Healthsouth Case

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COSO Attribute

Point of Focus/Control Objective

Does this control exist? (Explain)

1

Integrity & Ethical Values

Employees clearly understand what behavior is acceptable and unacceptable under the company's code of conduct and know what to do when they encounter improper behavior.

NO, this control does not exist. From reading Aaron Beam’s Wagon to Disaster, it appears there was no corporate code of conduct consistently adhered to and signed off by employees. This caused upper management to feel less threatened when they constantly violated corporate ethics.

2

Integrity & Ethical Values

Individual compensation awards are in line with the ethical values of the company and foster an appropriate ethical tone (e.g., bonuses are not given to those that meet objectives, but in the process circumvent established policies, procedures or controls

NO, this control does not exist. From watching the 60 Minutes interview with Richard Scrushy from 2004 and also from reading Beam’s Wagon to Disaster, it is apparent that Scrushy wanted to meet Wall Street expectations only, so he could benefit too. Established policies, procedures, and controls were circumvented to get the company’s profits to meet Wall Street expectations. When they didn’t meet Wall Street’s expectations, Scrushy told them to “fix it.” In The Wagon to Disaster, Beam alleged that Scrushy told them early and often that the “accounting tail does not run the business”

3

Integrity & Ethical Values

Actual losses arising from violations of laws and regulations are regularly identified, measured and reported.

NO. While the actual losses were identified, they were due from actual company losses in the beginning, not from violations of laws and regulations. Once the fraud was perpetuated, then laws and regulations were broken and accumulated losses were the result. Health South’s continued acquisitions of other health-related companies covered up potential losses from other sectors, according to Beam’s Wagon to Disaster. There was nothing illegal with using acquisitions to cover losses, but it painted an inaccurate portrait of the company’s profits. It does not appear these acquisitions were firmly disclosed in the Notes to the Financial Statements either because investors kept investing.

4

Commitment to Competence

Company personnel have the competence and training necessary for their assigned duties.

YES. There is no evidence anyone in upper management was incompetent. Judging from the novel The Wagon to Disaster, it appears that upper management and the financial team was competent in their duties and they were highly educated and came from great institutions of learning and business. Richard Scrushy surrounded himself with bright, competent individuals who could carry out and perpetuate his fraud.  Ethics and white collar criminal violations were not the result of incompetency in their positions. They understood what was unethical, but did not blow the whistle until the final CFO before the fraud went public. Everyone prior profited from the fraud.

5

Board of Directors or Audit Committee

Board committees exist. This independent governing body provides oversight for management's activities.

YES. However, While there was a Board of Directors at Health South, they appeared to be independent in form but not in substance. They would not actively challenge Richard Scrushy. When they did challenge him, he would berate them and they would not govern him and his activities. He constantly reminded them that he started the company and he knew what was best. Therefore, Scrushy controlled the Board of Directors as he did other management.

6

Board of Directors or Audit Committee

The audit committee meets privately with the chief accounting officer, internal auditors and external auditors to discuss the reasonableness of the financial reporting process, system of internal control, significant comments and recommendations.

NO. There was no audit committee ever mentioned by Aaron Beam or in other readings at Health South prior to Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 made it a requirement for non-accelerated filers.

7

Management's Philosophy & Operating Style

Turnover in management or supervisory personnel is monitored and the reasons for significant turnover are evaluated.

NO. Turnover occurred five times at the CFO level from 1997-2002. It was never evaluated by Management or the Board. Scrushy did not care as long as the company kept reporting shadow profits and Wall Street investors remained happy.

8

Management's Philosophy & Operating Style

Management exemplifies attitudes and actions reflecting a sound control environment and commitment to ethical values including financial reporting as it relates to appropriate resolution of disputes over application of accounting treatments.

NO.There was no sound control environment at Health South. If an accounting treatment did not match Scrushy’s vision of profits, he overruled it and the CFO’s took the fall. As mentioned before, according to the Wagon to Disaster, Beam alleged early on that Scrushy told him “the accounting tail does not wag the business tail” before the company went public. Furthermore, though not against the law, the company’s reported profits were shadowed by acquisitions, thus covering losses from other business units. Finally, the company entered approximately 120,000 transactions to cover up losses in one or more reporting periods.

9

Organizational Structure

Executives clearly understand their responsibility and authority for business activities and how they relate to the entity as a whole. Executives should possess the requisite experience and levels of knowledge to properly execute their positions.

YES. The previous answer that dealt with the competency level of management applies here as well. Although everyone clearly understood their responsibility and authority for business activities, they did not challenge Scrushy and assisted him in perpetuating the fraud. Even Aaron Beam in The Wagon to Disaster closed with “The time has come…I should have stood up to you a long time ago.” Scrushy’s tight grip and micro-management overruled the organizational structure in place.

10

Assignment of Authority & Responsibility

Employees are empowered, when appropriate, to correct problems or implement improvements.

NO. Problems at Health South were not corrected, and Richard Scrushy did not empower his management team to correct them or implement improvements. He was directing the fraud, as opined by Mike Wallace in the 60 Minutes interview

11

Assignment of Authority & Responsibility

The board of directors and/or audit committee gives adequate consideration to understanding how management identifies, monitors and controls business risks affecting the organization (i.e., strategic, operational, financial and disclosure risk).

NO. Since the Board of Directors was only independent in form and not substance, they allowed Scrushy to do as he wished. Scrushy pretty much ran the Board of Directors as well by all accounts. Anyone who challenged him was berated.

12

Human Resources Policies & Procedures

Disciplinary actions send a message that violations of expected behavior will not be tolerated.

NO. No evidence from the readings, videos, or other materials suggests good Human Resource policies. In fact, there appeared to be a secretive, “in-house” violation of the Civil Rights Act of 1964, according to Aaron Beam in his book, The Wagon to Disaster. For instance, although Mr. Scrushy befriended the African-American theology community before his trial, there was a secret internal policy of not hiring African-Americans at Health South, alleged by Mr. Beam. Furthermore, there could have been violations of the Equal Pay Act of 1963 if female employee’s salaries were ever investigated. According to Beam in The Wagon to Disaster, Health South had several attractive females who held positions. It would be interesting to examine if their pay was equal to a male counterparts salary.