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SowdersDMGT7019-8-8
Learner: Daniel Edward Sowders
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#<Course ID Number> #<Faculty Mentor>
MGT7019-8 Dr. Stephanie Lyncheski
#<Course Title> #<Assignment Number or Title>
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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