HealthSouth’s auditors—and maybe even government regulators—were tipped off to a possible massive accounting fraud at the company five years ago. Or at least that’s the takeaway from a shareholder’s memo that was released by a congressional committee yesterday.
The memo, dated November 1998, was apparently written by an anonymous HealthSouth shareholder and sent to auditor Ernst & Young. In it, the shareholder alerts the audit firm to alleged bookkeeping violations at the rehabilitation-services company. Reportedly HealthSouth’s top lawyer assured its independent auditor that it would conduct an internal investigation of the allegations. The committee notes no record of such an inquiry, however.
The Securities and Exchange Commission is currently conducting a civil investigation into the bookkeeping at HealthSouth. The commission is investigating whether the company—and its ousted CEO Richard Scrushy—perpetrated a $2.5 billion accounting fraud.
The Justice Department is conducting its own investigation into the alleged fraud. So far, the DoJ has leveled charges against 11 former HealthSouth executives, including all five of the company’s past and present CFOs. The finance chiefs have all pleaded guilty to securities fraud.
“You bring the smoke, I’ll bring the mirrors,” the unnamed shareholder wrote in the memo.
The shareholder’s list of alleged violations at HealthSouth included an assertion that the company booked charges to outpatient clinic patients before checking that insurers would reimburse the claims. The shareholder also alleged that HealthSouth continued to record these charges as revenue even after payments were denied. “How can the company carry tens of millions of dollars in accounts receivable that are well over 360 days?” the shareholder asked in the letter.
More questions followed: “How can some hospitals have NO bad debt reserves? How did the E&Y auditors in Alabama miss this stuff? Are these clever tricks to pump up the numbers, or something that a novice accountant could catch?”
At the time the memo was sent, the stock price of HealthSouth had dropped sharply and state authorities were investigating its billing practices, according to the House committee and an Associated Press report.
In a statement issued yesterday, E&Y reportedly said it conducted a review at the time the allegations were made and “determined the issues raised did not affect the presentation of HealthSouth’s financial statements.”
E&Y, which provided the memo to the House committee, originally indicated that it was first alerted to potential accounting problems at HealthSouth last June.
Ken Johnson, committee spokesman, reportedly said it was not clear whether all the parties listed on the memo had received it. In addition to E&Y, the memo lists distribution to the SEC’s enforcement division, the federal agency that oversees Medicare and Medicaid, and the head of the American Institute of Certified Public Accountants. Spokesman for the SEC and the AICPA declined comment on the memo, the AP reported.
“You people and I have been hoodwinked,” the shareholder concluded in the memo. “This note is all that I can do about it. You all can do much more, if all you do is look into it to see if what I say is true.”
Scrushy Lawyer Wants to Buy HealthSouth
Meanwhile, a lawyer for Scrushy yesterday said he was organizing a group of potential investors to purchase the company.
We’re not kidding. Donald Watkins, owner of both the Alamerica Bank in Birmingham and an energy company, reportedly said he and other investors would like to make a bid to acquire a controlling interest in the besieged HealthSouth and take it private. Watkins also said that Scrushy could become an adviser in the buyout, according to a Reuters report.
HealthSouth spokesman Andy Brimmer, however, seemed to bristle at the suggestion, telling Reuters that the HealthSouth board would not allow the sale. “We cannot imagine any circumstance where Richard Scrushy and his associates would be permitted to acquire control of HealthSouth,” said Brimmer.
Of course, getting control of HealthSouth would seem to be a lot easier these days—or at least cheaper. Thanks to the tremendous amount of bad press stemming from the government’s ongoing investigations into the company, HealthSouth’s stock is now trading at about 27 cents a share.
For his part, Watkins believes the operator of physical therapy and surgical centers is worth a lot more. “It is not due to any inability of the company to succeed,” he said of the severely depressed stock price. “It’s like a thoroughbred winning the Kentucky Derby without a jockey on top.”
Watkins told Reuters he believes the company is undervalued by as much as $3 billion. HealthSouth has approximately $3.3 billion of debt outstanding, and creditors are waiting for financial data from forensic accountants working to determine the true value of the company.
Watkins, according to Reuters, failed in previous bids to buy Major League Baseball’s Anaheim Angels and Minnesota Twins.
Scrushy has not been charged with any crime relating to investigations into the accounting at HealthSouth. He denies any wrongdoing in the alleged fraud.
PwC Settles with SEC
The SEC announced on Thursday a settled enforcement action against PricewaterhouseCoopers LLP. The SEC found the audit firm to be engaged in improper professional conduct in connection with its audit of SmarTalk TeleServices Inc.’s annual report for year-end 1997, which contained materially false and misleading financial statements.
The issues in question related to an audit of a $25 million restructuring reserve and changes to those amounts at year-end. SmarTalk, a provider of prepaid telephone cards and wireless services, is now in bankruptcy.
The SEC noted that PwC, through Philip Hirsch, former partner on the audit, failed to comply with generally accepted accounting standards in the conduct of its audit. Reportedly, after Hirsch left the firm, PwC identified potential issues with the statements in question and its audit. SmarTalk also became involved in a class-action shareholder lawsuit alleging accounting fraud against the company as well as some of its officers and directors.
In addition, the SEC uncovered that PwC produced documents to the staff in February 1999 that included listings of computer files showing that certain working paper files had been accessed in early August 1998. But PwC did not tell the staff until November 1999 that some of those working papers and other documents relating to PwC’s audit report had been revised, created, and discarded.
In addition to the censure of PwC, the audit firm agreed to pay a fine of $1 million. It also agreed to establish new document-retention policies to preserve working papers, and to retain an independent consultant to review PwC’s software system to ensure that it is designed to meet the new objectives. PwC and Hirsch did not admit to or deny the SEC’s findings.
Short Take
On Wednesday, the SEC announced that it unanimously approved the appointment of William McDonough to be chairman of the Public Company Accounting Oversight Board. He officially assumes the top spot on June 11. The appointment completes the selection process, which included a background investigation after his nomination on April 15. McDonough is currently the president of the Federal Reserve Bank of New York, where he also serves as the vice chairman and permanent member of the Federal Open Market Committee.