Law on CEO Awareness on Trial With HealthSouth's Scrushy

Weston L. Smith, former HealthSouth finance chief, decided to expose the company's accounting fraud after the passage of the Sarbanes-Oxley Act. (Gary Tramontina -- Bloomberg News)

"The certification requirements make it much harder for top management to pass the buck by blaming lower-level employees or a rogue subsidiary for improper accounting that leads to inaccurate financial statements," said Washington corporate defense lawyer W. Neil Eggleston.

To prevail in a criminal case, however, government lawyers must prove that the executives intended to break the law -- typically a tough case to make since corporate officials rarely leave a paper trail if they are engaging in fraud, said former SEC lawyer Jacob S. Frenkel.

That burden may be even more insurmountable at large companies, where top executives have tried to build structures to protect themselves by forming multiple layers of checks and balances since the law took effect in the summer of 2002.

Many chief executives and finance chiefs require employees further down the chain of command to prepare their own written certifications, modeled on documents the top officials must sign. The process helps top executives establish a record that they took reasonable steps to ensure accurate numbers.

Colleen S. Cunningham, chief executive of Financial Executives International, a trade group for finance officials, said about 90 percent of public companies require the heads of individual business units to sign their own internal certification letters.

"It just adds an extra degree of comfort," Cunningham said. "If someone doesn't sign it, you're scratching your head and saying, 'Maybe I should spend more time at that unit.' "

Legal experts say the principle of chief executive awareness lies at the heart of the ongoing Scrushy trial, where three former HealthSouth finance executives already have testified that Scrushy ordered them to "fix" or "help" the numbers to meet ambitious earnings targets dating to the mid-1990s. In all, prosecutors say, a long-running fraud at the rehabilitation hospital chain amounted to $2.7 billion.

Smith, who has yet to be sentenced on related criminal fraud charges to which he pleaded guilty in 2003, is expected to take the witness stand later this month in the government's case.

William T. Owens, Smith's friend and former colleague, testified last month that Smith agitatedly told him in August 2002, less than a week after the Sarbanes-Oxley law passed, that he "just couldn't sign the certifications and was quitting."

U.S. Attorney Alice H. Martin, who is leading the Scrushy prosecution, successfully batted back an attempt last year by defense lawyers to have the law declared invalid because it was allegedly too vague for the average corporate official to understand.

In her opening statement to jurors in January, Martin highlighted wildly inaccurate securities filings signed by Scrushy -- who she said spent more than $200 million on fancy cars, diamond jewelry and waterfront property, mostly in profit from sales of HealthSouth stock, between 1996 and 2002.

"Richard Scrushy gave phony numbers to the public," she said. "The purpose was to make HealthSouth look like it was making more money than it was."