The steady stream of bad news for HealthSouth Corp. continued last week with another guilty plea by one of its top executives, the resignation of a new board member and a stock price that hovered a few cents above worthless.
While two former top executives have pleaded guilty to fraud as the beleaguered rehabilitation giant edges toward bankruptcy, HealthSouth's founder, Richard Scrushy, had as of late last week avoided criminal charges.
But the 50-year-old Scrushy, who founded HealthSouth in 1984, may face criminal charges in the near future as part of a wide-ranging, still-developing investigation that observers said is likely to snare a number of other top company officials, board members and perhaps even its outside auditor, Ernst & Young.
"I think the scope of the criminal investigation will be much broader than initially thought," said Russell Jackson Drake, of the Birmingham, Ala., law firm of Whatley Drake, who represents clients in a class-action lawsuit filed in mid-March against HealthSouth. "Ultimately, I think you're going to see a lot of midlevel people who either plead guilty or will be indicted. I think some people on the board are going to be indicted. I think there are people outside the company who will be indicted-people like investment bankers and the auditing firm."
As they pored over financial records last week, federal investigators also were looking into whether HealthSouth and its top executives may have bilked Medicare out of millions of dollars at the same time they grossly overstated earnings, assets and cash flow. Authorities are trying to determine whether the company created tens of millions of dollars in improper expenses, mostly in the area of physical plants and equipment, that were improperly reimbursed under the federal cost-reporting system.
Federal authorities were tight-lipped about the implications. A spokesman for the Centers for Medicare and Medicaid Services referred calls to the U.S. Justice Department, which declined to provide any information about the allegations. Federal prosecutors in Birmingham, Ala., where HealthSouth is headquartered, also withheld comment.
"This investigation is relatively new-it's open and ongoing, but we can't identify any areas that we're looking at," said department spokesman Bryan Sierra.
Still, one glimmer of faintly positive news emerged. With top financial officers and high-level accountants lining up to cut deals and cooperate with federal authorities, key particulars of the alleged fraud-and vital information about the true worth of the embattled company-are expected to surface sooner rather than later.
A complete picture of HealthSouth's finances may help calm the storm and set the company on a new course as it struggles for survival, some financial experts said.
"At the rate people are talking, (auditors and accountants) will have a good, clear picture fairly quickly," said Frank Morgan, an analyst with Jefferies & Co., Nashville. "If everybody's singing, they should be able to start the process of restating the financials fairly quickly."
J.P. Morgan Chase & Co., which froze the company's $1.25 billion line of credit, announced last week that HealthSouth was in default on $367 million in principal and interest payments on convertible bonds coming due this week.
In its civil complaint filed March 19, the Securities and Exchange Commission alleged that Scrushy and key HealthSouth financial operatives overstated earnings by as much as $1.4 billion beginning in 1999, artificially inflating the company's assets by about $800 million in the process. Cash on hand, federal authorities said, was exaggerated by as much as $300 million in a three-year period.
Shares of HealthSouth stock, stuck at $3.91 when the SEC suspended activity March 19, resumed trading over the counter last week, dropping to about 9 cents a share by week's end. The New York Stock Exchange is asking the SEC to officially delist HealthSouth stock. The default notice, which prohibits HealthSouth from making payments on its debt and could lead to bankruptcy, will provide more time "to seek an orderly resolution that is in the best interests of the company and all of its stakeholders," said Joel Gordon, who took over as active chairman after the board stripped Scrushy of his dual titles of chairman and CEO.
"We cannot, however, provide any assurances that an agreement with our lenders will ultimately be reached," Gordon said.
Neil Selinger, the lead attorney in the class-action lawsuit filed two weeks ago against HealthSouth, said a bankruptcy filing would reduce the chances of shareholders receiving any return on their investments.
On the day of the SEC complaint, Weston Smith, 42, HealthSouth's former chief financial officer, pleaded guilty to four criminal charges and agreed to cooperate with federal authorities. Last week, his successor, William Owens, 44, suspended March 20, also pleaded guilty to federal fraud and conspiracy charges after agreeing to cooperate with investigators.
Those developments don't bode well for Scrushy, according to Selinger.
"I think they were waiting to get that second senior person before they lowered their sights on Scrushy," Selinger said.
Scrushy, who has not made himself available for comment since the SEC announced the charges, has sold about $187 million in HealthSouth stock in the last five years.
Also last week, HealthSouth's board of directors suffered the surprise resignation of Betsy Atkins, a wealthy venture capitalist from Coral Gables, Fla., who had been appointed just two weeks earlier in an effort to help restore some credibility in the wake of dozens of shareholder lawsuits. Atkins was unavailable for comment.