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Financial Statement Magic: an Insider's Account of a $2.8 Billion

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Financial Statement Magic: an Insider's Account of a $2.8 Billion Feature Financial Statement Magic: An Insider’s Account of a $2.8 Billion Fraud 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, Alabama 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.
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