UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF ALABAMA SOUTHERN DIVISION In re HEALTHSOUTH CORPORATION ) Master File No. CV-03-BE-1500-S SECURITIES LITIGATION ) ) This Document Relates To: All Actions ) ) In re HEALTHSOUTH CORPORATION ) Consolidated Case No. CV-03-BE-1501-S STOCKHOLDER LITIGATION ) ) CLASS ACTION This Document Relates To: All Actions ) ) In re HEALTHSOUTH CORPORATION ) Consolidated Case No. CV-03-BE-1502-S BONDHOLDER LITIGATION ) ) CLASS ACTION This Document Relates To: All Actions ) ) JOINT SECOND AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS [FACTUAL BASIS] DEMAND FOR JURY TRIAL TABLE OF CONTENTS Page INTRODUCTION ...........................................................................................................................1 The Scheme..........................................................................................................................3 Ernst & Young’s Participation in the Fraudulent Scheme...................................................5 Underwriters’ Knowing Involvement..................................................................................8 Financial Fraud ..................................................................................................................14 Medicare Fraud ..................................................................................................................15 Passage of the Balanced Budget Act and Defendants’ Sale of Stock and Notes...............16 Defendants Reinflate the Price of HealthSouth Stock .......................................................19 Transmittal 1753 ................................................................................................................20 JURISDICTION AND VENUE ....................................................................................................30 THE PARTIES...............................................................................................................................30 Stockholder Plaintiffs.........................................................................................................30 Bondholder Plaintiffs.........................................................................................................32 Defendant HealthSouth......................................................................................................33 Senior Officer Defendants .................................................................................................33 Employee Defendants ........................................................................................................40 Director Defendants...........................................................................................................44 Defendant Ernst & Young .................................................................................................49 Underwriter Defendants.....................................................................................................51 Additional Underwriter Defendants...................................................................................54 Individual Underwriter Defendants ...................................................................................59 Summary of Claims Against the Defendants.....................................................................63 Senior Officer Defendants’, Employee Defendants’ and Director Defendants’ Involvement in Scheme..........................................................................................64 - i - Page Insider Selling ....................................................................................................................67 Healthsouth’s Board of Directors Recklessly Allows the Misconduct to Occur and Continue Unabated..........................................................................................68 OVERVIEW OF THE SCHEME ..................................................................................................69 HealthSouth’s False Financial Statements.........................................................................70 The SARC Report Provides Further Details of the Accounting Misstatements................73 Contractual Adjustments/Improper Classification of Expenses ........................................75 Improper Entries on Facilities’ Results..............................................................................77 Acquisition Accounting .....................................................................................................80 Improper Accounting For Bonuses....................................................................................81 Investment Accounting ......................................................................................................82 Other Accounting Manipulations.......................................................................................84 Former HealthSouth Executives Disclose Facts of Wrongdoing ......................................89 The Balanced Budget Act of 1997...................................................................................100 HealthSouth’s Overbilling Fraud.....................................................................................106 The Qui Tam Actions.......................................................................................................107 The Devage Action ..........................................................................................................108 The Darling Action..........................................................................................................111 The Mandel Action ..........................................................................................................111 The Manning Action........................................................................................................111 HealthSouth Employees Complained to Their Supervisors About the Overbilling Fraud ....................................................................................................................112 Scrushy Knew that HealthSouth Was Improperly Billing Medicare When He Sold His Stock..............................................................................................................115 Scrushy Knew that Transmittal 1753 Would Have a Material Impact on HealthSouth’s Operations Before Selling His Stock to Repay His Loan ............116 - ii - Page The August 27 Press Release Causes HealthSouth Shares to Plunge in Price ................122 HealthSouth’s Document Destruction .............................................................................127 HealthSouth Falsely Claims Scrushy Is “Cleared”..........................................................128 DEFENDANTS’ USE OF THE INTEGRATED PUBLIC OFFERINGS TO CARRY OUT THEIR SCHEME – THE INVESTMENT BANKS INVOLVEMENT ................131 HealthSouth’s Integrated Public Offering Scheme..........................................................134 The March 1998 Integrated Public Offering....................................................................137 The June 1998 Integrated Public Offerings .....................................................................139 The September 2000 Integrated Public Offering.............................................................142 The February 2001 Integrated Public Offering................................................................145 The September 2001 Integrated Public Offerings ...........................................................147 The May 2002 Integrated Public Offering.......................................................................150 The Underwriter Defendants Are “Underwriters” and “Sellers” of the Notes ................152 HealthSouth and the Underwriter Defendants Improperly Exploited the Rule 144A Exchange Structure in a Scheme Intended to Evade the Registration Requirements of the Securities Act......................................................................158 HealthSouth’s Relationship with UBS, Citi/Salomon and Lorello and McGahan Compels the Inference that They Knew About and Actively Concealed HealthSouth’s Financial Fraud ............................................................................163 Defendants Lorello, McGahan and Capek Had Direct Knowledge of the Fraud at the Very Same Time Citi/Salomon or UBS Provided Investment Banking and Analyst Services for HealthSouth .................................................................180 ERNST & YOUNG’S PARTICIPATION IN THE MISSTATEMENTS ..................................184 E&Y’s Long Term Relationship with HealthSouth.........................................................185 E&Y’s False Classification of “Pristine Audits” as “Audit-Related” .............................206 FALSE AND MISLEADING STATEMENTS...........................................................................209 False and/or Misleading Statements Issued During the First and Second Quarters of 1997 .................................................................................................................211 - iii - Page Reasons Defendants’ Statements Issued During the First and Second Quarters of 1997 Were False and/or Misleading ....................................................................212 False and/or Misleading Statements Issued During the Third Quarter of 1997 ..............213 Reasons Defendants’ Statements Issued During the Third Quarter of 1997 Were False and/or Misleading.......................................................................................216