Feature

Financial Statement Magic: An Insider’s Account of a $2.8 Billion

An interview with Aaron Beam, Former Chief Financial Officer and Co-Founder of HealthSouth

the good life in lush homes and later, in Executive Summary stark federal prison cells, as punishment An extraordinary success and an unimaginable failure, HealthSouth, a rehabilitation for their crimes. Here is New Perspectives’ and outpatient surgery company, was a high-flyer and darling of Wall Street. interview with Aaron Beam. Started in 1984 by Richard Scrushy and three partners, HealthSouth’s success was NP: When exposed, the $2.8 billion the thing American dreams are made of. Starting humbly, with a single outpatient HealthSouth fraud was one of the largest rehabilitation center, the company grew exponentially to over $3.5 billion in annual corporate mis-doings in American sales. business history. Perhaps the first Midway through 1996, after meeting Wall Street analysts’ expectations for ten years question that should be asked is: “Could (40 straight quarters), the veneer of this success was wearing away. It was time to the fraud have been prevented if you report lower than expected earnings. Or, was it? Thus began a six-year period of and/or the HealthSouth Board opposed cooking the books, to the tune of $2.8 billion, and the unwinding of an American or challenged Scrushy during those early business Cinderella story. years?” AB: If the challenges had come, I am not ichard Scrushy’s rags to riches story As a HealthSouth co-founder he became sure the company would have ever gone R begins in a trailer park during his a multi-millionaire. However, in the public. But, Scrushy just would not let teenage years in Selma, where, second quarter of 1996 Beam and an others tell him how to run his company. in 1971, he worked as a gas station accomplice, at Scrushy’s urging, began to The lesson here is that people like Scrushy attendant and brick layer. Nineteen years falsify HealthSouth’s financial statements should not take a company public. after he founded HealthSouth, as its to meet Wall Street’s expectations and Personality types like this can never buy CEO, his riches approached $1 billion. to maintain its stock price. Plagued by into the concept that the public owns the He used his wealth to accumulate 11 conscience and reluctant to continue with company. homes, a Lamborghini and more than the fraud, Beam left HealthSouth in 1997. A lot of unethical things that Scrushy did three dozen other automobiles, as well as Convicted of bank fraud, he was would not have been wrong in a private a 92-foot yacht. He also had nine children, sentenced to three months imprisonment company. For example, the HealthSouth three marriages and vast local, state, and and a $275,000 fine. He now operates a helicopter was essentially for his personal national connections stretching from one-man lawn mowing company and use. He also arranged to purchase Birmingham, Alabama to New York City speaks on business ethics. computers from his father’s company at and Washington, DC. Scrushy was an above-market prices. If he was the sole over-achiever, smart, complex, quirky, Beam’s and Scrushy’s paths converged owner of the company those types of things and unscrupulous. He used people to get at Lifemark, a hospital management would not have been considered wrong. and do what he wanted. In 2003, he was company. Three years later, Lifemark It would have been his company and he indicted and ultimately acquitted on 85 was acquired by American Medical could do what he wanted. However, public counts of fraud related to HealthSouth. International (AMI). At this time, Richard company officers and board members have Later, he was convicted of political Scrushy’s idea of a national chain of an obligation to watch out for the interests bribery and sentenced to 88 months in outpatient rehabilitation centers surfaced. of the stock holders who are the real federal prison. Providing outpatient rehab services apart owners of the company. from the high cost-structure of hospitals By contrast, HealthSouth co-founder and made economic sense. Medicare had NP: Your company seemed to be a huge first CFO, Aaron Beam from Shreveport, recently approved another healthcare success right from the beginning and Louisiana, son of a small business provider category, the comprehensive seemingly for many years. When did the entrepreneur, was dedicated, competent, outpatient rehabilitation facility (CORF), fraudulent activities begin? conflict adverse, and knew right from which allowed payment for many wrong. He graduated from Louisiana AB: The HealthSouth fraud began outpatient therapy procedures. State University in 1967 with a degree in in the late 1990s, but the seeds were business, and served in the Navy during Poster children for corporate success sown in 1984 when the company was the Viet Nam era. and greed, Scrushy and Beam got to live incorporated. It is hard for me to believe

6 New Perspectives Association of Healthcare Internal Auditors December 2010 that another fraud very similar to that management should be honest, HealthSouth could occur today. ethical, and good corporate citizens. At the same time, the company was he external A lot has changed for the better to prevent buying all of their computers from his auditors another such a disaster. For example T father at above-market prices. Much of Sarbanes-Oxley (SOX), I believe, has actually found our HealthSouth’s real estate was sold to an made for positive change. People are REIT (real estate investment trust) formed fraud numerous much more aware of the importance of by Scrushy. The company was taken their actions now. For instance, companies times, but in their public and Scrushy cashed out founders used to make loans to officers so they stock costing pennies for millions. The list predilection for could buy stock options. That was of unethical activities is very long. These relatively common. Now this practice is ‘filling in the work things were taking place long before the prohibited. The compensation committees fraud and cooking the books began. paper blanks’ they of the board and audit committees are being held to a much higher standard NP: What is your candid view of missed the fraud. As these days than they were in the 80s and the public accountants and their an auditor, you need 90s. Weston Smith, who was my Director ‘contribution’ to allowing this huge to think about the of Reimbursement, and who eventually fraud to go unnoticed for six years? What became HealthSouth’s Chief Financial is wrong with their process, perspective, answer management Officer, blew the whistle to the FBI and/or training? Do you think SOX adds tells you. because of the SOX legislation. any practical value to the audit process? The venture capitalist’s desire for finding AB: I do believe HealthSouth’s auditors the next big winner, Richard Scrushy’s did a poor job of auditing the books. extreme aggressiveness and my non- HealthSouth’s audited balance sheet NP: What advice do you have to assist confrontational personality all helped the reflected $300 million in cash that was internal auditors in doing better fraud seeds to germinate. The venture not there. That is bad. Audit firms tend to financial audits and in identifying capitalists liked the ‘Scrushy style’ from hire recent college graduates that are shy fraud? the very beginning. He was intelligent, on business experience; they give them aggressive, driven, and wanted to make a scripted audit programs, and then work AB: First, I believe nothing beats lot of money. He was their kind of people. them long and hard. They, too willingly, experience. Auditors need more than accept any answer management gives accounting knowledge. They need to NP: Tell us about the ‘Scrushy style.’ them. When things that should be know and to understand the ‘why’ behind AB: You have to first judge people by followed up are found, they frequently what it is that they are doing, and they what they do, not just by what they say. aren’t. I heard a phrase that I think need to have developed a healthy amount Things need to line up. Scrushy always sums up a lot of the issues with public of skepticism. I noticed even before said the right things. Today, after the accounting. It goes like this: “One can go the fraud began at HealthSouth, that fraud, he now claims to be a minister, a through ‘process’ all day long, such as auditors didn’t pursue the final answer. man of the Lord, but yet he admits no with a canned audit program. However, They seemed more intent on just getting wrongdoing. if you want success, you’d better think.” a response to put in their work papers. I believe companies should be required In fact, the external auditors actually At the all-important HealthSouth to change auditing firms every three found our fraud numerous times, but in management meetings, he would preach years. SOX is helping to improve things. their predilection for ‘filling in the work paper blanks’ they missed the fraud by accepting any answer we gave them. As an auditor, you need to think about the answer management tells you. Our auditors left things hanging until next year and then never followed up on them the next year. Auditors should take more time to look for anomalies…things that don’t seem to make sense or are a bit out of whack. For instance, look at the entries toward the end of the month or at the end of a quarter. In our case, we made hundreds, if not thousands, of entries near quarter ends. Shouldn’t that look a bit funny to an auditor? Auditors should also increase the amount of reasonableness testing. What looks out of line, for instance, this year, compared to years past? What’s going on and does it make sense? If you don’t understand it, then understand it. Too much concern seems to be on getting the

December 2010 Association of Healthcare Internal Auditors New Perspectives 7 University (and a New Perspectives instincts are putting up yellow or red columnist), once responded “Not much” flags how should you respond? to a person who asked, “I wonder what AB: I believe your instincts can be very the difference is between someone who helpful. With age, instincts get sharper commits fraud and those of us who and more refined. First impressions are wouldn’t.” Is it really that easy to cross generally close to being right more often that line of wrongdoing? than not. As I pointed out in my book AB: Crossing the line happens when you HealthSouth: The Wagon to Disaster, my rationalize that it is an acceptable option. first impression of Richard Scrushy was If someone asked me to buy a gun and that he might be a con artist. A person’s rob a bank with him or her, I could easily instincts are not always 100% correct, but decide not to cross that line. White collar you need to give them heed when that crimes are easier to justify. It is much bell deep in your mind sounds. more likely that you believe many others NP: We believe people grow into are doing it, too. It does not seem to be unscrupulous behavior, meaning they such an obvious crime. That is why ethical tend to get worse or more brazen with business behavior needs to be taught at all each unethical success. Some actions are levels of our schools. obvious, but many seem to lie ‘behind NP: In your book, HealthSouth: The the curtains’ so to speak. What are Wagon to Disaster, you mention you some of the early signs and symptoms audit done in a specific amount of time. had worked with Richard Scrushy for a exhibited by an unethical personality? To me, when time is the primary audit half-hour when you saw his first breach determinant, that is a missed fraud in the AB: I think Paul Babiak and Robert Hare of ethical behavior. Years later, when making. do a great job of explaining how to spot the chips were down, and it was finally an unethical personality in their book necessary to report lower earnings per Another important item is the materiality Snakes in Suits, When Psychopaths Go to share, you were implored to ‘fix the threshold excuse. I believe auditors rely Work. They explain that the domains numbers’. What can an individual do to on that as their easy way out. Call it and traits the psychopath demonstrates prevent being managed into unethical audit laziness or sloppiness, but it was are: 1) superficial; 2) grandiose; 3) conduct by someone who thinks the a big factor and one HealthSouth used deceitful; 4) lacks remorse; 5) lacks rules should apply to others? to our advantage for the entire six-year empathy; 6) doesn’t accept responsibility; period the fraud lasted. We had small AB: You can prevent being managed into 7) is impulsive; 8) lacks goals; 9) is facilities with less than 15 employees unethical conduct by always asking the irresponsible; 10) has poor behavioral that should carry an orthopedic supplies question, “Is this the correct thing to do?” controls; and 11) adolescent, antisocial inventory of between $2,000 and $5,000. This must be a checklist item. Always behavior. Of course, this is a very complex These inventories were inflated to remember, even though you are told or subject and I would recommend reading $25,000–$100,000. The auditors never think a fraudulent action is a one-time their book to fully understand these traits. caught on, and when you do this across occurrence…it isn’t. Don’t get rushed 1,500 facilities, it really helps make the into a decision to do wrong. Do what NP: How should you respond when quarterly numbers. In other cases we you can to delay a decision for a day or someone encourages you to commit knew they never tested accounts below two. During that time, talk to someone, fraud or some unethical act? (As in… $5,000 so these were tweaked and we had preferably a lawyer, to get their opinion What do you do? What can you do?) many thousands of them. regarding the proposed action and the AB: It is very simple. If you are asked to possible consequences. NP: If you were an internal auditor commit fraud, there is only one response, responsible for auditing systems, say no. If you know the action is fraud processes, procedures, and functions, then the hard part is over. Do not justify what would you do to assure your board or rationalize why it might be ok. I think that things were working as planned and he board must we can take a lesson from childhood. We expected? are all told lying is wrong. As we get older question good we rationalize that ‘white lies’ are ok and AB: To assure the board that things are T especially so if they prevent hurt or result working as planned and expected, the results as well as in something good (usually for the liar). board must have access to employees poor results. White collar crime often comes about the and employees need access to the board. same way. Of course it is wrong to cheat Management cannot filter information (like on taxes), but you rationalize that sent to the board. The board must everyone cheats and as long as it is only question good results as well as poor a little cheat then it is ok. That’s a bit of results. The question for a board that finds NP: In your business dealings with what happened at HealthSouth. We were itself with phenomenal results is “How is Richard Scrushy over the years, there only going to ‘tweak’ the numbers for one this possible?” Internal auditors should must have been situations that gave quarter, ‘knowing’ that the next quarter employ that skepticism, too. you pause about certain circumstances things would turn around. You just can’t NP: Marianne Jennings, professor of and decisions that were made. Based on think like that. Things are what they are. legal and ethical studies at Arizona State your HealthSouth experiences, if your Deal with them.

8 New Perspectives Association of Healthcare Internal Auditors December 2010 NP: Most people are not asked or fortunes would turn around. They didn’t. encouraged to exceed corporate We continued this for four quarters and standards and policy. Nor are they the hole we were digging kept getting placed in a position to be required to deeper. I decided to resign rather than to violate a law. Because this can be quite continue on. a rare experience, who should you talk with for guidance when faced with NP: After you resigned from committing an illegal act? HealthSouth did you give any thought to blowing the whistle on the fraud? AB: If you are asked to violate the law you are in a legal situation. I would AB: No. When I left I had no contact with get personal counsel ASAP. This is HealthSouth. After two or three years, very serious. I would tell my spouse I began to believe they had managed to also because you owe it to her/him to turn things around and the company communicate such important events. was now making their numbers. The reality was they had needed to continue NP: Can you talk to us about your the fraud for five more years. They had personal motivation for why you dug a $2.8 billion hole and the jig was decided to participate in ‘fixing the up. Perhaps, if I had known they had numbers’ as the fraud began? continued to fabricate numbers it would AB: I guess you could say it was my have changed my thinking about whistle- pride. Not pride in the usual sense, but blowing. But, that’s really supposition at pride in HealthSouth as having built this point. an international reputation for clinical NP: At the height of Wall Street’s love excellence. Call it blind company pride. affair with HealthSouth, you acquired NP: It is said that Scrushy could be an We had physicians with international and a lot of wealth through company stock. intimidating personality. How does one national reputations. For instance, Dr. Jim Did this wealth affect your decision deal with a superior who manages by Andrews has an international reputation as making with respect to not doing the intimidation? an orthopedic surgeon. When professional right thing? athletes such as Troy Aikman, Emmitt AB: Many people use intimidation to Smith, and Bo Jackson needed medical AB: I didn’t participate in the fraud for manage others. The skill they use is not care, Jim and HealthSouth were there. personal gain, but I guess I can say that it necessarily dishonest or insincere. Social If Lebron James were to need shoulder helped me in making the wrong decision. manipulation begins to be insincere if surgery today, I’d bet a paycheck that Jim Bill Owens, who was our controller at the you really do not care about the feelings would be the guy to perform it. The names time, and I, told Richard Scrushy we had of others or you try to take unfair of VIPs we served just goes on. to report bad numbers. We had made the advantage of others. If you determine decision to do the right thing. We let him that your superior has these psychopathic So, I was proud of what we had talk us out of that decision. tendencies you need to get a new boss. accomplished clinically and in taking HealthSouth from nothing to being a NP: So then, it seems like a critical factor NP: Aaron, thank you for talking with darling of Wall Street. We had done a is that you have to stick to your guns. us and sharing from your experience at great job in just a few years. My thought HealthSouth and life. AB: Absolutely right. Richard was very was that if we could just give the good at the art of salesmanship. He could AB: It has been my pleasure. I hope earnings a little help we wouldn’t have to talk you into doing what you didn’t want internal auditors and compliance disappoint anyone. We were not a house to do. We wanted to report the facts, but professionals will learn you really of cards like Enron. We had real, tangible got talked into disguising them. have to play by the rules, and that bad value. I rationalized that this was a one- decisions, even if they are small, will have time rough spot in the road and that it NP: You wrote in your book, consequences. would help the company. I wasn’t looking HealthSouth: The Wagon to Disaster, that to help feather my nest, because this type Wall Street pressures were omnipresent. Aaron Beam has spoken to universities, cor- of fraud does not do that. I was quite How do these external factors influence porations, hospital groups, fraud and auditor satisfied with my salary. ethics in business today? groups, and the general public concerning In the second quarter, when things did not AB: I believe that Wall Street pressure fraud and business ethics. Information on how turn around I realized we had fallen into pushes you to keep “putting lipstick on to purchase his book HealthSouth: The Wagon a trap and it wasn’t going to be a one-time the pig.” It is a game to always make your to Disaster can be found on his website www. thing. My reasons for continuing changed. company and its results look the best. aaronbeam.net. You can reach Aaron via his Now it became an issue of not wanting to Disclosure of the real results is masked website, www.aaronbeam.net, by email at admit that we had committed fraud while in order to convince the public that they [email protected], or by phone 251- still hoping and expecting HealthSouth’s should not sell your stock. 214-4654. NP

When everyone is thinking alike, then someone is not thinking. ~General George S. Patton

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