Keeping Secrets

How five CFOs cooked the books at HealthSouth.

It could be an episode of “The Sopranos.” As revenues at $2.4 billion HealthSouth Corp. begin to falter, CEO Richard Scrushy in the role of Tony Soprano, browbeats “the family”, a group of top lieutenants including five CFOs, into falsifying a wide range of financial reports. Despite the family’s misgivings, their own greed and Scrushy’s threats keep the scam in operation for at least six years, until the “holes” become too big to fill with “dirt” alone. Only when a last-ditch effort conceal the fraud by taking the company private fails does the last CFO left standing finally crack under the pressure, and agree to wear a wire for the FBI.

That, at least, is the scenario described by the 15 executives who testified again Scrushy. (As of press time, no verdict in the trial had been reached.) Scrushy and his “family” are charged with recording as much as $2.7 billion of fake revenues on the company’s books over six years, and correspondingly adjusting the balance sheets and paper trails. Methods included overestimating insurance reimbursements, fiddling with fixed-asset accounts, improperly booking capital expenses, and overbooking reserve accounts.

According to the testimony of CFOs Aaron Beam Jr., Michael D. Martin, William T. Owens, Weston Smith, and Malcolm “Tadd” McVay, each one realized the error of his ways, but most felt helpless to blow the whistle or even leave the company. Scrushy “managed greatly by fear and intimidation,” according to Owens, who served as HealthSouth’s third CFO from 2000 to 2001 (and again for part of 2003). Second CFO Martin testified that he tried to quit at least three times during his 1997 to 2000 tenure. “[Scrushy] said, ‘Martin, you can’t quit. You’ll be the fall guy.’” The remark “petrified” him.

Now, facing federal criminal charges and possible jail time, all five CFOs have pleaded guilty and turned state’s evidence, hoping to put Scrushy in jail for the rest of his life — and reduce their own sentences.

A Sunny Surface

From the outside, HealthSouth looked like a normal company. The revenues and cash-flow figures the company disclosed seemed reasonable, according to Gimme Credit analyst Carol Levenson and others. A constant stream of acquisitions, along with HealthSouth’s unique mix of inpatient and outpatient facilities, made it hard to compare the company with others or even itself. And even after analysts like Levenson, Merrill Lynch’s A. J. Rice (a witness for the prosecution), and Jefferies & Co.’s Frank Morgan (a witness for the defense) began to question the quality of the numbers in late 2002, they overwhelmingly said they never suspected the massive fraud.

HealthSouth also maintained impeccable corporate policies — on paper. A confidential whistle-blowers’ hotline had been set up in 1997. The company’s nonretaliation policy gave the compliance director direct access to the board of directors. Its centralized finance function seemed like an advantage at the time, since other health-care companies were falling apart because of problems in field offices.

Many employees of HealthSouth, particularly those who worked at medical centers in other parts of the country, thought they worked for an ethical company. A former regional manager who oversaw finances for facilities in several states says that the message from headquarters never conflicted with her personal values. “They were always stressing honesty in what we did, and that was how we ran it in the field,” she says. “We had no reason to think they did any different.”

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