HealthSouth Corp. fired its founding chief executive and its auditors yesterday as a third finance official from the embattled Alabama hospital chain pleaded guilty to criminal fraud.
Separately, the Securities and Exchange Commission filed civil charges of accounting fraud and insider trading against all three finance executives.
The company is struggling to avoid bankruptcy -- it announced last week that its lenders had blocked it from making $367 million in bond and interest payments due today. HealthSouth spokesman Ernie Knewitz said the company notified chief executive Richard Scrushy that his contract was "null and void" on Sunday. Scrushy had been on administrative leave since March 19, when the SEC charged the company with inflating earnings by $1.4 billion since 1999.
The company believes it cannot remove him as a director, but the board asked him to resign, a company statement said. Scrushy, who faces an SEC complaint but has not been charged criminally, may have to return his bonuses if the company has to restate its financial results, under the new Sarbanes-Oxley law. Scrushy's two attorneys did not return phone messages.
The SEC charged former chief financial officers William T. Owens and Weston L. Smith and Vice President Emery Harris with accounting fraud. The SEC also charged Owens and Smith with engaging in insider trading for selling stock when they knew the books were cooked. Both have already pleaded guilty to criminal fraud.
Yesterday, Harris, 33, also pleaded guilty to criminal fraud, admitting he helped the company's "senior officials" falsify financial results. All three have agreed to cooperate with the U.S. attorney's office for Northern Alabama.
HealthSouth's decision to fire its longtime auditor, Ernst & Young, comes at a difficult time for that Big Four accounting firm. Ernst & Young is being sued by several former clients who bought tax shelters that are now being challenged by the Internal Revenue Service.
Ernst & Young said in a statement that it is cooperating with the investigation into HealthSouth and has not been told that it is the subject of an investigation.
The SEC complaint against HealthSouth alleges that company officials sought to deceive Ernst & Young by making fraudulent adjustments to items that were too small to attract notice from auditors. But the SEC may decide that the auditor should have been checking such items, said David C. Fischer, a securities lawyer at Loeb & Loeb.
Any decision whether to bring charges against the accountants "will depend on how negligent the SEC believes Ernst & Young to be," Fischer said.
The criminal investigation into Scrushy's role in the HealthSouth scandal, meanwhile, may provide the first real test of the Sarbanes-Oxley law requiring executives to certify their companies' financial reports. In August, Scrushy signed documents saying he had reviewed and stood behind HealthSouth's 2001 annual report and its second-quarter report for 2002, so prosecutors could make him the first person tried under the new statute.
The certification also may remove an excuse -- employed by a number of high-level executives in last year's corporate scandals -- that they were too removed from day-to-day operations to know about accounting problems.
Scrushy "is not in a position to say, 'I never even looked at it.' His defense is going to [have to] be either they were accurate or 'I was misled,' " said securities lawyer Joel Greenberg, of Kaye Scholer LLP.