Case 5-4 Health South - Teaching Notes Case 5-4 Health South Teaching Notes This case discusses

the HealthSouth scandal, which was one of the first cases under the Sarbanes Oxley required that the CEO and CFO of a company certify the financial statements as non misleading. Ethical Issues The ethical issue of this case is whether it is fair that the former CEO of HealthSouth was acquitted of certifying misleading and false financial statements while the CFO is serving five years for the same act. Questions 1. Is it fair that the former CEO of HealthSouth, Richard Scrushy, is acquitted while the key government witness against him, William Owens, is sentenced to five years in prison for his role in the $2.7 billion accounting fraud at HealthSouth? Scrushy, the non-accountant, ordered or convinced each CFO and each controller accountant to manipulate accounting entries. Sarbanes Oxley tries to hold bosses accountable for telling accountants what to do. Past common law traditions and one jury have said, Accountants do not have to give in to pressure and only accountants are responsible for keeping professional accounting promises. It may not be fair that Scrushy was acquitted, but it was fair that the accountants were held responsible for not meeting professional obligations. 2. Scrushy had allegedly certified false financial statements filed with the SEC, a violation of the Sarbanes-Oxley Act. Given that Scrushy was acquitted, does that mean the Act is not working? Explain the reasons for your answer. One case does not prove that the Act is not working. The threat of law works as long as CEOs and CFOs think that they will not fare as well as Scrushy in trial. However, if there are a series of trials in which CEOs are acquitted and not held responsible, then the fear deterrence of the Act will not work. The prevention portion (section 404) of the Act may be working better.

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Case 5-4 Health South - Teaching Notes

3. The main tool used by HealthSouth to overstate net income during a 3 year period was to understate contractual allowances, a contra account to revenue. Given the scope of the fraud and time period involved, do you think the auditors should have been able to discover the fraud? Briefly explain what techniques the auditors might have used to identify the fraud. In medical billings, hospital and medical groups negotiate with insurance companies on billing rates. A reimbursement sheet from an insurance company to a patient shows amount billed less agreed to insurance rate, amount disallowed, amount insurance is paying and the amount owed by the patient. The amount billed is almost irrelevant as it is the agreed to insurance rate that will be paid and collected. HealthSouth inflated the amounts billed and then understated the amounts disallowed. For the auditors to have identified the fraud a detailed comparison of the net of amounts billed less contractual allowance to the actual paid and collected would need to be made. An auditing technique that might be used to detect the fraud would be that on a test basis, an auditor would test that billings for like procedures and services were all billed similarly and that the offsetting contractual allowance for that procedure and service would net the billings to the agreed insurance rates. 4. Scrushy was paid $14.5 million in salary and bonuses during the period of the fraud. Do you think Scrushy is ethically entitled to keep that money? Use ethical reasoning to support your answer. Since Scrushy was acquitted, many will agree that he is legally and ethically entitled to keep the money. If Scrushy decided that he should be stripped of the money, to who should the money be restored? 5. Comment on the statement made by Judge Blackburn: White collar criminals merit stiff sentences, if only to send a message of deterrence to other business executives. Do you agree with the statement? Why or why not. Judge Blackburn it stating that public punishment scares potential perpetuators. This statement does not address the facts that most white collar criminals get to keep most of their ill-gotten gains, so the sentence of time might not deter as much as might be hoped. For example, the fine of Andy Fastow, former CFO of Enron, was $30,000,000 for filing false Enron financial statements. Yet, Fastows gains from sale of Enron stock were $33,675,000 and Fastow received an estimated $60,000,000 in bonuses and gains from the SPEs he helped set up. That nets $63,675,000 gains that Fastow is getting to keep from the Enron scandal. Over the six year sentence he will have won $10,612,500 per year or $29,075 per day for the Enron scandal. Until the fines take away all gains, even stiff sentences will not deter white collar criminals.

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