Ex-CEO Cleared in $2.7-Billion Fraud

A federal jury in Birmingham, Ala., on Tuesday acquitted HealthSouth Corp. founder Richard M. Scrushy of all charges in a $2.7-billion accounting fraud at the healthcare chain, delivering a stinging setback to the government.

After a string of high-profile convictions of business figures -- including former WorldCom Inc. leader Bernard J. Ebbers and media tycoon Martha Stewart -- the government stumbled in its first major prosecution of a chief executive under the 2002 Sarbanes-Oxley corporate reform law.

On its 21st day of deliberations, and the fifth day after an alternate replaced an ailing juror, the Birmingham jury rejected all 36 felony counts against Scrushy, a celebrity in local business, philanthropic and evangelical Christian circles.

The jurors said they had misgivings about the credibility of key prosecution witnesses, including five former HealthSouth chief financial officers who pleaded guilty in the fraud and testified that Scrushy had encouraged them to falsely inflate the company’s earnings.

Jurors also cited the lack of a “smoking gun� definitively linking Scrushy to the fraud.

Former federal prosecutor Steven R. Peikin called it a “devastating blow to the government� that, over the objections of prosecutors, local federal judges had meted out light, non-prison sentences to some of the cooperating witnesses.

Defense lawyers hammered away at that point during the trial, at one point sarcastically asking former CFO Michael Martin whether, during his six months of home confinement, he was sleeping in his own bed and enjoying his big-screen TV.

Legal experts not involved in the proceeding said the government’s case also might have been hurt by its complexity and by the difficulties of prosecuting a well-known figure in his hometown.

Given these hurdles, the acquittal should not be viewed as a repudiation of the Sarbanes-Oxley reform law, said John Coffee, a securities law professor at Columbia University. The law, passed in response to the collapse of Enron Corp., requires chief executives to personally attest to the accuracy of corporate financial statements.

Even so, the acquittal was a rare setback for government prosecutors. In addition to Ebbers and Stewart, the string of recent convictions has included John Rigas, founder of Adelphia Communications Corp., and his son Timothy, former Tyco International Ltd. CEO L. Dennis Kozlowski and his deputy Mark Swartz, and former star investment banker Frank Quattrone.

For Scrushy, 52, conviction could have meant spending the rest of his life in prison and forfeiting $279 million in assets. The charges against him included conspiracy, securities fraud, wire fraud and money laundering. He also was cleared of one count of knowingly signing off on false financial statements, a provision of the Sarbanes-Oxley law.

“God is good,� Scrushy declared at a news conference in sweltering heat outside the courthouse after the verdicts were read around noontime.

He was joined on the sidewalk by his third wife, Leslie Scrushy, his beaming legal team and a crowd of supporters, including Bishop Jim Lowe, pastor of Guiding Light Church, a predominantly African American congregation that Scrushy joined after being ousted from HealthSouth in 2003. Scrushy himself was ordained last year as a nondenominational Christian minister.

Describing his ordeal as “two years of torture,� Scrushy asked: “What happened to the compassion in this world?�

Scrushy has contended that the accounting fraud was perpetrated by subordinates without his knowledge. Despite his acquittal, the company says he will not be welcomed back as an executive.

U.S. Atty. Alice H. Martin, the chief prosecutor, shook hands with Scrushy in the courtroom after the verdicts and they exchanged brief words.

“He said I was a nice person and he knew I was just doing my job,� Martin said in a telephone interview. “I said, ‘Thank you, sir.’ �

Martin said she was “obviously disappointed� by the verdicts. “We thought we had strong evidence with the testimony of five CFOs and [audio] tapes in which Mr. Scrushy indicated that he knew all was not right with the financial reports,� she said.

Based on discussions with jurors after the verdict, Martin said: “It appears that they judged the credibility of the CFOs harshly,� partly because of the light sentences some of them received.

“It was a gift to us,� defense lawyer James W. Parkman III acknowledged in a phone interview Tuesday. “We were able to argue to the jury that they were in bed with the prosecution.�

A federal appeals court recently vacated several of the sentences, including Michael Martin’s, as unreasonably lenient, but that was well after the case had gone to the jury May 19.

Early in its deliberations, the jury seemed to be heading toward a mistrial. Jurors repeatedly sent notes to U.S. District Judge Karon O. Bowdre declaring themselves deadlocked on one or more charges.

In the fourth such note, on June 3, the panel said it couldn’t agree on any charges. Bowdre then delivered a so-called Allen charge to the jury, admonishing them to try harder to resolve their differences.

The jurors returned to work without outward signs of dissension, but several times their sessions were curtailed because of a juror’s illness. Last week, Bowdre replaced an ailing juror with an alternate and directed the panel to start over.

Legal observers said the new juror apparently acted as a catalyst, driving the panel to a decision with surprising speed. In fact, Charles Russell, Scrushy’s chief spokesman, was home in Colorado on Tuesday. He said he and Scrushy had decided there was no need for him to be in Birmingham because neither of them expected a verdict this week.

“The reason behind our verdict was the lack of substantial evidence and witnesses’ credibility,� the jury said in a statement released after the verdicts.

Eight of the jurors stayed to discuss the case in the courtroom. Several said Scrushy, who did not take the witness stand during the trial, was a smart businessman who had no motive to lead a fraud at a company that he built.

They said they were not persuaded by secret recordings that former CFO William Owens had made under FBI guidance of his conversations with Scrushy.

“You could definitely tell there was a fraud,� said Juror No. 538, whose name was not released. “The smoking gun just wasn’t there pointing to Mr. Scrushy.�

Scrushy, who began his career as a respiratory therapist, became a philanthropist in the Birmingham area as his health services empire expanded.

But after the HealthSouth investigation began in early 2003, Scrushy’s public profile took on an increasingly religious cast. Long an evangelical Christian, he left his church in the upscale suburbs and joined Bishop Lowe’s Guiding Light congregation in Birmingham’s blue-collar Roebuck section.

He and his wife began hosting a paid, half-hour morning prayer program on local TV. Their guests often included black clergy members.

Critics portrayed these efforts as a cynical attempt to influence Birmingham’s large African American and evangelical Christian jury pool. The 12 jurors who acquitted Scrushy included seven African Americans.

Jurors on Tuesday denied that race played a part in their verdicts.

“I don’t know what part of Alabama you’ve been hanging out in,� said Juror No. 300, a black man. “But where I work, there are several whites who hang out with blacks.�

Prosecutors alleged that Scrushy had induced subordinates to inflate HealthSouth’s reported earnings by $2.7 billion from 1996 to 2002 to meet Wall Street’s increasingly rosy expectations.

According to testimony, bookkeepers would pump up quarterly earnings by millions of dollars by making relatively small upward adjustments -- often $10,000 or less -- in hundreds of accounting line items.

The sheer number of false entries posed such a problem for HealthSouth’s current auditors that it took them until this week to finally file a restatement of the company’s financial results for the years 2000 to 2002.

In a filing with the Securities and Exchange Commission on Monday, HealthSouth said profit during those three years was overstated by $1.23 billion and revenue by $1.87 billion.

Scrushy has said he hopes to return to the company he founded, but HealthSouth’s new management said Tuesday that would not happen.

“Under no circumstances will Mr. Scrushy be offered any position within the company by this management team or by this board of directors,� HealthSouth Chairman Bob May said in a statement.

Scrushy remains on the HealthSouth board because, the company said, he has refused “numerous� requests to resign.

Since removing Scrushy as chief executive in March 2003, the board has been meeting without him. The other directors formed a special committee without Scrushy and have been meeting in that context.

Scrushy can be removed from the board only by a vote of shareholders. Because the company has not been up to date with its financial filings, it has been unable to hold an annual meeting. Such a meeting is expected to be held next year.

Scrushy still faces civil fraud charges brought by the SEC, seeking unspecified fines and restitution, as well as private lawsuits from HealthSouth shareholders. The company’s stock, which traded at about $30 a share before being delisted from the New York Stock Exchange, fell 5 cents to $5.93 in the over-the-counter market Tuesday.

Times staff writers Walter Hamilton in New York and Tom Petruno in Los Angeles contributed to this report and Times wire services were used in compiling it.

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(BEGIN TEXT OF INFOBOX)

HealthSouth case files

Chronology

Key events leading up to Tuesday’s acquittal of former HealthSouth Chief Executive Richard Scrushy:

March 19, 2003

The Securities and Exchange Commission sues HealthSouth Inc. and Scrushy, alleging that the Birmingham, Ala., company’s earnings had been vastly overstated since 1999.

March 31, 2003

HealthSouth fires Scrushy as chairman and CEO.

Nov. 4, 2003

Scrushy is indicted on 85 criminal counts accusing him of masterminding a scheme to overstate company earnings by $2.7 billion and to enrich himself by $267 million. He pleads not guilty and is freed on a $10-million bond.

March 1, 2004

Scrushy begins hosting a local morning TV show in Birmingham.

Sept. 29, 2004

A new indictment cuts the number of counts to 58 and adds perjury and obstruction-of-justice charges. Many counts are dropped later.

Jan. 25

Scrushy’s federal trial begins in Birmingham.

Feb. 2

Former HealthSouth finance executive William Owens testifies that Scrushy ordered aides to continue a huge fraud because Scrushy wanted to sell $100 million in stock.

April 14

Prosecutors show jurors photographs of some of Scrushy’s purchases, including vintage cars, a 42-foot boat and a 21.8-carat diamond ring.

April 20

The prosecution rests.

May 11

The defense rests without Scrushy’s taking the stand.

May 12

Judge Karen O. Bowdre dismisses two charges against Scrushy.

May 21

The jury begins deliberating Scrushy’s case.

May 26

Jurors say they are deadlocked on the key conspiracy charge, but Bowdre urges them to continue working toward a verdict.

June 8

HealthSouth says it will pay $100 million to settle SEC fraud charges.

June 22

Bowdre dismisses a sick juror, requiring the deliberations to start over with an alternate juror installed.

Tuesday

The jury acquits Scrushy on all counts.

Other defendants

Five former HealthSouth chief financial officers who testified against Scrushy previously pleaded guilty to criminal charges:

Aaron Beam

May 2003: Pleaded guilty to bank fraud and making false representations to HealthSouth’s lenders.

Not yet sentenced.

Michael Martin

April 2003: Pleaded guilty to conspiracy to commit wire fraud and securities fraud and to falsifying financial information.

Sentenced to six months of home detention and five years of probation, fined $50,000 and ordered to forfeit $2.38 million.

The sentence was overturned by an appeals court June 21.

Malcolm “Tadd� McVay

April 2003: Pleaded guilty to conspiracy and fraud.

Sentenced to six months of home detention and five years of probation and fined $50,000.

William Owens

March 2003: Pleaded guilty to conspiracy, wire fraud and making false regulatory filings.

Not yet sentenced.

Weston Smith

March 2003: Pleaded guilty to conspiracy, securities fraud and filing false certification of financial information with the Securities and Exchange Commission.

Not yet sentenced.

Source: Times research, Associated Press

Los Angeles Times