Fraud at HealthSouth Corp

Written by: Victor Flores

HealthSouth Corporation (HRC) is the nation’s largest provider of outpatient surgery, diagnostic and rehabilitative healthcare services according to the SEC website. The company is based out of Birmingham, Alabama and it operates across many states. The company was founded in 1984 and had successfully kept rising to the top early in its career. The founders were Aaron Beam and Richard Scrushy, who were also the chairmen and CEO at the time. Scrushy had successfully made the company public after two years after he presented the potential of the company to some groups of Wall Street investors. The stock prices of the company kept risen between the late 90s and into the early 2000, making it look like a very successful company in Wall Street. Sadly, the success of the company and the numbers that had been reported to the SEC had a dark background.

Scrushy had been requesting his employees to manipulate numbers in the financial statements in order for the numbers to look good for the investors. He was inflating its earnings so they would match Wall Street expectations and allow the company to keep the price of the stock. The overstated earnings totaled to at least 1.4 billion dollars which were directed to fake accounts. The fact was that the company was actually falling short of the expectations and Scrushy’s way to fix was by telling management to record false earnings in the accounting records that would make up for the short fall (SEC, 2003). Some of the false entries that were made to “fix it” were reduction of contra revenue accounts, decreasing expenses, which will automatically increase earnings, and decreasing assets or decreasing liabilities. Scrushy was benefiting from this because even though the company was doing badly internally, he was still getting his big salary and big bonuses based on the inflated earnings. The downfall to this scheme came about in 2003 right after congress had passed the Sarbanes-Oxley Act in 2002. Scrushy sold $75 million worth of HealthSouth stock which raised red alerts to the SEC. Investigations began and later on Scrushy was found not guilty for the accounting frauds, but later on he was found guilty for bribery. He allegedly bribed the governor of Alabama and was sentenced to a seven year prison sentence.

This type of fraud case has its similarities with previous cases like Enron, Tyco, and WorldCom. Top executives like in the case of Richard Scrushy take advantage of their CEO power to influence their subordinates to manipulate accounts for their benefit. These types of frauds were very easy to accomplish because of the lack of controls both internally and externally. Fraud cases are still happening but they are not as high as they used to be. With Sarbanes-Oxley Act, CEO’s have to think twice about committing an accounting fraud because the chances of them getting caught are higher and the punishment is also more severe. This Act has reduced fraud like the one in HealthSouth and has helped investors be able to trust companies as they report their earnings.

From Wall Street to Prison: The HealthSouth Story – Chicago Booth News. (n.d.). Retrieved August 5, 2015, from http://www.chicagobooth.edu/news/2011-05-31-healthsouth.aspx

Securities and Exchange Commission. (2003, March 20). Retrieved August 5, 2015, from https://www.sec.gov/litigation/litreleases/lr18044.htm

Categorizing the Enron Scandal

Written by: Stacey Mikesh

In today’s business environment, company leadership is constantly met with overwhelming pressures and expectations to succeed. For these reasons, among many others, management may feel it necessary to “cook the books” when the company’s financial results are not favorable. Since there is an infinite number of ways in which accounting fraud can be committed, studies suggest we segregate them into two categories – financial statement fraud and misappropriation of assets. In this blog, we will discuss these two categories and then review the Enron scandal to determine how this case should be categorized.

Financial statement fraud deals with knowingly or intentionally altering accounting records or omitting accounts from the financial statements to present better than actual results. These cases most often involve higher management. Additionally, while this is the least common type of fraud, only occurring in roughly 10% of all fraud cases, it is by far the most expensive (Coenen, n.d.). These types of fraud generally include improperly recording revenue, overstating assets and failing to present proper disclosures. Misappropriation of assets is when an employee steals a company’s assets for which they are responsible for managing and uses deception to hide that the assets are missing. Misappropriation of assets is the most common type of fraud and represents over 91% of all fraud cases. This type of fraud can consist of the various types of money theft as well as inventory theft (Coenen, n.d.).

The Enron scandal was very much the icing on the cake as far as Wall Street was concerned. The Enron case, along with several other significant fraud scandals during the 90’s and into the early 2000’s, had severely shaken public confidence in the accounting profession. To restore some credibility after the Enron scandal, the Sarbanes Oxley Act was written to reduce these types of fraud cases going forward. Enron was formed in 1985 with the merging of Houston Natural Gas and InterNorth. Kenneth Lay, who was the prior CEO of Houston Natural Gas, remained on as CEO of Enron. Enron had major expansion into new industries which led to rapid growth over the next 15 years. In 2000, the company reached $100 billion in revenues as well as earning the titles as the seventh-largest company on the Fortune 500 and sixth-largest energy company in the world. These achievements helped the company to reach its peak stock price at $90 (CBS News, 2006). Unfortunately, by then end of the 90’s, Enron was hiding much of its debt from bad deals and failed projects in offshore partnerships and were using aggressive accounting methods to overstate revenues. Based on our definitions above, hiding debt and overstating revenues would classify this case as financial statement fraud. By the end of 2000, through 2001, rumors were swirling about Enron’s troubles and on October 16, 2001, Enron announced that it was going to report a loss for the first time in four years as well as make over a billion dollar reduction in shareholder equity. With concerns and interest mounting, the SEC had opened a full investigation. On November 8, 2001, Enron had revised their financial statements for the last five years and acknowledged that while they had previously reported profits, they had actually earned significant losses. From there, the stock tanked and on December 2, 2001, Enron had filed for bankruptcy. As a result of this financial statement fraud, thousands of Enron employees were left without jobs, key executives went to prison, and business units were sold as Enron was dismantled.

Coenen, T. (n.d.). Three Basic Fraud Types. All Business. Retrieved July 30, 2015.

CBC News. (2006, May 25). The rise and fall of Enron: a brief history. Retrieved July 30, 2015.

The Fall of Worldcom

WorldCom, formerly known as LDDS, was a major telecommunications company that took the industry by storm in the late 1990s by merging with several other companies of the sort. After acquiring a number of businesses, such as IDB Communications Group, Williams Telecommunications Group, and MCI Communications Corp, WorldCom’s acquisition proposal to merge with Sprint was rejected in 2000. Sadly, this was only the beginning of the downfall of the industry leader of the time.

On March 11, 2002 the SEC requested information regarding WorldCom’s accounting methods and loans to officers. Soon thereafter, the company’s stock price fell from $64 to $2.65, and the company declared they would be cutting 6% of WorldCom’s group staff (Reuters, 2005). Why such a huge plummet you might ask? According to an article from the Maryland School of Law, on June 25, 2002, WorldCom announced that it had “overstated earnings in 2001 and the first quarter of 2002 by more than $3.8 billion” (Lyke & Jickling, 2002). In order to inflate the company’s profits, WorldCom had recorded current expenses as capital expenditures and later admitted that the reserve accounts had also been misappropriated. The sad part is, the company’s external auditing firm, Arthur Anderson, “had worked with Scott Sullivan (CFO), David Myers (Controller) and Buford Yates (Directors of General Accounting) to increase the price of WorldCom’s stock by falsely inflating the profitability” (WorldCom Fraud).  In 2005, Ebbers was sentenced to 25 years in prison with charges of fraud, conspiracy, and filing false documents. Other executives associated with the WorldCom fraud were also found guilty.

There are several reasons that drive executives of a company to commit fraud, such as to maintain a reputation, manage the large amount of pressure on their shoulders, and sustain their own financial status.  In the case of WorldCom, the tremendous growth that took place in the 1990s caused the company to be the leader of the telecommunication industry at that time, and therefore required them to uphold a high reputation. After the rejected Sprint merger proposal, Ebbers “wished to maintain the company’s increasing revenue and income so that the company could show a positive financial picture to its investors” (WorldCom Fraud). Unfortunately, this continuous pressure drove executives to begin underreporting expenses and reducing the reserve accounts.

Another reason that causes executives to commit fraud is the overwhelming amount of weight they have to carry in order for the company to be successful. For example, WorldCom had acquired a large amount of other telecommunication businesses in a short period, and the company was not exactly prepared for the amount of time it would take to adjust accounting procedures; this also lead to the misstatements. Lastly, executives are sometimes compelled to commit fraud because of their own personal status. In the WorldCom example, another reason fraud was committed is because Ebbers was not only worried about the reputation of the company, but he was also concerned about his individual financial standing. If WorldCom’s stock price was not increasing, neither was his salary.

Written by: Shelby Wakefield

Lyke, B., & Jickling, M. (2002, August 29). WorldCom: The Accounting Scandal. Retrieved July 29, 2015.

Reuters. (2005, March 15). WorldCom Company Timeline. Retrieved July 29, 2015.

WorldCom Fraud was Committed in Two Main Ways. (n.d.). Retrieved July 29, 2015.

Fraud at Tyco

Written by: Alex Cordray

Fraud is defined as “wrongful or criminal deception intended to result in financial or personal gain” and negatively impacts all stakeholders of a company, including investors, employees, customers, suppliers, the community, government and trade associations.  Fraudulent actions in companies are increasing at a rapid rate.  In fact, 45% of United States businesses have experienced some form of fraud in the past two years (Susco, 2014).  In this blog, we will explore popular accounting fraud cases, why they happened, and how the fraud could have been avoided.  First, we look at a fraud scheme at Tyco in the early 2000’s.

According to the New York Times, Former Tyco Chief Executive Officer, Dennis Kozlowski, and former Chief Financial Officer, Mark Swartz, were indicted on charges resulting from stock fraud, unauthorized bonuses, and falsified expense accounts.  The two acquired $430 million by secretly selling Tyco stock while “artificially inflating” the value.   They made additional improper payments to themselves in the form of bonuses and company loans in order to cover personal expenses, such as apartments, homes, jewelry, and art.  They hid the cost of these illegal loans by bullying employees into hiding the amounts in falsified expenses with phony journal entries.

This is an example of executive fraud and bullying.  Lower employees are often scared to lose their jobs, so they do what they are told to do by superiors, even if it is illegal.  Fraud by executives resulting in a loss of millions of dollars by a company can be avoided by implementing more internal controls, such as a harsher system of checks and balances and whistleblower protection.  Checks and balances on superior management’s actions in a company can reinforce a company’s fraud detection.  Even high-up management should be held accountable for their actions in a company.   Offering whistleblower protection can encourage lower employees to speak out against wrongful actions of other employees.  The fraud at Tyco teaches us that strong internal controls can help better protect a company against fraud and loss

Susco, J. (2014, March 14). Businesses Face Growing Accounting Fraud. Bond Beebe. Retrieved July 27, 2015.

Sorkin, A. (2002, September 13). 2 Top Executives Charged With $600 Million Fraud Scheme. The New York Times. Retrieved July 21, 2015.

Fraud in Accounting

In this blog, we will be exploring cases of accounting fraud, why they happened, and how they could have been avoided.