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Health South: The Scrushy Way
Table of Contents
Outcome and Fairness of Punishment
In November 2003, Richard Scrushy, was indicted by a federal grand jury “on 85 counts including conspiracy, securities fraud, money laundering and charges related to overstating HealthSouth’s earnings by nearly $3.0 billion” (Manmohan 2006, p. 1). The Securities and Exchange Commission had accused the former CEO of Healthsouth and the company of “inflating earnings to the tune of $1.4 billion since 1999” (Manmohan 2006, p. 1). This essay will give consideration to the ethical issues involved in this case and particularly with regard to stakeholders in the company. It will also attempt to provide some relativity in terms of ethics to the outcome and final punishments received by Scrushy and fellow directors and employees of the company. This will include an analysis of the court cases of some of the parties in relation to the alleged gains made by them. In terms of justice, this must be weighed against the harm and difficulties caused to, for example, investors, who were clearly misinformed and who thus made investments in good faith based on the alleged fraudulent mis-reporting of the company performance and thus true value.
Before proceeding with these analyses and discussions, it is pertinent to provide a background as well as some contextualization to the case. Ethics and Company Culture (Unit 4, p. 183) informs us that Health South was a chain of hospitals and rehabilitation centers which “used its celebrity and sports figure patients as a means of marketing and distinction.” It tried to be a brand leader and suggested that its hospitals were leading the way in terms of facilities and practices. The extent to which this branding and the value of the company rose can be exemplified by noting that, in the period from 1987 to 1997, the stock of the company rose at an average rate of 37 per cent a year (Ethics and Company Culture, Unit 4, p. 183). The good news for investors was that the IPO value of its stock was $1 in 1986 but $31 in 1998. However, while it had apparently become a “billion-dollar” company, its profits were re-stated in 2002 and 2003 to “reflect $2.5 billion less in earnings,” and the shares were down from the $31 mark in 1998 to $0.165 in April 2003 (Ethics and Company Culture Unit 4, p. 183).
It should, perhaps, first be established what a stakeholder is in terms of which are relevant to this discussion. Four primary groups can be identified – customers, employees, shareholders and the community (Clarkson (1995, p. 106), and those with similar stakeholder interests can be grouped within the same broad categories. This means that we can suggest that the groups that are most likely to be affected by the actions of Mr Scrushy and his fellow directors are those listed above, but we must consider each in terms of potential relative loss. Customers may have suffered some difficulties or even loss of credibility if they were one of those celebrities who endorsed the hospitals, but their status (as customers) would allow them to seek treatment elsewhere. If we similarly consider the community, or society, it would be entitled to feel aggrieved at the actions and these could be seen as undermining the integrity of it (society) as a whole. We can also view society and community in terms of being the arbiter of punishment, which is necessary if it is to be maintained. Therefore, the actions of Mr Scrushy and fellow directors may be viewed as a threat to the community as a whole.
However, if we are concerned with relative injury, those who were primarily most affected are shareholders and employees. Again, we can consider these in terms of groups. Employees who had been employed for a longer time may have been more severely hurt and victimized than those employed for shorter periods due to factors such as benefits, pension plans etc., as well as age in terms of finding new employment. Stockholders may also be categorized because although sometimes inaccurately portrayed, in fact many people invest for income and dividends rather than speculative gains. Therefore, some stockholders may have lost parts or even significant portions of their incomes. Larger investors may have lost amounts which were not necessarily insignificant to them and even large mutual funds with diversified portfolios will have lost some points, and thus relatively small investors (in such funds) will have lost some potential gains. So, we can identify sub-groups who, in the worst case scenario, as either employees or shareholders, may have had their lives ruined financially.
However, whilst we can point to potentially severe consequences for both employees and shareholders, and while the ‘community’ can be viewed as a victim, it can also be arguably seen as complicit because it allowed this and other frauds to happen. Indeed, we can note the extent to which the ‘system,’ which is created by the socially constructed will of the ‘people,’ the community, has enabled a method which places the possibility of great rewards by over-inflating returns. On one level, this can be seen as easy to justify and it could be said that by over-inflating such figures, CEO’s and directors are acting in some senses responsibly by ensuring the success of the company and therefore security of employments etc. Even if this is somewhat tenuous, it can further be posited that the ‘rules’ which govern financial reporting have made such frauds relatively easy. For example, Dyck et al (2007, p. 2) make the point that there were “large and numerous frauds that emerged in the US at the turn of the millennium,” and that their research suggests that often the person or people who ‘blow the whistle’ are also punished. For example, “auditing firms are more likely to lose the job when they reveal it than when they do not,” and that “in 82% of cases with named employees, the individual alleges that they were fired, quit under duress, or had significantly altered responsibilities as a result of bringing the fraud to light” Dyck et al (2007, p. 3).
Indeed, we can further consider the extent to which some ethical responsibility lies with the ‘community’ in terms of systems which do not encourage the detection of fraudulent activities. On the one hand, for example, the Sarbanes Oxley Act (SOX) was “an immediate legislative response” to the numerous frauds exposed in the United States at the turn of the century (Dyck et al 2007, p. 3), and was the basis for the arrest and trial of Mr Scrushy), but on the other “fraud detection relies on a wide range of, often improbable, actors” (Dyck et al 2007, p. 40). The point is that while there may be some political will to ensure that such frauds are exposed, there appears also to be a malaise – some hesitancy – to definitively deal with it.
It could further be argued that the coming to light of the problem was predicated more in some poor judgments by Mr Scrushy rather than in positive efforts by authorities to ‘find’ such dealings. For instance, according to Pressman (2011), Mr Scushy sold $75 million of stock in the company a few days before it announced a substantial loss, and this was as well as $77 million dollars worth of stock sold between 1999 and 2001. This prompted the Securities Exchange Commission (SEC) to begin an investigation to determine “whether this sale was related to the loss, which would have violated insider trading laws.”
This therefore leads to two further questions, namely is insider trading considered to be more heinous than, for example, deliberately inflating profit figures in order show untrue value to shareholders, and if this is the case, why is there a difference. It could be argued that, if anything, the latter is the more serious because it implies deliberate and intentionally planned fraud, whereas the former may be seen as somewhat opportunist. Nevertheless, we are reminded by Barr (2005) that, for insider trading, the punishment is related to the gain. Therefore, for example, in 2005 it was determined by a judge that a defendant accused of insider trading had benefitted by $105 million and thus received a punishment of 292 months in prison. When we consider the level of punishment in the case of Mr Scrushy, perhaps we should ponder why the lesser level of severity was applied in his case.
Newkirk and Robertson (1998) explain that the basis of the success of stock markets lies in a commonly held perception amongst investors that “they enjoy the world's highest level of confidence” and “investors put their capital to work- and put their fortunes at risk - because they trust that the marketplace is honest.” The implications of investors losing confidence in the fairness of the system, which is fundamentally based in an understanding and a belief that the same information is available to all interested parties, are enormous. If investors lost this confidence, there would be no investments and the value of companies would crash – the 1930’s would not just be re-visited, but the economic consequences would probably be even more severe. On the other hand, if fraud is committed where one company is over-valued, it does not have the potential to absolutely undermine the whole system – one isolated group of stock-holders and one isolated group of employees is affected.
This leans towards the possibility that ‘wrong’ is not determined by some subjective evaluation of what wrongdoing might actually mean in terms of deliberate fraud or actions, nor on the actual gain made by the individual, but on the wider economic consequences for the society at large. Objectively, therefore, it can be suggested that the potential monetary cost to a wider society determines ethical values rather than the extent to which individuals may be harmed. So a sort of utilitarian approach can be seen.
Of course, Mr Scrushy did not act alone in the fraud and Hamilton (undated, p. 1) poses a number of questions, including why and under what circumstances people who are ‘just doing their job’ cross the line for being “law-abiding citizens to law-breaking villains.” The relevant point is made that, in the 1990’s, factors converged which meant that economic growth and wealth were “created at a pace never seen before” (Hamilton, undated, p. 1). This led to a situation where the growth of revenues was considered a greater marker for value than profits or margins.
Interestingly, furthermore, a “strange legalism” developed whereby if the applied accounting policies and procedures “didn’t violate Generally Accepted Accounting Principles (GAAP) then it was viewed as compliant with GAAP” (Hamilton, undated, p. 1). This ‘legality then gave actions which were compliant with GAAP moral and ethical acceptability. This rather strange interpretation of behaviour, however, did not prevent Scrushy and other former company executives from being tried. Pressman (2011) makes the point that, whilst there are extravagant claims about how Scrushy went about ‘forcing’ others to manipulate the accounts, the other Health South officials had pleaded guilty and gave evidence against the former CEO under an agreement that their sentences would be reduced by so doing. The extent of the ‘legality’ under whose guise Mr Scrushy and his colleagues operated may find some exemplification if we note that the judge dismissed 49 of the charges against him and the jury acquitted him of the remaining 36 (Pressman 2011). However, Scruchy was subsequently found guilty of bribery and was convicted in 2006. His sentence, in 2007, was 82 months in prison, three years of probation and a $150,000 fine, as well as $267,000 in restitution (Pressman 2011).
A number of examples of the punishments of other executives and officials may be briefly noted. An assistant controller, Mr Livesay, would alter the actual revenues to be commensurate with the forecasts of market analysts and, according to Hamilton (undated, p. 2), became a willing participant. He was sentenced to six months of house arrest and ordered to repay the money he had made - $760,000. Mr Crumpler, whose role was adjudged to be more involved than other employees, is described as a “willing participant” who left HealthSouth for an affiliated company when the fraud had already reached $300,000. However, he continued with the fraudulent activities and was ultimately given the longest prison sentence of all the defendants, of 8 years and with a $1.4 million fine (Hamilton, undated, p. 3).
This leads firstly to consideration of why there was such disparity in the sentencing and particularly why Crumpler in particular was so heavily sentenced despite giving evidence against Scruchy. According to Malone and Pitre (2009, p. 326) Mr Scruchy did not have a degree in accounting, an MBA, or a CPA, and declared at his trial that he had played no part in the false accounting and, they suggest, it was this lack of an accounting degree which led to the not guilty verdicts against him. Of the remaining employees, fifteen pleaded guilty and one – Crumpler – not guilty (Malone and Pitre 2009, p. 328).
Ethics and Company Culture (unit 4, p. 157) makes the point that people who become part of a larger organization feel, at times, “that their personal values are in conflict with the organization.” These can cause ethical difficulties in areas such as “conflicts of interest and issues such as honesty, fairness and loyalty” Ethics and Company Culture (unit 4, p. 157). The extent to which these issues may determine the levels at which an employee is prepared to compromise their ethical values may depend on subjective areas such as relative dependence on income and job security. There may also be moral and ethical conflicts in terms of potentially harming other members of a family by ‘doing the right thing’ and getting fired in the process (see above and Dyck et al, 2007). Against these backgrounds, there may be further influences such as a domineering employer who utilizes, for instance, reward and potential retribution to achieve his aims.
In a wider and societal sense, it may be suggested that the ethical ‘atmosphere’ in which companies operate is an exogenous determinant of what becomes ‘acceptable’ within the culture of a company, and the period under discussion may be seen as one where accounting practices could be interpreted as ‘ethical’ provided they nominally complied with some standard of practice (see above, page 7).
Therefore, if some ‘ethical’ judgment is to be made of the employees of Health South, these factors must be weighted in and relativity assigned. Similarly, if judgment is to be made of the CEO, we must try to understand the extent to which he understood his actions as being potentially harmful to employees and stock holders as stakeholders. Perhaps, however, if we are to make such a judgment, he should be seen as the most complicit because he chose the path of fraud (to avoid possible bankruptcy of the business), whereas others followed.
If some apportionment of ethical responsibility and fairness is to be applied in a wider sense, we must question why a punishment can be proportionally so severe by exercising a constitutional right to be judged by one’s peers (Crumpler) and also why insider trading is punished so much more heavily than insider fraud.
Clarkson M. B. E. (1995), A Stakeholder Framework for Analyzing and Evaluating Corporate Social Performance, Academy of Management Review, Vol. 20, No. 1, pp 92-117
Dyck I. J. A., Morse A. & Zingales L. (2007), Who Blows the Whistle on Corporate Fraud? National Bureau of Economic Research (NBER)
Ethics and Company Culture (Unit 4, undated)
Hamilton (undated), HealthSouth: A Case Study in Corporate Fraud, Arxis Financial
MaloneF. L. & Pitre P. (2009), The HealthSouth “Family,” Taylor and Francis Group
Manmohan D. C. (2006), HealthSouth Corporation: Fraud, Greed and Corporate Governance, International conference on management cases
Newkirk T. C. & Robertson M. A. (1998), Insider Trading – A U.S. Perspective, 16th International Symposium on Economic Crime
Pressman S. (2011), HealthSouth Scandal, American Business
United States vs Hannibal sonny Crumpler (2007), Appeal from the United States District Court for the Northern District of Alabama