HealthSouth Corp. took great pains last week to persuade its bondholders to remain patient.
As the Birmingham, Ala., company laid out financial projections for the first time since federal investigators accused the company of massive accounting fraud in March, HealthSouth said it is a going concern that can repay its creditors eventually. HealthSouth and some of its creditors agreed to delay some payments shortly after the alleged $2.5 billion fraud came to light, but those creditors could choose to force the company into bankruptcy.
The besieged rehabilitation provider may have another audience for its message-the U.S. attorney's office in Birmingham and the criminal division of the U.S. Justice Department-as it seeks to avoid the corporate death penalty of a criminal indictment. The criminal investigation is running parallel to the Securities and Exchange Commission's civil lawsuit, filed in March, that first alleged the accounting fraud. Last week, a 12th HealthSouth executive agreed to plead guilty to criminal charges connected to the alleged fraud and a congressional inquiry was expanded to include questions about a stock analyst's reports on the company.
Historically, criminal prosecutions of corporate wrongdoing have focused on the individuals responsible, not the company they work for, but times have changed, said Thomas Hill, a former federal prosecutor. "I think in the current climate, in what I would call the `post-Enron world,' I think there is more pressure on prosecutors to hold companies criminally responsible, as well as individuals," said Hill, who heads the white-collar criminal defense and government investigations practice for Washington law firm Shaw Pittman.
A criminal indictment by itself wouldn't necessarily cause HealthSouth to be excluded from federal health programs, but a criminal conviction for a "program-related crime" would mean an automatic exclusion, according to a September 1999 bulletin on exclusion published by HHS' inspector general's office. But as HealthSouth officials made clear last week, any interruption in reimbursements from payers could tip the company into bankruptcy, and an indictment could be grounds for the Centers for Medicare and Medicaid Services to halt payments-at least temporarily.
Hill and Anton Valukas, a former U.S. attorney who heads the white-collar crime group with the firm Jenner & Block in Chicago, said prosecutors take into account several factors when weighing whether to seek a criminal indictment of a company. The factors they cited seem to add up to a mixed bag for HealthSouth.
For instance, Valukas said, prosecutors will ask "is the activity being done by low-level employees, where you might think it isn't being done with the company's knowledge?" The higher up the fraud goes, Valukas said, the worse it is for the company. In HealthSouth's case, the allegations have been made against the highest level of management, starting with Richard Scrushy, founder, former chairman and chief executive officer, and continuing with all five chief financial officers in the company's 19-year history. Scrushy has not been charged with a crime, but he was sued by the SEC. All five of the CFOs have agreed to plead guilty to charges connected to the fraud allegations.
Another factor is whether those participating in the fraud were spread throughout the company, Hill said. The more the corruption appears to be widespread, he said, the more likely a prosecutor will pin blame on the company as a whole. The plea agreement that former HealthSouth executive Jason Brown reached last week with prosecutors was the first one outside of the accounting department, authorities said. Brown, 34, was vice president of finance and worked in the company's treasury department. He is accused of falsifying records related to a $27 million stock sale in 2001 to alter HealthSouth's balance sheet to cover up the alleged inflation of the company's earnings, prosecutors said.
Collusion between a company's accounting and treasury departments "is typically evidence of a much broader fraud, much more pervasive," said Clifton Brown, a professor of accountancy at the University of Illinois at Urbana-Champaign. (Jason Brown and Clifton Brown are not related.) The idea of separating the treasury, which physically controls the company's assets, from the accounting department, which tracks its assets, goes back thousands of years, "to the time of the Pharaohs," he said. Each department serves as a check on the other, because the treasury's cash accounts have to be reconciled with the entries kept by the accounting department.
On the other hand, HealthSouth has a few things going for it. Once the allegations are known, Hill said, a company's board must "take swift, credible action in response." Those steps should include cooperating completely, ridding the company of those who are responsible for the wrongdoing and installing new policies and practices, such as a compliance program, that will avoid a recurrence, Hill said.
Interim CEO Bob May, who is a HealthSouth director, emphasized the board's quick moves to hire turnaround firm Alvarez & Marsal, new auditors PricewaterhouseCoopers and the well-known legal team of Skadden, Arps, Slate, Meagher & Flom. "It should be apparent to everyone that the board acted quickly to bring in the best of the best," May told investors.
Chief Restructuring Officer Bryan Marsal, managing director with the turnaround firm, emphasized HealthSouth's cooperation with federal investigators. "That's not just lip service," Marsal said. "There's no cover-up here. There's been continuous communication (with the investigators). The board took a stand and waived all board legal privileges in discussions with these parties."
The welfare of shareholders, employees and patients also will factor into the decision prosecutors face, Valukas said. Marsal told investors last week that HealthSouth expects revenue of $4.1 billion and pre-tax operating earnings of $650 million in the 12 months ended June 30, 2004. With the cooperation of bondholders, Marsal said, bankruptcy can be avoided, preserving value for shareholders and easing the minds of the company's 49,000 employees who weren't involved in the alleged fraud.
The successful prosecution of the accounting firm Arthur Andersen last year for its role in the balance sheet manipulations at Enron Corp. shows how times have changed. For practical purposes, Andersen has ceased to exist. What's left of the firm can no longer audit public companies as a result of the conviction.
Company indictments are "some part of the arsenal" of a prosecutor, Valukas said. "As far as this Justice Department is concerned, they are going to seek (company) indictments where it's appropriate, and they're not going to shy away from it."