The many extracts on these pages are from copyright material. They are owned by the reference given or its owner. They are reproduced here for educational purposes and to stimulate public debate about the provision of health and aged care. I consider this to be "fair use" in the common interest. They should not be reproduced for commercial purposes.

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The intention is to show the general thrust of corporate practices as well as the nature and extent of any allegations made. Material contained here represents my views based on my study of the operation of the health care marketplace and the material available to me. It should not be assumed to represent the views of any other individual or organization.

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This page examines the worrying relationships HealthSouth had with other sectors of the marketplace including Ernst & Young, KPMG, UBS Warburg and AmSouth. Is it credible that they did not know of the fraud?

In reading this page, which was written in 2004, take note that Richard Scrushy was acquitted of any involvement in the fraud by a jury. He blamed his staff for deceiving him. Take account of what happened there.

Nevertheless, the magnitude of the HealthSouth fraud is such that Ernst & Young, the now fired auditors, should have been able to pick something up over the years.
Heading South: The Burglar of Birmingham Jenks Healthcare Business Report April 2003'

Based on our interviews with a key whistle-blower, there was an incestuous-like relationship between top HealthSouth officials and a small group of investment bankers and analysts. We intend to haul them all in for a matter of weeks,' committee spokesman Ken Johnson told Reuters.
Congress Seeks UBS Records on HealthSouth The New York Times May 8, 2003

Eight weeks ago UBS received a subpoena from the agency; reportedly, other financial advisors did too. The question is whether Lorello & Co., who were said to be deeply involved in HealthSouth's operations, knew about the hanky-panky.
HealthSouth's Go-to Guy :: The collapse of HealthSouth is putting pressure on UBS Warburg. FORTUNE April 15, 2003

Lawmakers harshly criticized HealthSouth Corp. board members, outside auditors and investment bankers yesterday, saying they repeatedly missed red flags that might have helped uncover an alleged $2.7 billion fraud at the Birmingham-based health care chain.
HealthSouth Advisers Rebuked Washington Post November 5, 2003

A group of HealthSouth investors led by the Retirement Systems of Alabama has filed a lawsuit in U.S. District Court in Birmingham, Ala., alleging that the company's investment bankers and auditors "knew that fraud existed at the health care company or that they ignored clear signs of wrongdoing," the Wall Street Journal reports (Wall Street Journal, 1/9).
The suit names investment bank UBS Warburg and accounting firm Ernst & Young LLP as defendants
Group of HealthSouth Investors Files Suit Against Auditors, Investment Bank Kaiser Daily Health Policy Report Jan 9, 2004




Some of the most troubling issues surrounding HealthSouth include its dealings with its auditors Ernst and Young, its tax accountants KPMG, its loan bankers, its investment bankers and the stock analysts who advise the market. The question is whether those in these powerful and influential groups knew of the fraud? Did they choose to look past it because they did so much business with HealthSouth and associated companies? It is difficult to believe that so many large and experienced commercial groups closely studied HealthSouth's business when making decisions on behalf of their shareholders yet failed to detect a US $2.5 billion empty hole in the profits.

Scrushy himself was undoubtedly charismatic, extremely plausible, persuasive and adept at getting what he wanted - in one sense the ultimate con man. He recruited staff, often young from the organisations with which he did business in Birmingham Alabama. They would have had extensive knowledge of these supporting businesses and also personal contact and some standing in these organisations.

Scrushy seems to have created a company in which it was legitimate for senior staff to exploit their knowledge and the vulnerability of the organisations from which they were recruited. It is clear that some of these previous employees were induced to participate in the fraud. Could they really have carried this off convincingly without their friends and previous colleagues smelling a rat? Unless of course those colleagues knew and chose not to notice!

As chief executive, they say, he (Scrushy) held sway over a circle of young, ambitious locals glad to accept an opportunity that was rare in Birmingham: a chance to be a leader in a Fortune 500 company and amass wealth. The parties and glamorous lifestyle were even more of a draw.
Diagnosis of fraud. Financial Times April 15, 2003

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Ernst and Young Auditors

Ernst & Young became auditors for HealthSouth in 1984. It has been suggested that Scrushy fired the previous auditors because they refused to meet his requirements.

Ernst and Young's role in HealthSouth's fraud must be seen in the light of the conduct of its accounting peers in ignoring fraud and sometimes actively participating in it. This is well illustrated by the complicity of auditors in both the Columbia/HCA and Enron frauds.

This sort of thing is not recent or restricted to the USA. In December 1991 Andersens did an independent report on National Medical Enterprises (NME) for the shareholders of the West Australian hospital company Markalinga. Shareholders were asked to approve the purchase of a majority stake by NME, a move supported by Anderson's independent report. The report did not mention the disturbing senate inquiry and fraud investigation in Texas or the earlier fraud settlement in New Jersey. Both were to have a major impact on the company's prospects in Australia.

Concerns about Ernst and Young are not restricted to its dealings with HealthSouth.

Ernst & Young is being sued by several former clients who bought tax shelters that are now being challenged by the Internal Revenue Service.
HealthSouth CEO Is Fired Washington Post 31 March 2003

A number of HealthSouth staff, including the most recent CFO, William Owens were past employees of Ernst and Young. They would have known Ernst and Young's practices well and probably retained many friends there. They were well placed to design and implement a fraud that would not too obviously trigger the auditor's alarm bells.

Three of those admitting their guilt came to HealthSouth after working for Ernst & Young, which the company has fired.
Ernst & Young executive testifies about HealthSouth fraud The Associated Press April 23, 2003

Whether the auditors deliberately connived, turned a convenient blind eye or simply trustingly accepted the accounts from their mates without looking closely at their contents is not known. They did a lot of very profitable business with HealthSouth and its interconnected companies, business they might have lost if they were "picky". They failed to detect the fraud even after they were tipped off in 1998 and again early in 2002.

At that time, a number of HealthSouth executives besides Scrushy were on the MedPartners (now Caremark) board of directors. At one point both companies had Ernst & Young as their auditors.
Diagnosis of fraud. Financial Times April 15, 2003 P19

Congressional investigators yesterday released copies of an unsigned memorandum, apparently faxed to HealthSouth's auditor, Ernst & Young, outlining concerns about fraud as early as November 1998 at the company, based in Birmingham, Ala.

"How can the company carry tens of millions of dollars in accounts receivable that are well over 360 days?" the memorandum, which was turned over to the staff of the House Energy and Commerce Committee on Friday, asks. "How can some hospitals have NO bad debt reserves? How did the E & Y auditors in Alabama miss this stuff?"
Scrushy Chided Staff About Profits, Tape Reveals The New York Times May 22, 2003

A disgruntled shareholder in HealthSouth, the rehabilitation services company embroiled in a $2.5 billion accounting scandal, alerted the company's auditors five years ago to alleged bookkeeping violations, a document released Wednesday by a House committee indicates.

``You bring the smoke, I'll bring the mirrors,'' the unnamed shareholder wrote in the memo. It listed a series of such violations that included booking as revenue the charges to clinic patients even when insurers denied payment.
"Someone should have been suspicious when HealthSouth officials said, `Trust us, we're looking into this,''' committee spokesman Ken Johnson said

The committee chairman, Rep. Billy Tauzin, R-La., and Rep. Jim Greenwood, R-Pa., head of the investigative subcommittee, said the memo was evidence that Ernst & Young, and possibly federal regulators, were warned five years ago about the ``accounting shenanigans'' at HealthSouth.

"Yet no one appears to have listened. Why?'' they asked. "This memo provides a road map leading to possible fraud.''

The House lawmakers also are concerned that HealthSouth may have submitted hundreds of thousands of claims for reimbursement to Medicare and Medicaid based on improper billing of certain rehabilitation therapy claims.

"How can the (HealthSouth) outpatient clinics treat patients without precertification, book the revenue, and carry it after being denied payment?'' the shareholder asked in the memo.

``How can the company carry tens of millions of dollars in accounts receivable that are well over 360 days? How can some hospitals have NO bad debt reserves? How did the (Ernst & Young) auditors in Alabama miss this stuff? Are these clever tricks to pump up the numbers, or something that a novice accountant could catch?''

"You people and I have been hoodwinked,'' the shareholder wrote. ``This note is all that I can do about it. You all can do much more, if all you do is look into it to see if what I say is true.
HealthSouth Shareholder Alerted Auditors New York Times May 21, 2003

A House of Representatives committee has unearthed a 1998 memo, signed only "Fleeced Shareholder," which outlines many of the accounting shenanigans that have landed the Alabama-based health-care services provider in hot water five years later.

"We don't know who sent the memo and one of the reasons we released the memo was because we'd like that individual to step forward," said Rep. James Greenwood, head of the investigative subcommittee of the House Energy and Commerce Committee.

"We're sure that whoever wrote this memo five years ago knew then and knows now a lot more than was in this brief memo. So we would love for that individual to identify himself to the committee
US lawmaker appeals to HealthSouth whistle-blower Reuters Thu May 22, 2003

Mr Lamphrom said an employee of HealthSouth had written to the E&Y audit team (in June 2002) suggesting that in three specific areas of the accounts there could be problem. E&Y had checked out the allegations, Mr Lamphrom said, and determined that there had been no wrongdoing.
Auditor had early warning on HealthSouth. Financial Times April 24, 2003

But the minutes of HealthSouth's board meetings from late 1998 through 1999, presented as evidence by the SEC last month, don't indicate that any such investigation took place.
Memo: HealthSouth Warned On Accounting 5 Years Ago USA TODAY - May 22, 2003

Since leaving the company in May 2002, Mr. Vines tried to spread the word about alleged questionable practices in the department -- but at every turn his disclosures came to nothing. He sent an e-mail to HealthSouth's auditor, Ernst & Young LLP, flagging one small area of alleged fraud, but Ernst concluded that the accounting was legitimate. Later, he tried to make his case online, where readers of the Yahoo forum dismissed his claims as typical Internet blather.

But his warnings were on target -- and today they offer a lesson in how hard it can be to sound the alarm against corporate wrongdoing
By late 2001, he had become uncomfortable with how the accounting department operated. Over the course of that year, according to his testimony at the April federal court hearing, he came to believe that people in the department were falsifying assets on the balance sheet. - - - - - Mr. Vines identified about $1 million in entries he believed were fraudulent.
Not long afterward, he sent the e-mail to Ernst, alleging fraudulent transactions between the company's accounts and identifying three account numbers that Ernst should investigate.
Mr. Vines acknowledges that he didn't mention the falsification of invoices. But he argues that the three accounts he pointed out raise plenty of serious questions by themselves -- and an accounting expert agrees.

For example, court documents show that one of the expenses that was shifted to the balance sheet was the sponsorship of the Erie Otters junior-league hockey team in Pennsylvania - - - -
Missed signal accountant tried in vain to expose HealthSouth fraud The Wall Street Journal May 20, 2003

Internal investigators at HealthSouth have found evidence of dubious accounting that raises new questions about the role of the company's former auditor, Ernst & Young.
"If you knew about a misstatement and you recklessly or intentionally didn't correct it, then as long as it's material, it's a securities law violation," said Michael A. Perino, a professor at St. John's University School of Law in New York. "That represents a much greater risk."
More commonly, though, the company did not write down the value of amounts owed by outside vendors like health care technology companies, even when it was readily apparent that they would not be paid.

That is a classic problem and the kind of thing that auditors should find, said Stanley D. Bernstein, a plaintiff-side securities lawyer at Bernstein Liebhard & Lifshitz in New York. "It's the `don't recognize the loss now, put off the inevitable and maybe a miracle will happen,' " he said. "That violates all accounting principles.`
 HealthSouth Looks Deeper Into Its Books New York Times July 12, 2003

 Also Tuesday, Ernst & Young LLP said it has sued HealthSouth, claiming it hid the massive accounting fraud from the auditing firm, exposing it to lawsuits and damaging its reputation.
Ex-CFO for HealthSouth says execs took no joy in plotting fraud scheme Chicago Tribune March 30, 2005

HealthSouth's counterclaim, filed Friday in Jefferson County Circuit Court, answers Ernst & Young's claims and accuses the auditor of either ignoring the fraud it discovered or negligence for not figuring it out.
SEC agent says news report was tip to HealthSouth fraud Birmingham Business Journal April 4, 2005

It (HealthSouth's action) alleges that "E&Y either intentionally and knowingly turned a blind eye to the accounting fraud, manipulation and misconduct perpetrated by Scrushy and the pleading officers and employees, or E&Y negligently, recklessly, wantonly breached its agreements and duties implied in law in failing to discover the accounting fraud and to report the fraud to HealthSouth's board of directors and audit committee."
Over the course of the (Scrushy) trial, former HealthSouth financial officers have testified about the lengths they went to keep Ernst & Young and others in the dark about the fraud.

Former Chief Financial Officer Weston Smith admitted in court that HealthSouth was given false documents and that in order to give the auditors less time for scrutiny the conspirators would push deadlines as tight as possible and dump a lot of information on E&Y at the last minute.
HealthSouth Corp. countersues E&Y, accuses Scrushy Reuters Apr 5, 2005

What is clear is that Ernst and Young were exceedingly slack. In retrospect it is clear that there were pointers which should have alerted them to the fraud.

Nevertheless, the magnitude of the HealthSouth fraud is such that Ernst & Young, the now fired auditors, should have been able to pick something up over the years.
Heading South: The Burglar of Birmingham Jenks Healthcare Business Report April 2003

- - - - critics have questioned why Ernst & Young wasn't able to detect massive fraud that reportedly went on for at least three years and possibly from the time HealthSouth went public in 1986.
Scrushy gets the boot from HealthSouth
Modern Healthcare's March 31, 2003

The role of HealthSouth's existing auditors, Ernst & Young, has been questioned by accounting experts. Itzhak Sharav, an accounting professor at the Columbia University Graduate School of Business, said today that "internal contradictions and inconsistencies" in HealthSouth's numbers "should have triggered a very extensive audit" by Ernst & Young.

For example, he said, HealthSouth reported growth of 143 percent in income before income taxes and minority interest from 1999 to 2000, although sales increased only 3 percent. The following year, he said, this type of income increased by 89 percent in the HealthSouth financial report, although sales rose only 8 percent.

More Charges Expected in HealthSouth Inquiry
New York Times March 25, 2003

- - - legal experts warn the accounting firm could find it hard to escape legal claims stemming from its role as the company's auditor.
"In all likelihood, when we amend the complaint, we probably will include the accountants," David Rosenfeld in the New York office of the law firm told Reuters. "They make a lot money in fees, they should do something to earn it."
Particularly troublesome for Ernst & Young is that the alleged accounting fraud at HealthSouth stretched over more than a decade and a half, begging the question of how auditors could be fooled for so long, experts say.

Often, warning signs pop up over several years, ranging anywhere from a remark made by an executive leaving a company to a document that seemed out of place, Cheffers said.
HealthSouth auditors could be next in firing line Reuters March 26, 2003

But E&Y is scarcely exonerated. It will have to explain not only why it signed off fraudulent books for so long but also its action on specific accounting issues. The amount of cash on HealthSouth's balance sheet, one of the easiest items to check, was overestimated by $300m at one point.

Diagnosis of fraud.
Financial Times April 15, 2003

HealthSouth constituted a classically compelling situation that called for an extended rigorous audit of reported income for several reasons that are enumerated in the Codification of Statements on Auditing Standards of the American Institute of Certified Public Accountants. The following reason stands out in the case of HealthSouth: - - - - the risk of fraud perpetrated by management increases if its compensation is greatly affected by reported income. - - - CEO Richard M. Scrushy received in 2001 a bonus of at least $6.5 million
Letters to the Editor: An Accounting The Wall Street Journal April 25, 2003

The committee
(Congressional Committee) wants to explore the following areas:
*The role of Ernst & Young in the fraud. The committee wants to know the names of key audit partners and get hold of any relevant paperwork between E&Y and HealthSouth.

House joins Justice, SEC in HealthSouth scrutiny USA Today April 23, 2003

- - - - an executive with its
(HealthSouth) longtime outside auditor testified Wednesday his firm relied on a few people for information about the rehabilitation giant and didn't check some accounts. Ernst & Young got most of its financial data on HealthSouth from some of the same executives who have pleaded guilty in the scam, according to testimony by William Curtis Miller, a principal with the auditing firm. Also, he said, Ernst & Young did not audit a contractual adjustment account the government claims was used in a scheme to overstate HealthSouth's earnings by some $2.5 billion since 1997.
Before audits, Richey-Fowler said, HealthSouth accounting employees were told "not to have any loud discussions regarding numbers" and not to leave any documents about company finances lying around. Also, she said, workers were told to give any documents requested by Ernst & Young to either Emery Harris or Kay Morgan, two of the HealthSouth executives who have pleaded guilty. Miller identified Harris and Morgan as two of the people who auditors were told to approach when in need of information.

U.S. District Judge Inge Johnson expressed surprise that a leading auditing firm would agree to such restrictions and not dig deeper when reviewing a company's books. "Have you never learned that you don't go just through the authorized channels?" she asked, referring to Miller's accounting courses in college.
Ernst & Young executive testifies about HealthSouth fraud The Associated Press April 23, 2003

The suit also alleges that Ernst & Young knew as early as 1994 that HealthSouth had overstated its earnings (New York Times, 1/9). It states that G. Marcus Neas, then a partner on Ernst & Young's audit of HealthSouth's 1993 financial statements, "turned [his] head" on $27 million in overstated earnings, according to the Journal (Wall Street Journal, 1/9). Charles Perkins, a spokesperson for Ernst & Young, said, "The problems at HealthSouth were the direct result of former management at the company, and Ernst & Young should not be included in the lawsuit."
Group of HealthSouth Investors Files Suit Against Auditors, Investment Bank Kaiser Daily Health Policy Report Jan 9, 2004

Unlike past civil suits that claimed HealthSouth's UBS Warburg bankers and its Ernst & Young auditor should have known about the fraud, the sweeping suit depicts specific instances where officials at the firms apparently had direct knowledge of the fraud.

The suit accuses an Ernst & Young auditor, G. Marcus Neas, of using his knowledge of the fraud to force HealthSouth to pay his firm $3 million in additional fees.
HealthSouth's bankers, auditors knew about fraud, lawsuit says (Associated Press) Jan. 10, 2004 

(Added 2007) HealthSouth settled the action taken by its shareholders for US $445 million at the end of 2006 and then joined with them in their actions against UBS and Ernst & Young. In 2007 this had not yet been resolved. For more about these shareholder actions, Ernst & Young and UBS see the section on shareholder actions in the HealthSouth Court Actions web page.

Investors are seeking hundreds of millions of dollars more from UBS, Ernst & Young and Scrushy. U.S. Judge Karon Bowdre excluded those parties in mediation. The firms asked her to dismiss the fraud claims against them. Bowdre said Feb. 9 she'd probably deny that request.

Under the settlement, securities investors also would get 25 percent of any judgments that HealthSouth recovers in pending lawsuits against Scrushy, Ernst & Young, and UBS, the former primary investment bank.
The investor case is In Re HealthSouth Securities Litigation, No. 2:03cv01500, U.S. Northern District of Alabama, Birmingham.

HealthSouth Settles Investor Fraud Suits for $445 Mln Bloomberg News February 23, 2007

HealthSouth and Ernst and Young traded law suits in regard to the fraud.

Litigation by and Against Former Independent Auditors
On March 18, 2005, Ernst & Young LLP filed a lawsuit captioned Ernst & Young LLP v. HealthSouth Corp., CV-05-1618, in the Circuit Court of Jefferson County, Alabama. The complaint asserts that the filing of the claims against us was for the purpose of suspending any statute of limitations applicable to those claims. The complaint alleges that we provided Ernst & Young LLP with fraudulent management representation letters, financial statements, invoices, bank reconciliations, and journal entries in an effort to conceal accounting fraud. Ernst & Young LLP claims that as a result of our actions, Ernst & Young LLP's reputation has been injured and it has and will incur damages, expense, and legal fees. Ernst & Young LLP seeks recoupment and setoff of any recovery against Ernst & Young LLP in the Tucker case, as well as litigation fees and expenses, damages for loss of business and injury to reputation, and such other relief to which it may be entitled. On April 1, 2005, we answered Ernst & Young LLP's claims and asserted counterclaims alleging, among other things, that from 1996 through 2002, when Ernst & Young LLP served as our independent auditors, Ernst & Young LLP acted recklessly and with gross negligence in performing its duties, and specifically that Ernst & Young LLP failed to perform reviews and audits of our financial statements with due professional care as required by law and by its contractual agreements with us. Our counterclaims further allege that Ernst & Young LLP either knew of or, in the exercise of due care, should have discovered and investigated the fraudulent and improper accounting practices being directed by Richard M. Scrushy and certain other officers and employees, and should have reported them to our board of directors and the Audit Committee. The counterclaims seek compensatory and punitive damages, disgorgement of fees received from us by Ernst & Young LLP, and attorneys' fees and costs.
HealthSouth form 10-K filing with the SEC June 27, 2005

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KPMG tax accountants

Ernst and Young were not the only auditors looking at HealthSouth's books. It employed KPMG, a firm also accused of selling questionable tax shelters to do its tax returns. KPMG was investigated in relation to the Columbia/HCA fraud. KPMG also failed to blow the whistle in the case of HealthSouth.

Federal investigators are expanding their investigation of accounting fraud at HealthSouth Corp. , - - - and asking questions about the work of the company's tax firm, KPMG LLP, people familiar with the matter told The Wall Street Journal.
Separately, the Journal reported that KPMG, also among the largest audit firms under scrutiny for allegedly selling questionable tax shelters, has been reducing its tax staff.
Probe of HealthSouth Expanding, to Include KPMG Tax Firm The New York Times April 28, 2003

It is not clear who advised HealthSouth that because it had paid tax on fraudulently claimed earnings which it had never received it could now claim that tax back from the tax office. Understandably the comments in the media and on the internet have been scathing.

- Jim Peaslee, a tax lawyer at Cleary Gottlieb Steen & Hamilton, said: "Now that fraud has been exposed these companies have a right to claim refunds. They have paid tax on income they never earned, so they should be able to get it back."

HealthSouth, a Birmingham, Alabama-based healthcare provider, reportedly paid at least $300m in tax on some $2.5bn of income that it now says it never earned.
Corporate black cloud descends on the IRS. Financial Times May 3, 2003

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Investment Banks and their analysts

Background fraud in the US banking system

Over the last year America's largest investment banks have been the subject of a massive fraud investigation. They have reached a US $1.4 billion settlement with the government. Private action by defrauded investors who believed deceptive analyst's reports is likely to reach US $10 billion. The fraud essentially relates to the provision of deceptive positive market reports, by market research analysts working for bankers. These were about companies like Worldcom with whom the bankers did billions of dollars in business. In addition supposedly objective reports were sometimes paid for. I examined these issues and wrote pages, using Citigroup as the focus, in 2004, a year after I wrote the HealthSouth pages.

Some well known analysts were heavily fined and barred from this work. Onerous new laws have been passed in the USA to curb these practices but it remains to be seen whether these frustratingly complex procedures can be effectively adopted and policed.

Those familiar with the "Mouths for Money" scandal in Australia, will recognise the sort of thinking and the sort of practices behind this.

(In the "Money for Mouths" talkback radio scandal in Australia supposedly independent talk back hosts had arrangements with large corporations and banks. They received handsome payments in return for positive comments. They believed these were legitimate commercial practices)

The broad outline of the settlement was announced last December when 10 securities firms agreed to pay $1.4 billion to resolve charges that many of their research analysts issued overly bullish reports in order to generate investment banking business.
Still, despite having increased their legal reserves, experts estimate that the cost to firms for settling government and civil litigation could exceed $10 billion in the coming years.
Analysts to Pay Millions in Fines New York Times April 28, 2003

Wall Street's most powerful firms will pay $US1.39 billion ($2.26 billion) in a final deal to end a massive scandal over biased stock research, regulators announced on Monday.
They were accused of deliberately providing overly optimistic research on stocks to lure investment banking business from the companies involved.
World number one Citigroup's brokerage arm, Salomon Smith Barney, took the heaviest blow with a record fine of $US150 million.

In related actions, two star stock analysts during the 1990s market boom - Citibank's Jack Grubman and Merrill Lynch's Henry Blodget - were fined and barred for good from the industry.

If an analyst signed a research report supporting a stock while privately admitting to doubts, "the only appropriate reaction is outrage," Donaldson said.

"When a firm publishes favourable research about a company without revealing to its customers that that research - far from being independent - was essentially bought and paid for by the issuer, we had no choice but to conclude that the research system was broken."
Besides Citigroup, the firms involved are Bancorp Piper Jaffray, Bear Stearns, Credit Suisse First Boston, Goldman Sachs Group, JP Morgan Chase, Lehman Brothers, Merrill Lynch, Morgan Stanley and UBS Warburg.

As part of the settlement, Credit Suisse First Boston (CSFB), Merrill Lynch and Citigroup's brokerage unit were found to have issued fraudulent stock research reports.
'Biased' Wall St firms fined $2.26bn Australian Financial Review April 29, 2003

"It was a boatload of money in a bad business environment," said an investment banker who knows Mr. Lorello. "But the reason Ben hired her was to get banking business from the companies that she covers."

As Wall Street firms prepare to pay $1.4 billion in an agreement with regulators over investment banking-research conflicts, the fact that outsize pay packages have persisted even in the spotlight has some people fretting that the old ways of the Street will be hard to change.
Conflict Issue Over Analyst's Deal New York Times April 8, 2003

UBS Warburg, CSFB, Merrill, J.P. Morgan and Citigroup's Salomon Smith Barney unit are among 10 Wall Street firms paying $1.4 billion in a settlement with regulators over analysts who misled the public by touting certain stocks to win investment-banking business.
Corporate Fraud Cases Focus on Bankers The New York Times, May 13, 2003

Sierra, the Justice Department spokesman, said the task force has brought charges against more than 200 individuals and secured convictions or guilty pleas from about 75. He said more precise numbers were not available.
- - - - the settlement included a bombshell about the sordid ways of Wall Street: that several securities firms were paying other research shops to write favorable reports on companies they were bringing public.
FBI takes up heavy load of corporate fraud probes The Boston Globe May 6, 2003

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HealthSouth's bankers and analysts

While HealthSouth's affairs were not a part of this fraud investigation, its very similar relationships with its investment bankers during this period and subsequently has been investigated. The US Securities and Exchange Commission (SEC) and the Congressional House Energy and Commerce committee in Washington looked at this.

In essence the investigations centred around the close relationships with HealthSouth of an investment banker Benjamin Lorello and a series of research analysts working with him while he held contracts with Smith Barney and later after1999 when they moved to UBS Warburg. UBS Warburg was involved in the 2002 analyst scandal referred to above. Lorello was paid US $70 million over 3 years and his analysts also received massive salaries of up to US $10 million a year, much more than most others in the business.

The research analysts consistently maintained positive reports about HealthSouth and other Scrushy related companies. While others started expressing concern about HealthSouth in 2002, Lorello's analyst maintained positive assessments until 2 days after the charges which followed the raid in March 2003. At the same time Lorello acting for the parent company did billions of dollars in business with HealthSouth, business brought to him by the analysts reports.

The relationship was so close that Lorello and his analysts attended HealthSouth board meetings on multiple occasions to advise the company. One of Lorello's staff William McGahan was particularly close to HealthSouth, Scrushy and Martin. It seems that he even had office facilities, a desk and computer for his personal use at HealthSouth facilities. The plan to split the company and so hide the fraud in 2002 was (it was claimed) developed by these investment bankers including Lorello. They deny knowledge of the fraud. Can we believe them?

In July an email sent by
Howard G. Capek, who had become Lorello's main analyst supporting HealthSouth was discovered. He had been strongly supporting the stock yet at the same time was scathing about it to a friend. He was quickly fired and his career ruined.

M Sage Givens, a long term director of HealthSouth was a venture capitalist from First Century Partners, a venture capital arm of Smith Barney. A relationship with Lorello is not mentioned in the press reports. They would certainly have met later when Lorello attended HealthSouth board meetings.

The descriptions of the flamboyant Lorello in the press suggest that he and Scrushy may have been birds of a feather.

UBS Warburg had Wall Street's most bullish research on HealthSouth while UBS bankers were raking in millions in fees for deals done for the scandal-plagued company.

Analyst Howard Capek waited until March 21 two days after the SEC accused HealthSouth and CEO Richard Scrushy of "massive accounting fraud" to downgrade HealthSouth from a "strong buy" to an "reduce," a signal to dump the stock.
Lorello's team has been HealthSouth's principal bankers for more than 15 years, first at Salomon Smith Barney and then at UBS Warburg, where Lorello and his team moved in March 1999 for a reported $70 million payday.

Lorello's team managed more than $6.5 billion in mergers and acquisitions, $1.2 billion in equity offerings and $3 billion in debt for HealthSouth since 1990, according to CommScan Dealogic.
Lorello's group, and banker William McGahan in particular, was very close to Scrushy and HealthSouth.

"When HealthSouth made a request for information," says one person that has worked with the team, "everyone dropped everything."

UBS' OWN GRUBMAN The New York Post - April 4, 2003

Mr. McGahan had a particularly close relationship with Michael D. Martin, HealthSouth's chief financial officer from 1997 to 2000, who has agreed to plead guilty to fraud charges, say bankers who knew both men. Mr. McGahan's brother, Martin, is the chief financial officer for HealthTronics Surgical Services Inc., where Mr. Martin served on the board from April 2001 to January.
Banker Resigns From Warburg
The New York Times - April 11, 2003

The letter suggests that the committee is zeroing in on the role of UBS and Mr Lorello as they prepare to hold hearings this summer on the massive accounting fraud at HealthSouth.
Mr Tauzin and other committee members are questioning how Mr Lorello and his team could have worked so closely with UBS and Mr Scrushy without detecting the long-running fraud.

They are investigating claims that one UBS banker, William McGahan, actually maintained an office and computer at HealthSouth.

"There was an incestuous relationship between top officials at HealthSouth and a group of Wall Street bankers and analysts," said Ken Johnson, a spokesman for Mr Tauzin.
Call For UBS HealthSouth Papers FT.COM - May 9, 2003

Behind every great corporate empire they say, lies a filthy-rich investment banker. For HealthSouth, that banker is Ben Lorello, a brash Wall Street kingpin. Though HealthSouth is most closely associated with its recently deposed CEO and founder, Richard Scrushy, Wall Street insiders say the long arm of Lorello held considerable sway over the company.

Lorello heads UBS Warburg's health-care investment banking group. Wall Streeters say he and his partner William McGahan, who resigned suddenly on April 10, are the kinds of bankers who give bankers a bad name
Eight weeks ago UBS received a subpoena from the agency; reportedly, other financial advisors did too. The question is whether Lorello & Co., who were said to be deeply involved in HealthSouth's operations, knew about the hanky-panky.
Lorello, who has been known to sport Master of the Universe attire, circa 1986 (dress shirts replete with French cuffs and English collars), came to UBS in 1999 for a reported three-year pay package worth $70 million. He and McGahan, who handled the day-to-day relationship with HealthSouth, helped it raise billions of capital, netting UBS millions in fees. Prior to that Lorello and McGahan worked to build HealthSouth deal by deal beginning in the mid-'80s, first at Smith Barney, then at Salomon Smith Barney.

HealthSouth wasn't the only Lorello client to run into trouble. MedPartners, Integrated Health Services, and Five Star Quality Care, for instance, have all had serious financial problems. "A company would tell me they were doing a deal," says a health-care analyst at a major New York hedge fund, "and I would say to management, 'Please tell me you aren't doing it with Ben Lorello.' Everything he touched blew up."
In 1996, I interviewed Scrushy and Lorello and wrote of the latter that he "... is widely viewed as the premier health-care investment banker--as he'll be the first to tell you."
HealthSouth's Go-to Guy :: The collapse of HealthSouth is putting pressure on UBS Warburg.FORTUNE April 15, 2003

Meirav Chovav, a biotechnology stock analyst at Credit Suisse First Boston, agreed last April to join UBS Warburg, whose health care banking group is led by Benjamin Lorello. Her compensation: a guaranteed $10 million over three years, say bankers with a knowledge of her contract.
- - - - number of bankers to suggest that the only way UBS Warburg could justify paying her over $3 million a year is if she brings in a substantial amount of investment banking business.
But few bankers have been so successful using research to generate investment banking business, say a number of bankers who have worked with Mr. Lorello over the years.
Ms. Chovav was hired to replace Geoffrey E. Harris, a longtime colleague of Mr. Lorello, also from Smith Barney. Mr. Harris covered HealthSouth in the mid-1990's and moved with Mr. Lorello to UBS Warburg in early 1999, getting a contract that guaranteed him $10 million a year for three years, say bank officials.

Currently, the UBS Warburg analyst for HealthSouth is Howard G. Capek. Mr. Capek had a strong buy recommendation for the company - - - . He maintained that rating until August 2002, - - - - In the time that Mr. Capek has been the analyst for HealthSouth, the company has done $2 billion in banking business at UBS.
Dating back to 1986, when Mr. Lorello was an up-and-coming banker at Smith Barney, his research analysts have served as a crucial component of the investment banking machine that made him one of the best paid health care bankers on Wall Street.

By the mid-1990's, Mr. Lorello was one of the most aggressive and successful health care bankers. A graduate of the University of Rhode Island, he frequented strip bars, wears loud ties and has a taste above all for deals, say people who have spent time with him. Instead of focusing on established companies, he went after smaller ones, like HealthSouth, that lacked a Wall Street pedigree. These companies were eager to grow and expand but needed the help of Mr. Lorello and Mr. Harris, Smith Barney's top health care analyst.

Mr. Harris joined Smith Barney in 1991 as a health care services analyst. By 1995, he was covering a broad range of companies, including HealthSouth. - - He also tracked MedPartners and - - - Integrated Health Services, a nursing home chain. All three were substantial banking clients of Smith Barney and Mr. Lorello. - - - - - But HealthSouth was always at the top of his list, say bankers who worked with Mr. Harris, and it was that company's success that made his reputation as an analyst. In the mid-1990's
HealthSouth's stock soared, more than 250 percent from 1995 through 1998.
During Mr. Harris's time covering HealthSouth, Smith Barney did more than $8 billion in deals with the company.

Bankers who have worked with Mr. Lorello say that Mr. Harris's positive coverage was in many respects a crucial factor in landing investment banking business for Smith Barney.

In some cases, these bankers say, when Mr. Lorello was proposing to a company that it go public, he would present mock research reports, with a buy rating, written and prepared by Mr. Harris.

In 1999, when Mr. Lorello moved his team from Smith Barney to UBS, he received a contract for $20 million a year over three years, - - - - - Mr. Harris received a three-year $30 million package.

Conflict Issue Over Analyst's Deal New York Times April 8, 2003

The disclosures show that UBS, a securities firm - - - was far more involved in the inner workings of HealthSouth than previously disclosed and maintained an unusually close relationship with HealthSouth's embattled founder, Richard Scrushy.
But according to the minutes of HealthSouth board meetings - - - - Benjamin Lorello and William McGahan, the co-heads of UBS's health-care investment-banking team, attended a combined total of at least eight HealthSouth board meetings between late 1999 and late 2002. During the meetings, - - - , Messrs. Lorello and McGahan helped guide the company on everything from financing and investor sentiment to a "detailed overview of strategic alternatives" for the company's "long-term objectives."

And just weeks before an SEC investigation into HealthSouth became public, in September 2002, several UBS bankers presented a plan called "Project Crimson," which called for breaking up the company and selling off divisions. If successful, the plan might have helped HealthSouth avoid disclosure of the alleged accounting fraud.
UBS Helped Set HealthSouth Moves Leading to Scandal Yahoo! News May 14, 2003

Congressional investigators are to examine the role of a prominent Wall Street banker's dealings with HealthSouth, the beleaguered healthcare company.
"We're interested in some of his [Mr Lorello's] business dealings, and he will have a lot of questions to answer," said Ken Johnson for the House Energy and Commerce Committee.

Congress examines banker's role in HealthSouth
The Financial Times Wed May 7, 2003

The request from the House Energy and Commerce Committee asks if UBS was "diligent in their review and assessment of HealthSouth's financial health and the interwoven financial relationships of many officers and directors of HealthSouth."

The letter seeks information about UBS' role in several side companies in which former CEO Richard Scrushy had an interest, and specifically asks about the company's relationship with UBS bankers Benjamin Lorello and William McGahan, The Wall Street Journal reported.
Congress Looking at HealthSouth Bankers May 9, 2003

A U.S. congressional panel on Thursday asked Swiss-controlled investment bank UBS Warburg (UBSZn.VX) to hand over records of its financial dealings with scandal-plagued HealthSouth Corp. and accused executives at both firms of 'an incestuous-like relationship.'
In a statement, Rep. James Greenwood said: 'The cozy financial relationship that UBS Warburg appears to have had with HealthSouth and other related entities raises serious questions about whether investors were misled by these guys to further their own financial gain.'
'Based on our interviews with a key whistle-blower, there was an incestuous-like relationship between top HealthSouth officials and a small group of investment bankers and analysts. We intend to haul them all in for a matter of weeks,' committee spokesman Ken Johnson told Reuters.
Congress Seeks UBS Records on HealthSouth The New York Times May 8, 2003

But the move by the House Energy and Commerce Committee, which is probing charges of insider trading and shifty bookkeeping at HealthSouth Corp., was in fact just the latest instance of turning the focus to Wall Street and the banks behind big-money business deals.
In the HealthSouth case, the House Energy and Commerce Committee asked UBS Warburg to turn over documents related to, among other things, its work on a $1 billion bond sale for HealthSouth and its role in several ``side'' companies in which ousted HealthSouth CEO Richard M. Scrushy had a financial interest.
Corporate Fraud Cases Focus on Bankers The New York Times May 13, 2003

A top health care analyst for UBS resigned under pressure yesterday after bank officials discovered an e-mail message in which he disparaged HealthSouth just months after he had given the stock the highest possible rating.

The stock analyst, Howard G. Capek, sent the message to an institutional investor in September 1999, saying, "I would not own a share" of HealthSouth.
Mr. Capek was a vocal proponent of HealthSouth and was one of the last analysts to downgrade his coverage from a buy rating when the stock began its plunge in March.
"Clearly, Mr. Capek had an amazing change of heart," said Representative James C. Greenwood, Republican of Pennsylvania and the chairman of the House Energy and Commerce Subcommittee on Oversight and Investigations. "One day he said it's a dog and then he said it was a darling. The question is what or who changed his mind. Frankly, we can't wait to interview him."
(email to friend)- - - - HRC, what a mess. I would not own a share. We need to speak on this."
Mr. Capek did not drop his buy rating until March 2003, after the company said it was being investigated for fraudulent accounting practices.
Indeed, Mr. Lorello's aggressive promotion of Mr. Capek's capabilities sometimes backfired.
UBS Analyst Forced Out for Remark New York Times July 3, 2003

The issue of course is whether Lorello and his team from UBS knew of the fraud at HealthSouth and either ignored it or were complicit in helping HealthSouth hide it. It can certainly be argued that they should have suspected it if they had been diligent. Healthsouth executives involved so far have given evidence indicating that Lorello and his team did know and were complicit. Shareholders have included UBS in their court actions claiming UBS helped HealthSouth defraud them. HealthSouth itself has joined their action.

Specifically, the suit alleges that between 1999 and 2002, UBS banker William McGahan had "regular" conversations about the fraud at HealthSouth with a former company executive (Wall Street Journal, 1/9). The discussions addressed such topics as the likelihood of criminal prosecution and the penalties that could result from conviction, according to the Times.
Group of HealthSouth Investors Files Suit Against Auditors, Investment Bank Kaiser Daily Health Policy Report Jan 9, 2004

The suit also contends that the investment bankers, Benjamin Lorello and William McGahan, and the analyst, Howard Capek, helped HealthSouth finance a series of acquisitions that covered up its bad results.
Suit: Auditors, bankers aided HealthSouth fraud Modern Healthcare's Daily Dose January 9, 2004

Though the acquisition pickings were slim, the suit said top HealthSouth executives zeroed in on HCR Manor Care, an operator of high-end nursing homes, as a takeover target. The suit, however, says the HealthSouth executives feared the deal would reveal the books were being cooked.

"In June or July 1999, after UBS was retained to act as HealthSouth's investment banker for this prospective acquisition, a senior executive of HealthSouth told McGahan that HealthSouth had been systematically falsifying its financial statements, explained the manner in which the fraud was being accomplished and stated that the company was on track to miss earnings estimates for that year by $280 (million) to $300 million," the suit says.
HealthSouth's bankers, auditors knew about fraud, lawsuit says (Associated Press) Jan. 10, 2004

 UBS, New York, said Securities and Exchange Commission staff may recommend that civil charges be brought against the investment bank because of work it did with HealthSouth Corp., Birmingham, Ala. However, UBS said it will first have an opportunity to present its position to the staff.
UBS may face charges over HealthSouth work Modern Healthcare Daily Dose Dec 21, 2004

Martin said the fraud could have been exposed either during due diligence or after the merger was completed.

Martin recalled that Scrushy asked him if McGahan knew about the accounting fraud.

"I told him, but he won't tell anybody, because he has as much to lose as we do," Martin said.

Martin said he told McGahan that HealthSouth was $10 million a week short of sales targets.
Former CFO says banker knew HealthSouth fraud Reuters March 3, 2005

Michael D. Martin, the third former HealthSouth CFO to testify against Scrushy at his corporate fraud trial, also said an investment banker who helped dissuade Scrushy from pursuing the deal was aware of the scheme to inflate earnings.

Martin said he and banker William McGahan flew to Scrushy's lakeside mansion in 1999 to talk him out of a proposed deal with HCR Manor Care, a nursing home company in Toledo, Ohio.

The merger didn't go through, Martin said, after he warned Scrushy that "the fraud would be exposed" if it did. Martin said he hadn't previously used the word "fraud" with his boss.

Martin said Scrushy asked him later whether McGahan knew of the earnings overstatement.

"I said, 'Yeah, I told him, but he won't say anything because he has as much to lose as we do,'" said Martin, who pleaded guilty and is cooperating with prosecutors. The testimony was the first indicating that anyone outside HealthSouth knew of the fraud.
Ex-CFO warned Scrushy of 'fraud' : He used word to describe finances at HealthSouth The Baltimore Sun March 4, 2005

The negotiations between HealthSouth Corp. and Manor Care had progressed far enough to consider the downtown Toledo firm's chief executive Paul Ormond to be CEO of the newly created company, with HealthSouth founder Richard Scrushy to be chairman.
Martin, who pleaded guilty to his role in the $2.7 billion fraud, said on the stand: "If Mr. Ormond was CEO, he would quickly realize what HealthSouth was doing, and the fraud would be revealed."
 Manor care eyed '99 deal March 4, 2005

Martin also testified he replayed for numerous HealthSouth executives a 1998 phone message left for him by Salomon Smith Barney investment banker Ben Lorello, who Martin earlier said knew about on the fraud.

"It was like something from a Mafia movie," Martin said of the phone message. "All about the rules and the family."
Defense attorney asks ex-CFO if fraud covered his mistakes The Birmingham News March 09, 2005

McGahan did not testify at Scrushy's trial; authorities said he was believed to be either living or moving outside the country at the time. His whereabouts now are unknown.
Former aide: Scrushy made threats to get money for lottery bid The (Associated Press)Jan. 24, 2006

HealthSouth settled the action taken by its shareholders for US $445 million at the end of 2006 and then joined with them in the action against UBS and Ernst & Young. In 2007 this had not yet been resolved. For more about these shareholder actions, Ernst & Young and UBS see the section on shareholder actions in the HealthSouth Court Actions web page.

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Lending Banks AmSouth

Scrushy had also recruited at least two staff from AmSouth. These staff would have had contacts and credibility there, and also known how the bank conducted its business. The banks led by AmSouth seem to have been gullible in accepting HealthSouth's profits at face value and lending it money.

Mr. Scrushy's partners in Capstone were John W. McRoberts, a former health care banker at AmSouth Bank in Birmingham who became Capstone's chief executive, and Michael D. Martin, a former chief financial officer at HealthSouth who had also been a banker at AmSouth.
Scrushy Ran HealthSouth Real Estate on the Side The New York Times April 14, 2003

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This page created July 2003 by
Michael Wynne
Revised and Updated October 2007