the financial-market regulatory cleanup. The Independent Review, 11(1), 53-66

Terhune, C., and Mollenkamp, C. (2003). HealthSouth officials may sign plea agreements - Moves by finance executives would likely help build criminal case against CEO. Wall Street Journal, pp. A.14-A.14. Retrieved from http://search.proquest.com/docview/398806118?accountid=28180

Tomberlin, M. Scrushy Charity Gave to Churches: Foundation Sent $700,000 to Groups Supporting Him, Birmingham News, Dec. 25, 2005

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