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Weston Smith Crossing the Line- An Insider’s Story of the Healthsouth Fraud www.westonsmith.biz.

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Presentation on theme: "Weston Smith Crossing the Line- An Insider’s Story of the Healthsouth Fraud www.westonsmith.biz."— Presentation transcript:

1 Weston Smith Crossing the Line- An Insider’s Story of the Healthsouth Fraud

2 Healthsouth founded by Richard Scrushy Inspired by changes in Medicare reimbursement More efficient, less costly settings Within 15 years located in all 50 states, and 5 countries Annual revenues exceeding $4 Billion Nation’s Largest provider of Outpatient Physical Therapy Inpatient Rehabilitation Hospitals Surgery Centers Diagnostic Centers

3 Richard Scrushy Tone is set at the top

4 Is there a difference between one’s personal life and professional life?

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7 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves II.Acquisition Accounting III.Mergers & “One-Time” Charges IV. Dirt and Hole Accounting

8 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves Manipulation of contractual and bad debt reserves Limited life as A/R must convert to cash, and reserves can only go so low Should be easy to audit thru subsequent collections testing & testing of payments

9 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves II. Acquisition Accounting Start up cost capitalizations “Conservative” accounting for acquisitions Understate assets and overstate liabilities Overstate goodwill Effect was to create socks for earnings entries Audit focus on opening entries

10 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves II. Acquisition Accounting Example: Acquisition of a Medical Practice Actual Cash Consideration$800,000 Assumed Debt200,000 Total Consideration$1,000,000 Net Assets600,000 Intangible Assets (Goodwill)$400,000

11 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves II. Acquisition Accounting Example: Acquisition of a Medical Practice Opening ActualEntryDifference Cash Consideration$800,000 Assumed Debt200,000300,000$100,000 Total Consideration$1,000,000$1,100,000 Net Assets600,000450,000$150,000 Intangible Assets (Goodwill)$400,000$650,000$250,000 The Fraud: $250,000 in socks have been created to make room for subsequent fictitious debits, with the corresponding credits to earnings overstatements.

12 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves II. Acquisition Accounting ACTUAL HEALTHSOUTH ACTIVITY FOR JUST ONE YEAR: Total Consideration$766,707,000 Total Net Assets? Goodwill? % of consideration allocated to Goodwill ?

13 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves II. Acquisition Accounting ACTUAL HEALTHSOUTH ACTIVITY FOR JUST ONE YEAR: Total Consideration$766,707,000 Total Net Assets15,570,000 Goodwill$751,137,000 % of consideration allocated to Goodwill 98%

14 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves II. Acquisition Accounting III. Mergers & “One-Time Charges” Frequent charges for merger costs, impairments, contract terminations and “write-down of certain assets to net realizable value” Horizon/CMS acquisition – Goodwill overstated by over $300M with the other side going to earnings – Reported TOTAL net income for the year was $330M

15 The 4 Stages of the Healthsouth Fraud I. Accounts Receivable Reserves II. Acquisition Accounting III. Mergers & “One-Time Charges” IV. Rabbits Pulled out of Hats and Hole and Dirt Accounting Suspense and Intercompany accounts used to spread fraudulent entries all over the balance sheet – primarily to PP&E 126,000 Journal Entries per Quarter Unrecorded Sale-leaseback of $30M Gulfstream V Jet Unrecorded sale of $15M Caremark stock Amount due from affiliate overstated by over $35M Valuations on private company investments grossly overstated

16 The Snowball Effect Year over year growth expectations Subsequent earnings dilution Amortization Depreciation Income Taxes Property Taxes More participants & more people looking the other way STOPPING WILL CAUSE DETECTION

17 WARNING: EGO BEING FUELED AT 40,000 FEET

18 The Sarbanes-Oxley Act of 2002

19 FOR IMMEDIATE RELEASE AUGUST 27, 2002 HEALTHSOUTH ANNOUNCES SEVERAL NEW DEVELOPMENTS: o PROPOSED SEPARATION OF SURGERY CENTER DIVISION INTO NEW PUBLIC COMPANY o CHANGES IN SENIOR MANAGEMENT o IMPACT OF CHANGES IN OUTPATIENT THERAPY REIMBURSEMENT BIRMINGHAM, Alabama -- HEALTHSOUTH Corporation (NYSE: HRC) announced that its Board of Directors had approved in principle a plan to effect a tax-free separation of its surgery center division into a new publicly traded company, which would be the largest independent operator of freestanding outpatient surgery centers in the United States. The Board of Directors has authorized HEALTHSOUTH's management to proceed with development and implementation of the plan, subject to the satisfaction of certain conditions. If consummated, the plan will result in the issuance of shares in the new surgery center company to HEALTHSOUTH stockholders on a tax-free basis. HEALTHSOUTH believes that the new surgery center company would have improved access to the capital markets in order to take advantage of growth opportunities, and would enjoy competitive advantages not available to it as part of HEALTHSOUTH's existing network of facilities. The company also indicated that the separation would allow the surgery center business to grow without concerns relating to recent adverse developments in reimbursement for the company's outpatient rehabilitation operations, which are discussed below.

20 If the proposed plan is implemented, HEALTHSOUTH will continue to operate the largest network of inpatient and outpatient rehabilitation facilities in the United States, with facilities in all 50 states and overseas. HEALTHSOUTH's operations will include approximately 1,427 outpatient rehabilitation centers and 118 inpatient rehabilitation facilities, as well as four medical centers and 136 outpatient diagnostic centers. The new surgery center company will be the largest operator of freestanding outpatient surgery centers in the United States, with 209 facilities in 37 states. It is currently expected that the new company will operate under the name "Surgical Care Affiliates". Additional details about the proposed transaction and the expected management of the two companies are provided below. The company indicated that it was moving forward with the separation plan at this time in part because of unfavorable developments in outpatient therapy reimbursement. Effective July 1, the Centers for Medicare and Medicaid Services ("CMS") issued a directive to Medicare Part B carriers requiring that outpatient therapy services provided to two or more patients in a single time period be paid for under the "group therapy" payment code, regardless of whether such patients were engaged in the same activity. This directive, which significantly lowers reimbursement for services previously paid as individual therapy, is inconsistent with many providers' understanding of appropriate coding practice, which looks to the nature of the services provided and the clinical judgment of the therapist to determine whether the group code or individual codes are appropriate.

21 Because this program transmittal was not directed to Medicare providers or to Medicare Part A fiscal intermediaries, who administer payments under Part B to rehabilitation agencies such as those typically operated by HEALTHSOUTH, and because it appears to conflict with other statements by CMS and practices followed in the therapy industry, there has been substantial confusion regarding the impact and applicability of the directive. HEALTHSOUTH sought clarification through several meetings with its national Medicare intermediary and CMS officials in July and August and continued to receive somewhat conflicting guidance. However, pending further clarification, the company has implemented policies and procedures designed to reflect a conservative interpretation of current Medicare coding requirements in light of the recent directive. Management believes that, over time, it will be able to adjust scheduling and staffing patterns to reduce the negative impact of this new interpretation. However, compliance with the conservative policies will adversely impact its revenues and expenses relating to outpatient rehabilitation services in the near term. The company has implemented these policies with respect to both outpatient services provided through its Ambulatory Services division and outpatient services provided through its inpatient rehabilitation operations, which have a substantially higher Medicare population than the facilities in the Ambulatory Services division. The company believes that this new Medicare policy interpretation may also affect reimbursement from private payors who utilize the Medicare outpatient therapy fee schedule and coding policies in establishing payment policies and rates.

22 As part of its preliminary 2003 budgeting process, HEALTHSOUTH is evaluating the potential negative impact of the new Medicare group therapy directive in the context of its overall business model for its outpatient rehabilitation operations. While the final impact of these reimbursement developments cannot be determined with certainty, and while HEALTHSOUTH expects to explore operational changes intended to mitigate their effects, the company currently believes that the impact of this reimbursement change will require material revisions to its business model and operating strategy in outpatient rehabilitation. In light of this assessment, and based on available information, the company currently believes that its earnings before interest, taxes, depreciation and amortization will be lower than previously projected by approximately $175 million annually. Because of the uncertainties surrounding the full impact of these developments at this time, this initial assessment may prove incorrect, and the company is accordingly discontinuing earnings guidance for the remainder of 2002 and 2003 at this time.

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26 The Immediate Fallout Healthsouth offices raided by FBI Company delisted from NYSE Over a dozen other officers admit involvement in fraud Richard Scrushy charged with 80+ felony counts, pleads not guilty

27 “We are going to rehabilitate Richard Scrushy’s name in the community” Scrushy’s first attorney at a legal association luncheon after being charged with 80+ counts of fraud “If you can do that, you’re a miracle worker” someone at the luncheon, which was met with thunderous laughter and applause “Don’t pray on my time, pray on your own time”: Richard Scrushy at Healthsouth, after he caught his administrative assistant praying on her phone

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29 The Trial Tried in Birmingham 2 years to go to trial 6 month trial Jury deliberated 6 weeks All 5 former CFO’s testified against Scrushy Over $20M spent on defense by Scrushy Jury was not sequestered The defense held daily press conferences on the courthouse steps Scrushy’s TV station hosted shows morning and night “breaking down” the trial RMS pleading the 5 th before Congress Daily press conference on the courthouse steps

30 Post-trial Juror Comments: “No fingerprints” “No papers with his signature on them” “No smoking gun” “He seemed like such a fine man”

31 Why Did the Auditors Miss the Fraud?

32 Many “ Many “one-time” charges Limited transparency in results from operations Results significantly better than similar companies Frequent changes in executive management Frequent hiring from within Executive compensation with heavy ties to profits Frequent changes in business plan or focus Extreme personalities Very Public Red Flags No single red flag may be telling, but when waving together, speak volumes.

33 The Toll on the Company and the Innocent

34 “This tragedy has called into question our company’s safety and emergency response procedures and practices,” said Micky Arison, Chairman and CEO of Carnival Corporation.

35 Jean-Francois (Charles) Blondin “The Great Blondin” 1859 Do You Believe?

36 Feel free to contact


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