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  6. On March 19, 2003, the SEC filed
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Question: On March 19, 2003, the SEC filed

On March 19, 2003, the SEC filed accounting fraud charges in the Northern District of Alabama against HealthSouth Corporation and its CEO, Richard Scrushy. Scrushy was also charged with knowingly miscertifying the accuracy and completeness of the company’s financial statements. Consequently, Scrushy became the first CEO to be charged under the governance- reforming SOX. Although five HealthSouth CFOs testified that Scrushy had knowingly directed the fraud, on June 28, 2005, the Alabama jury acquitted him of all thirty-six criminal charges, and later some civil charges were initially dismissed. In contrast, the five CFOs were initially sentenced to receive a total of 115 years in prison and $11.2 million in fines. One of the CFOs, Weston Smith, had become a whistleblower who had launched a qui tam1 lawsuit under the False Claims Act against HealthSouth and first told prosecutors about the financial statement falsification process. He was sentenced to twenty-five years and a $2.2 million fine. How did all this happen? According to the SEC complaint,2 HealthSouth was founded in 1984 and grew to become the largest provider of outpatient surgery, diagnostic, and rehabilitative health care services in the United States. By 2003, it owned or operated over 1,800 different facilities with worldwide revenues and earnings of $4 billion and $76 million, respectively, in 2001. HealthSouth’s stock was listed on the New York Stock Exchange (NYSE), trading under the symbol HRC. Scrushy, who founded HRC, served as its chairman and CEO from 1994 to 2002. He relinquished the CEO title on August 27, 2002, but reassumed it on January 6, 2003. The SEC claim states that Scrushy instructed that HRC earnings be inflated as early as just after the company’s stock was listed on the NYSE in 1986. Specifi- cally, during the forty-two-month period between 1999 and the six months ended on June 30, 2002, HRC’s income (loss) before income taxes and minority interests was inflated by at least $1.4 billion. Each quarter, HRC’s senior officers would meet with Scrushy and compare HRC’s actual results with those expected by Wall Street analysts. If there was a short- fall, “Scrushy would tell HRC’s manage- ment to ‘fix it’ by recording false entries on HRC’s accounting records.”3 HRC’s senior accounting personnel then convened a meeting—referred to as “family meetings”—to “fix” the earnings. How this was done and how the auditors were deceived is outlined in the SEC complaint as follows: At these meetings, HRC’s senior accounting personnel discussed what false entries could be made and recorded to inflate reported earnings to match Wall Street analyst’s expectations. These entries primarily consisted of reducing a contra revenue account, called “contractual adjustment,” and/or decreasing expenses, (either of which increased earnings), and correspondingly increasing assets or decreasing liabilities. The contractual adjustment account is a revenue allowance account that estimates the difference between the gross amount billed to the patient and the amount that var- ious healthcare insurers will pay for a specific treatment. [This difference was, in reality, never to be received by HealthSouth.] . . . HRC falsified its fixed asset accounts [at numerous of its facilities] to match the fictitious adjustments to the income statement. The fictitious fixed asset line item at each facility was listed as “AP Summary.” HRC’s accounting personnel designed the false journal entries to the income statement and balance sheet accounts in a manner calculated to avoid detection by the out- side auditors. For example, instead of increasing the revenue account directly, HRC inflated earnings by decreasing the “contractual adjustment” account. Because the amounts booked to this account are estimated, there is a limited paper trail and the individual entries to this account are more difficult to verify than other revenue entries. Additionally, each inflation of earnings and corresponding increase in fixed assets were recorded through several intermediary journal entries in order to make the false inflation more difficult to trace. Furthermore, HRC increased the “AP Summary” line item at various facilities by different amounts because it knew that across the board increases of equal dollar amounts would raise suspicion. HRC also knew that its outside auditors only questioned additions to fixed assets at any particular facility if the additions exceeded a certain dollar threshold. Thus, when artificially increasing the “AP Summary” at a particular facility, HRC was careful not to exceed the threshold. HRC also created false documents to support its fictitious accounting entries. For example, during the audit of HRC’s 2000 financial statements, the auditors questioned an addition to fixed assets at one particular HRC facility. HRC accounting personnel, knowing that this addition was fictitious, altered an existing invoice (that reflected an actual purchase of an asset at another facility that approximated the dollar amount of the fictitious addition) to fraudulently indicate that the facility in question had actually purchased that asset. This altered invoice was then given to the auditors to support the recording of the fictitious asset in question. Also, when the auditors asked HRC for a fixed assets ledger for various facilities, HRC accounting personnel would re-generate the fixed asset
On March 19, 2003, the SEC filed accounting fraud charges in the Northern District of Alabama against HealthSouth Corporation and its CEO, Richard Scrushy. Scrushy was also charged with knowingly miscertifying the accuracy and completeness of the company’s financial statements. Consequently, Scrushy became the first CEO to be charged under the governance- reforming SOX. Although five HealthSouth CFOs testified that Scrushy had knowingly directed the fraud, on June 28, 2005, the Alabama jury acquitted him of all thirty-six criminal charges, and later some civil charges were initially dismissed. In contrast, the five CFOs were initially sentenced to receive a total of 115 years in prison and $11.2 million in fines. One of the CFOs, Weston Smith, had become a whistleblower who had launched a qui tam1 lawsuit under the False Claims Act against HealthSouth and first told prosecutors about the financial statement falsification process. He was sentenced to twenty-five years and a $2.2 million fine. How did all this happen? According to the SEC complaint,2 HealthSouth was founded in 1984 and grew to become the largest provider of outpatient surgery, diagnostic, and rehabilitative health care services in the United States. By 2003, it owned or operated over 1,800 different facilities with worldwide revenues and earnings of $4 billion and $76 million, respectively, in 2001. HealthSouth’s stock was listed on the New York Stock Exchange (NYSE), trading under the symbol HRC. Scrushy, who founded HRC, served as its chairman and CEO from 1994 to 2002. He relinquished the CEO title on August 27, 2002, but reassumed it on January 6, 2003. The SEC claim states that Scrushy instructed that HRC earnings be inflated as early as just after the company’s stock was listed on the NYSE in 1986. Specifi- cally, during the forty-two-month period between 1999 and the six months ended on June 30, 2002, HRC’s income (loss) before income taxes and minority interests was inflated by at least $1.4 billion. Each quarter, HRC’s senior officers would meet with Scrushy and compare HRC’s actual results with those expected by Wall Street analysts. If there was a short- fall, “Scrushy would tell HRC’s manage- ment to ‘fix it’ by recording false entries on HRC’s accounting records.”3 HRC’s senior accounting personnel then convened a meeting—referred to as “family meetings”—to “fix” the earnings. How this was done and how the auditors were deceived is outlined in the SEC complaint as follows: At these meetings, HRC’s senior accounting personnel discussed what false entries could be made and recorded to inflate reported earnings to match Wall Street analyst’s expectations. These entries primarily consisted of reducing a contra revenue account, called “contractual adjustment,” and/or decreasing expenses, (either of which increased earnings), and correspondingly increasing assets or decreasing liabilities. The contractual adjustment account is a revenue allowance account that estimates the difference between the gross amount billed to the patient and the amount that var- ious healthcare insurers will pay for a specific treatment. [This difference was, in reality, never to be received by HealthSouth.] . . . HRC falsified its fixed asset accounts [at numerous of its facilities] to match the fictitious adjustments to the income statement. The fictitious fixed asset line item at each facility was listed as “AP Summary.” HRC’s accounting personnel designed the false journal entries to the income statement and balance sheet accounts in a manner calculated to avoid detection by the out- side auditors. For example, instead of increasing the revenue account directly, HRC inflated earnings by decreasing the “contractual adjustment” account. Because the amounts booked to this account are estimated, there is a limited paper trail and the individual entries to this account are more difficult to verify than other revenue entries. Additionally, each inflation of earnings and corresponding increase in fixed assets were recorded through several intermediary journal entries in order to make the false inflation more difficult to trace. Furthermore, HRC increased the “AP Summary” line item at various facilities by different amounts because it knew that across the board increases of equal dollar amounts would raise suspicion. HRC also knew that its outside auditors only questioned additions to fixed assets at any particular facility if the additions exceeded a certain dollar threshold. Thus, when artificially increasing the “AP Summary” at a particular facility, HRC was careful not to exceed the threshold. HRC also created false documents to support its fictitious accounting entries. For example, during the audit of HRC’s 2000 financial statements, the auditors questioned an addition to fixed assets at one particular HRC facility. HRC accounting personnel, knowing that this addition was fictitious, altered an existing invoice (that reflected an actual purchase of an asset at another facility that approximated the dollar amount of the fictitious addition) to fraudulently indicate that the facility in question had actually purchased that asset. This altered invoice was then given to the auditors to support the recording of the fictitious asset in question. Also, when the auditors asked HRC for a fixed assets ledger for various facilities, HRC accounting personnel would re-generate the fixed asset ledger, replacing the “AP Summary” line item with the name of a specific fixed asset that did not exist at the facility, while leaving the dollar amount of the line item unchanged. While the scheme was ongoing, HRC’s senior officers and accounting personnel periodically discussed with Scrushy the burgeoning false financial statements, trying to persuade him to abandon the scheme. Scrushy insisted that the scheme continue because he did not want HRC’s stock price to suffer. Indeed, in the fall of 1997, when HRC’s accounting personnel advised Scrushy to abandon the earnings manipulation scheme, Scrushy refused, stating in substance, “not until I sell my stock.” 4 These manipulations were testified to during the trial by the five men who served as CFO during the interval under review, all of whom pled guilty to charges such as conspiracy to commit securities and wire fraud and falsification of financial records. On “August 14, 2002, Scrushy and HRC’s CFO certified under oath that HRC’s 2001 Form 10-K contained no ‘untrue statement of material fact’” even though “this report overstated HRC’s earnings … by at least 4,700%.”5 The SEC complaint did not detail all of the fraud at HealthSouth, estimated to total $3.8 billion to $4.6 billion, which was reportedly made up of the following: The same special report7 stated that HRC profit was overstated by $2.74 billion from 1996 to 2002 inclusive and that Scrushy received $265 million in remuneration, consisting of $21.9 million in salary, $34.5 million in bonuses, and $208.9 million from the sale of shares. In 2002, Scrushy’s remu- neration totaled $112.3 million, including $99.3 million from sale of shares. The timing of Scrushy’s 2002 stock sales is of interest. In May 2002, the U.S. Justice Department joined the qui tam whistleblower lawsuit of Bill Owens, which accused Health- South of fraudulently seeking payments for services provided by unlicensed employ- ees, including interns and students. On the same day, Scrushy exercised 5.3 million stock options at $3.78 and sold them for $14.05 for a gain of over $54 million. The major Scrushy-directed Health- South fraud is not the first or only one to take place in Scrushy’s companies. Earlier frauds, bankruptcies, or questionable busi- ness dealings are part of the history of sev- eral companies owned at least in part by Scrushy and/or HealthSouth and controlled by Scrushy with interlocking Boards of Directors to HealthSouth. These companies include MedPartners, Caremark National, Integrated Health Services, Capstone Cap- ital, and HealthSouth for Medicare frauds ($1 million paid in 2000; $8.2 million in 2001).8 It is alleged, however, that Scrushy began to “fix” earnings in the early 1990s, and it is evident that he became involved in questionable business dealings during the same time frame. Significantly, the people involved with Scrushy in these and other questionable business dealings were often current and/or former HealthSouth employees or members of the HealthSouth Board of Directors.9 Scrushy, however, appears to have been the common link among the corporations involved. In spite of the SEC’s evidence on Health- South manipulations, which was supported by the testimony of five CFOs and ten other employees (all of whom pled guilty to the fraud), the jury of seven black and five white jurors voted to acquit Scrushy. Why was this? According to the Report on Fraud, the reasons were multifaceted,10 as follows: Surrounded by reporters as he left the courtroom, an elated Scrushy said: “Thank God for this.” It was not a throwaway line, for his acquittal was partly due to a defence strategy that focussed on Scrushy’s religious devo- tion (in fuller flourish during the trial), an unusual racism tactic, smear campaigns against key witnesses, an overabundance of prosecution doc- uments (six million) but no smok- ing gun, and a victory for southern charm over northern sophistication. More than any contributing fac- tor to Scrushy’s acquittal, however, was location.… “New York juries, like those in other metropolitan areas, often include people who have worked in the financial field and are more skeptical of CEOs who claim ignorance.” “One of the questions in a very complex case like this is: ‘How much did they understand?’” Another was: who did they believe?… Scrushy was a prominent and respected figure in Birming- ham, where HealthSouth employed thousands of residents. Perceived as “local boy made good,” as he was often described, he donated lavishly to community causes … Faced with the enormous evidence against their client, … how could his defence team convince a jury their client was not guilty? Step number one: combine race and religion. It was a strategy led by defence counsel Donald Watkins, a black civil rights lawyer turned energy tycoon and banker, . . . As part of the defence strategy, Scrushy, who is white, “left his sub- urban evangelical church and joined a black congregation in a blue- collar neighborhood,” reported the Washington Post. The Guiding Light congregation was the recipient of a $1-million donation from Scrushy. “He bought a half-hour of local TV for a morning prayer show featuring himself and his wife, and frequent guest spots by black ministers. He had a prayer group praying for him every day of the trial.” Also during the trial, Scrushy’s son-in-law bought a small TV station and began broad- casting daily reports bolstering the defendant’s case, says USA Today. Many members of Guiding Light turned up at Scrushy’s trial and sat directly behind him. . . . At the same time … his defence team successfully manoeuvred to have seven blacks on the jury and five whites, all from working class backgrounds. Faced with five former CFOs tes- tifying to Scrushy’s guilt, his defence team decided to impugn their cred- ibility, … all negotiated lenient sentences prior to testifying … char- acterized one witness as looking clean as a “Winn-Dixie chitlin” … por- trayed prosecution star witness Wil- liam Owens, … as a rat “who squeals ‘trust me, believe me.’” … “A witness was ridiculed because he used antide- pressants.” … “Another witness was accused of faking tears on the stand.” Yet another was forced to admit that he often cheated on his wife and lied about it.… The defence team’s goal … was to treat the group of CFOs as one … comprised [of] a group of liars and cheats … a bold move, but it worked, according to jurors. Several jurors speaking after the trial said they wanted to see fingerprints on any of the evidence documents or a smoking gun that would tie Scrushy directly to the fraud. Two poorly made audiotapes were not sufficient, and “defence lawyers argued that Scrushy never employed words such as ‘fraud’ or ‘illegal’ and no documents or emails produced during the trial implicated their client.”11 It took twenty-one days for the jury to reach a verdict. Originally, seven jurors wanted acquittal, but the number grew to ten. One of the jurors who wanted a guilty verdict was replaced due to recur- ring migraine headaches, and since the replacement juror wanted an acquittal, only one holdout remained. She was finally con- vinced to vote for acquittal. The issue of credibility—who to believe—seemed to be paramount. The words of one juror and one author probably captured the essence of the trial best: There were five CFOs who testified against Scrushy and they all seemed to have some reason to lie.… Based on that conclusion, he said, he had to vote to acquit. 12 [Scrushy] never took the stand. He chose, instead, to preach at his new congregation during the trial, although his pastor said he didn’t attend the service following his acquittal. 13 Expert observers do not view this verdict as a problem for the future enforcement of SOX. They view it as “a defeat for these particular prosecutors in this particular case.”14 Questions 1. What were the major flaws in Health- South’s governance? 2. What should HealthSouth’s auditors, Ernst & Young, have done if they had perceived these flaws? 3. How—in accounting terms—did the manipulation of HealthSouth’s financial statements take place? 4. Why did all the people who knew about the manipulation keep quiet? 5. What is the auditor’s responsibility in a case of fraud? 6. What are the proper audit procedures to ensure existence of assets in the financial statements? What are the proper audit procedures to validate estimates? 7. What areas of risk can you identify in HealthSouth’s control environment before 2003? 8. What areas of risk can you identify in HealthSouth’s strategy before 2002? 9. What changes could be made in HealthSouth’s control system and cor- porate governance structure to mitigate the risk of accounting fraud in future years? 10. Was Scrushy’s defense ethical? Note: Assistance in the preparation of this case is greatly appreciated from Miguel Minutti Meza, Catherine Hancharek, Lily Ding, Lei Guo, Joanna Qin, Crystal Wu, and Michelle Wu, all of whom were students in the Master of Management & Professional Accounting Program of the Rotman School of Management at the University of Toronto.
ledger, replacing the “AP Summary” line item with the name of a specific fixed asset that did not exist at the facility, while leaving the dollar amount of the line item unchanged. While the scheme was ongoing, HRC’s senior officers and accounting personnel periodically discussed with Scrushy the burgeoning false financial statements, trying to persuade him to abandon the scheme. Scrushy insisted that the scheme continue because he did not want HRC’s stock price to suffer. Indeed, in the fall of 1997, when HRC’s accounting personnel advised Scrushy to abandon the earnings manipulation scheme, Scrushy refused, stating in substance, “not until I sell my stock.” 4 These manipulations were testified to during the trial by the five men who served as CFO during the interval under review, all of whom pled guilty to charges such as conspiracy to commit securities and wire fraud and falsification of financial records. On “August 14, 2002, Scrushy and HRC’s CFO certified under oath that HRC’s 2001 Form 10-K contained no ‘untrue statement of material fact’” even though “this report overstated HRC’s earnings … by at least 4,700%.”5 The SEC complaint did not detail all of the fraud at HealthSouth, estimated to total $3.8 billion to $4.6 billion, which was reportedly made up of the following:
On March 19, 2003, the SEC filed accounting fraud charges in the Northern District of Alabama against HealthSouth Corporation and its CEO, Richard Scrushy. Scrushy was also charged with knowingly miscertifying the accuracy and completeness of the company’s financial statements. Consequently, Scrushy became the first CEO to be charged under the governance- reforming SOX. Although five HealthSouth CFOs testified that Scrushy had knowingly directed the fraud, on June 28, 2005, the Alabama jury acquitted him of all thirty-six criminal charges, and later some civil charges were initially dismissed. In contrast, the five CFOs were initially sentenced to receive a total of 115 years in prison and $11.2 million in fines. One of the CFOs, Weston Smith, had become a whistleblower who had launched a qui tam1 lawsuit under the False Claims Act against HealthSouth and first told prosecutors about the financial statement falsification process. He was sentenced to twenty-five years and a $2.2 million fine. How did all this happen? According to the SEC complaint,2 HealthSouth was founded in 1984 and grew to become the largest provider of outpatient surgery, diagnostic, and rehabilitative health care services in the United States. By 2003, it owned or operated over 1,800 different facilities with worldwide revenues and earnings of $4 billion and $76 million, respectively, in 2001. HealthSouth’s stock was listed on the New York Stock Exchange (NYSE), trading under the symbol HRC. Scrushy, who founded HRC, served as its chairman and CEO from 1994 to 2002. He relinquished the CEO title on August 27, 2002, but reassumed it on January 6, 2003. The SEC claim states that Scrushy instructed that HRC earnings be inflated as early as just after the company’s stock was listed on the NYSE in 1986. Specifi- cally, during the forty-two-month period between 1999 and the six months ended on June 30, 2002, HRC’s income (loss) before income taxes and minority interests was inflated by at least $1.4 billion. Each quarter, HRC’s senior officers would meet with Scrushy and compare HRC’s actual results with those expected by Wall Street analysts. If there was a short- fall, “Scrushy would tell HRC’s manage- ment to ‘fix it’ by recording false entries on HRC’s accounting records.”3 HRC’s senior accounting personnel then convened a meeting—referred to as “family meetings”—to “fix” the earnings. How this was done and how the auditors were deceived is outlined in the SEC complaint as follows: At these meetings, HRC’s senior accounting personnel discussed what false entries could be made and recorded to inflate reported earnings to match Wall Street analyst’s expectations. These entries primarily consisted of reducing a contra revenue account, called “contractual adjustment,” and/or decreasing expenses, (either of which increased earnings), and correspondingly increasing assets or decreasing liabilities. The contractual adjustment account is a revenue allowance account that estimates the difference between the gross amount billed to the patient and the amount that var- ious healthcare insurers will pay for a specific treatment. [This difference was, in reality, never to be received by HealthSouth.] . . . HRC falsified its fixed asset accounts [at numerous of its facilities] to match the fictitious adjustments to the income statement. The fictitious fixed asset line item at each facility was listed as “AP Summary.” HRC’s accounting personnel designed the false journal entries to the income statement and balance sheet accounts in a manner calculated to avoid detection by the out- side auditors. For example, instead of increasing the revenue account directly, HRC inflated earnings by decreasing the “contractual adjustment” account. Because the amounts booked to this account are estimated, there is a limited paper trail and the individual entries to this account are more difficult to verify than other revenue entries. Additionally, each inflation of earnings and corresponding increase in fixed assets were recorded through several intermediary journal entries in order to make the false inflation more difficult to trace. Furthermore, HRC increased the “AP Summary” line item at various facilities by different amounts because it knew that across the board increases of equal dollar amounts would raise suspicion. HRC also knew that its outside auditors only questioned additions to fixed assets at any particular facility if the additions exceeded a certain dollar threshold. Thus, when artificially increasing the “AP Summary” at a particular facility, HRC was careful not to exceed the threshold. HRC also created false documents to support its fictitious accounting entries. For example, during the audit of HRC’s 2000 financial statements, the auditors questioned an addition to fixed assets at one particular HRC facility. HRC accounting personnel, knowing that this addition was fictitious, altered an existing invoice (that reflected an actual purchase of an asset at another facility that approximated the dollar amount of the fictitious addition) to fraudulently indicate that the facility in question had actually purchased that asset. This altered invoice was then given to the auditors to support the recording of the fictitious asset in question. Also, when the auditors asked HRC for a fixed assets ledger for various facilities, HRC accounting personnel would re-generate the fixed asset ledger, replacing the “AP Summary” line item with the name of a specific fixed asset that did not exist at the facility, while leaving the dollar amount of the line item unchanged. While the scheme was ongoing, HRC’s senior officers and accounting personnel periodically discussed with Scrushy the burgeoning false financial statements, trying to persuade him to abandon the scheme. Scrushy insisted that the scheme continue because he did not want HRC’s stock price to suffer. Indeed, in the fall of 1997, when HRC’s accounting personnel advised Scrushy to abandon the earnings manipulation scheme, Scrushy refused, stating in substance, “not until I sell my stock.” 4 These manipulations were testified to during the trial by the five men who served as CFO during the interval under review, all of whom pled guilty to charges such as conspiracy to commit securities and wire fraud and falsification of financial records. On “August 14, 2002, Scrushy and HRC’s CFO certified under oath that HRC’s 2001 Form 10-K contained no ‘untrue statement of material fact’” even though “this report overstated HRC’s earnings … by at least 4,700%.”5 The SEC complaint did not detail all of the fraud at HealthSouth, estimated to total $3.8 billion to $4.6 billion, which was reportedly made up of the following: The same special report7 stated that HRC profit was overstated by $2.74 billion from 1996 to 2002 inclusive and that Scrushy received $265 million in remuneration, consisting of $21.9 million in salary, $34.5 million in bonuses, and $208.9 million from the sale of shares. In 2002, Scrushy’s remu- neration totaled $112.3 million, including $99.3 million from sale of shares. The timing of Scrushy’s 2002 stock sales is of interest. In May 2002, the U.S. Justice Department joined the qui tam whistleblower lawsuit of Bill Owens, which accused Health- South of fraudulently seeking payments for services provided by unlicensed employ- ees, including interns and students. On the same day, Scrushy exercised 5.3 million stock options at $3.78 and sold them for $14.05 for a gain of over $54 million. The major Scrushy-directed Health- South fraud is not the first or only one to take place in Scrushy’s companies. Earlier frauds, bankruptcies, or questionable busi- ness dealings are part of the history of sev- eral companies owned at least in part by Scrushy and/or HealthSouth and controlled by Scrushy with interlocking Boards of Directors to HealthSouth. These companies include MedPartners, Caremark National, Integrated Health Services, Capstone Cap- ital, and HealthSouth for Medicare frauds ($1 million paid in 2000; $8.2 million in 2001).8 It is alleged, however, that Scrushy began to “fix” earnings in the early 1990s, and it is evident that he became involved in questionable business dealings during the same time frame. Significantly, the people involved with Scrushy in these and other questionable business dealings were often current and/or former HealthSouth employees or members of the HealthSouth Board of Directors.9 Scrushy, however, appears to have been the common link among the corporations involved. In spite of the SEC’s evidence on Health- South manipulations, which was supported by the testimony of five CFOs and ten other employees (all of whom pled guilty to the fraud), the jury of seven black and five white jurors voted to acquit Scrushy. Why was this? According to the Report on Fraud, the reasons were multifaceted,10 as follows: Surrounded by reporters as he left the courtroom, an elated Scrushy said: “Thank God for this.” It was not a throwaway line, for his acquittal was partly due to a defence strategy that focussed on Scrushy’s religious devo- tion (in fuller flourish during the trial), an unusual racism tactic, smear campaigns against key witnesses, an overabundance of prosecution doc- uments (six million) but no smok- ing gun, and a victory for southern charm over northern sophistication. More than any contributing fac- tor to Scrushy’s acquittal, however, was location.… “New York juries, like those in other metropolitan areas, often include people who have worked in the financial field and are more skeptical of CEOs who claim ignorance.” “One of the questions in a very complex case like this is: ‘How much did they understand?’” Another was: who did they believe?… Scrushy was a prominent and respected figure in Birming- ham, where HealthSouth employed thousands of residents. Perceived as “local boy made good,” as he was often described, he donated lavishly to community causes … Faced with the enormous evidence against their client, … how could his defence team convince a jury their client was not guilty? Step number one: combine race and religion. It was a strategy led by defence counsel Donald Watkins, a black civil rights lawyer turned energy tycoon and banker, . . . As part of the defence strategy, Scrushy, who is white, “left his sub- urban evangelical church and joined a black congregation in a blue- collar neighborhood,” reported the Washington Post. The Guiding Light congregation was the recipient of a $1-million donation from Scrushy. “He bought a half-hour of local TV for a morning prayer show featuring himself and his wife, and frequent guest spots by black ministers. He had a prayer group praying for him every day of the trial.” Also during the trial, Scrushy’s son-in-law bought a small TV station and began broad- casting daily reports bolstering the defendant’s case, says USA Today. Many members of Guiding Light turned up at Scrushy’s trial and sat directly behind him. . . . At the same time … his defence team successfully manoeuvred to have seven blacks on the jury and five whites, all from working class backgrounds. Faced with five former CFOs tes- tifying to Scrushy’s guilt, his defence team decided to impugn their cred- ibility, … all negotiated lenient sentences prior to testifying … char- acterized one witness as looking clean as a “Winn-Dixie chitlin” … por- trayed prosecution star witness Wil- liam Owens, … as a rat “who squeals ‘trust me, believe me.’” … “A witness was ridiculed because he used antide- pressants.” … “Another witness was accused of faking tears on the stand.” Yet another was forced to admit that he often cheated on his wife and lied about it.… The defence team’s goal … was to treat the group of CFOs as one … comprised [of] a group of liars and cheats … a bold move, but it worked, according to jurors. Several jurors speaking after the trial said they wanted to see fingerprints on any of the evidence documents or a smoking gun that would tie Scrushy directly to the fraud. Two poorly made audiotapes were not sufficient, and “defence lawyers argued that Scrushy never employed words such as ‘fraud’ or ‘illegal’ and no documents or emails produced during the trial implicated their client.”11 It took twenty-one days for the jury to reach a verdict. Originally, seven jurors wanted acquittal, but the number grew to ten. One of the jurors who wanted a guilty verdict was replaced due to recur- ring migraine headaches, and since the replacement juror wanted an acquittal, only one holdout remained. She was finally con- vinced to vote for acquittal. The issue of credibility—who to believe—seemed to be paramount. The words of one juror and one author probably captured the essence of the trial best: There were five CFOs who testified against Scrushy and they all seemed to have some reason to lie.… Based on that conclusion, he said, he had to vote to acquit. 12 [Scrushy] never took the stand. He chose, instead, to preach at his new congregation during the trial, although his pastor said he didn’t attend the service following his acquittal. 13 Expert observers do not view this verdict as a problem for the future enforcement of SOX. They view it as “a defeat for these particular prosecutors in this particular case.”14 Questions 1. What were the major flaws in Health- South’s governance? 2. What should HealthSouth’s auditors, Ernst & Young, have done if they had perceived these flaws? 3. How—in accounting terms—did the manipulation of HealthSouth’s financial statements take place? 4. Why did all the people who knew about the manipulation keep quiet? 5. What is the auditor’s responsibility in a case of fraud? 6. What are the proper audit procedures to ensure existence of assets in the financial statements? What are the proper audit procedures to validate estimates? 7. What areas of risk can you identify in HealthSouth’s control environment before 2003? 8. What areas of risk can you identify in HealthSouth’s strategy before 2002? 9. What changes could be made in HealthSouth’s control system and cor- porate governance structure to mitigate the risk of accounting fraud in future years? 10. Was Scrushy’s defense ethical? Note: Assistance in the preparation of this case is greatly appreciated from Miguel Minutti Meza, Catherine Hancharek, Lily Ding, Lei Guo, Joanna Qin, Crystal Wu, and Michelle Wu, all of whom were students in the Master of Management & Professional Accounting Program of the Rotman School of Management at the University of Toronto.
The same special report7 stated that HRC profit was overstated by $2.74 billion from 1996 to 2002 inclusive and that Scrushy received $265 million in remuneration, consisting of $21.9 million in salary, $34.5 million in bonuses, and $208.9 million from the sale of shares. In 2002, Scrushy’s remu- neration totaled $112.3 million, including $99.3 million from sale of shares. The timing of Scrushy’s 2002 stock sales is of interest. In May 2002, the U.S. Justice Department joined the qui tam whistleblower lawsuit of Bill Owens, which accused Health- South of fraudulently seeking payments for services provided by unlicensed employ- ees, including interns and students. On the same day, Scrushy exercised 5.3 million stock options at $3.78 and sold them for $14.05 for a gain of over $54 million. The major Scrushy-directed Health- South fraud is not the first or only one to take place in Scrushy’s companies. Earlier frauds, bankruptcies, or questionable busi- ness dealings are part of the history of sev- eral companies owned at least in part by Scrushy and/or HealthSouth and controlled by Scrushy with interlocking Boards of Directors to HealthSouth. These companies include MedPartners, Caremark National, Integrated Health Services, Capstone Cap- ital, and HealthSouth for Medicare frauds ($1 million paid in 2000; $8.2 million in 2001).8 It is alleged, however, that Scrushy began to “fix” earnings in the early 1990s, and it is evident that he became involved in questionable business dealings during the same time frame. Significantly, the people involved with Scrushy in these and other questionable business dealings were often current and/or former HealthSouth employees or members of the HealthSouth Board of Directors.9 Scrushy, however, appears to have been the common link among the corporations involved. In spite of the SEC’s evidence on Health- South manipulations, which was supported by the testimony of five CFOs and ten other employees (all of whom pled guilty to the fraud), the jury of seven black and five white jurors voted to acquit Scrushy. Why was this? According to the Report on Fraud, the reasons were multifaceted,10 as follows: Surrounded by reporters as he left the courtroom, an elated Scrushy said: “Thank God for this.” It was not a throwaway line, for his acquittal was partly due to a defence strategy that focussed on Scrushy’s religious devo- tion (in fuller flourish during the trial), an unusual racism tactic, smear campaigns against key witnesses, an overabundance of prosecution doc- uments (six million) but no smok- ing gun, and a victory for southern charm over northern sophistication. More than any contributing fac- tor to Scrushy’s acquittal, however, was location.… “New York juries, like those in other metropolitan areas, often include people who have worked in the financial field and are more skeptical of CEOs who claim ignorance.” “One of the questions in a very complex case like this is: ‘How much did they understand?’” Another was: who did they believe?… Scrushy was a prominent and respected figure in Birming- ham, where HealthSouth employed thousands of residents. Perceived as “local boy made good,” as he was often described, he donated lavishly to community causes … Faced with the enormous evidence against their client, … how could his defence team convince a jury their client was not guilty? Step number one: combine race and religion. It was a strategy led by defence counsel Donald Watkins, a black civil rights lawyer turned energy tycoon and banker, . . . As part of the defence strategy, Scrushy, who is white, “left his sub- urban evangelical church and joined a black congregation in a blue- collar neighborhood,” reported the Washington Post. The Guiding Light congregation was the recipient of a $1-million donation from Scrushy. “He bought a half-hour of local TV for a morning prayer show featuring himself and his wife, and frequent guest spots by black ministers. He had a prayer group praying for him every day of the trial.” Also during the trial, Scrushy’s son-in-law bought a small TV station and began broad- casting daily reports bolstering the defendant’s case, says USA Today. Many members of Guiding Light turned up at Scrushy’s trial and sat directly behind him. . . . At the same time … his defence team successfully manoeuvred to have seven blacks on the jury and five whites, all from working class backgrounds. Faced with five former CFOs tes- tifying to Scrushy’s guilt, his defence team decided to impugn their cred- ibility, … all negotiated lenient sentences prior to testifying … char- acterized one witness as looking clean as a “Winn-Dixie chitlin” … por- trayed prosecution star witness Wil- liam Owens, … as a rat “who squeals ‘trust me, believe me.’” … “A witness was ridiculed because he used antide- pressants.” … “Another witness was accused of faking tears on the stand.” Yet another was forced to admit that he often cheated on his wife and lied about it.… The defence team’s goal … was to treat the group of CFOs as one … comprised [of] a group of liars and cheats … a bold move, but it worked, according to jurors. Several jurors speaking after the trial said they wanted to see fingerprints on any of the evidence documents or a smoking gun that would tie Scrushy directly to the fraud. Two poorly made audiotapes were not sufficient, and “defence lawyers argued that Scrushy never employed words such as ‘fraud’ or ‘illegal’ and no documents or emails produced during the trial implicated their client.”11 It took twenty-one days for the jury to reach a verdict. Originally, seven jurors wanted acquittal, but the number grew to ten. One of the jurors who wanted a guilty verdict was replaced due to recur- ring migraine headaches, and since the replacement juror wanted an acquittal, only one holdout remained. She was finally con- vinced to vote for acquittal. The issue of credibility—who to believe—seemed to be paramount. The words of one juror and one author probably captured the essence of the trial best: There were five CFOs who testified against Scrushy and they all seemed to have some reason to lie.… Based on that conclusion, he said, he had to vote to acquit. 12 [Scrushy] never took the stand. He chose, instead, to preach at his new congregation during the trial, although his pastor said he didn’t attend the service following his acquittal. 13 Expert observers do not view this verdict as a problem for the future enforcement of SOX. They view it as “a defeat for these particular prosecutors in this particular case.”14 Questions 1. What were the major flaws in Health- South’s governance? 2. What should HealthSouth’s auditors, Ernst & Young, have done if they had perceived these flaws? 3. How—in accounting terms—did the manipulation of HealthSouth’s financial statements take place? 4. Why did all the people who knew about the manipulation keep quiet? 5. What is the auditor’s responsibility in a case of fraud? 6. What are the proper audit procedures to ensure existence of assets in
On March 19, 2003, the SEC filed accounting fraud charges in the Northern District of Alabama against HealthSouth Corporation and its CEO, Richard Scrushy. Scrushy was also charged with knowingly miscertifying the accuracy and completeness of the company’s financial statements. Consequently, Scrushy became the first CEO to be charged under the governance- reforming SOX. Although five HealthSouth CFOs testified that Scrushy had knowingly directed the fraud, on June 28, 2005, the Alabama jury acquitted him of all thirty-six criminal charges, and later some civil charges were initially dismissed. In contrast, the five CFOs were initially sentenced to receive a total of 115 years in prison and $11.2 million in fines. One of the CFOs, Weston Smith, had become a whistleblower who had launched a qui tam1 lawsuit under the False Claims Act against HealthSouth and first told prosecutors about the financial statement falsification process. He was sentenced to twenty-five years and a $2.2 million fine. How did all this happen? According to the SEC complaint,2 HealthSouth was founded in 1984 and grew to become the largest provider of outpatient surgery, diagnostic, and rehabilitative health care services in the United States. By 2003, it owned or operated over 1,800 different facilities with worldwide revenues and earnings of $4 billion and $76 million, respectively, in 2001. HealthSouth’s stock was listed on the New York Stock Exchange (NYSE), trading under the symbol HRC. Scrushy, who founded HRC, served as its chairman and CEO from 1994 to 2002. He relinquished the CEO title on August 27, 2002, but reassumed it on January 6, 2003. The SEC claim states that Scrushy instructed that HRC earnings be inflated as early as just after the company’s stock was listed on the NYSE in 1986. Specifi- cally, during the forty-two-month period between 1999 and the six months ended on June 30, 2002, HRC’s income (loss) before income taxes and minority interests was inflated by at least $1.4 billion. Each quarter, HRC’s senior officers would meet with Scrushy and compare HRC’s actual results with those expected by Wall Street analysts. If there was a short- fall, “Scrushy would tell HRC’s manage- ment to ‘fix it’ by recording false entries on HRC’s accounting records.”3 HRC’s senior accounting personnel then convened a meeting—referred to as “family meetings”—to “fix” the earnings. How this was done and how the auditors were deceived is outlined in the SEC complaint as follows: At these meetings, HRC’s senior accounting personnel discussed what false entries could be made and recorded to inflate reported earnings to match Wall Street analyst’s expectations. These entries primarily consisted of reducing a contra revenue account, called “contractual adjustment,” and/or decreasing expenses, (either of which increased earnings), and correspondingly increasing assets or decreasing liabilities. The contractual adjustment account is a revenue allowance account that estimates the difference between the gross amount billed to the patient and the amount that var- ious healthcare insurers will pay for a specific treatment. [This difference was, in reality, never to be received by HealthSouth.] . . . HRC falsified its fixed asset accounts [at numerous of its facilities] to match the fictitious adjustments to the income statement. The fictitious fixed asset line item at each facility was listed as “AP Summary.” HRC’s accounting personnel designed the false journal entries to the income statement and balance sheet accounts in a manner calculated to avoid detection by the out- side auditors. For example, instead of increasing the revenue account directly, HRC inflated earnings by decreasing the “contractual adjustment” account. Because the amounts booked to this account are estimated, there is a limited paper trail and the individual entries to this account are more difficult to verify than other revenue entries. Additionally, each inflation of earnings and corresponding increase in fixed assets were recorded through several intermediary journal entries in order to make the false inflation more difficult to trace. Furthermore, HRC increased the “AP Summary” line item at various facilities by different amounts because it knew that across the board increases of equal dollar amounts would raise suspicion. HRC also knew that its outside auditors only questioned additions to fixed assets at any particular facility if the additions exceeded a certain dollar threshold. Thus, when artificially increasing the “AP Summary” at a particular facility, HRC was careful not to exceed the threshold. HRC also created false documents to support its fictitious accounting entries. For example, during the audit of HRC’s 2000 financial statements, the auditors questioned an addition to fixed assets at one particular HRC facility. HRC accounting personnel, knowing that this addition was fictitious, altered an existing invoice (that reflected an actual purchase of an asset at another facility that approximated the dollar amount of the fictitious addition) to fraudulently indicate that the facility in question had actually purchased that asset. This altered invoice was then given to the auditors to support the recording of the fictitious asset in question. Also, when the auditors asked HRC for a fixed assets ledger for various facilities, HRC accounting personnel would re-generate the fixed asset ledger, replacing the “AP Summary” line item with the name of a specific fixed asset that did not exist at the facility, while leaving the dollar amount of the line item unchanged. While the scheme was ongoing, HRC’s senior officers and accounting personnel periodically discussed with Scrushy the burgeoning false financial statements, trying to persuade him to abandon the scheme. Scrushy insisted that the scheme continue because he did not want HRC’s stock price to suffer. Indeed, in the fall of 1997, when HRC’s accounting personnel advised Scrushy to abandon the earnings manipulation scheme, Scrushy refused, stating in substance, “not until I sell my stock.” 4 These manipulations were testified to during the trial by the five men who served as CFO during the interval under review, all of whom pled guilty to charges such as conspiracy to commit securities and wire fraud and falsification of financial records. On “August 14, 2002, Scrushy and HRC’s CFO certified under oath that HRC’s 2001 Form 10-K contained no ‘untrue statement of material fact’” even though “this report overstated HRC’s earnings … by at least 4,700%.”5 The SEC complaint did not detail all of the fraud at HealthSouth, estimated to total $3.8 billion to $4.6 billion, which was reportedly made up of the following: The same special report7 stated that HRC profit was overstated by $2.74 billion from 1996 to 2002 inclusive and that Scrushy received $265 million in remuneration, consisting of $21.9 million in salary, $34.5 million in bonuses, and $208.9 million from the sale of shares. In 2002, Scrushy’s remu- neration totaled $112.3 million, including $99.3 million from sale of shares. The timing of Scrushy’s 2002 stock sales is of interest. In May 2002, the U.S. Justice Department joined the qui tam whistleblower lawsuit of Bill Owens, which accused Health- South of fraudulently seeking payments for services provided by unlicensed employ- ees, including interns and students. On the same day, Scrushy exercised 5.3 million stock options at $3.78 and sold them for $14.05 for a gain of over $54 million. The major Scrushy-directed Health- South fraud is not the first or only one to take place in Scrushy’s companies. Earlier frauds, bankruptcies, or questionable busi- ness dealings are part of the history of sev- eral companies owned at least in part by Scrushy and/or HealthSouth and controlled by Scrushy with interlocking Boards of Directors to HealthSouth. These companies include MedPartners, Caremark National, Integrated Health Services, Capstone Cap- ital, and HealthSouth for Medicare frauds ($1 million paid in 2000; $8.2 million in 2001).8 It is alleged, however, that Scrushy began to “fix” earnings in the early 1990s, and it is evident that he became involved in questionable business dealings during the same time frame. Significantly, the people involved with Scrushy in these and other questionable business dealings were often current and/or former HealthSouth employees or members of the HealthSouth Board of Directors.9 Scrushy, however, appears to have been the common link among the corporations involved. In spite of the SEC’s evidence on Health- South manipulations, which was supported by the testimony of five CFOs and ten other employees (all of whom pled guilty to the fraud), the jury of seven black and five white jurors voted to acquit Scrushy. Why was this? According to the Report on Fraud, the reasons were multifaceted,10 as follows: Surrounded by reporters as he left the courtroom, an elated Scrushy said: “Thank God for this.” It was not a throwaway line, for his acquittal was partly due to a defence strategy that focussed on Scrushy’s religious devo- tion (in fuller flourish during the trial), an unusual racism tactic, smear campaigns against key witnesses, an overabundance of prosecution doc- uments (six million) but no smok- ing gun, and a victory for southern charm over northern sophistication. More than any contributing fac- tor to Scrushy’s acquittal, however, was location.… “New York juries, like those in other metropolitan areas, often include people who have worked in the financial field and are more skeptical of CEOs who claim ignorance.” “One of the questions in a very complex case like this is: ‘How much did they understand?’” Another was: who did they believe?… Scrushy was a prominent and respected figure in Birming- ham, where HealthSouth employed thousands of residents. Perceived as “local boy made good,” as he was often described, he donated lavishly to community causes … Faced with the enormous evidence against their client, … how could his defence team convince a jury their client was not guilty? Step number one: combine race and religion. It was a strategy led by defence counsel Donald Watkins, a black civil rights lawyer turned energy tycoon and banker, . . . As part of the defence strategy, Scrushy, who is white, “left his sub- urban evangelical church and joined a black congregation in a blue- collar neighborhood,” reported the Washington Post. The Guiding Light congregation was the recipient of a $1-million donation from Scrushy. “He bought a half-hour of local TV for a morning prayer show featuring himself and his wife, and frequent guest spots by black ministers. He had a prayer group praying for him every day of the trial.” Also during the trial, Scrushy’s son-in-law bought a small TV station and began broad- casting daily reports bolstering the defendant’s case, says USA Today. Many members of Guiding Light turned up at Scrushy’s trial and sat directly behind him. . . . At the same time … his defence team successfully manoeuvred to have seven blacks on the jury and five whites, all from working class backgrounds. Faced with five former CFOs tes- tifying to Scrushy’s guilt, his defence team decided to impugn their cred- ibility, … all negotiated lenient sentences prior to testifying … char- acterized one witness as looking clean as a “Winn-Dixie chitlin” … por- trayed prosecution star witness Wil- liam Owens, … as a rat “who squeals ‘trust me, believe me.’” … “A witness was ridiculed because he used antide- pressants.” … “Another witness was accused of faking tears on the stand.” Yet another was forced to admit that he often cheated on his wife and lied about it.… The defence team’s goal … was to treat the group of CFOs as one … comprised [of] a group of liars and cheats … a bold move, but it worked, according to jurors. Several jurors speaking after the trial said they wanted to see fingerprints on any of the evidence documents or a smoking gun that would tie Scrushy directly to the fraud. Two poorly made audiotapes were not sufficient, and “defence lawyers argued that Scrushy never employed words such as ‘fraud’ or ‘illegal’ and no documents or emails produced during the trial implicated their client.”11 It took twenty-one days for the jury to reach a verdict. Originally, seven jurors wanted acquittal, but the number grew to ten. One of the jurors who wanted a guilty verdict was replaced due to recur- ring migraine headaches, and since the replacement juror wanted an acquittal, only one holdout remained. She was finally con- vinced to vote for acquittal. The issue of credibility—who to believe—seemed to be paramount. The words of one juror and one author probably captured the essence of the trial best: There were five CFOs who testified against Scrushy and they all seemed to have some reason to lie.… Based on that conclusion, he said, he had to vote to acquit. 12 [Scrushy] never took the stand. He chose, instead, to preach at his new congregation during the trial, although his pastor said he didn’t attend the service following his acquittal. 13 Expert observers do not view this verdict as a problem for the future enforcement of SOX. They view it as “a defeat for these particular prosecutors in this particular case.”14 Questions 1. What were the major flaws in Health- South’s governance? 2. What should HealthSouth’s auditors, Ernst & Young, have done if they had perceived these flaws? 3. How—in accounting terms—did the manipulation of HealthSouth’s financial statements take place? 4. Why did all the people who knew about the manipulation keep quiet? 5. What is the auditor’s responsibility in a case of fraud? 6. What are the proper audit procedures to ensure existence of assets in the financial statements? What are the proper audit procedures to validate estimates? 7. What areas of risk can you identify in HealthSouth’s control environment before 2003? 8. What areas of risk can you identify in HealthSouth’s strategy before 2002? 9. What changes could be made in HealthSouth’s control system and cor- porate governance structure to mitigate the risk of accounting fraud in future years? 10. Was Scrushy’s defense ethical? Note: Assistance in the preparation of this case is greatly appreciated from Miguel Minutti Meza, Catherine Hancharek, Lily Ding, Lei Guo, Joanna Qin, Crystal Wu, and Michelle Wu, all of whom were students in the Master of Management & Professional Accounting Program of the Rotman School of Management at the University of Toronto.
the financial statements? What are the proper audit procedures to validate estimates? 7. What areas of risk can you identify in HealthSouth’s control environment before 2003? 8. What areas of risk can you identify in HealthSouth’s strategy before 2002? 9. What changes could be made in HealthSouth’s control system and cor- porate governance structure to mitigate the risk of accounting fraud in future years? 10. Was Scrushy’s defense ethical? Note: Assistance in the preparation of this case is greatly appreciated from Miguel Minutti Meza, Catherine Hancharek, Lily Ding, Lei Guo, Joanna Qin, Crystal Wu, and Michelle Wu, all of whom were students in the Master of Management & Professional Accounting Program of the Rotman School of Management at the University of Toronto.

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> Satyam Computer Services Ltd was founded in 1987 by B. Ramalinga Raju. By 2009, it was India’s fourth-largest information technology company with 53,000 employees, operating in sixty-six countries. It provided a variety of services, including computer sy

> Employee stock options allow company executives to buy shares of their company at a specified price during a specified time period. They are given to executives as a form of noncash compensation. The option or “strike price” is normally equal to the mark

> Pierre Garvey, the CEO of Revel Information Technology, sat back in his chair and looked at his assistants. He frowned. “My son has been diagnosed with MLD,” he said. They all looked at him with shock. “Its proper name is metachromatic leuko dystrophy, a

> Walt Pavlo joined MCI in the spring of 1992. At that time, MCI was a growth company in the booming long-distance tele- communications industry that had 15% of the long-distance market, with revenues of $11 billion. In the 1990s, the major telecommunicati

> On November 17, 2005, Conrad Black and three other executives1 of Hollinger Inter- national, Inc., were charged with eleven counts of fraud with regard to payments allegedly disguised as “noncompete fees” or, in one case, a “management agreement breakup

> Tiger Woods, once probably the world’s greatest golfer, lost his number one ranking in October 2010, the same year that his marriage to Elin Nordegren blew up when she chased him out of the house and broke the windows of his vehicle with a 9 iron. His po

> In January 2006, the chair of Hewlett-Packard (HP), Patricia Dunn, hired a team of independent electronic-security experts to determine the source of leaked confidential details regarding HP’s long-term strategy. In September 2006, the press revealed tha

> Kelly Brown had been a member of the Board of Governors of the Wolfson General Hospital (WGH) for two years and had been asked to consider becoming the vice chair of the board. She had been a nurse before leaving to raise her family and now enjoyed parti

> The discussion between Don Chambers, the CEO, and Ron Smith, the CFO, was get- ting heated. Sales and margins were below expectations, and the stock market analysts had been behaving like sharks when other companies’ published quarterly or annual financi

> On September 30, 2004, Merck voluntarily withdrew its rheumatoid arthritis drug (Vioxx) from the market due to severe adverse effects observed in many of its users (Exhibit 1). As a result, Merck’s share price fell $11.48 (27%) in one d

> Johnson & Johnson (J & J) enjoyed a halo effect for many decades after their iconic precautionary recall of Tylenol capsules in 1982, which was greatly facilitated by the famous Johnson & Johnson Credo1 that stipulated patient well-being to be para- moun

> One of the world’s largest oil spills began on April 20, 2010, in BP’s Deepwater Hori- zon/Macondo well in the Gulf of Mexico. Although the world did not take significant notice until the next day, an estimated 62,000

> The NFL has known for some time that serious brain damage could be caused by the head trauma that is part of a normal football game. The sudden serious jarring of a football player’s head in normal tackling and blocking has been suspected for decades of

> The Kardell paper mill was established at the turn of the century on the Cherokee River in southeastern Ontario by the Kardell family. By 1985, the Kardell Paper Co. had outgrown its original mill and had encompassed several facilities in different locat

> In order to meet strong competition from Volkswagen as well as other foreign domes- tic subcompacts, Lee Iacocca, then president of Ford Motor Co., decided to introduce a new vehicle by 1970, to be known as the Pinto. The overall objective was to produce

> Antismoking advocates cheered in the summer of 1997 when the U.S. tobacco industry agreed to pay out more than U.S. $368.5 billion to settle lawsuits brought by forty states seeking compensation for cigarette-related Medicaid costs. Mississippi Attorney

> In June 2012, Jerry Sandusky was convicted of sexually abusing ten boys while he was an assistant football coach at Pennsylvani State University. His abuse of children went back almost fourteen years and was known by his superior, Joe Paterno, the head f

> In 1984, when he was eighteen years old, Cesar Correia murdered his father, killing him with a baseball bat. Cesar then dumped the body in the Assiniboine River. The body was eventually found, and Cesar confessed to the crime. He pleaded guilty to mansla

> Alex McAdams, the recently retired CEO of Athletic Shoes, was honored to be asked to join the Board of Consolidated Mines International Inc. Alex continues to sit on the Board of Athletic Shoes, as well as the Board of Pharma-Advantage, another publicly

> Adverse selection occurs when one party has an information advantage over the other party. In the case of insurance, people taking out insurance know more about their health and lifestyle than the insurance company. Therefore, in order to reduce informat

> Throughout 2009, the world was plagued with the H1N1 swine flu epidemic. The H1N1 influenza virus, which began in Mexico, spread rapidly. In June, the World Health Organization (WHO) declared it to be a global pandemic. Those who caught the virus suffere

> On October 1, 2012, IKEA apologized for removing women from the photographs in the IKEA catalogs that were shipped to Saudi Arabia. IKEA is a Swedish company that was founded in 1943. It is now the world’s largest furniture retailer with stores in over f

> Eric Hebborn (1934–1996) was an English painter and art forger. Hebborn attended the Royal Academy of Arts and then the British School at Rome, two of the most prestigious fine arts schools at the time. Underappreciated as an artist, he turned his hand t

> In the airline industry, passenger load capacity is the proportion of seats filled on each flight. The objective is to have all air- planes at full-load capacity on all flights. In October 2000, Jeffrey Lafond, a former Air Canada employee, joined WestJe

> On September 5, 2007, Steve Jobs, the CEO of Apple Inc., announced that the spectacularly successful iPhone would be reduced in price by $200 from $599, its introductory price of roughly two months earlier.1 Needless to say, he received hundreds of email

> Deutsche Bank (DB) is the largest bank in Germany and world’s sixth-largest investment bank.1 Unfortunately, the bank suffered from lackluster leadership, a poor organizational culture, and a complicated governance structure that result

> In 2006, Mercedes-Benz introduced Blue- TEC, an advanced system to trap and neutralize harmful emissions and particulates that allowed Mercedes to market “clean diesel” cars. VW and Audi made agreements to share the technology to enable all three compani

> In January 2002, the Boston Globe began a series of articles reporting that Fr. John Geoghan had been transferred from one parish to another in the Archdiocese of Boston, even though senior church officials knew that he was a pedophile. There was outrage

> On a fateful day in 2001, a GM engineer realized during preproduction testing of the Saturn Ion that there was a defect that caused the small car’s engine to stall with- out warning.1 This switch was approved in 2002 by an engineer, Raymond DiGeorgio, wh

> Should executives and directors be sent to jail for the acts of their corporation's employees?

> Why didn’t some corporations protect women employees from sexual abuse before 2017–2019?

> How can corporations ensure that their employees behave ethically?

> Why is it important for the clients of professional accountants to be ethical?

> Why might ethical corporate behavior lead to higher profitability?

> On any given day, a bank may have either a surplus or a deficiency of cash. When this occurs, banks tend to lend to and borrow from other banks at a negotiated rate of interest. These interbank loans could be as short as one day and as long as several mo

> What could professional accountants have done to prevent the development of the credibility gap and the expectations gap?

> Why are we more concerned now than our parents were about fair treatment of employees?

> Why have concerns over pollution become so important for management and directors?

> Should organizations that have a risk-taking culture, such as the one developed by Stan O’Neil at Merrill Lynch, enjoy the gains and suffer the losses, without recourse to government bailouts?

> Should the CEOs who refused to have their firms invest in mortgage-backed securities in the early years because the risks were too great receive bonuses in the latter years because their firms did not incur any mortgage-backed security losses? How would

> Should CEOs who made large bonuses by having their firms invest in mortgage-backed securities in the early years have to repay those bonuses in the later years when the firm records losses on those same securities?

> The government bailout of the financial community included taking an equity interest in publicly traded companies such as American International Group (AIG). Is it right for the government to become an investor in publicly traded companies?

> How much should the exiting CEOs of Fannie Mae and Freddie Mac have received when they were replaced in September 2008?

> Identify and explain five examples where executives or directors faced moral hazards and did not deal with them ethically.

> How could ethical considerations improve unbridled self-interest in ethical decision making?

> Wal-Mart has a brand image that triggers strong reactions in North America, particularly from people whose businesses have been damaged by the company’s over- powering competition with low prices and vast selection and by those who value the small-busine

> How could increased regulation improve the exercise of unbridled self-interest in decision making?

> What were the three most important ethical failures that contributed to the subprime lending fiasco?

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