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More Guilty Pleas in HealthSouth Scandal

Accountants, CIO reportedly admit to helping illegaly boost earnings; reserve accounts "bled out" into revenue. Plus: Ahold investigation spreading to other food makers, while Intel unveils beauty contest for auditors.
David M. Katz, | US
April 7, 2003

Five officers of HealthSouth—including several accounting executives and the company's CIO—pleaded guilty late last week to federal fraud charges. The charges are in connection with an apparent overstatement of profits that allegedly boosted HealthSouth's earnings by as much as $2.5 billion, according to press reports.

The executives of the outpatient surgery and medical rehab provider admitted they conspired to commit wire fraud, securities fraud, and filing false records. They were Kenneth Livesay, chief information officer; Rebecca Kay Morgan, group vice president, accounting; Cathy Edwards, vice president, asset management; Angela Ayers, vice president, finance and accounting; and Virginia Valentine, assistant vice president, finance and accounting.

The four finance executives got involved in the conspiracy in 1994, with the CIO joining the group in 1996, the New York Times reported. Ayers and Valentine admitted to making false entries into contractual-allowance accounts. Such accounts contain patient charges that won't be collected because of a contractual agreement with a third-party payer to accept less than the standard charge. Typically the allowances reduce patient accounts receivable.

Other accounting-related admissions: Morgan acknowledged falsifying cash accounts and Edwards said she falsified asset accounts.

Three other former HealthSouth finance executives have already pleaded guilty to fraud charges: William Owens and Weston Smith, who had both been CFOs, and Emery Harris, who was an assistant controller at the company.

The plea offered by Livesay, the CIO, put HealthSouth's profit overstatement at $2.5 billion since 1997, according to the Wall Street Journal.

Last month the Securities and Exchange Commission filed a lawsuit alleging that, since 1999, the company and its former CEO, Richard Scrushy, systematically overstated HealthSouth's earnings by at least $1.4 billion.

To boost profits, Livesay claimed, HealthSouth executives overbooked certain reserve accounts that were later "bled out" into revenue, according to the Journal story.

In his plea agreement, the CIO also said the company overstated pretax income by $440 million in 1997 and $635 million in 1998.

Besides its previous civil charges against Scrushy, the SEC reportedly accused the onetime HealthSouth CEO of insider trading. The commission indicated it would seek up to $743 million in penalties, forfeiture of illegal profits, and triple damages—if it is able to prove the new charges.

Scrushy was fired as HealthSouth's chairman and CEO last week.

Hold the Rebates
SEC and Justice Department investigators probing the alleged accounting fraud at Dutch supermarket giant Ahold NV are said to be looking into whether U.S. Foodservice, Ahold's distribution company, falsely boosted earnings by inflating the amounts it booked for rebates. Food manufacturers dish out rebates to motivate distributors to get the manufacturers' products onto grocery shelves.

On the face of it, the investigation appears to be widening. Executives at ConAgra Kraft Foods, Sara Lee, General Mills, H.J. Heinz, and Hormel Foods reportedly disclosed last week that federal authorities contacted them in connection with the probe. Executives of all the companies said they would cooperate with investigators.

In related news, a ConAgra representative said that earlier this year, two company sales staffers signed off on inaccurate documents provided by U.S. Foodservice, the Wall Street Journal reported. The documents were aimed at verifying the amount of rebates that ConAgra owed U.S. Foodservice.

But ConAgra claimed its accounting department quickly caught the errors and told U.S. Foodservice executives and Deloitte & Touche, Ahold's auditor, about them before the accounting scandal became common knowledge in February.

In February Ahold acknowledged that it overstated U.S. Foodservice earnings by at least $500 million.

Since then, Ahold has handed over information to federal investigators that suggests that U.S. food companies may have helped U.S. Foodservice inflate its earnings by okaying erroneous rebate-related documents, the Journal said, citing a person familiar with the situation.

Last week, another food distributor, Fleming Cos., filed for bankruptcy protection. In February the SEC launched an investigation into Fleming's accounting practices.

Up the North Face
The SEC and Christopher F. Crawford, the former CFO of The North Face, have reached a settlement on a revenue-inflation action the commission brought against Crawford.

During 1997 and 1998, Crawford schemed to artificially inflate the company's financial results, the SEC alleged. As a result of the scheme, The North Face overstated its revenue and gross-margin recognition.

The company fraudulently recognized revenue on barter transactions and recorded consignment sales as completed, regular sales, the SEC charged.

Crawford and others allegedly tried to hide the improper reporting from the company's auditors and from a special audit-committee investigation. The commission also charged the company's finance chief with making material misrepresentations to the auditors and omitting facts in an attempt to hide his misconduct.

Without admitting or denying the charges, Crawford agreed not to serve as an officer or director of a public company for five years, not to practice as an accountant before the SEC, and to give up $29,000 of his earnings, plus interest, and pay a civil penalty of $30,000.

Intel's Auditor Auction
Intel's audit committee has decided to take the unusual step of putting its 2003 audit business up for bids from the Big Four accounting firms.

The auction, of course, will include Ernst & Young, which has been the semiconductor maker's independent auditor since Intel's incorporation in 1968.

Intel's audit-committee members also say they might invite some smaller firms into the fray. The members think they'll likely take a few months to do the job. In fact, it's possible Intel's decision could end up being for 2004 rather than 2003.

Intel already currently uses all the Big Four for various services. While E&Y serves as the company's outside auditor, the other three provide it with tax and valuation services, financial-information system design and implementation, specialized audit work, and other types of consulting.

In fact, one of the firms was paid more for services rendered in 2002 and 2001 than E&Y received as independent auditor, according to Intel's recently issued proxy. The proxy did not reveal who that other firm was.

In 2002 Intel paid E&Y almost $11 million in fees, up about $1 million from the previous year. The 2002 figures included audit fees ($6 million), "audit-related" fees ($2.5 million), and tax fees ($2 million.)

Why did the company decide to put its 35-year union with E&Y at risk? Intel's audit-committee members say they wanted to do a detailed review of other audit firms and mull the benefits of changing firms. Such a review might increase auditor independence, audit-committee members think.

The committee also wants to take a "fresh look" at Intel's financial accounting and internal controls processes. The decision to put the company's audit business out to bid had nothing at all to do with E&Y's performance, nor is it a way to cut costs, they insist.

Nevertheless, it's got to be hard breaking up a 35-year marriage. Almost as if to show that there are no hard feelings, Intel audit-committee members are asking E&Y to take part in the process of hiring a new auditor.

Critical Operations
To comply with the new, real-time-reporting rules under the Sarbanes-Oxley Act, finance chiefs need to be in close touch with operations managers, experts agree. What's more, increasing numbers of finance chiefs see exposure to operations as a career booster.

Indeed, 46 percent of CFOs responding to a new survey say that an operations background is the best kind of experience for a finance chief.

Next in line in terms of the most desirable kinds of experience were information technology (28 percent), legal (26 percent), and sales and marketing (24 percent).

The survey, which polled 1,400 CFOs from U.S. companies with more than 20 employees, was sponsored by Robert Half Management Resources. The firm supplies senior accounting and finance professionals to companies on a project basis.