[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
THE FINANCIAL COLLAPSE OF HEALTHSOUTH
Part 2
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
of the
COMMITTEE ON ENERGY AND COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
NOVEMBER 5, 2003
__________
Serial No. 108-59
__________
Printed for the use of the Committee on Energy and Commerce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
__________
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COMMITTEE ON ENERGY AND COMMERCE
W.J. ``BILLY'' TAUZIN, Louisiana, Chairman
MICHAEL BILIRAKIS, Florida JOHN D. DINGELL, Michigan
JOE BARTON, Texas Ranking Member
FRED UPTON, Michigan HENRY A. WAXMAN, California
CLIFF STEARNS, Florida EDWARD J. MARKEY, Massachusetts
PAUL E. GILLMOR, Ohio RALPH M. HALL, Texas
JAMES C. GREENWOOD, Pennsylvania RICK BOUCHER, Virginia
CHRISTOPHER COX, California EDOLPHUS TOWNS, New York
NATHAN DEAL, Georgia FRANK PALLONE, Jr., New Jersey
RICHARD BURR, North Carolina SHERROD BROWN, Ohio
Vice Chairman BART GORDON, Tennessee
ED WHITFIELD, Kentucky PETER DEUTSCH, Florida
CHARLIE NORWOOD, Georgia BOBBY L. RUSH, Illinois
BARBARA CUBIN, Wyoming ANNA G. ESHOO, California
JOHN SHIMKUS, Illinois BART STUPAK, Michigan
HEATHER WILSON, New Mexico ELIOT L. ENGEL, New York
JOHN B. SHADEGG, Arizona ALBERT R. WYNN, Maryland
CHARLES W. ``CHIP'' PICKERING, GENE GREEN, Texas
Mississippi KAREN McCARTHY, Missouri
VITO FOSSELLA, New York TED STRICKLAND, Ohio
ROY BLUNT, Missouri DIANA DeGETTE, Colorado
STEVE BUYER, Indiana LOIS CAPPS, California
GEORGE RADANOVICH, California MICHAEL F. DOYLE, Pennsylvania
CHARLES F. BASS, New Hampshire CHRISTOPHER JOHN, Louisiana
JOSEPH R. PITTS, Pennsylvania TOM ALLEN, Maine
MARY BONO, California JIM DAVIS, Florida
GREG WALDEN, Oregon JAN SCHAKOWSKY, Illinois
LEE TERRY, Nebraska HILDA L. SOLIS, California
ERNIE FLETCHER, Kentucky
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
DARRELL E. ISSA, California
C.L. ``BUTCH'' OTTER, Idaho
Dan R. Brouillette, Staff Director
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______
Subcommittee on Oversight and Investigations
JAMES C. GREENWOOD, Pennsylvania, Chairman
MICHAEL BILIRAKIS, Florida PETER DEUTSCH, Florida
CLIFF STEARNS, Florida Ranking Member
RICHARD BURR, North Carolina DIANA DeGETTE, Colorado
CHARLES F. BASS, New Hampshire JIM DAVIS, Florida
GREG WALDEN, Oregon JAN SCHAKOWSKY, Illinois
Vice Chairman HENRY A. WAXMAN, California
MIKE FERGUSON, New Jersey BOBBY L. RUSH, Illinois
MIKE ROGERS, Michigan JOHN D. DINGELL, Michigan,
W.J. ``BILLY'' TAUZIN, Louisiana (Ex Officio)
(Ex Officio)
(ii)
C O N T E N T S
__________
Page
Testimony of:
Capek, Howard, former Managing Director, UBS Warburg Equity
Research and Healthcare Group.............................. 125
Davis, Lanny J., formerly of Patton Boggs, former Counsel to
HealthSouth and Richard Scrushy............................ 128
Givens, Sage, Board of Directors and Audit Committee Member,
HealthSouth Corporation.................................... 32
Gordon, Joel, Acting Chairman, Board of Directors,
HealthSouth Corporation.................................... 28
Hirsch, Hal, formerly of Fulbright & Jaworski, former Counsel
to HealthSouth............................................. 124
Lamphron, James P., former Engagement Partner on HealthSouth
account at Ernst & Young; Richard Dandurand, Engagement
Partner, HealthSouth account at Ernst & Young; and Wayne
Dunn, former Senior Manager on HealthSouth account at Ernst
& Young.................................................... 90
Lorello, Benjamin, Head of Global Healthcare Finance Group,
UBS Warburg................................................ 126
May, Robert, Acting Chief Executive Officer, HealthSouth
Corporation................................................ 40
McGahan, William, former Co-Head of Global Healthcare Finance
Group, UBS Warburg......................................... 127
Striplin, Larry D., Board of Directors and former Chairman of
Compensation Committee, HealthSouth Corporation............ 38
Wallance, Gregory J., Member, Ad Hoc Advisory Group,
Organizational Sentencing Guidelines, U.S. Sentencing
Commission................................................. 9
Watkins, Phillip, former Member of the Board of Directors and
Compensation Committee Member, HealthSouth Corporation..... 35
(iii)
THE FINANCIAL COLLAPSE OF HEALTHSOUTH
----------
WEDNESDAY, NOVEMBER 5, 2003
House of Representatives,
Committee on Energy and Commerce,
Subcommittee on Oversight and Investigations,
Washington, DC.
The subcommittee met, pursuant to notice, at 10 a.m., in
room 2123, Rayburn House Office Building, Hon. James C.
Greenwood (chairman) presiding.
Members present: Representatives Greenwood, Stearns, Burr,
Walden, Ferguson, Rogers, DeGette, and Davis.
Staff present: Kelli Andrews, majority counsel; Ann
Washington, majority counsel; Casey Hemard, majority counsel;
Mark Paoletta, majority counsel; Tom DiLenge, majority counsel;
Yong Choe, legislative clerk; Jill Latham, legislative clerk;
Auturo Silva, deputy communications director; Edith Holleman,
minority counsel; and Voncille Hines, minority research
assistant.
Mr. Greenwood. This hearing of the Oversight and
Investigations Subcommittee of the House Committee on Energy
and Commerce will come to order.
And the Chair recognizes himself for the purpose of making
an opening statement.
This morning we hold the second day of our hearing on the
financial collapse of HealthSouth. Yesterday HealthSouth's
former CEO and Chairman of the Board Richard Scrushy was
indicted by a Federal Grand Jury on 85 counts of criminal
conduct, including allegations of money laundering, securities
fraud and of being the ringleader of a vast conspiracy to
defraud HealthSouth's investors.
Mr. Scrushy stands accused of masterminding a scheme to
boost the company's income over a period of 7 years by $2.7
billion. $2.7 billion; that is an incredible amount of money.
How many retirees invested their savings with HealthSouth
relying on figures that told them the Company was in sound
financial health? How many young families just starting out
decided to invest their hard earned dollars in HealthSouth
relying on the public statements of CEO Richard Scrushy?
In my view, the overarching themes of Mr. Scrushy
indictment are greed and more greed with a good dose of
intimidation.
According to the indictment, over a period of 7 years Mr.
Scrushy received about $267 million in compensation from
HealthSouth, including $53 million in bonuses alone. These
amounts are truly staggering. Keep in mind, this does not
include any proceeds that Mr. Scrushy may have received from
investments made from HealthSouth related companies. It does
not include other business ventures that Mr. Scrushy
participated in with various HealthSouth Board members.
Mr. Scrushy's $267 million, 7 year compensation package
also does not include HealthSouth's financing of Mr. Scrushy's
entertainment vehicle that included the girl band Third Phase,
nor the 13 private jets that HealthSouth purchased under his
watch.
As we now know, Mr. Scrushy received with the blessings of
the Board's compensation committee a $10 million bonus in 2002.
This is the same year that HealthSouth's stock lost half its
value in a couple of days following the company's August 27
announcement. So while Mr. Scrushy raked in tens of millions,
HealthSouth's shareholders watched their investment
disintegrate.
Today we will have the opportunity to question members of
the Board of Directors about Mr. Scrushy's outrageous
compensation.
The criminal indictment of Mr. Scrushy also validates many
of the concerns raised by various witnesses in our hearings a
few weeks ago, including the intimidating atmosphere fostered
by Mr. Scrushy that included hidden cameras and armed security
guards. This indictment alleges that in connection with the
conspiracy to inflate HealthSouth earnings, Mr. Scrushy
controlled ``his coconspirators, HealthSouth employees and the
Board of Directors by threats, intimidation, taking various
steps to monitor the activities of such persons, including
obtaining and reading their emails, placing them under
surveillance and installing equipment that permitted him to
easedrop on electronic and telephonic communications, obtaining
large compensation package for coconspirators and recommending
the forgiveness of HealthSouth loans to coconspirator'' from
the indictment.
Today we will have the opportunity to hear from various
Board members about their experiences with Mr. Scrushy and the
ways in which he exerted control over them collectively and
individually.
Three weeks ago this subcommittee looked at internal
safeguards at the company failed allowing this fraud to take
place. Today we will look at the role other parties played in
this debacle, including the Board of Director, the external
auditors, the investment bankers and other advisors.
In the course of examining how management of a Fortune 500
company could commit a $2.7 billion fraud, we have reviewed the
oversight exercised by the Board of Directors over the years.
And what we have learned raises serious concerns. Among the
concerns is a lack of formal procedures. This was best
illustrated in our hearing 3 weeks ago when former corporate
counsel Bill Horton confirmed that although there were multiple
audit committee meetings in 2001, minutes were only maintained
at one of those meetings.
Our examination has also revealed that Board members had
business relationships with HealthSouth and Mr. Scrushy raising
questions about how they dealt with conflict of interest. These
are just a few of the areas I look forward to discussing with
Board members this morning.
As we probe how the massive fraud could go undetected for
so long, we will hear from HealthSouth's external auditor,
Ernst & Young. In addition to performing HealthSouth's
financial audits, Ernst & Young also performed operational
examinations known as pristine audits, for which they were paid
even greater fees than for the financial audits.
I look forward to hearing from Ernst & Young about how it
could maintain its independence in performing financial audits
when it was also engaged in another higher revenue area of work
with HealthSouth.
During our last hearing we heard from former HealthSouth
employee Michael Vines who contacted Ernst & Young with
allegations of fraud. This morning the former engagement
partner and senior manager on the account can describe for us
in detail how they responded to the allegations.
We are also joined by HealthSouth's lead investment bankers
for over 15 years. We are interested in learning from them
whether their do diligence process for large debt offerings
they were leading on behalf of HealthSouth they ever raised any
questions about HealthSouth's financial condition. And if not,
why not?
We are also interested in understanding how investment
bankers with expertise in healthcare companies and a
longstanding relationship with HealthSouth did not question
HealthSouth's assertion that a Medicare billing directive would
have an immediate impact of a significant portion of the
company's revenues.
Finally, we will explore the issues associated with a
company conducting its own internal investigation into matters
relating to conduct of its executive officers. For example, we
will explore the issue of independence surrounding these
internal investigations sanctioned by a corporation's Board of
Directors and whether HealthSouth's internal investigation was
in any way compromised at all.
We look forward to asking two of the attorneys that worked
on HealthSouth's internal investigation questions on these
matters.
I want to thank all of the witnesses for attending.
I now recognize the gentlelady from Colorado, Ms. DeGette,
for her opening statement.
Ms. DeGette. Thank you, Mr. Chairman, for holding this
second hearing on the multibillion dollar HealthSouth financial
fraud. But more importantly, thank you for this very
illuminating series of hearings we have had over the last few
years on corporate responsibility issues.
Three weeks ago this very subcommittee watched as the smug
former CEO of HealthSouth, Richard Scrushy, proclaimed his
innocence in an interview with ``60 Minutes.'' In that
interview Mr. Scrushy maintained that dispute the allegations
of fraud and the 15 executives of HealthSouth that had already
plead guilty to fraud, he did not anticipate criminal charges.
``I did not expect that at all,'' he said. ``I think an
objective review of the evidence will show that Richard Scrushy
was not involved in any of these alleged crimes, and they will
see that I was not part of the scheme.''
Indeed, an objective review of the evidence is in, and as
we just heard yesterday Mr. Scrushy was indicted with 85 counts
of fraud ranging from conspiracy to mail, wire and securities
fraud and money laundering. A veritable smorgasbord of charges.
The basic allegation is that Mr. Scrushy directed a broad
conspiracy of at least 15 other HealthSouth officers to inflate
HealthSouth's revenues quarter after quarter, year after year.
Allegedly, over a 7 year period Mr. Scrushy and his team
inflated revenues by $2.7 billion, cash by $370 million,
goodwill by $740 million and put a billion dollars of
fictitious assets on its balance sheet.
While the degree of alleged fraud at HealthSouth is
breathtaking, it is no means unique. We have seen this sort of
trickery, deceit and greed at Enron, Qwest, World Com and many
others. In each of these cases management's self-interest has
triumphed over its obligations to shareholders. And, of course,
the result is that investors have lost billions.
But as we take a step back and examine egregious instances
of fraud, another disturbing pattern emerges, a pattern in
which the Board of Directors, the very entity that has the
fiduciary duty to protect the shareholders of a company, merely
pandered to the whims of management in order to satisfy their
own selfish interests. These Boards, awash in conflicts,
functioned as a rubberstamp approving highly risky transactions
without question and never examining the dubious write-offs and
one time charges that were routine in the financial statements.
They consistently acted in their self-interest, not asking the
difficult questions nor conducting the proper due diligence for
fear that their takings may be in jeopardy. However, these are
not just instances of negligence and complacency. In the end
these Boards functioned as the enablers of corporate fraud.
In the case of HealthSouth, several of the Board members
who are here today have served on HealthSouth's Board for
nearly 20 years, presiding over, knowingly or otherwise the
fraudulent actions of Mr. Scrushy and yet not one of them
raised a red flag. There are some obvious reasons for this.
The HealthSouth Board was riddled with conflicts of
interests. The directors invested in Mr. Scrushy's business
ventures and he invested in theirs. They allowed HealthSouth to
sign contracts with companies in which they had financial
interested without even a cursory review of the fairness of
those contracts.
For example, they did not ask questions about why
HealthSouth was investing in and giving its business to Source
Medical, in which dozens of company officials had investments.
The audit company rarely met and seemed unconcerned that the
internal audit function was weak, underfunded and had no access
to the corporate books. The compliance committee, apparently,
never knew that there were no procedures in place for
independent investigation of potential criminal activities at
the highest levels of the company. They never heard about
employees' allegations of significant changes at the end of
every quarter.
Directors raised questions about the restructuring and the
one time write-off charges that appeared every year, but then
they never went any further to discuss them with the auditors.
The Board acquiesced in September 2002 when Mr. Scrushy
decided that the independent law firm hired by HealthSouth to
investigate the allegations against Mr. Scrushy would also
become the company's SEC defense attorney and, of course
consequently under Mr. Scrushy's control. It acquiesced when
Mr. Scrushy fired FTI Consulting, the company that was supposed
to be reviewing the impact of Transmittal 1753 before getting a
final report. The result was that they never heard that the
author had serious questions about the truth of the statements
made by Mr. Scrushy in the 2002 third quarter investor call
about the impact of Transmittal 1753.
But as in the case of Enron and others, such fraudulent
activity extends well beyond the management team and the Board
of Directors. It reaches the auditors who were signing off on
statements quarter after quarter. It extends to the bankers
who, suspicious of the company's finances, unconditionally
provided capital as well as a buy rating on the company's
stock. And Ernst & Young never noticed that $370 million in
cash on the HealthSouth books didn't exist, nor $740 million in
goodwill, or a billion dollars in fixed assets. They did not
notice the dozens of nonstandard journal entries made by the
corporate accounting department to change the contractual
adjustment entries submitted by the facilities. And I could go
on and on.
Yesterday's indictment of Mr. Scrushy, the first indictment
of a CEO under Sarbanes-Oxley, is an example of the
effectiveness of the legislation crafted by this committee
designed to curtail corporate malfeasance. However, Mr.
Chairman, such legislation is just a first step on the long
road to adequate corporate reform. We must ensure that there
are appropriate policies in place so to guarantee that
directors are truly independent and act in the interest of the
shareholders.
To date, Congress has addressed the responsibility of
corporate officers and auditors, and that is a good first step.
But we have not addressed the responsibility of the board to
assure shareholders that fraud is not being committed. It is
time that we do so.
Thank you, Mr. Chairman.
Mr. Greenwood. The Chair thanks the gentlelady and
recognizes for an opening statement the vice chairman of the
subcommittee, the gentleman from Oregon, Mr. Walden.
Mr. Walden. Thank you very much, Mr. Chairman. And thank
you for convening this second hearing on the financial collapse
of HealthSouth.
The subcommittee's previous hearing shed some light on the
internal workings of this healthcare giant. After the first
hearing I was left with the feeling that many opportunities to
report, address and halt the coordinated fraud that was
occurring at HealthSouth were either missed or ignored. One lie
led to another and each dishonest inflated profit statement
stood on the shoulders of the previous one.
Much of the fraud that was committed by former HealthSouth
executives preceded the landmark Sarbanes-Oxley Corporate
Accountability Act. Now, as a result of that act CEOs and CFOs
are now required to certify to the truthfulness of their
company's financial reports. External auditors must attest to a
company's internal controls. Audit committee members are
required to be independent of corporate management.
Whistleblower procedures must be established and complaints to
be made to the independent audit committee, not management. And
it's now a Federal offense for corporate officers to mislead
outside auditors.
The timing of this fraud relevant to the implementation of
Sarbanes-Oxley does not make it more palatable nor less lawful.
However, now that Congress has taken decisive steps to tighten
internal controls, enhance corporate governance and encourage
employees from executives to rank and file to report fraud, I
am hopeful the tide will turn and instances of unchecked
corporate fraud will become a thing of the past.
But at the end of the day Congress cannot legislate the
morality or integrity of CEOs and CFOs of our Nation's publicly
traded companies. However, we have an obligation to investors
to make the framework is in place to catch fraudulent and
criminal acts, force refunds of ill-gotten gains and exact
appropriate punishment on those who commit such acts.
We also have a responsibility to monitor current laws and
regulations and to investigate where gaps may exist, and fill
them.
With that said, I am eager to hear from our witnesses on
the usefulness of Sarbanes-Oxley in routing out fraud, on how
we regain investor confidence and present subsequent
devastating financial failures.
I am also interested in hearing from the Board of Directors
who are represented today on what they saw and what they did
not see, and how other boards of other major corporations might
spot what you missed.
Mr. Chairman, I look forward to the opportunity to hear
from our panel.
And I return the balance of my mine.
Mr. Greenwood. The Chair thanks the gentleman.
The gentleman from Michigan, Mr. Rogers, for an opening
statement.
Mr. Rogers. I will waive my statement this morning, Mr.
Chairman.
Mr. Greenwood. Mr. Ferguson from New Jersey.
Mr. Ferguson. Thank you, Mr. Chairman.
Thanks for holding this important hearing, this
subcommittee's second, on the egregious fraud carried out by
the management at HealthSouth. I want to commend you, Mr.
Chairman, and the committee staff for all the hard work that
has gone into holding these hearings and to investigate the
fraud that took place at this huge company.
Yesterday, as was noted, former HealthSouth CEO Richard
Scrushy received a special delivery from the United States
Department of Justice. Unfortunately for Mr. Scrushy, this
delivery was not another Rolls Royce or another Renoir or
Picasso to add to his collection. Instead, he was delivered a
38 page indictment detailing 85 criminal counts for his
suspected role as the ringleader in the massive fraud
propagated by the executive team at HealthSouth. This fraud has
led to no fewer than 15 former HealthSouth employees, including
6 former chief financial officers and other key executives to
plead guilty to crimes related to this fraud. Each has
implicated Mr. Scrushy as the fraud's mastermind.
The number of HealthSouth employees who have pled guilty in
this scheme number more than those who have been indicted in
the Enron, Tyco, WorldCom and Global Crossing cases combined.
Mr. Scrushy represents the first indictment of a corporate
executive under the newly enacted Sarbanes-Oxley Act. In fact,
the strict standards of accountability set up by Sarbanes-Oxley
may have been what led this massive collusive fraud to have
been revealed.
In our last hearing we heard from a panel of people who
noticed bad things happening at HealthSouth. They said they
wanted to do the right thing, but in each case they failed to
reveal the fraud to any outside the company. They dealt with it
internally and each time their concerns were stifled by
management complicit in the fraud.
One component of Sarbanes-Oxley was that an independent
whistleblower channel to the audit committee was established
for all public companies. Perhaps this would have motivated
whistleblowing employees to break away from internal management
and finally go to the audit committee, or even alert the
outside auditors.
Most importantly, however, I am pleased to see that this
law will hold accountable a man who, according to the
indictment, led a large group of conspirators to cook the books
for their own personal gain. Tragically, their gain came at the
expense of thousands of innocent shareholders and employees who
invested their savings, their careers, their whole livelihood
in HealthSouth. Unfortunately, the team of bad actors at
HealthSouth was bent on conspiring to defraud the investing
public, their auditors and even the Federal Government with no
regard for their fiduciary responsibilities to innocent
stakeholders and the public.
The company has now purged many of the bad actors. There
are still well meaning Board members and others, people who
care about this company and their employees and their
investors, and we will hear today about they are doing to right
the ship and to reform the ills that have plagued the company
prior to this year.
I look forward to hearing from the witnesses today and for
learning more about how to prevent these types of tragedies in
the future.
I thank you, Mr. Chairman.
I yield back.
Mr. Greenwood. The Chair thanks the gentleman.
The gentleman from Florida, Mr. Stearns, for an opening
statement.
Mr. Stearns. Good morning, and thank you, Mr. Chairman.
I also, like my colleagues, commend you for holding this
second hearing on the financial scandal at HealthSouth.
This is an important hearing. It comes at a time when many
things are converging on Wall Street and here in Washington.
We heard last month from employees inside. Today we broaden
our scope to hear from the accounting firm as well as the Board
of Directors.
I think the question most of us are asking with the
indictment of Mr. Scrushy, you have 15 other executives, senior
executives, 5 CFOs that go back intermittently I think almost
to 1986, and then you have 10 other senior level people,
treasurer, comptroller all cooperating, also admitting there
was fraud. So in this sea of fraud with 15 senior level
executives admitting and cooperating, is it possible that the
Board of Directors and the accounting firm knew nothing about
this? And I guess the question they would have to ask
themselves, since the Board of Director's primary
responsibility is to the shareholders, did they exercise their
fiduciary responsible and duty for them.
I read this interview, a portion of the interview in the
corporate Board minutes. And I say this to my colleagues, we
have this article ``My Sixteen Days on the HealthSouth Board.''
And this is by Betsy Atkins.
She went on the Board on March 7, 2003. And, of course, by
then came March 19, 11 days later when everything fell apart
when the FBI agents started to break down the door.
One of the first things she noticed and she says in the
article, is the ``dozen or so law firms that the company was
paying.'' ``Nationally and locally, and some of them were
billing like crazy.'' And so was this a telltale sign?
And I think, Mr. Chairman, it might be careful for our
counsel, our counsel to talk to her at some later time.
I think that, as someone else mentioned about the Sarbanes-
Oxley Act, I think it was in effect helping and working. So I
think that's a good point. There is some good news out of this
hearing.
As Chairman of the Commerce Consumer Protection Trade I
have jurisdiction over FASB, which the Financial Accounting
Standards Board. So I am interested to see if all of that has a
role here, the accounting standards and so forth. But it does
not appear to be as much as so as it was in Enron.
So, Mr. Chairman, I again commend you and this staff for
doing a good job in having this hearing. And I look forward to
the testimony.
Mr. Greenwood. The Chair thanks the gentleman.
If there are no other members prepared to make opening
statements, we'll call forth our first panel, which consists of
one individual, Mr. Gregory Wallance. Mr. Wallance, good
morning, sir.
Mr. Wallance is a member of the Ad Hoc Advisory Group on
the Organizational Sentencing Guidelines of the U.S. Sentencing
Commission.
Good morning, sir. Thank you for joining us.
Is your microphone turned on? Push the button there.
Before you begin, I need to advise you that this is an
investigational hearing and we take our testimony under oath,
and I need to ask you if you have any objections to giving your
testimony under oath.
Mr. Wallance. I do not.
Mr. Greenwood. Okay. You have the right to be represented
by counsel before this subcommittee. Do you wish to be
represented by counsel?
Mr. Wallance. No, no. I waive that right. Thank you.
Mr. Greenwood. You are not on the hot seat, sir. But I do
need you to stand your right hand.
[Witness sworn.]
Mr. Greenwood. Okay. Thank you, sir. You are now under oath
and now we would be delighted to hear your opening statement,
sir.
TESTIMONY OF GREGORY J. WALLANCE, MEMBER, AD HOC ADVISORY
GROUP, ORGANIZATIONAL SENTENCING GUIDELINES, U.S. SENTENCING
COMMISSION
Mr. Wallance. Great. Well, thank you, Chairman Greenwood,
thank you members for the opportunity to be here this morning.
My name is Gregory J. Wallance. I am currently a partner at
Kaye Scholer, a law firm in New York City. I served for 5 years
as a Federal prosecutor. My current practices involves
representation of both corporations and individuals in white
collar cases, as well as advising companies on corporate
compliance and internal investigations. And these are subjects
on which I write and lecture.
Recently I had the privilege of serving as a member of the
Ah Hoc Advisory Group to the United States Sentencing
Commission on the Organizational Sentencing Guidelines. Our
recent report, issued on October 7, addressed among other
issues the role and responsibility of the board of directors or
highest governing authority of an organization to assure that
the organization's business activities fully comply with the
law. And I think it is worth noting that the Sentencing
Commission gets a great deal of credit for, in effect,
revolutionizing the field of corporate compliance.
In 1991 the Commission promulgated the Organizational
Sentencing Guidelines to govern the sentencing of organizations
for most offense in Federal court. A critical feature of those
guidelines was an embedded carrot and stick. If a corporation
implemented an effective compliance program, then if it ended
up facing a criminal conviction, it would receive a
significantly more lenient fine if it had such a program. But,
if it failed to implement such a program, then it would receive
a significantly higher fine, and in some cases dramatically so.
And the Organizational Sentencing Guidelines describe seven
steps that a corporation could take to assure itself that it
had such an effective program, including certain auditing and
monitoring procedures, disciplinary measures and the like.
However, the guidelines were silent on the role of a board of
directors in ensuring compliance with law on the part of the
corporation.
On the tenth anniversary of those guidelines, the
Sentencing Commission announced the formation of our Advisory
Group. We were empaneled in February 2002. There were 15 of us,
a variety of experiences, academics, former prosecutors, former
high level Department of Justice official, and a sitting United
States Attorney. We were tasked with reviewing the
effectiveness of the Organizational Sentencing Guidelines with
special emphasis on these particular criteria for a compliance
program.
Two factors were very influential in our report. First, was
simply the passage of time. In the 10 years since the enactment
of these guidelines, there had been a great deal of experience
in the design and implementation of compliance programs. But
the second was that the formation of our committee, our
advisory group, coincided with the corporate scandals involving
Enron, WorldCom, Tyco and Adelphia, which greatly contributed
to the public's lack of confidence in the capital markets and
which also led to very significant legislative and regulatory
changes effecting corporate governance.
What struck was that in all of these, or most of these
scandals, the alleged malfeasance occurred at the senior
management level and occasionally at the board level. Even when
there was no actual malfeasance by members of the board, there
were often instances of negligence. As a result, we concluded
that the current absence in the organizational guidelines
criteria for an effect program of any mention of the board of
directors' role needed to be addressed. In effect, the obvious
needed to be stated. Ultimately the board of directors is
responsible for all of the activities of the organization
including its compliance with law.
And while I'll save for questions the details of some of
our recommendations, I want to give you the essence of what we
suggested needed to be incorporated in any amendments of these
guidelines, and it's that as follows:
That the board can only perform this oversight function if
it reasonably educated about the business of the organization
and the illegal activities to which it might be exposed to the
foolish and misguided deeds of its employees and, if the board
is actively, indeed proactively engaged in compliance
oversight.
And, again, I am happy to give you more details in response
to questions.
In making these recommendations, though--and pardon me, I
am a little bit horse. We do not think that we were breaking
new ground.
Mr. Greenwood. You are welcome to help yourself to a glass
of water there.
Mr. Wallance. Thank you.
Over the years I think you could find that essentially the
same standards laid out in a variety of pronouncements by both
courts, commentators and professional organizations. But,
unfortunately, over the past 2 years we have learned the bitter
lesson that lessons can never ben learned enough. And we
therefore hope that this report will be of assistance both to
the Sentencing Commission as it considers possible amendments
to the guidelines, as well as to this committee in the course
of its investigation.
So thank you, and I'd be pleased to answer any questions.
[The prepared statement of Gregory J. Wallance follows:]
Prepared Statement of Gregory J. Wallance
Thank you Chairman Greenwood, Members.
My name is Gregory J. Wallance. I am currently a partner at Kaye
Scholer LLP, a New York based law firm. I served for five years as an
Assistant United States Attorney in the Eastern District of New York.
My practice currently involves white collar defense representation of
both individuals and corporations, internal investigations and advising
corporations on corporate compliance. I also lecture and write on
corporate governance and compliance. I am grateful for the opportunity
to appear before this Committee to address the issue of the role and
responsibility of a board of directors of a corporation in assuring
that the corporation's activities fully comply with the law.
Recently, I had the privilege of serving as a member of the Ad Hoc
Advisory Group to the United States Sentencing Commission on the
Organizational Sentencing Guidelines, whose recent report addresses
this issue. As background, the Sentencing Commission deserves a great
deal of credit for, in effect, revolutionizing the field of corporate
compliance. In 1991, the Commission promulgated the organizational
sentencing guidelines (``OSG''), also known as the Chapter 8
guidelines, to govern the sentencing of organizations for most federal
criminal violations. The OSG became effective on November 1, 1991. They
provide incentives for organizations to report violations of law,
cooperate in criminal investigations, discipline responsible employees
and take the steps needed to prevent and detect criminal conduct by
their agents. A critical feature of the OSG was the creation of a
sentencing credit for organizations that put in place ``effective
programs to prevent and detect violations of law.'' For organizations
that have no such program, the OSG mandate high fines, in some
instances, dramatically so. The OSG described 7 steps that an
organization could take to implement such a program, including the use
of auditing and monitoring systems, dissemination of compliance
materials, and means for employees to report violations of law without
fear of retaliation.
Although such a compliance program is not a legal obligation,
corporations began implementing them. One commentator noted that,
``without question, the organizational sentencing guidelines ``greatest
practical effect thus far is to raise the business community's
awareness of the need for effective compliance programs.'' 1
The OSG even shaped corporate governance law. In 1995, the Delaware
Chancery Court, in In re Caremark Litigation, approved settlement of a
shareholder derivative suit alleging that the Caremark directors had
breached their duty of care by failing to supervise the conduct of
Caremark's employees. In doing so, the court emphasized the importance
of the role and responsibility of the board of directors to assure that
the corporation functions within the law to achieve its purpose. The
Chancery Court stated that the OSG ``offer powerful incentives for
corporations today to have in place compliance programs to detect
violations of law, promptly to report violations to appropriate public
officials when discovered and to take prompt, remedial efforts.'' The
Court distinguished a prior opinion that arguably could be read to
state that directors have no responsibility to assure that adequate
reporting systems are in place, by stating: ``Any rational person
attempting in good faith to meet an organizational governance
responsibility would be bound to take into account this development and
the enhanced penalties and the opportunities for reduced sanctions that
the federal sentencing guidelines offer.'' 2
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\1\ Dan K. Webb & Steven F. Molo, Some Practical Considerations in
Developing Effective Compliance Programs: A Framework for Meeting the
Requirements of the Sentencing Guiudelines, 71 Was. U.K.Q. 375 (1993).
\2\ In re Caremark Int'l, 698 A.2d 959, 970 (Del. Ch. 1996).
---------------------------------------------------------------------------
On the tenth anniversary of the OSG, the Sentencing Commission
announced the formation of the Advisory Group. We were empaneled in
February 2002. The Group consisted of 15 lawyers, former prosecutors
and Department of Justice officials, academics, compliance
professionals and a United States Attorney, all with wide experience in
corporate governance and compliance programs. The Advisory Group was
tasked with reviewing the general effectiveness of the guidelines for
sentencing corporations, with special emphasis on the application of
the criteria for an effective compliance program. We were asked to
submit a final report to the Commission in 18 months. The Advisory
Group sought and reviewed information from a variety of sources, both
in written statements and at a public hearing.
Two factors were especially influential in shaping our report. One
was simply the passage of time. In the 10 years since the OSG became
effective, a great deal of experience had been gained in designing and
implementing compliance programs. The other was that the formation of
the Advisory Group coincided with the corporate scandals involving
Enron, Worldcom and other companies, which greatly contributed to the
public's lack of confidence in the capital markets. The scandals also
led to significant legislative and regulatory changes affecting
corporate governance and compliance.
The Advisory Group delivered its report to the Sentencing
Commission on October 7, 2003. The report, 138 pages in length with 444
footnotes, contains an appendix setting forth the recommended OSG
compliance criteria. The report is notable for several important
proposals.
First, the Advisory Group recommended that the Sentencing
Commission promulgate a stand-alone guideline, 8 B2.1, defining ``an
effective program to prevent and detect violations of law.'' Currently,
the criteria for such a program is in the Chapter 8 guidelines'
commentary. The recommendation was intended to give the compliance
criteria for an effective program special emphasis and visibility.
Second, in the proposed new guideline, the Advisory Group proposed,
inter alia, the following changes to those criteria:
emphasizing the importance of an organizational culture that
encourages an organizational-wide commitment to compliance with
the law.
provision of a definition of ``compliance standards and procedures.''
specification of the responsibilities of an organization's governing
authority and organizational leadership for compliance.
providing adequate resources and authority to individuals with
responsibility for the implementation of the program.
revision of the current terminology ``propensity to engage in
violation of law,'' which has been the source of considerable
confusion in the past.
inclusion of training and dissemination of compliance training
materials and information as a criteria for an ``effective
program.''
requiring as part of monitoring and auditing the ``periodic
evaluation'' of the effectiveness of the compliance program.
a mechanism for anonymous reporting.
on-going risk assessments as part of the implementation of an
effective program.
Third, the Ad Hoc Group recommended modifications to the OSG to
clarify under what circumstances a waiver of the attorney-client
privilege and work product protections is required for an organization
to receive credit for cooperation with law enforcement.
Of special interest to this committee are the Advisory Group's
recommendations regarding the role of the ``governing body''--in most
cases a board of directors--in assuring that the corporation complies
with the law. In virtually all of the recent corporate scandals, the
alleged malfeasance occurred at the senior management end/or governing
authority level. Even where there was no actual malfeasance by members
of the governing authority, there were often instances of
negligence.3
---------------------------------------------------------------------------
\3\ See the role of the Board of Directors in Enron's collapse, S.
Rep. No. 107-70(2002).
---------------------------------------------------------------------------
As a result of the foregoing, the Advisory Group concluded that the
current absence in the OSG of any discussion of the role of the
governing authority needed to be addressed. In effect, the obvious
needed to be stated: ultimately, the governing authority is responsible
for the activities of the organization.4 It can only perform
this function if its members are reasonably educated about the business
of the organization and actively engaged in compliance oversight.
---------------------------------------------------------------------------
\4\ Most commentary received by the Advisory Group supported adding
specific references to the guidelines to amplify the role of the
governing authority, providing direct access between the governing
authority (or one of its committees) and a company's compliance
officer, to ensure prompt and unfiltered communications.
---------------------------------------------------------------------------
The Advisory Group therefore proposed a new guideline defining the
compliance roles of the organizational leadership at three levels: (1)
members of an organization's governing authority, which generally means
the Board of Directors; 5 (2) executives comprising an
organization's managerial leadership; and (3) one or more individuals
having primary, day to day responsibility for the organization's
program to prevent and detect violations of law. To quote from the
proposed guideline:
---------------------------------------------------------------------------
\5\ As defined in commentary to this proposed guideline and
Application Note 1, the ``governing authority'' of an organization is
``(A) The Board of Directors or (B) if the organization does not have a
Board of Directors, the highest level governing body of the
organization.''
``The organizational leadership shall be knowledgeable about the
content and operation of the program to prevent and detect
violations of law.''
``The organization's governing authority shall be knowledgeable about
the content and operation of the program to prevent violations
of law and shall exercise reasonable oversight with respect to
the implementation and effectiveness of the program to prevent
and detect violations of law.''
``Specific individual(s) within high-level personnel of the
organization shall be assigned direct, overall responsibility
to ensure the implementation and effectiveness of the program
to prevent and detect violations of law. Such individual(s)
shall be given adequate resources and authority to carry out
such responsibility and shall report on the implementation and
effectiveness of the program to prevent and detect violations
of law directly to the governing authority or an appropriate
subgroup of the governing authority.''
As to the top level body in charge of organizational affairs, i.e.,
the Board of Directors, the proposed guideline states that the Board
should be knowledgeable about the content and operation of the
organization's compliance program. The Board's knowledge about program
features and operations should include, inter alia, practical
management information about the major risks of unlawful conduct facing
their organization; the primary compliance program features aimed at
counteracting those risks; and the types of problems with compliance
that the organization and other parties with similar operations have
encountered in recent activities.
Significantly, the proposed guidelines do not specify the fact
finding procedures or methods that members of a governing authority
should use in acquiring this type of information. The proposed
guidelines leave to the particular organization the choice of methods
to gather and deliver information to governing authority in a manner
that best fits the organization's overall operations.
Under our proposed guideline, the governing authority should
exercise reasonable oversight with respect to the implementation and
effectiveness of the program. This obligation recognizes that such
oversight is a key part of the duties of top level organizational
officials. Effective management requires that a Board of Directors, for
example, be proactive. They must seek information about compliance
programs, evaluate such information when received, and monitor the
implementation and effectiveness of responses when compliance problems
are detected.
For example, the governing authority of the organization or some
appropriate subgroup (such as an audit committee) should receive
periodic reports from the person or persons in high level management
with direct, overall responsibility for an organization's compliance
program. The Advisory Group's report envisions that a board of
directors would hear from such persons periodically as to the nature,
progress and success of the compliance program without the potential
filtering or censoring influence of senior organization managers. In
cases of actual or apparent involvement in, or support for, illegal
conduct by top level organizational executives, our report suggests
that the head of the organization's compliance program should take
steps to ensure that the course of this behavior are made directly
known to the organization's governing authority, or an appropriate
subgroup of the governing authority, or the organization's qualified
legal compliance committee.
In addition, as described in the proposed new commentary at 8B2.1
Application Note 3 (B), the governing authority or an appropriate
subgroup, periodically should receive information on the implementation
and effectiveness of the compliance program from the individual or
individuals with day-to-day operational responsibility for the program.
Direct contact with those who have such day-to-day responsibility will,
for example, help the governing authority more effectively assess the
adequacy of resources being made available to the program.6
---------------------------------------------------------------------------
\6\ As stated in the Report at p. 61, ``Typically, however, members
of a governing authority will gain information on the features and
operations of a program to prevent and detect violations of law through
reports from senior organization managers or other experts (in large
organizations), or through information about program features and
operations gained in the course of day-to-day management and oversight
of related organizational activities (in small organizations). The
proposal anticipates that members of a governing body will update their
information about program features and operations periodically. This
update would occur at least annually, and more frequently when legal
changes or shifts in organizational activities raise new compliance
risks for the organization.''
---------------------------------------------------------------------------
In making these recommendations, we do not think that we were
breaking new ground. More than 7 years ago, the In re Caremark decision
had defined the role of the board of directors in substantially the
same terms.
More recently, the Conference Board's Commission on Public Trust
and Private Enterprise stated in a similar manner:
In fulfilling its oversight function, boards must monitor
management's operating performance as well as ethical and legal
compliance. In approving strategies, boards need to understand,
among other things, the corporation's capital allocation, debt
levels, risks and vulnerabilities, compensation strategy and
growth opportunities. Importantly, they must engage management
on the central issues facing the company and have a firm grasp
on the tradeoffs that lie at the heart of a corporate
enterprise. 7
---------------------------------------------------------------------------
\7\ The Conference Board Commission on Public Trust and Private
Enterprise, Findings and Recommendations, Part 2: Corporate Governance
(January 9, 2003) p.9.
---------------------------------------------------------------------------
Unfortunately, over the past two years we have learned the hard
lesson that lessons can never be learned enough. We therefore hope that
the Advisory Group's report will be of assistance to the Commission as
it considers amendments to the OSG and to this Committee in the course
of its investigations.
Thank you.
Mr. Greenwood. We thank you very much for your testimony
and for your willingness to help us in this endeavor.
The Chair recognizes himself for 10 minutes for our
questioning.
Mr. Wallance, would it be fair to say that the Advisory
Group's report was designed, at least in part, to help
companies improve their corporate governance by providing them
with additional guidance regarding the factors that are likely
to result in effective programs to prevent and detect
violations of law?
Mr. Wallance. Yes. Yes. That is correct. And I do not mean
to suggest in my remarks that the only issue we were addressing
was the role of the board of directors. In fact, we provided, I
think, which are a number of recommendations in a variety of
areas from auditing and monitoring to disciplinary measures,
to--and I think this is one of our significant
recommendations--that the objective of the compliance program
has to be to create a culture of compliance such that
commitments to compliance with law is as important a value to
the business as a profit margin or revenue growth, or what have
you.
Mr. Greenwood. Okay. At this point I would like you to turn
your attention to the report itself. One of the recommendations
in the report was to expand the definition of ``effective
program to present and detect violations of the law to include
two essential components: (1) Exercise do diligence, and; (2)
Otherwise promote an organizational culture that encourages a
commitment to compliance with law.'' That's on pages 52 to 54.
Mr. Wallance, how important is it for organizations to
create a culture in which compliance with the law is the
expected behavior rather than an unwelcome constraint?
Mr. Wallance. I think it is paramount. Ultimately to be
effective, the commitment to compliance has to come from the
very top of the organization, otherwise employees are not going
to respond. And it is the notion of creating an embedded
culture of compliance that we were driving at.
Now, we are not suggesting that there is some elusive goal
here that is somewhat touchy-feely, if you will. What we were
careful to point out is that you achieve this culture of
compliance, not simply by saying it or mouthing the words. It
is not enough to talk-the-talk, you have got to walk-the-walk.
And if the company implements the specific criteria or
recommendations that we sent out, then we think it will achieve
the corporate compliance culture which is best designed to
deter the kind of breakdowns in corporate governance that we
have witnessed over the last 2 years.
Mr. Greenwood. Okay. Can you detail some steps that
companies should or could take to ensure such a culture of
compliance?
Mr. Wallance. Well, I think it is a range, and let me
identify a couple of areas. I think companies need to do risk
assessments. What do our kinds of business, what kind of
potential violations of law do our business activities expose
us to? What kinds of legal problems have companies in similar
business lines encountered in the past? And then once it has
made that assessment, direct the resources of its compliance
program to deterring and preventing those kinds of violations
of law.
We suggested that not only does there need to be effective
auditing and monitoring, but in fact the compliance program
itself should be periodically audited and monitored for its own
effectiveness, which is a standard accounting tool. But it is
not enough to set it up. You have got to make certain it is
working.
We suggested that training should be a necessary part of
any compliance program. Training of all employees at virtually
of all levels, although of course training will vary depending
on the level. Whereas, the current guidelines do not make it an
essential component, it is sort of left open as an option.
We also suggested there have to be three levels of
oversight. The board, as I described.
Senior management has to be given, somebody in senior
management has to be given accountability and responsibility
for the day-to-day operation of the compliance program.
And, and these were complaints I heard over the years as I
tried to revise companies, they be given both the resources and
the authority to carry out that responsibility. We heard from
many people, very very well intentioned people in responsible
for compliance that they were not getting enough resources to
do their job.
And then, of course, at the lowest level we have to give
employees an opportunity to report violations of law that they
may have witnessed both free from retaliation, which is in the
current guidelines but we also recommend it. And this is
consistent with Sarbanes-Oxley, that a company as part of an
effective program set up a means of anonymous reporting so that
an employee can at least convey information that needs to be
acted on in the most comfortable manner for him so if he's
fearful he'll be retaliated against, at least he has this
means.
Mr. Greenwood. It would seem to me that this almost has to
be initiated from the very top or, at least, initiated by the
board.
Mr. Wallance. Right.
Mr. Greenwood. Because if a CEO has a character that isn't
the kind that would want to see this kind of compliance, then
it seems to me it would a fairly bold thing for an underling to
recommend the initiation of this kind of culture, would it not?
Mr. Wallance. Yes, I think that is an important point and
well worth taking. I think if the company encourages openness
and says we have zero tolerance for violations of law and we
want employees to report them and you will not be retaliated
against, it is likely to elicit the kind of information that I
think companies desperately need in order to fulfill their
obligations both to the shareholders as well as their
obligations imposed by law.
If on the other hand what is communicated, either directly
or implicitly is we cut corners, we are more interested in
profits, the bottom line counts, do not raise technical legal
considerations, then it is not going to get that information
and it will end up being, as we have seen in the last year, in
the position of many hapless companies and with, unfortunately,
consequences really for all of us.
Mr. Greenwood. And if it does not come from the management
side and if this culture of compliance is to be initiated by
the board of directors itself, I mean how would that come to
be? I mean, does a new director after being welcomed to the
board raise his or her hand and say I would like to initiate a
culture of compliance here?
Mr. Wallance. Well, I think that ultimately the board has
to take upon itself, and that is what we are recommending it be
given, the responsibility not for day-to-day management. I want
to be careful to draw that distinction. The boards cannot do
that. But to make certain that the procedures and controls are
in place to give the company as much assurance as possible that
it is doing what it needs to do to prevent violations of law.
And not only should it do that in the sense of saying let me
see your procedures, let me see your personnel handbook, let me
see your compliance infrastructure, show me the mechanism you
have got for anonymous reporting for hotlines, but it should be
out there talking to people. It should be, to some extent,
kicking the tires. It should have a regular line of
communication with the senior management person who has that
day-to-day responsibility and give him a direct reporting line
to the board.
And second, and we recommended this, it needs to be out
there talking to the people in the field with operational day-
to-day responsibility. This does not actually have to be done
by the whole board. It can be done by a subgroup such as the
audit committee. It does not require an enormous amount of
time, but it will require time. It may want to talk to the
internal auditors to find out what they are doing.
And just to give you an example of one I encountered, which
is a company, let us say, of 30,000 employees, a 100 factories
or office locations, has have five internal auditors who visit
those locations once every 10 years. That suggests that they
may not be focusing enough resources on the auditing function.
And then the board can say to the management why should we not
have more, should we not get more. And I think if management is
responsible, they will do something about it.
Mr. Greenwood. Have you looked at HealthSouth Corporation
enough to have an opinion as to whether the culture of
compliance that you have described existed there?
Mr. Wallance. I would say this: I am not familiar with the
details of how HealthSouth and the governance of HealthSouth,
but I will say that it is not rocket science when 15 high level
employees including CFOs for the last years all plead guilty to
felony conduct in connection with the conduct of the affairs of
the company to say this company does not have a culture of
compliance with law.
Mr. Greenwood. Okay. The report states in part ``Ultimately
the governing authority is responsible for the activities of
the organization. It can only perform this function of its
members are actively involved in compliance reviews and
reasonably educated about the business of the organization and
the legal and fiduciary duties of the governing authority
members.''
One of the Advisory Committee's proposed changes states:
``The organization's governing authority shall be knowledgeable
about the content and operation of the compliance program to
prevent and detect violations of the law and shall exercise
reasonable oversight with respect to the implementation and
effectiveness of the programs to prevent and detect violations
of the law.''
As a preliminary matter does governing authority generally
refer to a company's board of directors, is that what you're
referring to there?
Mr. Wallance. Yes. We had a definition. It means the board
or if there is no board, perhaps in a private company solely
owned, the highest authority within the company to decide
matters of substance for the company.
Mr. Greenwood. Okay.
The gentlelady from Colorado is recognized for 10 minutes.
Ms. DeGette. Thank you, Mr. Chairman.
Mr. Wallance, you have both served in the criminal arena
and now in the civil area. And as I was reviewing your
testimony last night it occurred to me these recommendations
that the Advisory Commission was preparing were for the
Sentencing Guidelines in the criminal arena, is that right?
Mr. Wallance. Well, yes.
Ms. DeGette. But the same principles I think would apply. I
mean, it is not just trying to set a criminal standard, but
really it is trying to say what should the highest and best
practices be for board conduct, correct?
Mr. Wallance. That is correct. And I would like to point
out that when we define a report an effective report to prevent
and detect violations of law, we did not limit, and we were
quite deliberate about this, the meaning of the term violations
of law to criminal violations.
Ms. DeGette. Right. Because in fact when you are talking
about board conduct, it will be infrequent if ever that you
could prove in a criminal court the means required for felony
conduct, right? I mean, most of this is taking place not at
that kind of level of specific intent, right?
Mr. Wallance. It tends to take place at the operational
level.
Ms. DeGette. Right.
Mr. Wallance. But the point is that if a corporation--a
corporation cannot deter and prevent violations of criminal law
unless it attempts to deter and prevent violations of all law.
Ms. DeGette. Exactly. And so what your recommendations are
really designed to do is to prevent the kinds of criminal
activity that we are seeing with HealthSouth and the
indictments we have seen out of that by a best practices kind
of system, right?
Mr. Wallance. Yes. That is essential.
Ms. DeGette. Now, what just occurred to me, though, is
having practiced myself both in the criminal and civil realm
some years ago, especially with white collar crime, what is
really effective in deterring that crime is if the individual
has personal exposure, which is in some ways why Sarbanes-Oxley
has been so effective not because of all the things we did, but
because they have to sign that financial disclosure, the
financials, right?
Mr. Wallance. Yes. I agree.
Ms. DeGette. Do you agree with that?
Mr. Wallance. Yes. I think that was one of the innovative
futures of Sarbanes-Oxley is the notion of personal
accountability for the financial reports and disclosure.
Ms. DeGette. Right. Because all the CEOs I know are
reviewing these things like they never have before, which is
good. Even in a company where you do have a good culture, it is
important, do you not agree?
Mr. Wallance. I do agree with that.
Ms. DeGette. Okay. So here's my question to you is what
kind of incentive can we give to corporate boards to have the
same level of care and concern for all these wonderful things
that your Advisory Commission has put in place? What is the
incentive for them to actually do this?
Mr. Wallance. Well, one of the incentives, and to some
extent it exists already, is that if the board fails to
adequately supervise the company, and particularly when it
comes to legal compliance, it is potentially exposed to
shareholder suits. And that was really the teaching of the
``Caremark'' decision in the Delaware Chancery Court in 1996
which suggested that in so many words that if a company fails
to follow the precepts of the organizational guidelines
compliance criteria, then the board is not doing its oversight
job and could be exposed to shareholder suits. So that is one
deterrent.
I also think that a deterrent has been set up in the past 2
years just by the sheer immensity of the scandals, their
devastating impact on individuals, the publicity and so on.
I do think that these kinds of hearings will also
contribute to that.
Ms. DeGette. I cannot help but think back to the boards I
have worked with in my life and, I am not sure before the last
few years and the congressional hearings and Sarbanes-Oxley and
everything, really corporate board members really understood
what their role was. Would you agree with that?
Mr. Wallance. Well, not entirely. I do think that the vast
majority of boards and companies in America are well
intentioned to take their responsibility seriously. I think
that over the last 10 years because of the Organizational
Sentencing Guidelines there has been a growing awareness of the
need for compliance. We have witnessed it. It is laid out in
our report, quotes from various people about just how 10 years
ago there was not a field of corporate compliance.
I think that we are always going to have people who do not
take the responsibility seriously or worse. All we can do is
try to put in place as many incentives as you're suggesting as
we can to defeat it to deter them from doing that kind of
either malfeasance or misfeasance.
Ms. DeGette. But I mean even though people have been aware
of these guidelines, I am not sure people have really
necessarily understood what their role is as a board member to
implement them, and especially in some of the high profile
situations we have had.
I have sat here and we have done Enron and Qwest and Tyco
and on and on and on. And the theme that runs through it
besides the evil doers at the top of the corporate management
is boards, many of the board members have been well meaning,
but they just did not understand. And they knew their role was
to have oversight, but they did not understand how to
accomplish that.
Mr. Wallance. Well, I agree that more needs to be done. And
we perceive of the absence in the guidelines of any recognition
of the role and responsibility of the board as something that
needs to be addressed.
Ms. DeGette. Have you had time, I know it is short notice,
to review the new SEC rules that were adopted by the New York
Stock Exchange and NASDAQ about the strengthening of corporate
governance standards? This just happened yesterday.
Mr. Wallance. I have not. But I was somewhat familiar with
the proposals before they were adopted.
Ms. DeGette. And do you think that is going to help this
along?
Mr. Wallance. Yes, I think it will. I think the notion of
compliance that address the high level officers, among other
things, I think all of them are very needed and necessary.
But let me explain, what we were trying to do in this
report and recommendations was pull all of this together. It
was not so much that we have invented something new under the
sun. But I think we have taken from Sarbanes-Oxley, from the
experience of the last 10 years, from the experience learned in
these scandals, from the regulatory changes and the SOR changes
and put it all in one place for the guidance of companies.
Ms. DeGette. And I think that is excellent guidance. But I
also think that if you have rules that are being required by
the SEC and other governing entities, that might put some legal
teeth behind the recommendations you are making.
Mr. Wallance. On that I completely agree. Because
ultimately what these guidelines are voluntary.
Ms. DeGette. Right. That is what I am trying to say.
Mr. Wallance. A corporation is not legally obligated to
adopt them. So to the extent they are embedded in law and
regulation, then obviously they will have that much----
Ms. DeGette. They will be that much more effective because
companies will have not just a recommendation, they will have a
requirement they have to abide by.
Now your report recommends that a company should do
proactive monitoring and auditing of its own compliance and
audit programs to see if they actually work instead of just
having a compliance officers and internal auditor make periodic
reports. How should that be carried out and who should do that?
Mr. Wallance. Well, we suggested that it could be done by a
subgroup, it could be the audit committee, particularly one
that may have independent directors on it. And we envision that
they would hear from persons involved in compliance
periodically as to the nature, the progress, the success of the
compliance program without the sort of the potential censoring
or filtering that senior managers might bring to that process.
Ms. DeGette. Right.
Mr. Wallance. So that is one way.
The other is to talk to people in the field. And I think
they have to become familiar with both the compliance program
in some detail as well as the business activities that may
expose the company to risk, and what is being done to avoid
that kind of risk.
Ms. DeGette. Now, in this case in 1999 there was a major
allegation of fraud by the top officers of the company. And
that turned out to be accurate, by the way. But it was
submitted to HealthSouth compliance officer. There was no
evidence that the compliance officer ever investigated the
allegation and the complainant was told that she needed to be
placated.
What type of structure could you put into place in that
type of situation to give that compliance officer more
authority and independence?
Mr. Wallance. I am not in a position to comment on that
specific situation.
I would say as a general rule it has to be made clear,
including by the board in various written statements, that
reports of wrongdoing need to be investigated. It doesn't mean
that people are presumed to be guilty before any investigation
has taken place. But when senior compliance officers receive
reports of wrongdoing, they need to be examined and
investigated and appropriate response implemented.
Ms. DeGette. And I would think it would be helpful also if
there were some kind of outside person that the compliance,
either independent director or someone on the board, they could
go to if they were not getting that kind of response
internally.
Mr. Wallance. Well, one thing many companies are doing is
providing separate outside counsel to the audit committee or
to, in effect, a litigation committee depending on the
circumstances so that that committee if it receives reports of
potential wrongdoing can have its own legal advice as to how to
respond to it.
Ms. DeGette. And those would be outside counsel with no
other conflicts, no other engagements with the company,
correct?
Mr. Wallance. Yes. I think in general what you're now
getting into is how internal investigations need to be
conducted.
Ms. DeGette. Right.
Mr. Wallance. And I can respond, perhaps, on that subject
briefly, which is I do think having done them, that it is
important to preserve the credibility of the investigation.
That it be done in a way that does not leave any question as to
whether things were not done because of potential----
Ms. DeGette. You know, my time has expired. And I
appreciate it. If we have some time for a second round, I will
come back to that.
Thank you.
Mr. Greenwood. The gentleman from Oregon, Mr. Walden, is
recognized for 10 minutes.
Mr. Walden. Thank you, Mr. Chairman.
I guess my first question is do you think that there is an
adequate mechanism in place for people who decide to represent
shareholders on a board to be trained in their
responsibilities? How do you ever as a board member know all
these rules and regulations?
You are off running your company and somebody says to you
that would be a great addition to our board. Let us see if they
run, and they do and they show up. And you have got a
domineering CEO that is quite successful and does all these
sort of strange things to board members, including having his
own security person follow him around.
My question is as a perspective board members, how do you
know what you are supposed to look for and is there any need
for some sort of requirement of training?
Mr. Wallance. Well, we did recommend that there be training
at all levels of the company. We did not exclude the board.
Now, obviously the training for the board is going to be a
little bit different than the training for the plant manager.
Mr. Walden. Yes.
Mr. Wallance. But there is no reason why a board cannot
insist on having the general counsel or the head of compliance
walk it through the compliance program in some detail just the
way it has presentations on the company's financial statements.
It does not mean it has to read every law or regulation. There
is a supervisory component to this. But it can be proactive in
getting information that would allow it to judge whether
processes and controls are properly being implemented through a
sure compliance with law.
Mr. Walden. But what if that board relies on an outside
auditors to evaluate those controls and that outside auditors
says the controls in place are permitable?
Mr. Wallance. Well, there is no question that a board is
ultimately going to have rely on the outside auditor. The
outside auditor is not doing his job, all right, absent some
red flags that the board perceives, then the system may break
down.
But I do think that the board has to be alert. I think this
is the teaching of these scandals is that the board has to be
alert to potential red flags that would indicate there may be a
conflict of interest. For example, transactions with no
apparent economic substances.
Mr. Walden. Right.
Mr. Wallance. Asking questions, why are we doing this if
there is no economic substance. What is the business purpose
behind this. Asking those kinds of questions in the course of
receiving information about the company's business operations,
I do think is a responsibility of a board to act on, again,
these kinds of red flags.
Mr. Walden. If an auditor's report showed that year after
year there's a red flag that came that said management is too
strong over the board, should that: (a) be reported to the
board and if so, what should be done about it?
Mr. Wallance. I honestly have not encountered that kind of
a management letter from an auditing company. Assuming it was
somewhat specific about why that created governance issues,
then yes. If that comes to the attention of the board, they
need to look into it and decide whether any particular remedial
action is called for.
Mr. Walden. How should an auditor handle a situation where
somebody sends them an email, their name, address on it says
look at these specific issues within this company. I think
there is a problem, and they are very specific in where to
look?
Mr. Wallance. I think it needs to be acted on and
investigated. There are a number of instances where it was that
kind of an anonymous note that was received either within
management or by an accounting firm that ultimately led to the
uncovery of serious problems. And to the extent that there is
enough detail to follow up and it presents at least on its face
an issue of concern, then it needs to be investigated.
Mr. Walden. What would be the appropriate response? If you
were the outside auditor and you got an email like that on a
company you were responsible for looking at, what would the
steps be you would take?
Mr. Wallance. Well, I am not an outside auditor. I am an
attorney. I would just suggest that I think it would be the
auditor's responsibility to make certain it is brought to the
attention of somebody within the company who has the discretion
and the authority to act on it, to then take it and deal with
it in an appropriate way.
Mr. Walden. Would it also be a recommendation that the
auditor would go back to the person making the claim?
Mr. Wallance. Well, again, you are now asking me for
standards governing the conduct of auditors, which is somewhat
outside of my expertise.
I think just in general I would say the organization needs
to follow up on that kind of information. And there is some
very practical reasons why. Because if it does not, the next
place that anonymous note or letter may go to is ``The Wall
Street Journal.'' And, if it does not go there, it may go to
the U.S. Attorney's Office.
So, hopefully, at the end it is not so much--and this is
part of it--that it is just that companies should want to be
good corporate citizens. That is certainly a part of it, they
should be. But there is a very practical self interest in
getting on top of these kinds of problems at the earliest
possible time when the company will have the most options
available to it to deal with those problems.
Mr. Walden. It appears in the case that we are reviewing
here, HealthSouth, that the people who were aware of potential
problems or alleged frauds were reporting to their compliance
officers who were apparently also involved in the fraud. How do
you get around that on a governance issue and does Sarbanes-
Oxley do that with the outside whistleblower protections and
things of that nature?
Mr. Wallance. It helps. Okay. All of these things help at
the end of the day. Will any of these programs prevent, and
again I am not referring to HealthSouth.
Mr. Walden. That is fine.
Mr. Wallance. But a determined effort, a conspiracy if you
will, by senior management including the people in charge of
compliance to avoid the law? No. At the end of the day it will
not. Some of these things are going to occur regardless of our
best efforts. What we can do is try to deter and prevent these
sorts of things from happening.
Mr. Walden. Do you see any remaining gaps out there after
we pass Sarbanes-Oxley? Is there something that has come forth
since then that causes you to say, gee, you ought to look here,
change this?
Mr. Wallance. Well, I think to the extent there are any
gaps, I would like to think that the Ad Hoc Advisory Group's
report fills them. But I want to stress, we were guided in
large part by Sarbanes-Oxley.
Mr. Walden. Right.
Mr. Wallance. And the other regulatory measures that have
been enacted in the last 2 years.
Mr. Walden. Right.
Thank you, Mr. Chairman. I yield back the balance of my
time.
Mr. Greenwood. And the Chair thanks the gentleman.
The gentleman from Florida is recognized for 10 minutes.
Mr. Stearns. Thank you, Mr. Chairman.
And, Mr. Wallance, as I understand your background you were
a prosecuting attorney on white collar crime?
Mr. Wallance. Yes, that is correct.
Mr. Stearns. And then you were a litigator on the private
side?
Mr. Wallance. Yes, that is what I currently do.
Mr. Stearns. And have you ever been on a board of
directors?
Mr. Wallance. No, I have not.
Mr. Stearns. Okay. So this information is pretty much just
from your perspective as a litigator?
Mr. Wallance. Well, it is partly from my perspective as a
litigator, partly from my experience in prosecuting
corporations as a prosecutor. And from participating in such
activities as this Ad Hoc Advisory Group.
Mr. Stearns. Give me a definition of what a proactive board
of directors? I mean, just maybe one or two sentence what the
definition is proactive?
Mr. Wallance. They do not wait to be told what is
happening.
Mr. Stearns. Okay.
Mr. Wallance. They ask, and go out and find out what is
happening in their company.
Mr. Stearns. Okay. At what point should a board of director
ask for forensic accounting audit? What flags do they have to
see forensic, you know, find out something is not right, we are
getting letters saying there is fraud? I mean, they had letters
going back to--I have one here from November 12, 1998 from a
``fleeced shareholder.'' It could be anybody.
But what is the thing that triggers in their mind that?
Mr. Wallance. Well, there is no hard and fast rule. I
cannot give you golden rule for triggering a forensic audit.
I think the company has to receive some kind of substantive
information that would appear to either be credible or derived
from some reliable source that suggests that there is a
potential for a violation of law, and then act on that. Whether
a forensic is required may not be apparent immediately. You may
have to do some initial investigation. And at a certain point
if the concerns appear serious enough, and again there is no--
--
Mr. Stearns. Hard and fast is what you are saying?
Mr. Wallance. Just generalizations, then it may be
appropriate to have that kind of level of scrutiny.
Mr. Stearns. If this board was proactive and they had some
concern, I think you have indicated they should meet with
members of the company's internal audit department?
Mr. Wallance. I want to be careful. We did not try to be
prescriptive, that prescriptive in our----
Mr. Stearns. Well, just let me ask you personally. If a
company, the board of directors had some indication that there
was a problem, should they in your definition of being
proactive meet with the company's internal audit department?
Mr. Wallance. If I were sitting on an audit committee of a
board of directors----
Mr. Stearns. Right.
Mr. Wallance. [continuing] and an issue arose that required
or should have been looked at by the internal auditors or was,
yes, I would meet with them.
Mr. Stearns. Okay.
Mr. Wallance. I would go talk to them.
Mr. Stearns. Okay.
Mr. Wallance. And ask them what are you doing about this or
what are you doing about complying----
Mr. Stearns. So we have a Board of Directors right behind
you. So they have to say in their mind there was enough for me
to say to the Chairman of the Board we should sit down and meet
with the internal audit department. And so in your own
estimation that is what the normal reaction if they have any
apprehension?
Mr. Wallance. Again, I am not in the position to address
HealthSouth specifically.
Mr. Stearns. Oh, no, I understand. But in a generic sense
you are saying yes?
Mr. Wallance. But, yes depending if there is a serious
issue that the internal auditors knew about or should have
known about, then there really is no reason why a proactive
audit committee would not hear from the internal auditors.
Mr. Stearns. Okay.
Mr. Wallance. Again, it is very case-by-case specific.
Mr. Stearns. If I went to the Fortune 500 companies, how
many of those board of directors are defined as proactive in
your opinion? I mean, just approximately? Most of them or none
of them?
Mr. Wallance. I could not--I would not----
Mr. Stearns. You would not venture a guess?
Mr. Wallance. I would not want to give you an opinion
having not done a survey.
I will point out that in the last week or 2 there was an
article in ``The Wall Street Journal'' about how much more time
board members are devoting to their duties. Again, I think the
vast majority of board members in this country are responsible.
I think they will be more active than ever, as suggested by
this ``Wall Street Journal'' article as a result of these
scandals.
Mr. Stearns. Yes.
Mr. Wallance. But we have work to do.
Mr. Stearns. Okay. So let us say we have this proactive
board of directors and under your guidelines there is some
flags. So they sit down and they say okay, we want to meet with
the internal audit department. Okay. So under your definitions
that is what they do.
They sit down with the internal audit department and they
find out that the internal audit department did not have access
to the company's corporate books and records. What would that
mean to you?
Mr. Wallance. Well, it would suggest potentially there has
been a breakdown of governance in at least that respect. The
way you present it, yes, if the auditors need those books and
records to do their job and they're not getting them, that is a
problem that needs to be addressed.
Mr. Stearns. Let me ask you about the composition of a
board of directors. You know, generally what happens these
board of directors are distinguished men and women in various
fields and they are friends of the CEO, and they are selected.
In your opinion is there an importance to the composition of
the board? Is that significant?
Mr. Wallance. Yes, I think it is but we did not try to
address that in the report. What I will point out is that there
has been legislation and regulation which addresses the need
for independent board of directors including independent
members of that board, including on the audit committee.
There is also, you know, a very health debate about what
size the board to be; too small or too big is not desirable.
There is, you know, an argument that it should be a certain
size. I do not really have views on those. Those are the sorts
of things that we have left, again in our report, to the
judgment of companies and boards to make as to how, in effect,
organize themselves.
Mr. Stearns. You mentioned the three levels of authority
earlier. You talked about the board, senior management and then
the employees to be able to whistleblow. I think those are the
three you mentioned. And you said in each case they must have
the resources and authority to act.
How do you provide a climate that people feel free to be
``a whistleblower'' or to go forward and say hey something is
wrong here? Because we have seen from the previous hearings we
have had like Ms. Watkins and others, that even when they lay
it out, A to Z, it is all covered up.
Mr. Wallance. Well, let us distinguish between the
reporting and then the acting on the reporting.
To encourage the reporting----
Mr. Stearns. Right. That is good.
Mr. Wallance. [continuing] there are a variety of ways, and
companies have been incredibly creative in the last 10 years
through training programs, dissemination of written materials,
personnel handbooks which employees are obligated to read and
sign that they have read, which all lay out the company's
commitment to compliance with law and give them means to report
with assurance of no retaliation which is now codified in
Sarbanes-Oxley.
Mr. Stearns. Right.
Mr. Wallance. And as we have suggested, anonymous
reporting. But I think that if that commitment is communicated
in sincere fashion from the highest levels of the company we
want you to talk to us, we want to know what is going on, I
think it will get the reporting in needs.
Mr. Stearns. In Tab 72 of our reports there is this memo
from a ``fleeced shareholder'' to HealthSouth as well as Ernst
& Young. And, frankly, in his roughly 250 words he lays out the
whole problem. And this was November 12, 1998. So 5 years ago.
And he talks about the clever tricks that are being used to
pump up the numbers. He says something that a novice accountant
could catch, but is not being caught. He talks about the
balanced budget amendment was passed and the impact it would
have in Medicare, and how is HealthSouth management being
effected by the balance budget amendments cutback. And they
cannot possibly be doing as well as they say. And does anyone
believe their nonsense about managed care pressure. And then he
has even little things like how can the company carry tens of
millions of dollars in account receivable that are well over, I
think it says 360 days or something.
But this kind of memo comes up.
Now, the Board of Directors would never know about this.
This could go to HealthSouth, or it could go to Ernst & Young.
And how do you protect this kind of information, say, this
could be a shareholder but it probably is an employee of
HealthSouth? Because to have this kind of detail that they
know, I do not think is a shareholder. I think this is somebody
inside. So, I would think this would be sort of a miniature
whistleblower. And how you get this information so it is
promulgated to the Board of Directors, and how do you get Ernst
& Young to act on it?
Mr. Wallance. Well, we suggest that there needs to be three
levels of corporate compliance responsibility. And, hopefully,
you are right, you would not expect that to get to the board.
You would hope that it would be brought to the attention, if
the procedures are working correctly, to at least the first or
second level. The day-to-day or they hope the person with
overall responsibility. If you have responsible people in those
positions, they will act on it. It does not mean they have to
hire an outside law firm and start an internal investigation or
hire forensic accountants. But they will want to follow up and
find out if there is any substances to this. And depending on
what they find out, they can either bring it to the attention
of the board and recommend that various measures be taken, or
they are satisfied that it does represent, let us say, a crank
there is no substance. Then if they have satisfied themselves,
then maybe no further action is needed.
But the board cannot do it all. I do not want to suggest
that.
Mr. Stearns. No, I know. It has got to be a team effort.
Mr. Wallance. Yes. Exactly.
Mr. Stearns. Thank you, Mr. Chairman.
Mr. Greenwood. The Chair thanks the gentleman.
Before we dismiss you, Mr. Wallance, one further question.
Ms. DeGette had a question on the table and we are both just
interested in your response as to how you would set up an
independent examination of the kind that this company did, and
what you would do, what your recommendations would be to a
company that wanted to set up a truly independent outside
review?
Mr. Wallance. Yes. I think we are now talking about
internal investigations, which we touched on earlier. I think a
company needs to--I think in general it would want to hire an
outside law firm. There is some debate, you know, in the
literature about whether it can do it itself or not. But I
think it has to be guided by this principle, which is if it
undertakes an internal investigation, the investigation has to
be done credibly. And the best way to assure credibility, the
appearance of credibility is to hire outside disinterested law
firms and accounting firms, again depending on the
circumstances, to conduct an independent investigation and give
the board or the appropriate subgroup or the next level of
compliance responsibility the unvarnished results of its
investigation so that the company can act responsibly on those
results.
Mr. Greenwood. And suppose that that outside law firm is
retained to do the internal examination and then subsequent to
that, defend the company? Can there be anything approximating
an independent examination if they have the expectation that
they may or may not continue to be retained for purposes of
defense work?
Mr. Wallance. You know, that is a harder question to
answer. The one that typically comes up is not so much when the
outside law firm represents the company in the ensuing
investigation, if there is one. And it may make a lot of sense
for it to do so, because it is familiar with facts. If it was a
credible law firm, then it may be the best firm to deal with,
for instance, investigators.
Typically where the issue comes up is when you hire a law
firm that has ongoing work, is doing ongoing work, especially
if the work that it is doing is the subject of the
investigation. Then I think the company has to ask itself,
okay, are we going to assure, you know, as great an opinion we
have of these lawyers, as well suited as they may to do this
investigation, are we going to assure the appearance of
credibility or would it be better to hire a law firm, or at
least one that has not done work in that area that is the
subject of the investigation.
Mr. Greenwood. And are there circumstances under which you
would think that that credibility could be maintained if the
subject of the investigation, the CEO for instance, had access
to that report before it was published?
Mr. Wallance. Well, that's another, that is a very tricky
area. And if I may, it is----
Mr. Greenwood. Before it was published or before it was
even presented to the board?
Mr. Wallance. And again, here is the thing and I have
lectured on this, I have set up hypotheticals based on it,
there is no real clear answer. You are sort of caught between
two issues.
First of all, the people managing the company do need to
know something about what is going on and the fact of the
internal investigation and what its findings are. On the other
hand, if the people managing the company's conduct, if their
conduct is the subject of the investigation, then you have the
problem with the appearance of credibility.
There is no easy answer. It is one of the most difficult I
know.
One solution that has been suggested is you do inform the
person whose conduct is at issue, but who is also a manager of
what is going on, but then suggest that he not be involved in
the day-to-day running of the internal investigation. And that
to the extent he receives information, he receives information
at the same time independent directors receive it. That has
been one suggestion.
Every case is different. It is an exquisitely difficult
issue for an outside lawyer advising a company under those
circumstances. And you have identified a very, very real issue
for internal investigations.
Mr. Greenwood. Well, we thank you again. You have helped
set the standards that will guide us in the rink throughout the
rest of the hearing today, and we appreciate that.
Mr. Wallance. Well, thank you for the opportunity.
Mr. Greenwood. Okay. You are dismissed, sir.
And we now call forward our second panel, consisting of Mr.
Joel Gordon, Acting Chairman of the Board of Directors of
HealthSouth Corporation; Mr. Robert May, Acting Chief Executive
Officer of HealthSouth Corporation; Ms. Sage Givens, Board of
Director and Audit Committee Member of HealthSouth
Corporation.; Mr. Larry Striplin, Board of Director and former
Chairman of Compensation Committee for HealthSouth Corporation,
and; Dr. Phillip Watkins, the former member of the Board of
Director and Compensation Committee Member for HealthSouth
Corporation.
You may be seated.
Welcome, and we thank you all for your attendance here this
morning.
It is my responsibility pursuant to the Rules of the
Committee to inform you that because this is an investigative
hearing, we take our testimony here under oath. And so I need
to ask if any of you object to giving your testimony under oath
this morning. Seeing no objection, I also would inform you that
you are entitled to be represented by counsel. And would ask if
any of the witnesses wish to be represented by counsel.
Mr. Gordon, do you, sir?
Mr. Gordon. Yes, I do.
Mr. Greenwood. And would you identify by name and by
pointing to your counsel, please?
Mr. Gordon. Yes. Pointing to No. 1, Mr. Bob Bennett, who is
counsel for the corporation and Mr. Mike Madigan, who is
counsel to the Board.
Mr. Greenwood. Thank you, sir.
Ms. Given, are you represented by counsel this morning?
Ms. Givens. Yes, I am. It is the same two gentlemen.
Mr. Greenwood. Same two gentlemen?
Dr. Watkins?
Dr. Watkins. Same two gentlemen.
Mr. Greenwood. Mr. Striplin?
Mr. Striplin. Same two gentlemen.
Mr. Greenwood. Mr. May?
Mr. May. Same two gentlemen.
Mr. Greenwood. How efficient. Very good.
I would ask now that if you would stand and raise your
right hands, please.
[Witnesses sworn.]
Mr. Greenwood. Okay. You each under oath. And are now
welcome to give your opening statements.
Mr. Gordon, do you have an opening statement?
Mr. Gordon. Yes, I do.
Mr. Greenwood. Okay. You are recognized for 5 minutes to
give that opening statement. I suggest that you pull your
microphone a little bit directly to you, and make sure it is
on. And we would look forward to your statement, sir.
TESTIMONY OF JOEL GORDON, ACTING CHAIRMAN, BOARD OF DIRECTORS,
HEALTHSOUTH CORPORATION; SAGE GIVENS, BOARD OF DIRECTORS AND
AUDIT COMMITTEE MEMBER, HEALTHSOUTH CORPORATION; PHILLIP
WATKINS, FORMER MEMBER OF THE BOARD OF DIRECTORS AND
COMPENSATION COMMITTEE MEMBER, HEALTHSOUTH CORPORATION; LARRY
D. STRIPLIN, BOARD OF DIRECTORS AND FORMER CHAIRMAN,
COMPENSATION COMMITTEE, HEALTHSOUTH CORPORATION; AND ROBERT
MAY, ACTING CHIEF EXECUTIVE OFFICER, HEALTHSOUTH CORPORATION
Mr. Gordon. Mr. Chairman, ranking member, and members of
the subcommittee, good morning.
My name is Joel Gordon and I am Interim Chairman of the
HealthSouth Board of Directors, having been appointed Interim
Chairman on March 19, 2003. On behalf of the entire HealthSouth
team and our more than 48,000 employees throughout the country,
I appreciate the opportunity to appear before the subcommittee.
As yesterday's indictment of Richard Scrushy, the former
Chairman and CEO, indicates, Mr. Scrushy, along with former
members of management, directed a massive accounting fraud at
HealthSouth. The Department of Justice has charged that they
not only defrauded the company and its shareholders, but also
the Board of Directors. I look forward to answering your
questions and describing the progress that the Board and the
company have made over the past 7 months in stabilizing our
business since the massive accounting fraud first came to
light.
As you may know, HealthSouth is a leader in inpatient and
outpatient rehabilitation, diagnostics and outpatient surgery.
In its short history, HealthSouth has grown to become the
Nation's largest provider of healthcare services, with nearly
1,700 locations throughout the country and abroad, and more
than 48,000 employees. With our broad network of outstanding
facilities, highly skilled physicians and therapists, and
state-of-the-art technology and equipment, we are able to
provide all of our patients easy access to high quality
healthcare.
Since March 2003, when we were first made aware of the
allegations of accounting fraud, the company and its new
management team have actively cooperated with, and assisted to
the best of our abilities, all government inquiries so that the
people who committed this fraud can be brought to justice. We
did this because it is the right thing to do--and it is in that
same spirit that I and my fellow board members have come here
today to answer your questions.
HealthSouth's public stockholders have clearly been harmed
by the fraud, and I can assure you that I understand very well
the frustration and outrage of shareholders who have lost value
in the company's stock. My family and I have been, and continue
to be, the largest non-institutional stockholder in
HealthSouth. I acquired these shares when I sold my company,
Surgical Care Affiliates, to HealthSouth in 1996 in an all
stock deal, and I have held on to virtually all these shares--
over 99.9 percent.
My family currently owns 9.5 million shares and I have
options on an additional 500,000 shares that came from the
acquisition of Surgical Care, which is the result of a lifetime
of work. The value of my shares has shrunk from a high of
approximately $290 million to a very small fraction of that
today, the largest loss of any individual shareholder. But, I
am determined to build HealthSouth back to a respected position
in the healthcare community and to help restore value for our
stakeholders.
When the accounting fraud first was disclosed last March,
the HealthSouth Board took quick and decisive action. We put
Mr. Scrushy on an immediate leave of absence and installed a
new leadership team. Shortly thereafter, Mr. Scrushy's
employment agreement was declared null and void.
We assembled a first-rate team of experienced outside
advisors to help the company through this crisis. We hired
PricewaterhouseCoopers to conduct a forensic review and
terminated our relationship with Ernst & Young as our auditors.
We also retained Skadden Arps as our coordinating legal counsel
to assist us. And we brought in the firm of Alvarez & Marsal
for their financial and operating restructuring expertise.
Immediately we began implementing measures to stabilize the
company's operations, without disrupting the most critical part
of our business; patient care. We have been able to make steady
progress in each of our primary goals of protecting our core
clinical and patient needs, improving and strengthening our
cash-flow, and restoring the company's financial credibility.
While there is much work to be done, we are seeing real and
measurable success day in and day out.
In addition to assisting with all government inquiries, we
recognize that many of our stakeholders; stockholders,
bondholders, suppliers, employees, and patients have been hurt
by the actions of the people who committed the fraud and we are
doing everything possible to rectify that.
On a business level, we have been working diligently to
meet our financial obligations, and to restore the company's
credibility with our stockholders and the investing public. In
mid-August, HealthSouth, a company that most people in the
early weeks predicted would file for bankruptcy protection,
made a payment of $117 million representing all past due
interest owed our creditors. On October 1, the regular
scheduled semi-annual interest payment due our bondholders of
approximately $40 million was made. We intend to remain current
on all upcoming interest payments, and to repay all the
principal amounts in full.
The progress we have been making over the past 7 months in
our business is due in large part to the hard work and
dedication of our thousands of employees throughout the
country, and I would like to take this opportunity to thank
them. They have remained focused on their work and have not let
the wrongdoings of a small group of individuals derail the
future of our company. Without this commitment to delivering
outstanding care to our patients each and every day, the recent
success at HealthSouth would not have been possible.
As the son of an immigrant who grew up in a coal mining
community of 600, I understand hard work and the commitment it
takes to ensure success.
To underscore my commitment to these employees and
stockholders, I have chosen to defer receipt of any salary as
Interim Chairman until the company's recovery is stable and
secure, and the company is on a solid financial footing.
I have also voluntarily canceled the consulting agreement I
had as a result of selling Surgical Care Affiliates to
HealthSouth in 1996.
Let me conclude by saying that throughout my 7 years of
service to the Board, I believe I have exercised independent
judgment in all matters. As a major shareholder, I am outraged
by the conduct of this company's former management, who
successfully concealed thousands of fraudulent accounting
entries from Ernst & Young and the Board, to the detriment of
all HealthSouth stakeholders.
The Board and management team remains committed to taking
the necessary action to ensure that we reach the goal of
restoring the long term health and vitality of HealthSouth.
Mr. Chairman, I will, to the best of my ability, be glad to
answer any questions you or other members of the subcommittee
may have.
[The prepared statement of Joel Gordon follows:]
Prepared Statement of Joel Gordon
Mr. Chairman, Ranking Member, and members of the Subcommittee, good
morning.
My name is Joel Gordon and I am Interim Chairman of the HealthSouth
Board of Directors, having been appointed Interim Chairman on March 19,
2003. On behalf of the entire HealthSouth team and our more than 48,000
employees throughout the country, I appreciate the opportunity to
appear before the Subcommittee.
As yesterday's indictment of Richard Scrushy, the former Chairman
and CEO, indicated, Mr. Scrushy, along with former members of
management, directed a massive accounting fraud at HealthSouth. The
Department of Justice has charged that they not only defrauded the
Company and its shareholders, but also the Board of Directors. I look
forward to answering your questions and describing the progress that
the Board and the Company have made over the past seven months in
stabilizing our business since the massive accounting fraud first came
to light.
As you may know, HealthSouth is a leader in inpatient and
outpatient rehabilitation, diagnostics and outpatient surgery. In its
short history, HealthSouth has grown to become the nation's largest
provider of healthcare services, with nearly 1,700 locations throughout
the country and abroad, and more than 48,000 employees. With our broad
network of outstanding facilities, highly skilled physicians and
therapists, and state-of-the-art technology and equipment, we are able
to provide all of our patients easy access to high quality healthcare.
Since March 2003, when we were first made aware of the allegations
of accounting fraud, the Company and its new management team have
actively cooperated with, and assisted to the best of our abilities,
all government inquiries so that the people who committed this fraud
can be brought to justice. We did this because it is the right thing to
do--and it is in that same spirit that I and my fellow Board members
have come here today to answer your questions.
HealthSouth's public stockholders have clearly been harmed by the
fraud, and I can assure you that I understand very well the frustration
and outrage of shareholders who have lost value in the Company's stock.
My family and I have been, and continue to be, the largest non-
institutional stockholders in HealthSouth. I acquired these shares when
I sold my company, Surgical Care Affiliates, to HealthSouth in 1996 in
an all stock deal, and I have held on to virtually all these shares--
over 99.9 percent. My family currently owns 9.5 million shares and I
have options on an additional 500,000 shares, which is the result of a
lifetime of work. The value of my shares has shrunk from a high of
approximately $290 million to a very small fraction of that today--the
largest loss of any individual shareholder. But, I am determined to
build HealthSouth back to a respected position in the healthcare
community and to help restore value for our stakeholders.
When the accounting fraud first was disclosed last March, the
HealthSouth Board took quick and decisive action. We put Mr. Scrushy on
an immediate leave of absence and installed a new leadership team.
Shortly thereafter, Mr. Scrushy's Employment Agreement was declared
null and void. We assembled a first-rate team of experienced outside
advisors to help the Company through this crisis. We hired
PricewaterhouseCoopers to conduct a forensic review and terminated our
relationship with Ernst & Young as our auditors. We also retained
Skadden Arps as our coordinating legal counsel to assist us. And we
brought in the firm of Alvarez & Marsal for their financial and
operating restructuring expertise.
Immediately we began implementing measures to stabilize the
Company's operations, without disrupting the most critical part of our
business--patient care. We have been able to make steady progress in
each of our primary goals of protecting our core clinical and patient
needs, improving and strengthening our cash flow, and restoring the
Company's financial credibility. While there is much work to be done,
we are seeing real and measurable success day in and day out.
In addition to assisting with all government inquiries, we
recognize that many of our stakeholders--stockholders, bondholders,
suppliers, employees, and patients--have been hurt by the actions of
the people who committed the fraud and we are doing everything possible
to rectify that.
On a business level, we have been working diligently to meet our
financial obligations, and to restore the Company's credibility with
our stockholders and the investing public. In mid-August, HealthSouth--
a company that most people in the early weeks predicted would file for
bankruptcy protection--made a payment of $117 million representing all
past due interest owed our creditors. On October 1st we made the
regularly scheduled semi-annual interest payment due to our bondholders
of approximately $40 million. We intend to remain current on all
upcoming interest payments, and to repay all the principal amounts in
full.
The progress we have been making over the past seven months in our
business is due in large part to the hard work and dedication of our
thousands of employees throughout the country, and I would like to take
this opportunity to thank them. They have remained focused on their
work and have not let the wrongdoing of a small group of individuals
derail the future of our Company. Without this commitment to delivering
outstanding care to our patients each and every day, the recent success
at HealthSouth would not have been possible. As the son of an immigrant
who grew up in a coal mining community of 600, I understand hard work
and the commitment it takes to ensure success.
To underscore my commitment to these employees and stockholders, I
have chosen to defer receipt of any salary as Interim Chairman until
the Company's recovery is stable and secure, and the Company is on a
solid financial footing. I have also voluntarily cancelled the
consulting agreement I had as a result of selling Surgical Care
Affiliates to HealthSouth in 1996.
Let me conclude by saying that throughout my seven years of service
to the Board, I believe I have exercised independent judgment in all
matters. As a major shareholder, I am outraged by the conduct of this
Company's former management, who successfully concealed thousands of
fraudulent accounting entries from Ernst & Young and the Board, to the
detriment of all HealthSouth stakeholders.
The Board and management team remain committed to taking the
necessary actions to ensure that we reach the goal of restoring the
long term health and vitality of HealthSouth.
Mr. Chairman, I will, to the best of my ability, be glad to answer
any questions you or other members of the Subcommittee may have.
Mr. Greenwood. Thank you, Mr. Gordon. We appreciate that.
Ms. Givens.
TESTIMONY OF SAGE GIVENS
Ms. Givens. Good morning, Mr. Chairman.
Mr. Greenwood. Good morning.
Ms. Givens. Ms. DeGette, and members of the subcommittee.
My name is Sage Givens. I am a member of the Board of
Directors of HealthSouth. I am the Founding Managing Partner of
Acacia Venture Partners, which was the first venture capital
firm to specialize in healthcare services. Since 1983 I have
helped many leading healthcare services companies from the
ground up by providing badly needed capital. Like HealthSouth
these companies have been successful because they provide
millions of Americans with high quality healthcare at
affordable prices.
I joined HealthSouth's Board of Directors in 1985, when my
firm First Century Partners invested in the company. After the
company went public in 1987, I was annually re-elected to the
HealthSouth Board by shareholders. I have remained on the Board
because I believe so strongly in what HealthSouth stands for;
high quality, affordable healthcare.
The HealthSouth Board over the years has included many
distinguished and accomplished individuals. This Board has also
surrounded itself with experts in the fields of finance,
compensation, financial reporting, compliance and ethics. The
Board was regularly briefed by nationally recognized firms such
as Ernst & Young, Mercer Human Resource Consulting, Strategic
Management Systems, and many others.
Although we do not have the details of how this fraud
occurred, what we have learned so far is that it was a very
carefully orchestrated, highly sophisticated accounting fraud,
designed to evade detection. Indeed, at HealthSouth we had
numerous controls and systems in place that should have helped
to detect this fraud. Unfortunately, when high-level management
conspires to commit a criminal act, I do not know of any
corporate governance policy that would prevent such criminal
behavior. From the beginning, I have been a vigilant, active
and well prepared Board member. I have asked the tough
questions and have been unafraid to express my thoughts
forcefully. Any implication to the contrary is just plain wrong
and goes against my reputation for being a tough but fair-
minded director of numerous companies over the years, both
public and private.
It is difficult to convey how shocked and saddened I have
been since learning of the fraud committed against the company.
After all, it was touted by many one of the best rehabilitation
companies and the first healthcare company to establish itself
in all 50 states. It was associated with numerous world-class
physicians and established a preeminent reputation in the
treatment of sports injuries, cardiac and stroke patients, and
was endorsed by prominent figures in many walks of life.
Now I would like to take the opportunity to address the
subject of the audit committee which was discussed during the
first day of your hearings, Mr. Chairman. I have been a member
of the audit committee since 1989. Early on, the company
selected Ernst & Young, one of the most highly experienced and
nationally recognized accounting firms in the country.
The audit committee met regularly and was often joined by
representatives of Ernst & Young. Detailed questions were asked
of Ernst & Young at these meetings about the company's finances
and we were regularly assured that the company's accounting
practices and internal control systems were among the best in
the country.
Audit committee members, as well as other Board members,
queried Ernst & Young about any and all accounting deficiencies
to be addressed and corrected. None, not one, was ever raised
by the auditors in the 13 plus years I served on the audit
committee. Indeed, in Ernst & Young's Management reports for
the last 3 years, the auditors declared that they found ``no
material errors, fraud, or possible material illegal acts.''
Finally, I would like to respond to questions about
business relationships with HealthSouth that are described as
``Related Party Transactions.'' As you know, Federal securities
law contemplates and permits such transactions.
I am a venture capitalist and I specialize in the
healthcare industry. My job is to find new and innovative
companies which can deliver superior healthcare services at
affordable prices to all Americans. When I found examples of
companies which provide good medical care at affordable prices,
I not only invested my company's capital in those companies,
but I thought it made good sense to share those opportunities
with HealthSouth. Sometimes HealthSouth thought it was in the
company's and its shareholders' best interests to invest and it
did so. And more times than not, HealthSouth declined to make
an investment.
There is not one example of a time when I or my firm
pressured HealthSouth to make an investment. In virtually all
of those transactions, HealthSouth and its shareholders have
benefited.
HealthSouth, despite the enormity of the malfeasance
committed by a few individuals, has clearly contributed a great
deal to the healthcare industry. The fact that the company is
still standing strong and has staved off bankruptcy is a
testament to its employees and the quality of medical care it
has provided to millions of patients. Indeed, I believe that
with the dedication and leadership of the Board and the new
management team, HealthSouth will continue to make an enormous
contribution to medical care in this country. My focus as a
Board member has always been, and continues to be, to ensure
HealthSouth's future as a viable, strong and ethical business.
Thank you.
[The prepared statement of Sage Givens follows:]
Prepared Statement of Sage Givens
Mr. Chairman, Ranking Member, and members of the Subcommittee, good
morning.
My name is Sage Givens. I am a member of the Board of Directors of
HealthSouth. I am the Founding Managing Partner of Acacia Venture
Partners, which was the first venture capital firm to specialize in
healthcare services. Prior to that, I was a principal at First Century
Partners, where I managed the firm's healthcare practice. The venture
funds with which I have been associated have helped build many leading
healthcare service companies from the ground up by providing badly
needed capital to help them get started and to grow. Like HealthSouth,
these companies have been successful because they provide millions of
Americans with high quality healthcare at affordable prices.
I joined HealthSouth's Board of Directors in 1985, when First
Century Partners invested in the Company. As a condition of its
investment, First Century required a seat on the Board, and my partners
selected me to fill that seat. At that time, HealthSouth was a private
company with only 2 facilities and less than $2.0 million in revenues.
After the Company went public in 1987, I was annually re-elected to the
HealthSouth Board by shareholders. I have remained on the Board because
I believe so strongly in what HealthSouth stands for--high quality,
affordable healthcare.
The HealthSouth Board over the years has included many
distinguished and accomplished individuals. This Board has also
surrounded itself with experts in the fields of finance, compensation,
financial reporting, compliance and ethics. The Board was regularly
briefed by nationally recognized firms such as Ernst & Young, Deloitte
& Touche, Mercer Human Resource Consulting, Strategic Management
Systems, and many others.
Although we do not have all of the details of how this fraud
occurred, what we have learned so far is that it was a very carefully
orchestrated, highly sophisticated accounting fraud, designed to evade
detection. Indeed, at HealthSouth we had numerous controls and systems
in place that should have helped to detect this fraud. Unfortunately,
when high-level management conspires to commit a criminal act, I do not
know of any corporate governance policy that would prevent such
criminal behavior. How to prevent this type of fraud in the future is
certainly a challenge for boards all across this country.
As long as I have served on this Board, I have strongly believed
that this was a company which simultaneously rewarded its shareholders
while providing outstanding service to hundreds of thousands of
patients per year. From the beginning, I have been a vigilant, active
and well-prepared Board member. I have asked the tough questions and
have been unafraid to express my thoughts forcefully. Any implication
to the contrary is just plain wrong and goes against my reputation for
being a tough but fair-minded director of numerous companies, both
public and private.
It is difficult to convey how shocked and saddened I have been
since learning of the fraud committed against the Company. After all,
HealthSouth was touted by many as being a premier healthcare company.
It was the first and best national rehabilitation company and the first
healthcare company to establish itself in all 50 states. It was
associated with numerous world-class physicians and established a
preeminent reputation in the treatment of sports injuries, as well as
of cardiac and stroke patients, and was endorsed by prominent figures
in many walks of life.
I would like to take the opportunity to address the subject of the
Audit Committee which was discussed during the first day of your
Hearings, Mr. Chairman. I have been a member of the Audit Committee
since 1989. Early on, the Company selected Ernst & Young, one of the
most highly experienced and nationally recognized accounting firms in
the United States. The Audit Committee met regularly and was often
accompanied by representatives of Ernst & Young. Detailed questions
were asked of Ernst & Young at these meetings about the Company's
finances and we were regularly assured that the Company's accounting
practices and internal control systems were among the best in the
country.
Audit Committee members, as well as other Board members, queried
Ernst &Young about any and all accounting deficiencies to be addressed
and corrected. None, not one, was ever raised by the auditors in the
13+ years I served on the Audit Committee. Indeed, in Ernst &Young's
Management Reports for the last 3 years, the Auditors declared that
they found ``no material errors, fraud, or possible material illegal
acts.''
Finally, I would like to respond to questions about business
relationships with HealthSouth that are described as ``Related Party
Transactions.'' As you know, federal securities law contemplates and
permits such transactions. I am a venture capitalist and I specialize
in the healthcare industry. My job is to find new and innovative
companies which can deliver superior healthcare services at affordable
prices to all Americans. That is why my company invested in HealthSouth
to begin with. When I have found examples of companies which provide
good medical care at affordable prices, I not only invested my
company's capital in those companies, but I thought it made good sense
to share those opportunities with HealthSouth. Sometimes HealthSouth
thought it was in the Company's and its shareholders' best interests to
invest and did so. And more times than not, HealthSouth declined to
make an investment. There is not one example of a time when I or my
firm pressured HealthSouth to make an investment. In virtually all of
those transactions, HealthSouth and its shareholders have benefited.
HealthSouth, despite the enormity of the malfeasance committed by a
few individuals, has clearly contributed a great deal to the healthcare
industry. The fact that the Company is still standing strong and has
staved off bankruptcy is a testament to its employees and the quality
of medical care it has provided to millions of patients. Indeed, I
believe that with the dedication and leadership of the Board and the
new management team, HealthSouth will continue to make an enormous
contribution to medical care in this country. My focus as a Board
member has always been, and continues to be, to ensure HealthSouth's
future as a viable, strong and ethical business.
I support this Committee's efforts to identify the facts and to
seek ways of preventing this type of fraud in the future. Thank you.
Mr. Greenwood. Well, thank you, Ms. Givens.
Dr. Watkins, do you have an opening statement, sir?
TESTIMONY OF PHILLIP WATKINS
Mr. Watkins. Good morning, Mr. Chairman, ranking member,
and members of the subcommittee.
My name is Dr. Phillip Watkins. I am a former member of the
HealthSouth Board of Directors. I resigned from the Board in
February 2003 and am proud of my long service on behalf of
HealthSouth and its stockholders. And I welcome the opportunity
to share with the subcommittee my insight into the Board's
functions.
Let me describe my background. I am a cardiologist in
private practice in Birmingham where I grew up. Went to
undergraduate and medical school, trained at the Mayo Clinic in
and specialized in cardiovascular disease.
I first became involved with HealthSouth, which was a
startup brand new company then known as Amcare, in 1983, after
I first met Richard Scrushy. Mr. Scrushy proposed a merger of
my practice's cardiac rehabilitation facility with Amcare to
form what is known at that time as a ``CORF'' or a
comprehensive outpatient rehabilitation facility.
In 1984, I was asked by Mr. Scrushy to join the company's
Board of Directors, 2 years before HealthSouth became a
publicly traded company. As a physician and director, it was
determined that I could add valuable insight by talking to our
physicians and helping to meet their needs in working at and
with our facilities. Our ability to provide high quality,
efficient, low cost patient care was the core of the company's
business.
Early on, I was appointed Chairman of the Board's audit &
compensation committee. At that time the company was a startup
with such a small Board that these two functions were combined
to form one committee. At that time, many companies followed
that practice. Later, the committees were separated into two
distinct committees.
As Chairman of the audit & compensation committee, I worked
with and relied upon the outside experts hired by our Board.
For example, we hired Mercer Human Resource Consulting to
assist our committee on compensation questions and act as our
compensation consultants. Mercer retains a reputation as one of
the largest and most relied upon compensation consulting firms
in the country. Mercer analyzed the compensation trends of
similar firms in the healthcare industry and, along with other
experts we employed, advised the compensation committee on our
compensation plans. It was based upon this information and
advice that we determined the compensation packages of
HealthSouth's management team.
By all accounts, HealthSouth was growing at an exciting
pace, and was singled out by publications such as ``Forbes''
and ``Fortune,'' as an up and coming star in the field of
outpatient surgery and rehabilitation. Since I joined the
HealthSouth Board in 1984, I have seen HealthSouth grow from a
company with two rehabilitation facilities, one in Little Rock
and one in Birmingham, to become the largest outpatient
surgery, rehabilitation and diagnostic services company in the
world with over 48,000 employees.
The compensation for HealthSouth senior executives,
including Mr. Scrushy, was based upon this apparent outstanding
performance, and the committee was always assured by the
independent analyses of experts such as Mercer that the Board's
compensation philosophy was entirely in keeping with the best
practices at the time. Specifically, we implemented a
performance based incentive-compensation program, which
included annual bonuses, stock option grants under a
stockholder approved option plan. We now know the numbers we
relied on and were certified by our outside accountants to
calculate these numbers were fraudulent. If the compensation
committee had known of the fraud, Mr. Scrushy and others had
done, we would have been terminated him immediately and they
would never have received any of their salaries, bonuses or and
stock options.
I was as shocked and angry as the rest of the public when I
learned that senior members of HealthSouth's management team
had been perpetrating a fraud on HealthSouth's stockholders. As
the indictment stated, the Board of Directors was similarly
deceived by fraud. These criminal conspirators were able to
fraudulently conceal or otherwise alter information and
documents that all of the experts including the accounting firm
of Ernst & Young could not detect the fraud. As a corporate
director, I relied upon the accuracy of information provided to
me by both management and by outside experts such as Ernst &
Young. It is now evident that because the truth had been so
thoroughly concealed by certain former members of management,
the probing questions and activism of this Board could not have
discovered the existence of this accounting fraud.
Let me conclude by saying that I am proud of my service to
the HealthSouth Board. HealthSouth enabled me to combine my
obligation as a medical doctor to patients along with that as a
director to the company to its stockholders. Had I known of the
hidden fraud being perpetrated on us all, I would have acted
quickly and decisively, just as the current Board has done in
removing those responsible.
HealthSouth is one of the great healthcare companies in
America and I am confident that it will continue to go forward
under the guidance of the new management team.
I look forward to answering any questions.
[The prepared statement of Phillip Watkins follows:]
Prepared Statement of Phillip Watkins
Mr. Chairman, Ranking Member, and members of the Subcommittee, good
morning.
My name is Dr. Phillip Watkins, and I am a former member of the
HealthSouth Board of Directors. I resigned from the Board in February
2003 and am proud of my long service on behalf of HealthSouth and its
stockholders. I welcome the opportunity to share with the Subcommittee
my insight into the Board's functions at HealthSouth.
First, let me describe my background. I am a cardiologist in
private practice in Birmingham where I grew up. I attended the
University of Alabama, the Medical College of Alabama, trained at the
Mayo Clinic in Internal Medicine and specialized in Cardiovascular
Disease. I am currently the Medical Director of The Autonomic Disorders
and Mitral Valve Prolapse Center located in Birmingham, Alabama.
I became involved with HealthSouth, a brand new company then known
as Amcare, in 1983, after I first met Mr. Scrushy. Mr. Scrushy proposed
a merger of my practice's cardiac rehabilitation facility with Amcare
to form what is known as a ``CORF''--Comprehensive Outpatient
Rehabilitation Facility. The unique concept of a CORF was to combine
outpatient surgery and rehabilitation facilities into one stand-alone
medical complex in order to ease patient burden and expense, and
ultimately provide for more successful patient recoveries.
In 1984, I was asked by Mr. Scrushy to join the Company's Board of
Directors, two years before HealthSouth became a publicly traded
company in 1986. As a physician and director, it was determined that I
could add valuable insight by talking to physicians and helping to meet
their needs in working with our facilities. Our ability to provide high
quality, efficient, low cost patient care was the core of the Company's
business.
Early on, I was appointed Chairman of the Board's Audit &
Compensation Committee. At that time the Company was a startup with
such a small board that these two functions were combined to form one
committee. At that time, many companies followed this practice. Later,
the committees were separated into two distinct committees.
As Chairman of the Audit & Compensation Committee, I worked with
and relied upon the outside experts hired by our Board. For example, we
hired Mercer Human Resource Consulting to assist the Committee as our
compensation consultants. Mercer retains a reputation as one of the
largest and most relied upon compensation consulting firms in the
country. Mercer analyzed the compensation trends of similar firms in
the healthcare industry and, along with other experts, advised the
Compensation Committee. It was based upon this information and advice
that we determined the compensation packages of HealthSouth's
management team.
By all accounts, HealthSouth was growing at an exciting pace, and
was singled out by numerous industry publications, including Forbes and
Fortune, as an up and coming star in the field of outpatient surgery
and rehabilitation. Since I joined the HealthSouth Board in 1984, I
have seen HealthSouth grow from a company with two rehabilitation
facilities--one in Little Rock and one in Birmingham--to become the
largest outpatient surgery company, rehabilitation company and
diagnostic services company in the world with over 48,000 employees
throughout the country. The compensation for HealthSouth senior
executives, including Mr. Scrushy, was based upon this apparent
outstanding performance, and the Committee was always assured by the
independent analyses of experts such as Mercer that the Board's
compensation philosophy was entirely in keeping with the best practices
at the time. Specifically, we implemented a performance based
incentive-compensation program, which included annual bonuses and stock
option grants under a stockholder-approved option plan.
We now know the numbers we relied on and were certified by our
outside accountants to calculate senior management compensation were
fraudulent. If the Compensation Committee had known of the fraud, Mr.
Scrushy and others would have been terminated immediately and would
never have received these salaries, bonuses, and stock options.
I was as shocked and angry as the rest of the public when I learned
that senior members of HealthSouth's management team had been
perpetrating a fraud on HealthSouth's stockholders. The Board of
Directors was similarly deceived. These criminal conspirators were able
to fraudulently conceal or otherwise alter information and documents
such that all of the experts including the accounting firm of Ernst &
Young did not detect the fraud. As a corporate director, I relied on
the accuracy of information provided to me by management and by outside
experts such as Ernst & Young. It is now evident that because the truth
had been so thoroughly concealed by certain former members of
management, the probing questions and activism of this Board could not
have discovered the existence of this accounting fraud.
In addition to questioning former management and outside experts,
the Company had in place internal control systems designed, in part, to
catch fraud. But every system of checks and balances is only as good as
the people who are there and use them. Ms. Henze testified that she did
use the compliance system we had set up to receive and act upon such
information. That's how the compliance system was supposed to work. It
is incomprehensible to me how designated compliance personnel could
have received such apparently clear information and could not have told
Ernst & Young, the Audit Committee or the Board.
Just to be clear, the fraud occurred at a corporate level. Ernst &
Young conducted the corporate-wide audit. In contrast, internal audit
conducted facility level audits. The Subcommittee heard testimony two
weeks ago from Ms. Teresa Sanders and Mr. Greg Smith of HealthSouth's
internal audit department. The Audit Committee did meet on a regular
basis with Ms. Sanders and Mr. Smith and received their reports and
questioned both of them. In fact, I had more internal auditors added to
the internal audit staff after talking to Ms. Sanders. They never told
us they had any suspicion of impropriety.
Let me conclude by saying that I am proud of my service to the
HealthSouth Board. HealthSouth enabled me to combine my obligation as a
medical doctor to patients with that as a director of the Company to
the stockholders. Had I known of the hidden fraud being perpetrated on
us all, I would have acted quickly and decisively, just as the current
Board has in removing those responsible. HealthSouth is one of the
great healthcare companies in America and I am confident that it will
continue to be under the guidance of the new management team. I look
forward to answering any questions you or any other members of the
Subcommittee may have.
Mr. Greenwood. Thank you, Dr. Watkins.
Mr. Striplin, do you have an opening statement, sir?
TESTIMONY OF LARRY D. STRIPLIN
Mr. Striplin. Mr. Chairman, ranking member, and members of
the subcommittee, good morning.
Mr. Greenwood. You need to turn on your microphone and
maybe point it toward you a little bit. Turn it down a little
bit so it's pointing toward you. There you go.
Mr. Striplin. Mr. Chairman and ranking member, and members
of the subcommittee, good morning.
My name is Larry Striplin, and I am a member of the
HealthSouth Board of Directors. And I joined the Board in April
1999, and have been proud to serve with the talented and
experienced directors seated next to me today.
As you know, HealthSouth grew from a company with two
patient care facilities, one in Little Rock and one in
Birmingham, to a company with more than 1,700 facilities across
the country. HealthSouth has set the standard for providing
state-of-the-art rehabilitation services to patients ranging
from professional athletes recovering from sports injuries to
grandparents recovering from strokes.
First, let me tell you a little of my background. I am a
native of Selma, Alabama. I graduated from Birmingham-Southern
College with a degree in education. I pursued my education at
George Peabody College (now a part of Vanderbilt University) in
Nashville, Tennessee, where I obtained a master's degree in
Education.
I have owned and operated my own business, Nelson Brantley
Glass Company, since 1963 and am currently the Chairman and CEO
of this company. I also serve as CEO of Circle ``S''
Industries. Also, in 1977, I established American Fine Wire,
which was one of Selma's largest employers. I am a member of
the Boards of directors of Kulicke & Suffa Industries, Inc.,
which purchased American Fine Wire.
In addition to my work with my own companies, I have always
been actively involved in various civic activities. I was
instrumental in establishing the Alabama Sports Hall of Fame
and have served on its Board of Directors for 23 years, 13 of
those as Chairman.
I also founded and serve as Chairman of the Bryant Jordon
Student Athletic Foundation, which provides scholarships to
student athletes.
And have served as Chairman of the Birmingham Park and
Recreation Board, a member of the Birmingham Business
Leadership Council, and a board member of the Alabama Sports
Foundation and the American Sports Medicine Institute.
I am currently a trustee of Birmingham-Southern College and
its executive committee. And I also serve on the board of the
University of South Alabama.
In part, it was HealthSouth's work in the field of sports
rehabilitation that drew me to the company. I was proud to help
direct a company that had such a positive impact on the health
and fitness of people of all walks of life.
When the allegations of fraud came to light in March 2003,
I was as shocked and dismayed as my fellow directors.
Nonetheless, the Board quickly took steps to stem the crisis
and stabilize the business. As you know, Mr. Scrushy was put on
an immediate leave of absence, and we appointed Joel Gordon as
interim Chairman and Bob May as interim chief executive.
Additionally, we brought in a first-rate experienced outside
advisors headed by Bryan Marsal, our chief restructuring
officer, to assist us in getting control of the situation.
These three people, with the help of many others, have done an
outstanding job. And our first priority, of course, was to
ensure that HealthSouth was able to continue to provide the
much needed healthcare services to all of its patients.
I am pleased to report that HealthSouth has made tremendous
progress over the past 7 months under the leadership of these
interim management team. Our employees have also played a very
large role in the company's recovery, and I would like to take
this opportunity to thank them. They have remained focused on
the task at hand and they have continued to deliver high
quality care to thousands of patients every day.
Mr. Chairman I will, to the best of my ability, be glad to
answer any questions you or other members of the subcommittee
may have.
[The prepared statement of Larry D. Striplin follows:]
Prepared Statement of Larry D. Striplin
Mr. Chairman, Ranking Member, and members of the Subcommittee, good
morning.
My name is Larry Striplin, and I am a member of the HealthSouth
Board of Directors. I joined the Board in April 1999, and have been
proud to serve with the talented and experienced directors seated next
to me today. As you know, HealthSouth grew from a company with two
patient care facilities--one in Little Rock, Arkansas, and one in
Birmingham, Alabama--to a company with more than 1,700 facilities
across the country. HealthSouth has set the standard for providing
state of the art rehabilitation services to patients ranging from
professional athletes recovering from sports injuries to grandparents
recovering from strokes.
First, let me tell you about my background. I am a native of Selma,
Alabama. I graduated from Birmingham-Southern College with a degree in
education. I pursued my education at George Peabody College (now
Vanderbilt University) in Nashville, Tennessee, where I obtained a
masters degree in Education.
I have owned and operated my own business, Nelson Brantley Glass
Contractors, since 1963 and am currently CEO of this company. I also
serve as CEO of Circle ``S'' Industries. Also, in 1977, I established
American Fine Wire, which was one of Selma, Alabama's largest
employers. I am a member of the boards of directors of Kulicke & Suffa
Industries, Inc., which purchased American Fine Wire.
In addition to my work with my own companies, I have always been
actively involved in various civic activities. I was instrumental in
establishing the Alabama Sports Hall of Fame and have served on its
board of directors for twenty-three years, thirteen of those as
Chairman. I also founded and serve as Chairman of the Bryant Jordon
Student Athletic Foundation, which provides scholarships to student
athletes. I have served as Chairman of the Birmingham Park and
Recreation Board, a member of the Birmingham Business Leadership
Council, and a board member of the Alabama Sports Foundation and the
American Sports Medicine Institute. I am currently a Trustee of
Birmingham-Southern College and its Executive Committee. I also serve
on the board of the University of South Alabama.
In part, it was HealthSouth's work in the field of sports
rehabilitation that drew me to the Company. I was proud to help direct
a company that had such a positive impact on the health and fitness of
people from all walks of life.
When the allegations of fraud came to light in March 2003, I was as
shocked and dismayed as my fellow directors. Nonetheless, the Board
quickly took steps to stem the crisis and stabilize the business. As
you know, Mr. Scrushy was put on an immediate leave of absence, and we
appointed Joel Gordon as Interim Chairman and Bob May as Interim Chief
Executive Officer. Additionally, we brought in a first-rate team of
experienced outside advisors--including Bryan Marsal, our Chief
Restructuring Officer--to assist us in getting control of the
situation. These three people--with the help of many others--have done
an outstanding job. Our first priority, of course, was to ensure that
HealthSouth was able to continue to provide the much needed healthcare
services to all of its patients.
I am pleased to report that HealthSouth has made tremendous
progress over the past seven months under the leadership of the interim
management team. Our employees have also played a very large role in
the Company's recovery, and I would like to take this opportunity to
thank them. They have remained focused on the task at hand and have
continued to deliver high quality care to thousands of patients every
day.
Mr. Chairman I will, to the best of my ability, be glad to answer
any questions you or other members of the Subcommittee may have.
Mr. Greenwood. Thank you, Mr. Striplin.
Mr. May?
TESTIMONY OF ROBERT MAY
Mr. May. Mr. Chairman, ranking member, and members of the
subcommittee, good morning.
My name is Robert May, and I am the interim chief executive
officer of HealthSouth, and a member of the HealthSouth Board
of Directors. I appreciate the opportunity to appear before the
subcommittee today and look forward to answering your
questions. I also look forward to describing for you the
deliberate and purposeful steps taken by our Board of
Directors, our management team, and our employees since we,
along with the rest of the public, first became aware of the
allegations of accounting fraud at the company.
I joined the company's Board of Directors at the end of
September 2002 along with my fellow Board member, Jon Hanson,
as independent directors. Among our other duties, we looked
forward to helping the company to conform its governance
platform to the requirements of the newly enacted Sarbanes-
Oxley Act and the proposed listing standards of the New York
Stock Exchange.
From 1973 to 1993, I held a variety of executive and
operational positions at Federal Express Corporation, most
recently as President of Business Logistics.
Following my tenure with FED EX, I became chief operating
officer and a director of Cablevision Systems Corp., where I
was part of the executive team that helped transition the
company through new operating strategies and the use of new
technologies.
Since the allegations of accounting fraud were first
disclosed last March, the Board acted quickly and decisively to
ensure that Mr. Scrushy and those members of management alleged
to have assisted him in perpetrating a fraud on HealthSouth
stockholders were immediately terminated.
For the past 7 months, I have been serving as the interim
CEO, helping to lead the company's day-to-day operations. As a
part of the interim management team, I have worked to help
stabilize the company's financial situation and refocus our
core operations on patient care.
As you have heard from previous testimony, some employees
at HealthSouth felt afraid and intimidated, feelings no
employee should have in the workplace. We have sought to
transform the culture of HealthSouth, especially at the
corporate headquarters. On a symbolic level, we have taken down
Mr. Scrushy's name from our corporate conference center; opened
up the formerly restricted executive floors to all employees;
and closed the executive dining room so that our leadership
team eats in our cafeteria with the company's employees.
I also hold regular, open, informal brown bag lunch
meetings with employees from all levels and departments of the
Company; encouraging them to ask questions or raise issues and
sharing information about our plans and goals for the company.
While this is not an unusual practice in corporate America, it
began at HealthSouth only when the interim management team took
charge. The response has been encouraging at all levels of the
company. We also hold regular broadcasts to reach our 48,000
employees in the field, and we have traveled extensively to
many of our field locations throughout the country.
We have also looked closely at our governance policy and
compliance programs. I chair the corporate governance
committee. My fellow committee members and I have recently
updated our governance and compliance systems, a process that
began when I joined the Board. Further changes are about to be
incorporated as a result of adopting recent changes suggested
by the New York Stock Exchange.
Assisting in our effort is a team of outside expert
advisors, including the noted Professor Charles M. Ellson, the
Director of the Center for Corporate Governance at the
University of Delaware.
With the aid of this governance advisory panel, my fellow
directors and I drafted corporate governance policies for our
Board committees that meet or exceed the requirements of
Sarbanes-Oxley and the New York Stock Exchange with respect to
important issues such as director independence. These new
guidelines take into account not only legal and regulatory
requirements, but also current corporate governance best
practices.
HealthSouth's governance committee, again with the input
from our governance advisory panel, began to search for
additional corporate directors who could bring valuable new
experience and abilities to the Board. We have retained two
nationally recognized search firms and have interviewed
numerous candidates. Despite a lapse in our directors and
officers insurance, we have attracted a talented, courageous
new Board member, Lee Hillman, who now serves as Chairman of
the audit committee.
I know this Committee is interested in the internal
investigation conducted by the outside law firm of Fulbright &
Jaworski into the issue of insider trading and management's
knowledge, specifically that of Richard Scrushy, of the impact
on company earnings of a new Medicare billing rule known as CMS
Transmittal 1753.
The Board retained Fulbright & Jaworski on September 17,
2002, prior to my Board appointment, and granted Fulbright &
Jaworski total access to all corporate records and mandated
that all management and employees cooperate fully in this
internal investigation. The Board received regular updates, and
ultimately, on October 21, 2002, received a report which
indicated that, based on Fulbright's review, they could find no
evidence that Mr. Scrushy had known of the impact of
Transmittal 1753 at the time of certain stock sales executed by
him. The Board was never given a reason to believe that the
Fulbright & Jaworski investigation was anything other than a
thorough and adequate investigation into insider trading
allegations. I and other directors certainly understood from
the briefings conducted by Fulbright & Jaworski that they had
found no evidence of inappropriate or illegal conduct by Mr.
Scrushy connected with his sale of stock. We continue to
cooperate with all government authorities as they look into
this and other areas.
My focus now is on stabilizing the company's financial
position in order to ensure a viable future. We have made
progress, and I am pleased to say that we are strengthening
relationships with our payors, vendors, doctors and other
outside parties critical to the continued success of
HealthSouth.
We are also developing new sources of revenue in our core
areas, as demonstrated by new and expanded contracts with
payors. As interim CEO, I have promised our 48,000 employees
that we are committed to a future where the company's goal of
providing excellent patient care comes first.
We believe the fundamentals are in place at numerous levels
of HealthSouth for renewed success, but we will continue to
improve the corporate culture to ensure that appropriate
principles are effectively put into practice. Continuing to
examine and enhance policies to prevent corporate fraud is
important. However, in my opinion, the most critical element in
prevention is providing a culture where employees are able to
ask questions, challenge decisions and communicate with
management in an open and direct fashion. It was a group of
individuals who committed the fraud and engaged and criminal
activities at HealthSouth, and without an employee stepping
forward in this case, we still might not know the depths of the
fraud that was perpetrated against the company and its
stakeholders.
Let me end by saying that the Board and the management team
are committed to taking the necessary actions to ensure that we
reach the goal of restoring the long-term health and viability
of HealthSouth, and we are committed to assisting this
subcommittee in its work.
Mr. Chairman, I appreciate this opportunity and will, to
the best of my ability, be glad to answer questions you or any
other members of the subcommittee may have.
[The prepared statement of Robert May follows:]
Prepared Statement of Robert May
Mr. Chairman, Ranking Member, and members of the Subcommittee, good
morning.
My name is Robert May, and I am the Interim Chief Executive Officer
of HealthSouth, and a member of the HealthSouth Board of Directors. I
appreciate the opportunity to appear before the Subcommittee today and
look forward to answering your questions. I also look forward to
describing for you the deliberate and purposeful steps taken by our
Board of Directors, our management team, and our employees since we,
along with the rest of the public, first became aware of the
allegations of accounting fraud at the Company.
I joined the Company's Board of Directors at the end of September
2002 along with my fellow Board member, Jon Hanson. Among our other
duties, we looked forward to helping the Company to conform its
governance platform to the requirements of the newly enacted Sarbanes-
Oxley Act and the proposed listing standards of the New York Stock
Exchange.
From 1973 to 1993, I held a variety of executive and operational
positions at Federal Express Corporation, most recently as President of
Business Logistics. Following my tenure with FED EX, I became chief
operating officer and a director of Cablevision Systems Corp., where I
was part of the executive team that helped transition the Company
through new operating strategies and the use of new technologies.
Since the allegations of accounting fraud were first disclosed last
March, the Board acted quickly and decisively to ensure that Mr.
Scrushy and those members of management alleged to have assisted him in
perpetrating a fraud on HealthSouth stockholders were immediately
terminated.
Since late March 2003, I have been serving as the Interim CEO,
helping to lead the Company's day-to-day operations. As part of the
interim management team, I have worked to help stabilize the Company's
financial situation and refocus our core operations on patient care.
As you have heard from previous testimony, some employees at
HealthSouth felt afraid and intimidated, which should have no place in
any workplace. We have sought to transform the culture of HealthSouth,
especially at the corporate headquarters. On a symbolic level, we have
taken down Mr. Scrushy's name from our corporate conference center;
opened up the formerly restricted executive floors to all employees;
and closed the executive dining room so that our leadership team eats
in our cafeteria with the Company's employees.
I also hold regular, open, informal brown bag lunch meetings with
employees from all levels and departments of the Company--encouraging
them to ask questions or raise issues--and sharing information about
our plans and goals for the Company. While this is not an unusual
practice in corporate America, it began at HealthSouth only when the
interim management team took charge. The response has been encouraging
at all levels of the Company. We also hold regular broadcasts to reach
our 48,000 employees in the field, and we have traveled to many of our
field locations throughout the country.
We have also looked closely at our governance policies and
compliance programs. I chair the Corporate Governance Committee. My
fellow committee members and I have recently updated our governance and
compliance systems, a process that began when I joined the Board.
Further changes are about to be incorporated as a result of adopting
recent changes suggested by the New York Stock Exchange. Assisting in
our effort is a team of outside expert advisors, including the noted
Professor Charles M. Ellson, the Director of the Center for Corporate
Governance at the University of Delaware. With the aid of this
governance advisory panel, my fellow directors and I drafted corporate
governance policies for our Board committees that meet or exceed the
requirements of Sarbanes-Oxley and New York Stock Exchange with respect
to important issues such as director independence. These new guidelines
take into account not only legal and regulatory requirements, but also
current corporate governance best practices.
HealthSouth's Governance Committee, again with the input from our
governance advisory panel, began to search for additional corporate
directors who could bring valuable new experience and abilities to the
Board. We have retained two nationally recognized search firms and have
interviewed numerous candidates. Despite a lapse in our Directors and
Officers insurance, we have attracted a talented, courageous new Board
member, Lee Hillman, who now serves as Chairman of our Audit Committee.
We have also drafted and approved charters for Board committees and
reengineered our compliance programs. As part of those revised
compliance procedures, the Corporate Compliance Officer now reports
independently to the Compliance Committee. In that same vein, the
internal auditor reports independently to the Audit Committee.
I know this Committee is also interested in the internal
investigation conducted by the outside law firm of Fulbright & Jaworski
into the issue of insider trading and management's knowledge,
specifically that of Richard Scrushy, of the impact on Company earnings
of a new Medicare billing rule known as CMS Transmittal 1753. The Board
retained Fulbright & Jaworski on September 17, 2002, prior to my Board
appointment, and granted Fulbright & Jaworski total access to all
corporate records and mandated that all management and employees
cooperate fully in this internal investigation. The Board received
regular updates, and ultimately, on October 21, 2002, received a report
which indicated that, based on Fulbright's review, they could find no
evidence that Mr. Scrushy had known of the impact of Transmittal 1753
at the time of certain stock sales executed by him. The Board was never
given a reason to believe that the Fulbright & Jaworski investigation
was anything other than a thorough and adequate investigation into
insider trading allegations. I and other directors certainly understood
from the briefings conducted by Fulbright & Jaworski that they had
found no evidence of inappropriate or illegal conduct by Mr. Scrushy
connected with his sale of stock. We continue to cooperate with all
government authorities as they look into this and other areas.
My focus now is on stabilizing the Company's financial position in
order to ensure a viable future. We have made progress, and I am
pleased to say that we are strengthening relationships with our payors,
vendors, doctors and other outside parties critical to the continued
success of HealthSouth. We are also developing new sources of revenue
in our core areas, as demonstrated by new and expanded contracts with
payors. As interim CEO, I have promised our 48,000 employees that we
are committed to a future where the Company's goal of providing
excellent patient care continues to come first.
We believe the fundamentals are in place at numerous levels of
HealthSouth for renewed success, but we will continue to improve the
corporate culture to ensure that appropriate principles are effectively
put into practice. Continuing to examine and enhance policies to
prevent corporate fraud is important. However, in my opinion, the most
critical element in prevention is providing a culture where employees
are able to ask questions, challenge decisions and communicate with
management in an open and direct fashion. It was a group of individuals
who committed the fraud and engaged in criminal activities at
HealthSouth--and without an employee stepping forward in this case, we
still might not know the depths of a fraud that was perpetrated against
the Company and its stakeholders.
Let me end by saying that the Board and management team are
committed to taking the necessary actions to ensure that we reach the
goal of restoring the long-term health and viability of HealthSouth,
and we are committed to assisting this Subcommittee in its work.
Mr. Chairman, I appreciate this opportunity and will, to the best
of my ability, be glad to answer questions you or any other members of
the Subcommittee may have.
Mr. Greenwood. The Chair recognizes himself for 10 minutes.
And, Mr. Gordon, I would like to pose some questions to
you, if I might.
If you would turn to Tab 6 in your binder. Okay. See that
document there? And there are handwritten notes. Those
handwritten notes, is that in your writing?
Mr. Gordon. Yes it is.
Mr. Greenwood. Okay. And identify what the document is,
please.
Mr. Gordon. It's the Board minutes of August 7, 2002.
Mr. Greenwood. Okay. Turn to page 3 of that document. Is
that your handwriting there?
Mr. Gordon. Yes, it is.
Mr. Greenwood. Okay. Can you say what that says? Read what
that says, next to where ``The Chairman's review.''
Mr. Gordon. Okay. What it says, we were discussing a
presentation made by the bankers in regard to spinoff for other
things. And I commented that I thought the presentation was
very poorly devised and not achievable.
Mr. Greenwood. Now, did you comment that that reflects what
you said outside or does that reflect your thoughts at the
time?
Mr. Gordon. No, that reflects my thoughts when the minutes
came in, and I put this on and sent it back to the secretary--
for his consideration to be included in the minutes.
Mr. Greenwood. Okay. And when did you get these minutes?
Mr. Gordon. I cannot give you the exact dates. Basically we
had--minutes came very slowly. I have in my records where I had
a waiver of notice of 13 minutes that came--that covered the
period from February--probably from November 2002 through March
2003 that I received in probably February to sign a waiver of
notice of minutes, and I never signed that and returned it.
Mr. Greenwood. Okay. When you wrote ``presentation was
poorly designed and not achievable,'' what were you referring
to who made this presentation to the Board?
Mr. Gordon. Well, this was a presentation made by Mr.
McGahan, and I guess the presentation was that the surgery
center division was worth eleven times--and from my experience
in the industry, I just did not think that was an achievable
number. I thought something more like seven times would be
something would be a market that would be received.
Mr. Greenwood. All right. And did you say at that time, at
the time of the presentation?
Mr. Gordon. I said that at the time of the meeting. The
time of the Board meeting.
Mr. Greenwood. Was Mr. Scrushy there at that time?
Mr. Gordon. Yes.
Mr. Greenwood. And how did he react? Did he react to your
comment?
Mr. Gordon. He reacted that the bankers had thought they
had sources that would pay that much to buy the surgery center
operation.
Mr. Greenwood. Is that the same meeting where Mr. Scrushy
told the Board that there was a Medicare transmittal regarding
out patient group therapy?
Mr. Gordon. Yes.
Mr. Greenwood. Okay. What did Mr. Scrushy say about the
impact of the transmittal at the time?
Mr. Gordon. I think that presentation was made by Mr.
Owens, and he said that it would effect the company somewheres
between $15 and $20 million.
Mr. Greenwood. He thought that would be the impact of the
Medicare, the transmittal?
Mr. Gordon. Yes.
Mr. Greenwood. Okay. Did you have concerns about the fact
that a few days earlier Mr. Scrushy had announced excellent
earnings for the company?
Mr. Gordon. Yes.
Mr. Greenwood. Okay. Can you explain those concerns?
Mr. Gordon. Well, I was concerned that we had reported on
August 6 that our earnings were within line and we expected to
achieve the goal for 2002, and then we came out on August 8 and
said we had this problem and that we would not make those
earnings. And I was concerned about dissemination of
information. I did not know if that was accurate.
Mr. Greenwood. Okay. And turn to Tab 7 on page 3, if you
would. Do you see that?
Mr. Gordon. See what?
Mr. Greenwood. These are Board minutes from the August 26,
2002 meeting.
Mr. Gordon. Yes.
Mr. Greenwood. Okay. Do you recall attending that meeting?
Mr. Gordon. Yes.
Mr. Greenwood. Okay. And during that meeting did Mr.
Scrushy ask the Board to ratify a spinoff of the surgery
division?
Mr. Gordon. That was--yes.
Mr. Greenwood. And did you agree with----
Mr. Gordon. A spinoff or a sale. At that time, I guess it
was a spinoff.
Mr. Greenwood. I beg your pardon?
Mr. Gordon. I did agree at that time, yes, at the right
price if we could do it.
Mr. Greenwood. Okay. So you agreed with the proposal?
Mr. Gordon. Yes.
Mr. Greenwood. Okay. Did you vote for the spinoff?
Mr. Gordon. I believe I did not vote against it. I think I
just choose to abstain.
Mr. Greenwood. You abstained?
Mr. Gordon. Yes.
Mr. Greenwood. And why did you abstain?
Mr. Gordon. I was not exactly confident that this was the
right thing to do for the company or for the stakeholders.
Mr. Greenwood. Did you not just say you thought it was a
good idea at the time?
Mr. Gordon. Well, I think basically if we could accomplish
it eleven times, it was. I did not feel confident we could do
that.
Mr. Greenwood. And did you say that?
Mr. Gordon. Yes.
Mr. Greenwood. So you said I do not think we are going to
be able to make the profit out of this that you have presented
here. Was there discussion about that?
Mr. Gordon. I do not think I did not say there would not be
a profit. I said we could not achieve----
Mr. Greenwood. The level?
Mr. Gordon. [continuing] the level of sale price that we
expected.
Mr. Greenwood. Okay. All right.
And was there discussion? I mean, was this not the division
that you brought in, was this not----
Mr. Gordon. I think there was discussion, but it was very
confidently expressed that this was achievable.
Mr. Greenwood. Okay. And so you abstained?
Mr. Gordon. Yes.
Mr. Greenwood. Now, is it accurately reflected in the
minutes that ``no votes were cast against the motion?''
Mr. Gordon. I do not recall that, and I do recall not being
in favor of it. But I do not know if it's--you know, it is--if
I recall I abstained.
Mr. Greenwood. Okay.
Mr. Gordon. Now I did not vote against it.
Mr. Greenwood. Okay. So then the minutes would reflect that
there were no votes cast against it?
Mr. Gordon. That is right, I did not vote against it.
Mr. Greenwood. Just your abstention?
Is that the way you would have wanted the minutes to
reflect your opposition?
Mr. Gordon. When I--again, I would not have wanted them to
be that way, but that is the way they turned out. And I think
later I did suggest if that was accurate, and I was told they
were accurate. And that was the way we reflected.
Mr. Greenwood. What was your reaction to Mr. Scrushy
announcement of the $175 million impact on the company?
Mr. Gordon. To me it was shock. I was just shocked to how
it could have been one number so--in early August and be such--
--
Mr. Greenwood. $15 or $20 million you were told initially?
Mr. Gordon. Yes.
Mr. Greenwood. Okay. And then Mr. Scrushy said actually it
is $175 million, not $15 or $20 million?
Mr. Gordon. I think Mr. Owens probably made that--made that
report.
Mr. Greenwood. Were you suspicious?
Mr. Gordon. I wondered why such a large change in such a
short amount of time, why it was.
Mr. Greenwood. Did you wonder that out loud?
Mr. Gordon. I do not recall saying that out loud at that
time.
Mr. Greenwood. Why would you not? I mean, you are a member
of the Board of Directors, you are sitting there, you are
shocked. You said you are shocked, you are amazed that a number
that was originally presented at $15 to $20 million had----
Mr. Gordon. I requested----
Mr. Greenwood. [continuing] quickly grown to $175 million.
You are an important member of the Board of Directors you are
shocked, you yet kept silent?
Mr. Gordon. I requested further information where I could
search for myself what the consequence was. At the time I was
not totally familiar with 1753. I wanted to read that and see
what the consequences. I thought----
Mr. Greenwood. At that Board meeting at that moment you
said I would like some more information on this, or was that--
--
Mr. Gordon. I think privately I told some officers that I
would like to have a copy of it 1753 and see if could see----
Mr. Greenwood. Okay. Would you turn to Tab 8, please.
Mr. Gordon. Sir?
Mr. Greenwood. Tab 8 in your book. Do you see that document
there?
Mr. Gordon. Yes. Yes.
Mr. Greenwood. Would you identify that document?
Mr. Gordon. This is a letter on August 30 that I wrote to
Richard Scrushy.
Mr. Greenwood. Okay. And why did you write this letter?
Mr. Gordon. Why? I was concerned that I did not have enough
information about what was taking place in regard to this
spinoff or sale of the facilities, what was taking place
generally in regard to the future of the company and I was
writing for more information for my consideration.
Mr. Greenwood. You said in this letter, you said ``Based on
the information provided by UBS Warburg, I remain unconvinced
that this is the best route to maximize shareholder value, as
you no doubt surmised from my comments during the Board meeting
and my abstention vote with regard to this matter on the August
26, 2002 Board of Directors meeting.
Mr. Gordon. Right.
Mr. Greenwood. So you were unconvinced on August 30.
Did Mr. Scrushy ever respond to this letter and, in fact,
give you the information that you wanted?
Mr. Gordon. No.
Mr. Greenwood. Did you continue to register opposition to
the spinoff?
Mr. Gordon. I continued to--yes. I continued to write him
about further information that I required, and I never received
anything I asked for.
Mr. Greenwood. Were any other Board members aware of your
concerns? Did you share your concerns with other Board members?
Mr. Gordon. I do not believe I did at this time. I did in a
later correspondence.
Mr. Greenwood. Okay. What did you make of the fact that you
wrote this? You had enough concern to write this letter and you
never got a response to it?
Mr. Gordon. Well, starting about this time, Mr. Scrushy and
I had many differences. We have had differences from day one
that I had been on the Board. Those differences got more and
more evident as time went on.
Mr. Greenwood. In the indictment that was issued yesterday,
there was talk of intimidation used by Mr. Scrushy. As you and
Mr. Scrushy had this apparent falling out and you had lots of
difference of opinions, can you characterize the way he treated
you? Was he abusive toward you?
Mr. Gordon. Well, he never intimidated me, because I am the
type of fellow that someone such as him would not intimidate.
And many times he dressed me down that I was not one to
grow the company, I did not hear what he had to say; when I
asked questions, I got that thing. But it never intimidated me.
Mr. Greenwood. Did he do that in front of others?
Mr. Gordon. Yes.
Mr. Greenwood. Okay. Did Mr. Scrushy ever say to you that
he wanted to remove certain members from the Board?
Mr. Gordon. Yes.
Mr. Greenwood. And who were those Board members and what
were the circumstances?
Mr. Gordon. Well, I had a private meeting with him in
February 2003. And----
Mr. Greenwood. How did that come to be? Why was that? Was
that at your request or his?
Mr. Gordon. I had been corresponding him with on a regular
basis and he could tell that my correspondence was, I guess,
getting more and more concerned. And he called and asked me
would I come down and visit him. At the time, I said I will
wait until the next Board meeting. And then he called back, his
secretary called and said he would sure like to visit with you.
And I asked, I said well I will try to work it into my
schedule.
And so I went down and visited with him.
Mr. Greenwood. Where was this meeting?
Mr. Gordon. In Birmingham at the corporate office.
Mr. Greenwood. At the corporate office. Okay.
Mr. Gordon. And at the time he proposed to me that there
may be some people did not want me on the Board, but he would
like to have me on the Board under one condition, and if I
would vote against Bob May, he would support me. My response
was ``Richard, I do not play games like that.''
Mr. Greenwood. Okay.
Mr. Gordon. And I did not have any----
Mr. Greenwood. My time has expired.
A final question for me. As we now know from the criminal
indictment, this $175 million impact was a sham designed by
Scrushy to hide the fraud. Did you have any suspicions about
that? During the fall of 2002 did you think it was more than
just an overly optimistic expectation, or rather, excuse me.
Did you think it was more than just bad corporate news, but in
fact might have been a scheme or a sham to hide other dealings?
Mr. Gordon. I did not have--at that time, I did not have
any idea that it was a sham. You know, as the things turned
out, I see that it probably was. But at that time I had no
thought of that.
Mr. Greenwood. The gentlelady from Colorado is recognized
for 10 minutes.
Ms. DeGette. Thank you, Mr. Chairman.
Mr. Gordon, did you ever see Mr. Scrushy attempt to
intimidate others the way you just described to the Chairman he
was trying to intimidate you?
Mr. Gordon. I do not think I did, no.
Ms. DeGette. Now, when the allegations of insider trading
and other allegations of misconduct came to your attention in
the summer of 2002, you decided that an independent counsel
should be hired by the compliance committee, right?
Mr. Gordon. As Chairman of the compliance committee, I
decided that was my responsibility.
Ms. DeGette. And you decided to hire them, right?
Mr. Gordon. Yes.
Ms. DeGette. And why did you do that?
Mr. Gordon. I read the charter of the compliance committee
and in that it said the responsibility of the Chairman of the
compliance committee and the compliance committee was to point
out----
Ms. DeGette. And there were allegations made, and so you
decided to hire an independent counsel?
Mr. Gordon. There were allegations made and it was our
responsibility to hire an independent outside counsel to do
that.
Ms. DeGette. I know.
Mr. Gordon. At the compliance committee's direction and at
corporate expense.
Ms. DeGette. Now you told our sommittee staff yesterday
that you had raised the concerns that you had about the large
one-time charges that HealthSouth seemed to take every year.
And I think as it was relayed to me, you said this did not seem
to be a good way to do business.
Did you bring those concerns to Mr. Scrushy?
Mr. Gordon. I brought to him that I was concerned that we
took large write-offs on a frequent basis, and that was
recognized because I had never been a member of the audit
committee. I was invited in the audit committee in 2002 because
he said you are always interested in write-offs. Why do you not
come to the committee and see what is going on.
Ms. DeGette. So how long had you been bringing this issue
of the write-offs to Mr. Scrushy, how many years?
Mr. Gordon. I cannot tell you how many. I know on numerous
occasions I said why do we have to take write-offs.
Ms. DeGette. Well, was it like 2002?
Mr. Gordon. Probably 2001 and 2002.
Ms. DeGette. Thank you.
And what did Mr. Scrushy say when you brought these
concerns to him?
Mr. Gordon. That we had facilities that were closed, no
locations that were no longer productive. They had to write
those off and they had substantial goodwill that had to be
written off.
Ms. DeGette. Did you go to the audit committee or to your
external auditors and ask them to look further into these
write-off?
Mr. Gordon. I did--on my own, I did not go.
Ms. DeGette. Why not?
Mr. Gordon. I was assured that this was in the normal
course of business of----
Ms. DeGette. Who assured you of that?
Mr. Gordon. Mr. Scrushy.
Ms. DeGette. Now, do you know from your experience whether
the audit committee had any better understanding than you do
about why these write-offs occurred?
Mr. Gordon. I do not.
Ms. DeGette. Now, Mr. Gordon, you were also the first Board
member to suggest that the Board get an inside counsel to
investigate the various allegations against Mr. Scrushy.
Fulbright & Jaworski was hired on September 17. And on
September 18 there was an unrecorded telephonic meeting in
which the Board hired Fulbright as its SEC defense counsel
instead of any independent counsel. Did you participate in that
telephone call?
Mr. Gordon. I participated in that meeting. I do not
believe it was telephonic. The decision was made at an in-
person meeting.
Ms. DeGette. There was an in-person meeting. When was that,
do you remember?
Mr. Gordon. I believe September 17.
Ms. DeGette. Okay. And why did you go along with this
decision about Fulbright if you were the one that suggested the
independent----
Mr. Gordon. Well, I had suggested Wilmer Cutler, and I had
talked to them about accepting the commission as independent
counsel. I reported----
Ms. DeGette. But Fulbright & Jaworski was hired?
Mr. Gordon. That is right.
Ms. DeGette. Not Wilmer Cutler, right?
Mr. Gordon. At that meeting the name Fulbright & Jaworski
came up.
Ms. DeGette. Yes.
Mr. Gordon. And I responded, I know the firm, they have
done work for me in the past and I have high regard for them. I
have no problem with them representing.
Ms. DeGette. So why did you then go along with them hiring
Fulbright as the SEC counsel, defense counsel instead of
independent counsel?
Mr. Gordon. Why did I go along?
Ms. DeGette. Do you understand the difference? I assume you
do?
Mr. Gordon. Yes, I do.
Ms. DeGette. So why did you go along with that?
Mr. Gordon. Well, what I understood and I registered it in
several later afterwards, I thought the compliance department
had been taken out of the decisionmaking process. And if you go
to further letters, I expressed that very strongly in a number
of letters to Mr. Scrushy and others about my concern about how
the counsel, independent counsel was selected.
Ms. DeGette. Okay. So now, but see, that is the problem
exactly. They are no longer independent now, right?
Mr. Gordon. I had concerns about that.
Ms. DeGette. Well, so what happened with those concerns?
Did anybody get back to you about that?
Mr. Gordon. I wrote several letters.
Ms. DeGette. And did you hear back?
Mr. Gordon. I finally got a response from Lanny Davis, I
believe.
Ms. DeGette. And what did Mr. Davis say?
Mr. Gordon. Well, I had written I wanted copies of the
investigation, I wanted copies of the engagement letter and so
forth. And he suggested they would be forthcoming.
Ms. DeGette. And were they?
Mr. Gordon. No.
Ms. DeGette. You never heard a thing?
Mr. Gordon. No.
Ms. DeGette. Okay. Now, I want to ask Ms. Givens a couple
of questions. You were on the audit committee, I think from its
inception right?
Ms. Givens. No, I was on the audit committee since 1989.
Ms. DeGette. I'm sorry. You have been on the audit almost
15 years then, right?
Ms. Givens. Since 1989 until the present.
Ms. DeGette. Okay. Now, we have received testimony of two
internal auditors that the committee rarely met with them and
it was often in the presence of the full Board. We heard about
this at our last hearing where they would say now we are having
an audit committee meeting in the middle of the Board meeting.
The current internal auditor did not meet with your
committee for a stretch of 17 months. Do you think that is
vigilance on the part of the audit committee?
Ms. Givens. Well, I would not characterize the facts the
way you have. We as an audit committee met with the internal
auditors on regular basis. And, indeed, we thought that it was
so important that we included them in the full Board meeting--
--
Ms. DeGette. Did you meet with them separate from the Board
meetings?
Ms. Givens. Yes.
Ms. DeGette. And how often?
Ms. Givens. It depended on the year. But often----
Ms. DeGette. Okay. In 2000, how often did the audit
committee meet separately with the external auditors?
Ms. Givens. With the external auditors?
Ms. DeGette. I'm sorry, with the internal auditors.
Ms. Givens. Well, generally we met with the internal
auditors on about the same frequency as we met with the
external auditors.
Ms. DeGette. Okay. So how many was that in 2000?
Ms. Givens. In 2000, it was--I do not know the exactly
number, but I would say 3 or 4 times.
Ms. DeGette. Separate from the Board meetings?
Ms. Givens. Sometimes--generally the way that we worked it
was that we had committee meetings prior to the Board meetings.
And then the audit committee along with the external auditors
would join the full Board.
Ms. DeGette. Would there be separate minutes then of the
audit committee meeting that was before the Board meeting if
that had in fact occurred?
Ms. Givens. There generally were.
Ms. DeGette. Okay. Yes, I mean we have had people come in
and say that most of the time the audit committee met during
the Board meeting. They would be lying if they said that? What
your testimony is----
Ms. Givens. Again, I cannot----
Ms. DeGette. By the way, you are under oath. Is that you
generally had separate audit committee meetings either right
before the Board meeting or at different times, is that right?
Ms. Givens. If I can--if I can clarify for you.
Ms. DeGette. Sure.
Ms. Givens. I would appreciate it.
We regularly had audit committee meetings that were
separate from the Board. In addition to that, the auditors as
well as the audit committee would join the full Board to give a
presentation. So that we would preclude the full Board from
having to listen to all of the details that we needed to get
into, but a general presentation would be made subsequently to
the full Board.
Ms. DeGette. Okay. If you will take a look at Tab 31, the
second page of that. That is the proxy statement. And what it
says as a final second to last paragraph is ``The audit
committee met separately from the Board once in 2001.'' Would
that be your recollection?
It is the very bottom of the page. The third full paragraph
on the page.
Ms. Givens. Yes. I assumed that you are referring to I
think what I have tried to correct a couple of times before.
The proxy reflected that the audit committee met only once
during 2001. That is not correct.
Ms. DeGette. So this is wrong?
Ms. Givens. This is incorrect, that is right.
Ms. DeGette. How often did the audit committee meet in 2001
separate from the Board?
Ms. Givens. In 2001 the audit committee met, to the best of
our ability in going--in going over calendars, etcetera, we met
three times in person and there was an additional three times
that the Chairman of the audit committee met with the auditors
to go over quarterlies.
Ms. DeGette. And were there minutes kept at these meetings?
Ms. Givens. Apparently there was minutes kept of only one
meeting, and that was why it was reflected that way.
Ms. DeGette. Whose job was it to keep the minutes of the
audit committee meetings?
Ms. Givens. Generally we had a secretary there to keep
minutes.
Ms. DeGette. And at the three meetings that you had in-
person meetings and additional telephonic meetings, was there a
secretary there?
Ms. Givens. There should have been. Someone named Brad Hale
generally took the minutes.
Ms. DeGette. Do you recall Brad Hale being there?
Ms. Givens. I recall Brad Hale being in the vast majority
of committee meetings I have been in. But I cannot tell you----
Ms. DeGette. Now, as a member of the audit committee, were
you circulated drafts of the minutes when you met?
Ms. Givens. If you could just me finish my----
Ms. DeGette. I'm sorry.
Ms. Givens. [continuing] answers, it would be very helpful.
Because I--please----
Ms. DeGette. Go for it.
Ms. Givens. The full answer to the last question was that I
could not tell you exactly which meetings Mr. Hale was in. But
he generally took notes and minutes at most of the Board
meetings and the committee meetings.
Ms. DeGette. So as a member of the audit committee were you
circulated minutes of the audit committee meetings which you
had attended either in person or telephonically to review?
Ms. Givens. Generally, that would have been the Chairman of
the audit committee would have reviewed them.
Ms. DeGette. You were not the Chairman of the audit
committee?
Ms. Givens. That is correct.
Ms. DeGette. So your view is you never saw--you would not
have seen the audit committee----
Ms. Givens. I saw some of them, but it was the
responsibility of the audit committee Chairman.
Ms. DeGette. Okay. Mr. Chairman, my time has expired.
Mr. Greenwood. The gentleman from Florida, Mr. Stearns.
Mr. Stearns. Thank you, Mr. Chairman. And I appreciate the
gentleman letting me go forward. I have to go to luncheon, so I
will just get my questions in.
I am not going to go into it, but I have a quick questions.
This Mike Vines memo, which is Tab 78, it was in the summer of
2002. Let me ask staff, was this addressed to the Board of
Directors or was this addressed to the--okay. So this went to
Ernst & Young.
But did you folks know about Mike Vines? He said I know
that HealthSouth based out of Birmingham, Alabama has severe
problems in the accounting department. So this was sort of a
whistleblower, a former employee and he sent this to Ernst &
Young. Was this ever brought to your attention.
Mr. May, I do not think you were on the Board. Were you on
the Board?
Mr. May. No, I was not.
Mr. Stearns. Okay. Let me just go right on down, just yes
or know, did you know about Mike Vines' memo talking about the
severe problems in accounting at HealthSouth?
Mr. Striplin. No, I did not.
Mr. Stearns. Did not.
Mr. Watkins?
Mr. Watkins. No, I did not.
Mr. Stearns. Ms. Givens?
Ms. Givens. No, I did not.
Mr. Stearns. Okay.
Mr. Gordon?
Mr. Gordon. No, I did not.
Mr. Stearns. Okay.
Now, Ms. Givens, you are a audit committee member, Board of
Directors, so I guess you are in charge of the audit committee.
Did you ever hear anything about this ``fleeced shareholder''
letter that was sent in November 12, 1998?
Ms. Givens. I was not made aware of it until recently.
Mr. Stearns. Just recently? So recently being when?
Ms. Givens. The last 2 or 3 months.
Mr. Stearns. Last 2 or 3 months? So that is 5 years ago the
memo was saying there is severe problems at HealthSouth, it was
addressed to the company as well as Ernst & Young and you were
never told of it.
Anyone else on the Board? Mr. Gordon, were you told about
it?
Mr. Gordon. No.
Mr. Stearns. Mr. Watkins?
Mr. Striplin. What's the date of the memo?
Mr. Stearns. The memo is November 12, 1998.
Mr. Striplin. Well, I was--I got on the----
Mr. Stearns. Could you bring the mike just a little closer
to you?
Mr. Striplin. I got on the Board in April 1999, but----
Mr. Stearns. So you would not know.
Mr. Striplin. But I would not know.
Mr. Stearns. But even so, there was no rumor, no one ever
told you about this memo----
Mr. Striplin. No.
Mr. Stearns. [continuing] describing all the problems at
the corporation?
Mr. Striplin. No.
Mr. Stearns. Okay.
Let me ask you then about this pristine audits that Mr.
Scrushy did. He asked Ernst & Young to go in and to see if the
magazine racks were arranged and whether the toilets were clean
and to do a complete audit of the facilities in terms of
cleanliness, which seems a little bit unusual for an accounting
firm, a large accounting firm like Ernst & Young to be doing
that. Did all of you know about the pristine audits?
I mean, Mr. Gordon, did you know about it?
Mr. Gordon. Yes.
Mr. Stearns. Ms. Givens?
Ms. Givens. Yes, I did.
Mr. May. Yes.
Mr. Stearns. And did you know that Mr. Ernst & Young was
charging more for the pristine audits, at least it looks like
from the audit piece proxy disclosure, they were charging more
for those audits than they were for the actual audit of the
books of the company?
Mr. Gordon. No.
Mr. Stearns. Okay. We have here a 2000 a charge to audit
fees were about a million dollars and then 2001 it was a $1.1
million. The pristine audit fees, this is to check the
laboratories, the toilets, the magazine racks, the bowls in the
men's room, that was $1,250,000 in 2000. And in 2001 it was
$1,332,000. So you can see by hundreds of thousands of dollars
Ernst & Young was charging more to check the magazine racks and
the toilets than they were to do the audit.
Let me just go from left to right. Mr. Gordon, did you know
about this?
Mr. Gordon. I saw it. I did not know about the total
charges until I saw the annual report information. I knew that
we were doing a pristine audit----
Mr. Stearns. But you did not know what the figures were?
Mr. Gordon. I did not know what the figures were.
Mr. Stearns. Okay. And Ms. Givens, you were now the audit
committee Chairman, did you--you were a member, and I guess
your designation is audit committee member.
Ms. Givens. That is correct.
Mr. Stearns. Did you know about these figures that they
were charging more for the pristine audits than actual audit of
the books?
Ms. Givens. I did not really compare the two, but I was
ware that we were paying a significant amount to oversee those
facilities, yes.
Mr. Stearns. I mean, we are going to ask Ernst & Young if
they have an overseas international division doing pristine
audits, but I do not think they do. This is probably one of the
few they ever did. Did you find that a little unusual to have
an audit firm who was doing your book to do the same thing to
check all the facilities like this?
Ms. Givens. Well, I think that it would make sense for me
to explain to you why we thought that the pristine audit was so
important. This is a national health service company----
Mr. Stearns. No, I understand. I can understand why it is
important. But for your audit of people who are auditing your
books to be doing it, it seems like it should be an outside
maintenance company or----
Ms. Givens. It is the same firm, but it is not the same
people.
Mr. Stearns. Okay.
Ms. Givens. And Ernst & Young----
Mr. Stearns. But it all goes to the same company?
Ms. Givens. Yes.
Mr. Stearns. Okay. But I mean, you are trying to justify--
are you saying today that it is acceptable for Ernst & Young to
do the pristine audits and to do the audit of the company? You
see no problem with that? Just yes or no.
Ms. Givens. Well, I would prefer not to answer just yes or
no.
Mr. Stearns. Well, it is pretty simple. The question is
Ernst & Young is doing pristine audits, which is basically
hotel/motel inspection of facilities at the same time you are
doing the books. Do you think that is a conflict of interest?
Just yes or no. You just say no or yes.
Ms. Givens. I think that different people were performing a
task and in their respective areas----
Mr. Stearns. Mr. Chairman, can I get a yes or no to this
question?
I mean, it is just a reasonable yes or no. Was there a
conflict of interest in your mind for them to be doing it?
Ms. Givens. No, there was not.
Mr. Stearns. Okay. That is fine. Listen, this is all
hindsight. I mean, I am asking you--I mean, I do not know
anyone of us had to do your job, I am not sure how we would do
it. So we are very empathetic here and we are just trying to
understand it.
Let me ask Mr. Watkins, did you know about the pristine
audits?
Mr. Watkins. Yes, I was aware of it. I was not aware the
actual amount split out for that portion versus the total fees
that we paid Ernst & Young until----
Mr. Stearns. And you had no idea that you folks were paying
them more to check the maintenance then you were to do the
books?
Mr. Watkins. My recollection is that I did not.
Mr. Stearns. Okay. And Mr. Striplin, did you?
Mr. Striplin. Yes. I was aware of the pristine audits, but
I did not--I was not aware of the fact that it was that much.
Had no breakout.
Mr. Stearns. And Mr. May, did you know?
Mr. May. These charges were before I came on board.
Mr. Stearns. Okay. Now, Ms. Givens, the way they show it in
the books here, it says audit related fees. I mean, do you
think it is appropriate if you are doing maintenance checking
of cleanliness that they would throw this into audit related
fees?
Ms. Givens. This is a question that the Chairman and I both
had and asked of E&Y, because we thought that it was a little
bit odd as well. But we were reassured by E&Y that it was an
appropriate----
Mr. Stearns. Okay. In retrospect, in hindsight what do you
say today? Do you think they should have had that type of
service thrown into audit related fees? Because I do not find--
I mean audit implies the books and there are other terms they
use in the military, in the hotel business, in various
businesses when you actually inspect a facility for
cleanliness. But in retrospect do you think they should have
included it as audit expenses?
Ms. Givens. That is something you will have to ask E&Y. I
was relying on their expertise to categorize it properly.
Mr. Stearns. Do you know if the company is still spending
money on pristine audits?
Ms. Givens. I believe that we have discontinued the
pristine audits.
Mr. Stearns. And why did you discontinue?
Ms. Givens. If you could address that to Bob May, I would
appreciate it.
Mr. Stearns. Okay. Mr. May? And when did you stop the
pristine audits?
Mr. May. Well, the pristine audits essentially have not
been conducted to any large degree during 1930. The checklist
for the operational audit still is up on our website. Our local
operations are doing self audits at the time being.
Mr. Stearns. Okay. Do you think that calling it audit
related, Mr. May, is false and misleading?
Mr. May. Actually, I do not. During my tenure at Federal
Express we had similar audits that we would call operational
audits. And I think it is just a matter of semantics.
Mr. Stearns. Was it done by your accounting firm?
Mr. May. Generally it was done by an internal audit group
within the company.
Mr. Stearns. That is right. But it was not done by the
accounting firm who were auditing your books?
Mr. May. Not that I recall, no.
Mr. Stearns. Yes. I just have about 30 seconds left. And I
just wanted to ask Mr. Striplin just a question about Scrushy's
salary. I just got to get this in.
In 2001 and 2002 did the compensation committee approve the
bonuses for Mr. Scrushy of $16.5 million?
Mr. Striplin. As I recall, we did.
Mr. Stearns. Yes, you did. And do you recall how the
compensation committee determined that?
Mr. Striplin. Well, obviously, it would not have been what
it was if we had known that it had fraud in it. But----
Mr. Stearns. Well, it turns out that in September 2, 2002,
HealthSouth shareholders lost over 50 percent of the value of
their stock in a matter of days. And the compensation committee
approved continuing Mr. Scrushy's salary at $1.2 million. And,
you know, I guess the question is as your role as the
compensation committee person on the Board, it seems like at
some point when shareholders are losing 50 percent of their
value, you might start looking at the salary of the CEO, just
a----
Mr. May. Well, I do not recall the timing on that.
Mr. Stearns. Yes.
Mr. May. But we always got mostly involved in the--in
relationship to salaries and bonuses.
Mr. Stearns. All right.
Thank you, Mr. Chairman.
Mr. Greenwood. The Chair thanks the gentleman.
And recognizes the gentleman from Oregon, Mr. Walden for 10
minutes.
Mr. Walden. Thank you, Mr. Chairman.
I was just reading through the HealthSouth operational
division 1998/99 pristine audit checklist. It is sort of a sad
irony. It is a good thing to check, but number 34 was 3 people
or less have a key to the cashbox or the safe combination, list
names and titles. And I just find it ironic when the company's
being in effect raided by allegedly the CEO and others that we
got to check for a cashbox key. It is important to do, I
realize, but it is still interesting.
And I do not have an objection, certainly to doing pristine
audit. I mean, I was on a hospital board. We did quality
control as well. We did these sorts of surveys. But we did them
internally, as Mr. May, I think you have suggested is being
done today. And I do think they are important because image is
important, cleanliness is important; all of that. So I do not
have a problem with that.
My question, though, Mr. May--well, you came on later so
maybe Mr. Gordon or Ms. Givens, is how this contract--the
question that gets raised is how did this contract get let? And
was it sole sourced. Did you put it out for bid? Is it
something Mr. Scrushy sort of negotiated with Ernst & Young on
the side? Do you recall why Ernst & Young--I think the question
we are all trying to get at is why Ernst & Young, not why a
pristine audit.
Ms. Givens. A good question, and I do not know the answer
to that.
Mr. Walden. A lot of money.
You do not know the answer to that?
Ms. Givens. I do not know the answer.
Mr. Walden. Does anybody know the answer to that? Yes, Mr.
Watkins--Dr. Watkins?
Mr. Watkins. One thing I recall is this was presented to
the Board as a good thing to do for patient safety,
cleanliness, etcetera, was----
Mr. Walden. Sure.
Mr. Watkins. [continuing] that the idea behind using Ernst
& Young was they had people in these areas, it would be less
expensive we were told to have them because they would not have
to travel from an airplane from corporate headquarters to
inspect these in 50 States. So theoretically it would have been
cheaper. As it turns out, it was not cheaper.
Mr. Walden. It was not true, right? And was there not
some--do I not recall reading something that the internal
auditor or someone said it could be done a lot cheaper
internally? Teresa Sanders, I believe said that. It is easier
for us, obviously, looking back now that all the documents are
here. But----
Mr. Watkins. I do not recall specifically, but our internal
audit people when they did their field audits did not inspect
every facilities, whereas with the pristine audit, I think we
tried to get a larger number of audits done and had a larger
field force by using Ernst & Young.
Mr. Walden. Are you aware of any other firms that do this
kind of work, pristine audit type work?
Mr. Watkins. I am not personally aware.
Mr. Walden. Yes. Okay. When was the pristine audit program
started? Do you remember, Dr. Watkins?
Mr. Watkins. I don't recall.
Mr. Walden. Okay. All right. I want to get into some other
expenditures as well just briefly.
In the ``Fortune'' magazine story about HealthSouth that
ran, I do not know, I do not know if I have a date on it. June
23, 2003. It talks about HealthSouth spending $13 million on
two seasons of a TV show in 2001 and how Mr. Scrushy recruited
Jason Hervey to become a HealthSouth executive, much to the
shock of many in the firm. Are you familiar with that
expenditure, anybody on the Board? Because this seems like a
lot of money to go off into TV.
Mr. Gordon, do you remember that instance?
Mr. Gordon. Is the microphone on?
Mr. Walden. Yes, it is, sir.
Mr. Gordon. The thing I remember about that, he was
promoting, and it did have some merit, about branding our
company and HealthSouth would be branded throughout the United
States and we have a sponsorship of TV shows. And that these
could be sold to cable channels and so forth. And he presented
it as being something that could be very profitable for the
company. And that was the basis. That it would build a brand
name, it would build a loyalty among teenagers, and so forth.
And it could be sold and be profitable to the corporation.
Mr. Walden. All right.
Let me move on to another issue, and I think this one is
probably one that concerns me as much as anything I have seen
so far. This is the so-called ``fleeced shareholder.'' I guess
it is a fax. And it was sent, it says regarding HealthSouth/
Ernst & Young to list is all it says. But it made its way into
the company, is my understanding.
Are any of you familiar with this now or were you when it
came in?
Mr. Watkins. I am not, not at the time.
Mr. Walden. Ms. Givens?
Ms. Givens. Not at the time.
Mr. Walden. And you two were not on the Board. All right.
Well, it is on Tab 72 of the book there if you want to take
a look. Because I think that gets to sort of a fundamental
issue here as well of what do you think happened to this memo?
My understanding is it went to Mr. Strong, who chairs the audit
committee. And while you are reading it, maybe I could share
with others.
It says ``You bring the smoke, I will bring the mirrors. At
least the market has shown the wisdom to devalue HS stock. Wish
I got out in time. I have a list of questions which I hope
might be of interest to you. How can the HS outpatient clinics
treat patients without precertification, book the revenue,
carry it after being denied payment? 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 E&Y auditors in Alabama miss this stuff?
Are these clever tricks to pump up the numbers or something
that a novice accountant could catch?'' It goes on and on.
``You people and I have been hoodwinked. This note is all
that I can do about it. You all can do much more. If you do
is'' I am just quoting. ``If all you do is look into to it to
see if what I say is true.'' And then lists distribution
various places.
Do you know if this got to Mr. Strong, Ms. Givens, since
you are on the audit committee? Do you know now since you did
not know then? Do you know if it eventually----
Mr. Givens. I believe that it went to Mr. Strong, yes.
Mr. Walden. Okay. And do you know what happened from there
on?
Ms. Givens. My understanding, and it is only secondhand.
Mr. Walden. Yes.
Ms. Givens. Is that Mr. Strong gave it to the auditors and
that there was a full investigation with the auditors and they
decided that it did not have any merit, and therefore they
dismissed it and it was not brought to the full audit
committee's attention.
Mr. Walden. Okay. And I guess that would be the next
question. Do you think as a member of that audit committee it
should have been brought to your attention?
Ms. Givens. It is hard for me to say in hindsight. I think
that Mr. Strong did the right thing in taking it to the
auditors.
Mr. Walden. Right.
Ms. Givens. And I think it was a judgment call on his part.
Mr. Walden. You are still on the audit committee today?
Ms. Givens. Yes, I am.
Mr. Walden. If a letter like this came in today, what
should happen?
Ms. Givens. I think under the circumstances, we would pay
very close attention to a letter like this. But I would use my
judgment and may, indeed, give it to E&Y immediately as well.
Mr. Walden. But not--you would share it with the other
members of the audit committee, though, would you not?
Ms. Givens. I think today I would, yes.
Mr. Walden. I would hope. I think as I have mentioned, I
served on a small bank committee and on the audit committee,
and I would be furious as a member of that audit committee if
something like that came in, even if it's anonymous and not
shared.
Ms. Givens. Well, I am--can I just say something to correct
myself?
Mr. Walden. Yes.
Ms. Givens. I had not seen the Vines' email or the
``fleeced shareholder'' until recently, so I have gotten them
confused. And apparently the Vines' email went to Mr. Strong,
but the ``fleeced shareholder'' letter never went to anybody on
the Board or the audit committee.
Mr. Walden. Oh, it did not?
Ms. Givens. So I misspoke.
Mr. Walden. All right. Then I may have misspoke, too. I was
under the impression that this did get into HealthSouth because
there is a memo from Mr. William T. Owens to Mr. William W.
Horton----
Ms. Givens. That would be our legal counsel.
Mr. Walden. Yes.
Ms. Givens. And our CFO, and they may indeed have received
it. But no one on the Board of the audit committee received it.
Mr. Walden. Okay. Because it says it is directed in your
memo dated November 11, ``I have completed a detailed review of
the matters raised in the anonymous correspondence sent to
Ernst & Young. My findings are as follows,'' and he goes
through and details bad debt, accounts receivable over 360
days, outpatient centers, precertification.
Was Bill Owens a member of the Board?
Ms. Givens. He has been a member of the Board and I do know
during that period if he was a member of the Board.
Mr. Walden. Okay. Do you think then that this should have
been referred to the audit committee?
Ms. Givens. I would have hoped it would have been.
Mr. Walden. Okay.
Ms. Givens. I think someone on the audit committee should
have seen it, yes.
Mr. Walden. Yes. Let me go onto something different.
Are you familiar with the FTI work, the work done by----
Ms. Givens. Are you speaking to me?
Mr. Walden. Yes, or anybody, but I assume the work done by
FTI?
Ms. Givens. Yes, I am.
Mr. Walden. We were told that the FTI--actually, I am going
to Mr. May, I guess. And the issue is FTI. And the work that
was done by FTI, was that ever presented to the Board?
Mr. May. No, it was not.
Mr. Walden. Was the Board told that it would cost a million
dollars to finish that work?
Mr. May. Yes. The Board was told that the current charges
to FTI were approximately $1.4 million, and it would be
approximately another million dollars to complete the study.
Mr. Walden. And do you know who told you that and when you
were told that?
Mr. May. Richard told the Board that in a Board meeting. I
am not sure if the entire Board was assembled. I was there.
Mr. Walden. Do you know about when approximately, which
Board meeting that was?
Mr. May. My recollection would be sometime in November.
Mr. Walden. Of 2002?
Mr. May. 2002, yes.
Mr. Walden. 2002. It is interesting, because on Tuesday,
November 12, 2002 Mr.--well, L. Davis at pattonboggs.com got an
email from Deborah Smith of fticonsulting.com that showed that
the expenses were about $116,756 to finish that audit. Does
that sound like something you now know?
Mr. May. That was never communicated to the Board.
Mr. Walden. Even recently?
Mr. May. Even recently.
Mr. Walden. Turn to Tab 23, if you would, in the book, sir.
Both of these were sent, right?
I will give you a chance to look at that.
Mr. May. Yes, I have looked at it.
Mr. Walden. Well, I am trying to figure out how to ask
this. Why would Mr. Scrushy tell you it would be a million to
finish at approximately the same time that this memo was being
sent to L. Davis from Deborah Smith, FTI Consulting saying that
$116,000 to finish the work? And have you had a chance to look
at FTI's first report now?
Mr. May. I saw a draft of it this week and looked at it
just very quickly.
Mr. Walden. Just this week?
Mr. May. Yes.
Mr. Walden. Wow.
Have any of you seen the FTI draft? Have you asked for it?
Ms. Givens. No.
Mr. Striplin. No.
Mr. Walden. Okay. Nobody's ask for it.
Did any of you ask why it was not finished, other the
million--Ms. Givens?
Ms. Givens. I was under the impression that FTI was
finished, that they had completed their work.
Mr. Walden. Who gave you that impression?
Ms. Givens. As I recall, we were told that at the Board by
Mr. Scrushy.
Mr. Walden. By Mr. Scrushy? Was Mr. Davis present at that
Board meeting?
Ms. Givens. I cannot recall.
Mr. Walden. Mr. May?
Mr. May. I do not recall, either.
Mr. Walden. Anyone?
Mr. Striplin. No.
Mr. Walden. Would your minutes reflect that, who is in
attendance at a Board meeting?
Mr. May. Minutes would, yes.
Mr. Walden. All right. We will check that.
Mr. Chairman, my time has expired.
Mr. Greenwood. The Chair thanks the gentleman.
And recognizes himself for 10 minutes for inquiry. And Mr.
May, I would like to ask a few questions of you, if I could.
Did the Chairman of the Board Richard Scrushy ever make
derogatory remarks about Board members to other Board members?
Mr. May. Yes, he did.
Mr. Greenwood. Okay. Was that typical of him?
Mr. May. I would say that it was--yes, it was typical.
Mr. Greenwood. Okay.
Mr. May. It became typical.
Mr. Greenwood. Okay. Did any Board member ever indicate to
you that Mr. Scrushy had said negative things about you to
them?
Mr. May. Other Board members said that he made negative
comments about myself and John Hanson, certainly.
Mr. Greenwood. What kind of comments?
Mr. May. That he was not certain that we should remain on
the Board, those sorts of comments.
Mr. Greenwood. Did Ms. Givens ever relay information to you
about what Mr. Scrushy had told her about you?
Mr. May. Ms. Givens related to me that Richard Scrushy had
informed here that Richard had had a private investigator
investigate me, yes.
Mr. Greenwood. Okay. Ms. Givens, can you corroborate that,
did you in fact tell Mr. May that Mr. Scrushy had a private
investigator looking into him?
Ms. Givens. Yes, I told the full Board that.
Mr. Greenwood. Okay. And how did you come to know that?
Ms. Givens. Mr. Scrushy shared that with me.
Mr. Greenwood. What is your understanding as to why he
would have done that?
Ms. Givens. My understanding was that he came upon some
information which made him doubt his selection of Mr. May, and
so he further investigated it.
Mr. Greenwood. And who did he hire to do that?
Ms. Givens. I have no idea.
Mr. Greenwood. Do you know, Mr. May?
Mr. May. I do not.
Mr. Greenwood. Okay. Mr. May, have you seen invoices for
payments for a private investigator by HealthSouth?
Mr. May. Yes, I have.
Mr. Greenwood. How many invoices have you seen?
Mr. May. Approximately 20, and just to be accurate, I have
seen the summary of those invoices, not the invoices
themselves.
Mr. Greenwood. Okay. Did you ever ask HealthSouth's head of
corporate security Jim Goodreau about whether an investigation
of you had occurred?
Mr. May. Yes, I did.
Mr. Greenwood. And what did he say?
Mr. May. He said I did not--we did not conduct an
investigation and we did not hire a private investigator to
have you investigated. And if we did, I would know about it.
Mr. Greenwood. And who would have had the authority to hire
such an investigator?
Mr. May. I cannot answer that question. I do not know who
would have the authority.
Mr. Greenwood. Okay. Ms. Given, when Mr. Scrushy told you
that there were some things about Mr. May might make him an
inappropriate Board members did he share with you what those
things were?
Ms. Givens. Yes, he did.
Mr. Greenwood. And can you share that with us, please?
Ms. Givens. Yes. He mentioned that he thought Mr. May was
using two different names and Social Security numbers, for what
purpose I do not know. He also indicated that he was associated
with numerous bankruptcies and with litigation with companies
with which he had been associated.
Mr. Greenwood. Mr. May, is that the case? Were you using
two different names and two different Social Security numbers?
Mr. May. No, sir.
Mr. Greenwood. Just Mr. May?
Mr. May. Just Mr. May.
Mr. Greenwood. Okay. Ms. Givens, I am interested to know
how you dealt with all of this. I mean, did you find it, as you
said in your opening, you had been involved in a lot of
corporate matters of corporations. Did you find it unusual that
a CEO would come to a Board member and say I am having another
Board member investigated because I think he is using two
Social Security numbers as two separate identities?
Ms. Givens. Well, I think that it is more customary today
than in the past to ensure that your Board members are good
upstanding citizens. And so if there were something that came
to his attention that made him wonder about that, I could
understand why he might pursue it. However, I did ask--I did
not repeat any of that information to anyone, and I asked for
the report so I could see it myself.
Mr. Greenwood. And did you receive that report?
Ms. Givens. I have not.
Mr. Greenwood. And when did that happen? When did you have
that discussion with Mr. Scrushy?
Ms. Givens. To the best of my recollection, it was probably
the first quarter of 2003.
Mr. Greenwood. Okay. So, here we are in the last quarter of
2003 and you still do not know whether it was ever determined
that Mr. May had a secret identity.
Ms. Givens. No. I asked for that report of the general
counsel as well since Mr. Scrushy was removed. And I have
encouraged Mr. May to find that report as well.
Mr. Greenwood. And it has never been found. You have never
found the results of such report?
Ms. Givens. No. And I do know who conducted it.
Mr. Greenwood. You said you shared with the Board as a
whole that Mr. Scrushy had told you that Mr. May was under
investigation?
Ms. Givens. On the day that--it was on the day or a couple
of days after we removed Mr. Scrushy, right after the fraud was
uncovered. We had, as you can imagine, numerous Board meetings
to decide how to manage the company. And during the Board
meeting where we selected Mr. Gordon to be the acting Chairman,
we also--someone nominated Mr. May to be the acting CEO. And I
thought it was my duty to at least let the rest of the Board
know with Mr. May on the call that there were certain
allegation to ensure that we were not putting in place someone
else whose background might not be appropriate to serving the
company. But I gave Mr. May the opportunity to respond, and he
did.
Mr. Greenwood. Mr. May, would you turn to Tab 66? You will
find there a memo that is to you and Mr. John Hanson from
Fulbright & Jaworski, dated October 31, 2002. And there are
photocopies attach that show shreds of documents. Do you see
that?
Mr. May. Yes.
Mr. Greenwood. Okay. These were found on the fifth floor of
the executive tower. The first question I have for you, whose
offices were situated on the fifth floor of the executive
office tower?
Mr. May. At the time of this memo, my recollection would be
Tom Carmon, Brad Hale, Weston Smith, Bill Owens, Richard
Scrushy. And there may be one or two others.
Mr. Greenwood. The senior management?
Mr. May. Senior management, yes.
Mr. Greenwood. Okay. Was the fifth floor easily accessible
by others?
Mr. May. No, it was not.
Mr. Greenwood. Why not?
Mr. May. There was a fairly elaborate locking system with a
card key that you needed to access to get to the fifth floor.
Mr. Greenwood. By elevator?
Mr. May. By elevator, yes.
Mr. Greenwood. Okay. So it would be not likely that other
employees could wonder in and have shredded these documents,
necessarily?
Mr. May. I would--I would guess not.
Mr. Greenwood. Okay. Looking at these shreds, you can
discern what some of them say.
For example, on the last page there's a quote ``7150''
which is the billing code for group therapy. There is also a
quote ``175M based on.''
When was the Board made aware that Fulbright had discovered
shredded documents on the fifth floor?
Mr. May. I believe that Fulbright first made us aware of
shredding of documents prior to me coming onto the Board, and
then again in their report on, I believe, October 21.
Mr. Greenwood. Mr. Gordon, were you aware of the fact that
these documents had been shredded and were you aware of that
before you received the report from Fulbright?
Mr. Gordon. Yes. I was aware that they had found at the
time they said a small amount of shredded documents on the
fifth floor. That they had been placed----
Mr. Greenwood. Who told you that?
Mr. Gordon. I do not recall exactly who did tell me that. I
do--I had heard it before the Fulbright, before it came out.
Mr. Greenwood. Did you not tell our committee staff just
yesterday that the first time you were aware of the shredded
documents was when you read about them in the Fulbright report?
Mr. Gordon. Yes, I did. That's right.
Mr. Greenwood. Right. So you said two different things on
two different days now; which would you like to stand by?
Mr. Gordon. The first time was--I did not hear about it
before the Fulbright report.
Mr. Greenwood. So you did or did not hear about it?
Mr. Gordon. I did not hear about it.
Mr. Greenwood. Your testimony today is that the first time
you heard about it was when you read it in the Fulbright
report?
Mr. Gordon. Right.
Mr. Greenwood. So you misspoke a moment ago?
Mr. Gordon. That is correct.
Mr. Greenwood. All right.
Mr. May, was there a discussion of hiring a firm to
reconstruct the shredded documents?
Mr. May. Yes.
Mr. Greenwood. Did the special litigation committee ever
issue reports or opinions from its investigation of allegations
in the derivatives lawsuit?
Mr. May. No. The special litigation committee never did
issue a report.
Mr. Greenwood. Okay. Okay. Mr. Gordon, would you go to Tab
15? Okay. What is that document?
Mr. Gordon. That is a letter that I wrote to Lanny Davis at
Patton Boggs.
Mr. Greenwood. And when did you write that letter?
Mr. Gordon. On November 1, 2002.
Mr. Greenwood. And what does the letter mean to convey?
Mr. Gordon. It was in response to a letter that I had
received by him on October 15.
Mr. Greenwood. And did you tender your resignation from the
corporate compliance committee in that letter?
Mr. Gordon. Yes. At a previous Board meeting they had said
I had conflict and they had asked me to resign as Chairman of
the compliance committee. And I told them I would consider that
and would confirm it back later. And I waited a week, and
thought about, and confirmed that back in a letter with my
thoughts on that.
Mr. Greenwood. Look at Tab 14, if you would. Are those the
minutes from the October 29 meeting?
Mr. Gordon. Yes.
Mr. Greenwood. They state that you resigned from the
committee at that meeting, is that correct?
Mr. Gordon. I did not resign the committee at that meeting.
It was suggested that I resign, but I told them that I would
consider it and get back. They asked me to resign. I did not
resign.
Mr. Greenwood. Why did you resign?
Mr. Gordon. Why did I?
Mr. Greenwood. Yes.
Mr. Gordon. They quoted me, I guess, things that said I had
a conflict. I had been--I had sold a company to HealthSouth and
as part of the acquisition deal, I had a consulting contract.
And they said that consulting contract put me into conflict.
Mr. Greenwood. And were those facts true?
Mr. Gordon. I did have a consulting contract.
Mr. Greenwood. And for how long prior to when they asked
you to resign?
Mr. Gordon. That was part of the deal that was concluded in
1996. Since 1996.
Mr. Greenwood. Did you feel that having that consulting
contract compromised your ability to act on behalf of the
investors of the company?
Mr. Gordon. Sir, most certainly not. I had, as I have
indicated early, $290 million of my family's--well, my family
had it at stake. And $250,000 it was certainly not going to
compromise my independence.
Mr. Greenwood. Okay. Back to your letter, I am going to
direct your attention to the last paragraph where you wrote ``I
have followed closely your statements to the press about the
company, the investigation and who is or is not responsible for
the issues that have faced the company recently. To the extent
that you'' Mr. Davis you are addressing, ``feel the need to
address any issues regarding my service as Chairman of the
compliance committee, I would expect that the circumstance
under which the compliance committee was not permitted to act
would be accurately and fairly disclosed as well. If this issue
is not handled properly, I will consider making my own
disclosure.''
What did you mean by that?
Mr. Gordon. At the time I did not feel that Mr. Davis was
properly respecting my position as Chairman of the compliance.
Mr. Greenwood. Can you elaborate on that? What made you
feel that way?
Mr. Gordon. Well, what made me feel that way originally, I
had proposed hiring Wilmer Cutler. That was not accepted. I
thought that was my responsibility. And from that, I had a
$4,000 bill from attorneys, which I did not think was
significant. Mr. Davis had indicated to me that that was a--I
guess, not a good way to spend the corporate money. It was an
inappropriate expenditure.
Mr. Greenwood. What was the $4,000 spent on?
Mr. Gordon. My counsel had been advising me as what my
duties were with the compliance committee.
Mr. Greenwood. Okay. Your words in the letter said ``I
would expect that the circumstances under which the compliance
committee was not permitted to act.'' So what did you think was
not being disclosed?
Mr. Gordon. What I thought----
Mr. Greenwood. And you had pretty much threatened to
disclose it yourself if he didn't.
Mr. Gordon. I was Chairman of the compliance committee.
Mr. Greenwood. Yes, sir.
Mr. Gordon. And by the charter of the compliance committee
it specifically spelled out that the compliance committee had
the responsibility to select and hire an independent counsel.
And I called a meeting of the committee. The committee approved
this.
When it came to the Board meeting, I reported when the time
come to report the compliance committee, I reported that I had
been in contact with Wilmer Cutler who has had experience the
New York Stock Exchange and others, was an outstanding firm.
And I would recommend they be hired.
And from somewhere in the Board a recommendation come why
do we not consider Fulbright & Jaworski.
Mr. Greenwood. Do you know who made that recommendation?
Mr. Gordon. I do not recall. I believe it was Mr. Newhall.
Mr. Greenwood. And was there discussion about that?
Mr. Gordon. Was a discussion. And I responded that I have
no objection to Fulbright, they had worked for me in the past
in my businesses, and I was perfectly comfortable if it was the
will of the Board, and I would support them.
Mr. Greenwood. So you have got one instance there. You are
the Chairman of the compliance committee. You and the
compliance committee decide that Cutler is the firm to hire.
And you go to the Board and you present that. And somebody else
makes another suggestion, and then you go along with it. But
was that the only--when you refer to your letter ``the
circumstances under which the compliance committee was not
permitted to act,'' were there other circumstances under which
the compliance committee in your opinion was not permitted to
act other than this one issue of the recommendation of a law
firm?
Mr. Gordon. Well, later when I found that the meeting went
forward and the suggestion was made we ought to get in touch
with Fulbright & Jaworski to discuss their selection, and the
attorney got on the phone he said ``I am really excited about
working for--with HealthSouth. I have been getting myself up to
speed for the last 3 days, and I am ready to hit the ground
running tomorrow.''
Mr. Greenwood. And what did you take from that?
Mr. Gordon. I did not say anything at that time. Later in
the meeting after things quieted down, I just said I have a
question. And I do not understand how my duties as Chairman of
the compliance committee got taken away and we did not have the
final authority on this.
Mr. Greenwood. So it sounds to me that the choice was a
fait d'accompli by the time of the Board meeting if that firm
had already spent 3 days gearing up to it?
Mr. Gordon. Well, the response, Mr. Chairman, is I didn't
know what you were up to.
Mr. Greenwood. That is what you said?
Mr. Gordon. That's what the Chairman, Mr. Scrushy said.
Mr. Greenwood. So the compliance committee ultimately had
no say whatsoever about which law firm would do the
investigation, is that correct?
Mr. Gordon. Yes, that is correct.
Mr. Greenwood. And the compliance committee itself did no
review, correct?
Mr. Gordon. Repeat that, please.
Mr. Greenwood. The compliance committee itself did not do
any kind of a review itself?
Mr. Gordon. No. It was--and then right after that I was
asked to resign.
Mr. Greenwood. Right after that you were asked to resign?
Mr. Gordon. Yes.
Mr. Greenwood. My time has expired.
The gentlelady from Colorado is recognized for 10 minutes.
Ms. DeGette. Ms. Givens, I will admit to being surprised by
your previous answers, which is why I was trying to probe. And
the reason is because 3 weeks ago when we had our first hearing
on this HealthSouth issue, Greg Smith, who has been the
internal auditor of the company since December 1999 testified
under oath that he had not met privately with the audit
committee during the first 18 months he was there, except for
once when he first started in December 1999. So that was the
period of the 2000, half of 2001, the period where you said
that the audit committee met separately at least 3 times and
had some telephone conversations. And Greg Smith also told that
he hasn't met with the audit committee since March 2003.
And the other reason I was surprised is because we have
been provided with minutes from only one audit committee
meeting during that period of time, and that was the one that
Greg Smith talked about.
So I guess my question to you is, is do you think Greg
Smith is lying to the committee?
Ms. Givens. I do not know if he is or not. I can tell you
what my recollection is.
Ms. DeGette. But you stick by what you said earlier today?
Ms. Givens. Well, I think there may be some confusion about
what meeting alone means. We met regularly with internal audit,
very often the external auditors were there as well. And so he
may be referring to meeting specifically alone as an individual
with the audit committee.
Ms. DeGette. No, actually what he was saying is meeting
with the audit committee separate and apart from meetings that
were part of the regular Board meeting. That is what he was
saying. And also without the other auditors.
Ms. Givens. Okay. Well, very often we did combine the audit
function internal and external.
Ms. DeGette. But your testimony is you did that separate
and apart from the Board meetings.
Ms. Givens. Sometimes----
Ms. DeGette. Either before it or----
Ms. Givens. Generally that was the case, yes.
Ms. DeGette. Okay. Mr. Gordon, I just wanted to follow up
on one of the chairman's questions, which was you had said that
this consulting contract would not--you would not feel that
that gave you any kind of conflict. But legally, and I think
the reason you had to step down from the Chairman of the
compliance committee, is legally because of that consulting
contract you would not be considered an independent director,
correct?
Mr. Gordon. Well, I think it is several interpretations of
that. And some things I have seen, I would be considered,
others I would not be.
Ms. DeGette. But in the interim you have discontinued that
consulting contract, correct?
Mr. Gordon. Yes.
Ms. DeGette. If you could, if you do not mind, take a look
at Tab 28 in the notebook. And this is an SEC proxy statement
for 1998. Do you see that there?
Mr. Gordon. I see schedule 14A, is that what----
Ms. DeGette. Yes, 14A information.
Mr. Ferguson. Okay.
Ms. DeGette. Now, on the third page of that it says about
the middle of the page, shareholder proposal. ``The Board of
Directors adopt a policy that no Board member shall serve on
the compensation committee if he or she is not an independent
director.'' And then it goes down to a definition.
Then the next page it says ``The purpose of this proposal
is to incorporate within the audit and compensation committee a
standard of independence that will permit objective
decisionmaking on compensation issues at HealthSouth.'' Do you
see that there?
Mr. Gordon. Right now I am looking for it.
Ms. DeGette. It's the very top, it says page 15 of 91. It
is the very top of the page.
Mr. Gordon. Okay.
Ms. DeGette. Have you ever seen this document before, by
the way?
Mr. Gordon. I think I saw that in a proxy statement before
the annual meeting.
Ms. DeGette. Okay. Before the annual meeting then, that
would be in 1998?
Mr. Gordon. That year. Yes.
Ms. DeGette. Okay. And then it goes on to say on that same
page 15 that HealthSouth has arranged a credit agreement with
Nations Bank allowing the company to invest up to $5 million in
Acacia Venture Partners, a private venture capital fund. C.
Sage Givens is the founder and the managing general partner of
Acacia Venture Partners. And it goes on to say that Givens'
firm recently invested $4 million in a Managed Care U.S.A.
contract. And then at the bottom of the page it says ``The
current members of the committee have all been directors since
the initial public offering in 1996 and have served on the
committee.'' And the basic suggestion here of the shareholders
is that people who serve on the audit and compensation
committee should be independent directors and should not have
these conflicts.
Do you recall what the response of the Board to these
proposals was?
Oh, I am sorry. And also, Mr. Watkins apparently jointly
owns some property in Florida with Mr. Scrushy.
So my question is do you recall the Board talking about
that proposal?
Mr. Gordon. I do, and I think the Board considered the
request and came up with the decision that the members were
acting in a very independent manner and they did not see the
conflict.
Ms. DeGette. So it did not bother you that these conflict
existed?
Mr. Gordon. Well, this was presented by Steel Workers or
something, I think.
Ms. DeGette. Yes, I know.
Mr. Gordon. It was not----
Ms. DeGette. But still it was a proposal.
Mr. Gordon. Making changes, we were going to make some
changes, but at this point we did not see anything critical in
it.
Ms. DeGette. Right. You did not see a problem?
Mr. Gordon. At that point.
Ms. DeGette. And then if you will take a look at Tab 2 of
the binder.
Mr. Gordon. Which one? Two?
Ms. DeGette. Tab 2. This is--yes, it is also 14A from April
1999. Have you seen this before?
Mr. Gordon. Where are you at? I am not keeping up with you.
Ms. DeGette. Tab 2.
Mr. Gordon. Okay. I am under Tab 2.
Ms. DeGette. At the top it says ``Begin privacy enhanced
message,'' see that there?
Mr. Gordon. Okay. Yes.
Ms. DeGette. Yes. Okay. That is page 1. Then if you flip
over to the second page, it says page 18 of 105 on the second
page.
Mr. Gordon. Okay.
Ms. DeGette. And I will just tell you, this is a 14A
information from April 1999, a year later, okay? And here there
is a shareholder resolution that is again requesting the Board
of Directors to amend the articles of incorporation and bylaws
to the extent necessary to provide that at least three quarters
of all Board members are ``independent.'' And it goes on to say
``The proposal seeks to establish a level of independence that
they believe will permit clear and objective decisionmaking in
the best long term interests of all shareholders by the
HealthSouth's 12 directors or company insiders, 6 is the CEO of
Med Partners and Mr. Scrushy as the former Chairman and current
director.'' And they go on to say they believe that there would
be a lack of independence and that is why they are proposing
that three-quarters of the Board members would be independent.
Do you recall seeing that shareholder proposal at the
annual meeting in 1999?
Mr. Gordon. I do not.
Ms. DeGette. Okay. Do you remember any discussion about
that?
Mr. Gordon. I am sure it would have been discussed. I do
not recall.
Ms. DeGette. You do not recall a discussion?
Mr. Gordon. I do not recall.
Ms. DeGette. What do you think of that proposal?
Mr. Gordon. I think in retrospect looking now it has some
merit. But I----
Ms. DeGette. Why is your consulting agreement not in this
proxy, do you know?
Mr. Gordon. If it was--it was--my consulting agreement was
a part of the original transaction before I became a director.
Ms. DeGette. Right.
Mr. Gordon. It was done in 1995, in I believe September.
And part of the legal papers HealthSouth and the Chairman of
the company insisted that I have a non compete for 10 years in
North America. That I could not be in any----
Ms. DeGette. No, I understand. I am sorry, I do not mean to
interrupt. We have limited time.
I understand that was your agreement, and I am not arguing
about that. I understand there was consideration and everything
else. But the question we are asking is about independent Board
members. And the question is why was that--do you know why that
was not discussed in 1999?
Mr. Gordon. As I recall, it was listed in the proxy
statement in 1997, in 1998. And then after that, I think it
just disappeared.
Ms. DeGette. Do you know why?
Mr. Gordon. I do not know why.
Ms. DeGette. Okay.
Mr. Gordon. I had nothing----
Ms. DeGette. But you still did have that agreement?
Mr. Gordon. I had a consulting contract for 10 years.
Ms. DeGette. Okay. And did it appear in 2000, 2001?
Mr. Gordon. I checked back, I do not believe I saw it in
2000.
Ms. DeGette. Who would have been in charge of listing that?
Mr. Gordon. Chief legal counsel, Mr. Horton.
Ms. DeGette. I just have a couple of last questions.
Yesterday we received, and I am sure all of you have seen,
maybe you have not read it in depth, this indictment of Mr.
Scrushy, 85 counts. And as someone who has been involved in all
these corporate responsibility hearings the last few years
along with the Chairman, what struck me when I read this and
when we had our hearings a few weeks ago, was this was not a
complicated financial unraveling like with Enron or it was not
some edgy accounting like it was with Qwest or some of the
other telecom companies. To me this is garden variety fraud.
What you have is some accounting practices which are just plain
to see.
And you have your CEO being indicted with 85 counts. You
have 15 senior employees of the company pleading guilty to
criminal fraud, which to me is extraordinary.
And so the question I want to ask all of you, particularly
those of you who have been on the Board for longer, excluding
Mr. May I would say, all of you have testified today that you
have taken extraordinary steps as Board members to exercise due
diligence. In retrospect, do you think there is anything the
Board could have done to identify or to prevent this kind of
fraud which had, as you have all stated today, seriously
threatened the financial health of this company?
Mr. Gordon?
Mr. Gordon. I think when you look back on it, the Board did
what were reasonable measures to perform in the best interest
of the stockholders and make the management abide by the proper
accounting and--when someone is determined to commit fraud, it
is very difficult to find. I think that Sarbanes-Oxley will
certainly be a great benefit going forward to this, because it
does----
Ms. DeGette. But there is nothing you think the Board could
have done?
Mr. Gordon. I think, you know, certainly there is something
we could have done. I would not say that at all. I think that
it is something that in retrospect could have been done. But
the company performed very well. The earnings were----
Ms. DeGette. Yes, it sure did.
Mr. Gordon. Now they certainly were manipulated. But in
retrospect of seeing the growth of the company over the last 5
or 6, 7 years and the performance, the first indication was the
company was doing very well. Now no one had any suspicion of
fraud.
Ms. DeGette. Okay. Ms. Givens, do you think there is
anything the company could have done differently to detect
this? I'm sorry, the Board.
Ms. Givens. I have certainly asked myself that daily since
learning about the fraud last March. And I have looked at what
we did as a Board, what I did as an individual and I can
sincerely say that I always exercised the highest ethics, that
I tried to be diligent in my duty as a Board--member of the
Board. And I went out and I actually sought, I just did not fly
in and fly out at Board meetings. I went out and I talked with
employees. I visited facilities. We talked with the financial
community. And never once did anything come to at least my
attention that would lead me to conclude that there was
anything wrong.
So in hindsight, I cannot think of how I would have been
aware of it.
Ms. DeGette. Dr. Watkins?
Mr. Watkins. I agree. We were repeatedly assured that we
had the proper measures in place for compliance, detection of
fraud. Our auditors in their letter to us repeatedly, as Ms.
Givens has quoted, found no material evidence of fraud or other
practices.
So at this point, I still do not know how we would have
detected this.
Ms. DeGette. Well, do you think--and I know my time is
close to being up, if you had had independent counsel that were
truly independent, would that have helped?
Mr. Watkins. Independent auditors or counsel?
Ms. DeGette. Counsel, the investigative counsel?
Mr. Watkins. Again, I do not know. This was so widespread
and this actually occurred even before----
Ms. DeGette. Right. So if they had been independent, would
they not have found that?
Mr. Watkins. Again, that would be pure speculation. I do
not know. I do not know.
Ms. DeGette. Mr. Striplin?
Mr. Striplin. I am not sure.
Mr. Greenwood. You are going to need your microphone, Mr.
Striplin.
Mr. Striplin. I am not sure looking forward, to answer your
question, that I would ever make another good Board members,
because I would be looking under every rock. And I call myself
being due diligence in this situation----
Ms. DeGette. You do not think that that is the definition
of a good Board member?
Mr. Striplin. Well, I thought I was doing what I was
supposed to be doing. I had no indication. If this man had been
my only son, I would not feel any different than I do now. We
just, all of us in shock. But the question answered--asked what
would we do, I think we would, obviously, on Monday morning
after you have played the game on Saturday night, you would--
and you know what your mistakes were, you certainly would not
go back and not be better and be more concerned about the due
diligence. You would do everything, particularly in the areas
of accounting and--there has got to be consenting that we could
do better.
And I think that I am so very proud of this Board of
Directors of what we are doing right now, and the results that
we have had. I think that Brian Marsal and Joel, and Bob have
just done an excellent job. And I think that the future of this
company is going to be safe.
Ms. DeGette. Mr. May, let me ask you, you are the captain
of the ship going forward. Are there changes that can be made
to the Board procedures? You know, I am not questioning the
commitment or dedication of the Board members. But are there
changes that the company can and will make to the Board
procedures to ensure that this kind of level of widespread
fraud can never happen again?
Mr. May. The answer is yes.
Ms. DeGette. And what would those be?
Mr. May. And there have been significant changes to our
governance guidelines. There have been significant changes to
our compliance program. Essentially, we have taken a look at
what, you know, what are those things that we could reasonably
do based on what we know today and have set in motion to put
corrective action in place as quickly as possible to make sure
that something like this never occurs again.
Ms. DeGette. Mr. Chairman, I know we are out of time. I
would just ask if Mr. May would mind supplementing his answers
with a brief summary of the changes that have been made toward
Board governance. That would be very helpful.
Mr. May. I will have those to you tomorrow.
Mr. Greenwood. Thank you, gentlelady.
Before I yield to Mr. Walden, a couple of quick questions
for Ms. Givens.
Ms. Givens, were you present at the Board meeting where Mr.
Scrushy asked Mr. Gordon to resign?
Ms. Givens. To resign?
Mr. Greenwood. From the compliance committee?
Ms. Givens. I do not recall that, no. I do not know if I
was or not. I do not recall.
Mr. Greenwood. Okay. Did you know whether you had an
opinion as to whether he should resign?
Ms. Givens. No.
Mr. Greenwood. Okay. So you were not involved in that
whatsoever? You did not have an opinion one way or the other?
Ms. Givens. I was not involved in that, no.
Mr. Greenwood. Okay.
Mr. Walden?
Mr. Walden. Thank you, Mr. Chairman.
This issue of hiring Fulbright & Jaworski is of interest.
Because if I understand it right, Mr. Gordon, your compliance
committee recommended a different firm. You took that to the
Board of Directors and you presented that as your committee's
recommendation. And then who is it, Mr. Newhall then recommend
a different firm. Well, no. You recommended Wilmer & Cutler?
Mr. Gordon. Right.
Mr. Walden. Wilmer Cutler and Pickering. And it was Mr.
Newhall then that recommended Fulbright & Jaworski. And then
there was some discussion. How would you characterize that
discussion? Was it heated, was it friendly, was it--I mean,
what took place in that Board meeting, because it's not
reflected? The tone is certainly not reflected here.
Mr. Gordon. That discussion was not heated, because at the
time I did not suspect anything was going on. And so when they
nominated Fulbright, I knew----
Mr. Walden. No, you nominated Wilmer, right?
Mr. Gordon. I nominated Wilmer Cutler.
Mr. Walden. Yes. Yes.
Mr. Gordon. And Fulbright was nominated. And I know the
firm. They are an excellent firm. And they have done work for
me. I have no problem with the company. If it is the will of
the Board, they are fine.
Now where I got disturbed was later when I found out they
had been talking to them before I gave my report.
Mr. Walden. And who is ``they?''
Mr. Gordon. The Chairman, I believe. And perhaps Mr. Davis
is what I surmised.
Mr. Walden. Perhaps Mr. Davis and certainly--well, the
Chairman. Because when they came on the phone, was this still
during a Board meeting you had the phone conversation?
Mr. Gordon. Yes.
Mr. Walden. They are like on speaker phone in the Board
room?
Mr. Gordon. Yes.
Mr. Walden. And they said great thanks, we have been
gearing up for 3 days?
Mr. Gordon. He said we are looking forward to going to
work. We have spent the last 3 days getting up to speed on
HealthSouth and we are ready to hit the ground running
tomorrow.
Mr. Walden. So somebody had already cut this deal with
them, in effect?
Mr. Gordon. That is what I suspected. I had no definite
knowledge, but I suspected that.
Mr. Walden. But had you not already agreed to retain
Wilmer?
Mr. Gordon. Yes. I had worked with a gentleman named--well,
I had worked with a gentleman named Harry Wise at that firm,
and he had committed he could take the assignment. And I told
him I had to get Board approval.
Mr. Walden. Right.
Mr. Gordon. And I would get back to him just as quick as
the Board met to confirm his hiring.
Mr. Walden. All right. And did I hear you correctly as
saying Mr. Scrushy said he did not know what your committee was
up to with regard to this?
Mr. Gordon. No. He said he did not know what I was up to.
Mr. Walden. What you were up to?
Mr. Gordon. Yes. Right.
Mr. Walden. All right. And do you know how he meant that?
How did you interpret that? He did not know you were looking at
hiring outside firm, or you did not know you were talking to
Wilmer & Cutler?
Mr. Gordon. I think he, in retrospect, was concerned that I
was trying to do a thorough and independent study and I do not
know if he wanted one done on it that way.
Mr. Walden. Do you know what prompted Mr. Newhall to make
this recommendation to the firm that, obviously, someone had
been talking to for 3 days?
Mr. Gordon. No, other than the fact that they are
outstanding firm and he was familiar with them.
Mr. Walden. Just sort of out of the blue he picks another
name?
Mr. Gordon. I do not know if it was out of the blue, but
that is the first I heard.
Mr. Walden. All right. Mr. May--oh, Mr. Gordon, before I
leave you, on the Fulbright & Jaworski supplemental letter
regarding Mr. Scrushy, the minutes on the meeting on October
29, 2002 say ``The Board reviewed Fulbright & Jaworski's
supplemental letter clearing Mr. Scrushy of all allegations of
insider knowledge concerning the impact of a Medicare
reimbursement rule change prior to his stock and loan repayment
transactions in May and July 2002. The Board voted to release
to the press the results of the findings on October 30, 2002.''
If you would turn to Tab 96 you will find a copy of these
minutes, and I do believe the handwriting on here is yours and
reflects, perhaps, your comments at some point. Tab 96.
Mr. Gordon. Ninety-six.
Mr. Walden. At the bottom of the first page, handwritten
there it says ``Did not clear RS of all knowledge.''
Mr. Gordon. Yes.
Mr. Walden. Is that your handwriting?
Mr. Gordon. Yes, it is.
Mr. Walden. What did you mean by that?
Mr. Gordon. As far as I was concerned, I did not think the
report cleared him of all knowledge of it.
Mr. Walden. Why? What did you know----
Mr. Gordon. I did not know anything. Excuse me, go ahead.
Mr. Walden. Yes. What did you know that led you to think
that?
Mr. Gordon. I did not know anything. I just from the way my
handling of my chairmanship of the compliance committee, I had
some suspicion. And I just did not think the report was
definitive in clearing him of all knowledge.
Mr. Walden. On the next page, Mr. Gordon, on page 2 at the
top, it says ``RS'' underlined and then it says ``challenges
Fulbright report.'' I think it says ``report on shredding and--
''
Mr. Gordon. Other items.
Mr. Walden. ``other items. Lanny Davis to meet with''--can
you read your handwriting for me there?
Mr. Gordon. Yes. To meet with Hal Hirsch to work out
wording.
Mr. Walden. What did you mean by that?
Mr. Gordon. When the Fulbright--original preliminary report
from Fulbright came in, and it was a discussion that it had
shredding in it. And he said shredding is not appropriate, it
is not appropriate in that report. It should be removed.
Mr. Walden. Why did he say that? Did anybody question him
on that; Mr. Scrushy, on why he would say shredding is not
appropriate?
Mr. Gordon. Well, it was just a general conversation. It
was in the document. He was instructing counsel, his counsel to
discuss this with Fulbright and see if there is some way to
work out getting the reference to shredding out of the
documents.
Mr. Walden. Before it was released, before it was
finalized? So Mr. Scrushy was trying to influence what was in
the Fulbright report?
Mr. Gordon. Yes, I would say so.
Mr. Walden. And did I not read somewhere here that in part
of the shredded documents that have been recovered there are
some documents where they have recovered pieces that indicate
transmittal or parts of the word Transmittal 1753?
Mr. Gordon. I think there was a suspicion of that, yes.
Mr. Walden. Then I want to go, Mr. May, to you if I could.
I have before me a copy of the news release. And I do not think
it is in the book, or at least in that book. It is actually in
the one for the next panel, but it is the news release that was
on your HealthSouth website. It is dated October 30. And it
says, this is quoting you now, ``This thorough outside review
conducted by Fulbright & Jaworski puts to rest any question
whether Mr. Scrushy had any inkling or knowledge of the
Medicare reimbursement rule change or its impact prior to his
stock transactions in May and July 2002.'' It said
``Independent director Robert P. May, Chairman of the Board
corporate governance committee and special litigation
committee.'' Are those your words?
Mr. May. Yes, they are.
Mr. Walden. Did you write them?
Mr. May. No, I did not.
Mr. Walden. Who wrote them?
Mr. May. A collection of the lawyers who were working for
the company at that time.
Mr. Walden. Was one of those Mr. Davis?
Mr. May. Yes.
Mr. Walden. Was he the principal author of those words?
Mr. May. I am not sure if he was the principal author, he
was one of them.
Mr. Walden. Okay. Because I have also from the ``Birmingham
Business Journal'' October 27, 2003--well, no. Yes, October 27,
2003 there is a quote and it says ``Davis had a hand in writing
the release and he now says'' this is quoting Davis ``I take
full responsibility'' for including May's quote embellishing
Fulbright & Jaworski's conclusion, a take that didn't set well
with the firm.
I want to read for you an email that we have from a Neil
Gold to Hal Hirsch with a cc to Felice Gallant. Privileged and
confidential. This is with regard to the news release. ``Hal,
this is hilarious. Is it a parity or is it for real? A few
thoughts and questions. One, I did not know we had the power to
clear Richard.'' And if you look at--well, you do not have the
news release. ``The first paragraph of the news release
indicates that Mr. Scrushy was cleared by an outside
investigation. In fact, our letter says quite the contrary,''
according to Mr. Gold.
``Second, what is the legal definition of inkling? Is it
more than a scintilla.'' And the word ``inkling'' is used in
your quote written apparently in part by Mr. Davis saying that
Scrushy had--puts to rest any question whether Mr. Scrushy had
any inkling or knowledge.
``Three,'' and I am quoting here, ``do these idiots realize
that 2 months after May 14 is July 14?
Four, our investigation began on September 24, not
September 17.'' The news release says September 18. ``And was
essentially completed except for the supplemental reports by
October 21, a period of 4 not 6 weeks.'' And the 6 weeks is
listed in your press release.
``Five, we did not review 59,000 documents and 546,300
pages, we merely applied our search parameters to those
documents and pages. Our report specifically states that we did
not examine documents not responsive to the search terms.
Six, our conclusion is not stated accurately as it omits
the `in the view of' clause the Fulbright & Jaworski has
uncovered.
Seven, there is no way to confirm a person's absence of
knowledge.
These are just top-of-the-head thoughts about this. Have a
good flight,'' it says.
Do you still stand by what is in this news release and your
quotes?
Mr. May. I am not familiar who--with the individual who
wrote that email. My principal contact with Fulbright &
Jaworski was Hal Hirsch.
Mr. Walden. Okay.
Mr. May. Hal Hirsch reviewed that quote. Hal Hirsch
approved that quote. And therefore, yes, I stand by that quote.
Mr. Walden. Let me quote an email from Hal Hirsch, dated
October 29, 2002, 1:30 p.m. This followed the one I quoted from
Neil Gold which was at 11:52 the same day.
``Carl and I told Horton much of what you stated, though we
all acknowledge a lack of control. Horton is working on
improving the statement be good. HMH.''
My question is do you still stand by these statements
today?
Mr. May. I said by the quote that was made at the time.
Mr. Walden. Mr. Gordon, do you think those statements are
accurate in the news release?
Mr. Gordon. I would question them.
Mr. Walden. Could you speak just a little closer? I am
sorry.
Mr. Gordon. I would question it.
Mr. Walden. You would question the statements in the news
release?
Mr. Gordon. Yes.
Mr. Walden. Why?
Mr. Gordon. I guess as I have expressed earlier, I think
that I do have some questions about the independence of the
investigation.
Mr. Walden. Did you raise any objections at the time to the
news release, or did you even get a chance to see it?
Mr. Gordon. I did not see it until after it was in the
papers.
Mr. Walden. Did not see it?
One final question or set of questions. One of the things
that strikes me as I listen to your testimony and having talked
with you all, and with the testimony of others, was this a
company that was dominated by a CEO who engaged in intimidation
and manipulation to the point that people feared for their own
safety and jobs if they questioned Mr. Scrushy?
Mr. Gordon?
Mr. Gordon. Repeat that again for me, if you would?
Mr. Walden. I will try. Was this a company where employed
and perhaps even Board members felt or today feel intimidation
or that Mr. Scrushy was manipulative based on his actions? When
I hear about the fact that he had his security guard, you know,
follow you out of a Board meeting. You know, you hear these
other things about the security arrangements at the company.
And, sure, companies have those. But the taping in the back of
his pickup. The fact his security guard finds the CFO committed
suicide. These things sound unusual.
Mr. Gordon. Well, I think the company--or I may go back.
The company was enjoying unparalleled success and people were
making really good money on salary and options. So there was a
lot of harmony. And I never saw a lot discord in--around the
company. Everybody seemed to be very happy and working on a
progressive basis. The company was growing and so forth.
Now, as things got tough over the last 6 or 8, 10 months--
--
Mr. Walden. Sure.
Mr. Gordon. [continuing] I saw some of that. I did see on
occasionally when I disagreed with him, he would raise his
voice and express his dissatisfaction. There was not a
discussion. It was him demanding why you saying this, why you
doing this, and so forth.
Mr. Walden. I mean, I do not know, maybe it is the way it
works. But when I think about manipulation, basically saying
you know, Mr. Gordon, they want you off the Board but I will
keep you on if you get Mr. May off the Board and----
Mr. Gordon. He had a history of working one Board member
against the other.
Mr. Walden. Is that not manipulation?
Mr. Gordon. I would think so.
Mr. Walden. Do any of you, given the indictments, given the
statements, do any of you fear for your individual safety
throughout this process?
Mr. Gordon. Honestly, when I drive around Birmingham at
night in a Yukon that they provide me to go, I do have some
concerns. I definitely do. There has been remarks that you got
to be watching yourself.
Mr. Walden. Anyone else?
Mr. May. I would have to say that my wife certainly has
expressed her concern for my safety. I do not have any concern.
And I also, if you would not object, I would like to just
clarify my statement on my quote.
Mr. Walden. Sure.
Mr. May. What I want to be clear is that at the time I made
that quote, I believed that quote to be correct.
Mr. Walden. How about today?
Mr. May. Today, you know, we understand that things are
very much different and there is a different set of facts in
place in terms of the conspiracy, you know, committed against
the company by a group of individuals and what information was
known by those individuals during this same period of time.
Mr. Walden. So today you think maybe Mr. Scrushy had
insider knowledge?
Mr. May. I think based upon what was in the indictment and
what has been known, there has never been a transaction that
Mr. Scrushy took part of that did not have insider information.
Mr. Walden. All right. Anyone else want to comment on any
of this? If not, thank you, Mr. Chairman.
Mr. Greenwood. The Chair thanks the gentleman.
Before recognizing Mr. Stearns, there are just a couple of
things that are hanging out there that need to be clarified.
Ms. Givens, when I asked you earlier if you were present at
the Board meeting when Mr. Gordon was asked, it was recommended
that he be removed from the compliance committee, you either
indicated that you were not there or that you do not recall
being there. If you want to, you can consult--I am not sure
what tab this is. I will get that for you in a moment. But I
think it is 28. It is the Board meeting for October 29 at Tab
14.
Tab 14 is the Board meeting and it is from October 29. It
indicates that you were at that Board meeting, and it indicates
that the Board discussed Mr. Gordon's ineligibility to serve on
the compliance committee because of his status as an employed
consultant of the corporation.
So, now that you have looked at the Board minutes and see
that they indicate you were there, does that fresh your memory
and do you recall that, in fact, you were there?
Ms. Givens. I have not approved these minutes and one of
the reasons that I did not approve the minutes was that they
had me being there at some of the Board meetings where I was
not. And I actually, indeed, was present at some where they did
not have me recorded.
And it is also unclear as to whether or not we participated
by phone or in person.
And so the fact that--and it has only been in the recent
minutes where that has been a problem.
Mr. Greenwood. Okay. As you look at these minutes and the
discussion that they reflect, is your memory jogged to recall
that you in fact were there?
Ms. Givens. If you can give me a moment, I would be happy
to do that.
Mr. Greenwood. Certainly. It says ``all directors and
guests were physically present with Mr. Scrushy in the Board
room.'' It does not indicate that the Board members were
telephonically linked.
Ms. Givens. This sounds familiar, yes.
Mr. Greenwood. Okay. So you were there when the Board
discussed Mr. Gordon's ineligibility to serve on the compliance
committee because of his status as an employed consultant of
the corporation.
Ms. Givens. Yes.
Mr. Greenwood. During that discussion did you agree that
that would be a good reason to remove Mr. Gordon from the
compliance committee because of that conflict of interest?
Ms. Givens. As I recall that issue, that was recommended to
us by our corporate counsel who let us know that he was now
disqualified from being on the compliance committee.
Mr. Greenwood. Because of that consulting fee?
Ms. Givens. That is right.
Mr. Greenwood. Which had been around for how many years,
Mr. Gordon?
Mr. Gordon. Seven.
Mr. Greenwood. Okay. So Mr. Gordon's got a consulting fee
for $250,000 for 7 years. He has got a multi-hundred million
dollar stake in the company. And you sat there and thought that
it made sense to remove him because he would have a conflict of
interest because of the consulting fee, is that correct?
Ms. Givens. Well, that was under the recommendation by the
corporate counsel.
Mr. Greenwood. Okay.
Ms. Givens. And I would have to rely on their expertise.
Mr. Greenwood. Right. Now, has been mentioned, you yourself
had financial dealings of significantly greater magnitudes with
the company, millions of dollars. Did it occur to you to say
well wait a minute, if that applies to him, what about me?
HealthSouth had arranged a credit agreement with Nations Bank
allowing the company to invest $5 million in a Acacia Venture
Partners, a private venture capital fund with Sage Givens as
the founder and managing partner. Did you say, wait a minute,
if that constitutes a conflict of interest for him, $250,000,
what about me?
Ms. Givens. The potential conflicts of interest were always
disclosed and reviewed by our internal counsel.
Mr. Greenwood. So were Mr. Gordon's, correct?
Ms. Givens. Apparently the internal counsel thought that it
was inappropriate for Mr. Gordon to continue to serve. He did
not mention my inability to----
Mr. Greenwood. I understand that. But, I mean, Mr. Gordon,
they had this arrangement for 6 or 7 years. You are sitting
there in the Board room. They say we have suddenly discovered--
in the interim Mr. Gordon writing some strong letter
questioning what is going on at HealthSouth. After Mr. Gordon
starts writing these letters, the general counsel suddenly up
and discovers the $250,000 is a conflict of interest for which
he should be removed from the compliance committee.
You are sitting there. Did it not go through your head that
I have got multi-million dollars of conflict of interest. And
if he should go, then I should go. And, in fact, according to
the minutes they asked you to take his seat on the compliance
committee, is that correct?
Ms. Givens. You have just asked me 2 or 3 questions.
Mr. Greenwood. Okay. You can answer them all.
Ms. Givens. The first one is when you talk about conflicts
of interests, I would not characterize my relationship with the
company as having a conflict of interest.
Second----
Mr. Greenwood. What did you think conflicted the interests
of Mr. Gordon? What would constitute the conflict of interest?
What is the difference? In other words, the theory I would
assume that, gee, Mr. Gordon would not dare question the way
this company is managed because after all, they are paying him
$250,000. You know, the implication is that he would not be a
good steward of the investor's dollars because he is being
influenced by $250,000 a year gain. Is that not the theory of
conflict of interest?
Ms. Givens. In this case I really relied on our internal
counsel----
Mr. Greenwood. Not your own judgment at all?
Ms. Givens. I am not a lawyer. And I relied on legal
expertise.
Mr. Greenwood. Neither am I. I am not a lawyer. But I can
understand----
Ms. DeGette. Will the gentleman yield?
Mr. Greenwood. Just a second, I will.
I can understand what this is about. This is about making
sure that members of boards of directors execute their
fiduciary responsibility to the investors and that their
judgment in executing that responsibility is unclouded by their
own personal financial interests. That is a no-brainer.
Everybody understands that concept.
Ms. Givens. I would agree with that.
Mr. Greenwood. And so Mr. Gordon gets bounced off the
compliance committee, you take his seat and I cannot understand
why you would not say if they are bouncing him for that, what
about me.
Ms. Givens. At no time have I thought that I have not acted
in the best interest of the shareholders.
Mr. Greenwood. Did you think Mr. Gordon was not acting in
the best interests or that he had an apparent conflict of
interest? In other words, to remove your fellow Board member
from the compliance committee is not about--nobody said he is
not acting wisely. This $250,000 has clouded his judgment. They
said well he is getting the $250,000, so it might appear to our
stockholders and to others, our investors, that he is
conflicted. So did you think he was conflicted? Did you think
he was acting and using poor judgment?
Ms. Givens. No, sir, I did not. But I relied on the
internal counsel to make a judgment as to whether or not it was
appropriate for him to continue to serve. And I believe that
the issue then was that he was deemed an employee of the
company because of that compensation. Not that it was a
conflict of interest, but the rules and regulations, I think,
required that he get off.
Mr. Greenwood. And who was the counsel whose judgment you
relied upon?
Ms. Givens. Bill Horton.
Mr. Greenwood. Mr. Gordon, you are shaking your head no. It
was not Mr. Horton who made that recommendation?
Mr. Gordon. Lanny Davis.
Mr. Greenwood. It came from Lanny Davis.
Mr. Gordon. Yes.
Mr. Greenwood. You did not know that, Ms. Givens?
Ms. Givens. I did not.
Mr. Greenwood. Okay. Did you want to question----
Ms. DeGette. Yes. I just wanted to follow up and say if you
were relying on advice of counsel and counsel said Mr. Gordon
had that conflict of interest, did it not occur to you to ask
counsel what about my financial dealings with the company, or
why is that different?
Ms. Givens. I have asked that on a regular basis, and I
have always been given the response that I was not conflicted.
And, indeed, most recently I had to have an independent
evaluation of whether or not I was independent to be able to
serve on the audit committee. And that evaluation was
performed, and I have been deemed independent.
Ms. DeGette. Who has told you at various times that advice?
What are the names?
Ms. Givens. Independent internal counsel Bill Horton.
Ms. DeGette. Okay.
Ms. Givens. And more recently Wilkie Farr of New York.
Ms. DeGette. A layer in New York?
Ms. Givens. A law firm in New York.
Ms. DeGette. Okay. Great. Thank you.
Mr. Greenwood. The gentleman from Florida is recognized for
10 minutes.
And I appreciate the indulgence of the panel.
Mr. Stearns. Thank you, Mr. Chairman.
I would just say to this panel here, it is like the dentist
chair. We are almost over, so we appreciate your forbearance
here. And I just have the last set of questions here, right,
Mr. Chairman? So after me we are all done.
There is a couple of things we just want to get on the
record, so I will just take you through it.
And I will start with Mr. Striplin, if you would answer
this, what was the first that the company, that you learned
that the company was going to be financially impacted by the
Medicare reimbursement policy about $175 million? Was it at a
Board meeting?
Mr. Striplin. Yes. Yes.
Mr. Stearns. And we understand it was, I think, in prior
testimony you have given August 26, 2002?
Mr. Striplin. Yes. Yes.
Mr. Stearns. So over a year ago you were told about the
$175 million impact because of the Medicare reimbursement,
right?
Mr. Striplin. Right.
Mr. Stearns. Did Mr. Scrushy tell the Board about the
material impact of this $175 million?
Mr. Striplin. Yes, he did.
Mr. Stearns. Did you have any suspicions about the
announced impact on the company?
Mr. Striplin. Well, we had just been told that it was going
to be about $15 million--$15 to $20 million, as I recall within
30 days of that. And it was sort of a shock to all of us.
Mr. Stearns. To hear $175 million?
Mr. Striplin. That is right.
Mr. Stearns. Go up from $15 million to $175 million?
Mr. Striplin. That is correct.
Mr. Stearns. In a matter of how many days?
Mr. Striplin. As I recall, it was in 30 days.
Mr. Stearns. Yes.
Mr. Striplin. The prior Board meeting.
Mr. Stearns. Do you recall the committee staff telling us
that you were shocked by the amount and you felt snookered by
Mr. Scrushy? Do you remember those words? We are just trying to
get these on the record. I think you indicated that you were
sort of flabbergasted and I think the words you used, you were
shocked and snookered by Richard Scrushy. So we are just asking
confirmation for the record on that.
Mr. Striplin. I think I did make that statement.
Mr. Stearns. Okay. And perhaps you would maybe just give us
why you felt that way. Was it just an emotional or did you have
an intellectual reason for it?
Mr. Striplin. No. I just felt like that in a short period
of time that we didn't know what we were talking about.
Mr. Stearns. Yes, it was getting out of hand.
Mr. Striplin. One of those kind of things.
Mr. Stearns. Did you ever call Mr. Scrushy after the Board
meeting of that August 26, 2002 to discuss the $175 million
impact?
Mr. Striplin. I do not recall.
Mr. Stearns. Yes.
Mr. Striplin. I do not think I did.
Mr. Stearns. Well, we have here you do recall it in a prior
testimony, so we are just----
Mr. Striplin. Well, remind me.
Mr. Stearns. In fact, you said yes and then you went on to
say you asked Mr. Scrushy, you said ``What the hell is going on
here with this number.'' That is what, Mr. Striplin, you told
us, the staff here. So we are just trying to get it on the
record.
Mr. Striplin. Well, if I said that, I think that it was
true.
Mr. Stearns. Okay. I mean, it is a pretty quote, what in
the hell is going on.
Mr. Striplin. Yes.
Mr. Stearns. I think that was a good quote. Yes.
I guess the next question is after you said that, what did
Mr. Scrushy say to you?
Mr. Striplin. I do not recall. I was known to confront a
lot on different things.
Mr. Stearns. Oh, you were?
Mr. Striplin. Yes.
Mr. Stearns. Do you recall, this is what you told our
staff, you said that Mr. Scrushy responded ``We have just got
some things we have got to charge off.'' Do you remember him or
recall him saying that to you?
Mr. Striplin. I do not really recall that. But if I said
that at the time, I did remember it.
Mr. Stearns. Okay. All right.
Mr. Striplin. Yes.
Mr. Stearns. Did you ever tell any other Board members
about this conversation, your feelings and your conversation
with Mr. Scrushy? I mean, this is a pretty big impact. It goes
from $15 million to $30 million to $175 million. At some point
did you share this with other Board members?
Mr. Striplin. Not that I recall.
Mr. Stearns. Let me ask the rest of the Board members if
the conversations that we have just had did Mr. Striplin, Mr.
Gordon, tell you anything about his conversation with Mr.
Scrushy in which he said what the hell is going on and Scrushy
oh, we're just charging off a couple of things? Do you remember
that?
Mr. Gordon. No.
Mr. Stearns. Ms. Givens?
Ms. Givens. No, I do not.
Mr. Stearns. And Dr. Watkins?
Mr. Watkins. No.
Mr. Stearns. And Mr. May?
Mr. May. I was not aware of the conversation.
Mr. Stearns. Okay. I guess, Mr. May, you were not there at
the time.
Let me go then, Mr. Gordon, if you would be so kind, we are
going to Tab 90. And I will take a moment here for you to get
to Tab 90. And specifically I am talking about page 2 at the
bottom of the page. This Tab 90 represents minutes of the
February 7, 2003 Board meeting, and I draw your attention to
the bottom that states ``Mr. Scrushy also advised the Board
that he was seeking approval from the Board to leave Dr.
Watkins' stock options open until their normal expiration date
as part of his agreement to be available to consult with the
Board on an as-needed-basis. After discussion upon mother duly
made by Mr. Striplin and second by Mr. Newhall, the following
motion was approved with Mr. Gordon abstaining.''
So the question is in the whole matter of life do you
remember that, Mr. Gordon, abstaining?
Mr. Gordon. Yes, I do.
Mr. Stearns. Okay. I guess the question we are all asking
is why did you abstain?
Mr. Gordon. I abstained because I had recognized Bill's
excellent service to the Board and I thought Dr. Watkins had
been a very capable Board member. But he had options that were
remaining outstanding that expired over the next 6 or 8 years.
And I did not think it was appropriate that a Board member who
resigned should maintain his stock options. If he resigned, he
could exercise them at that point. But he was not entitled to
maintain them over the next 6 to 8 years. So I discussed the
fact that I did not think it was appropriate for him to have
his options extended that long.
Mr. Stearns. That sounds like a square shooter. I think you
are saying something that most of us would all agree with. But
what did Mr. Scrushy say about why Dr. Watkins' stock options
should be extended? I mean, did he say something in a meeting
that you recollect?
Mr. Gordon. Yes. He says let us let him have them, we might
need him to testify sometime.
Mr. Stearns. He said we might need him to testify. Now,
testify, what did you think he meant when Mr. Scrushy said let
us give him the stock option and by so doing would you not
consider that quid pro quo or some kind of salve here to get
him in case he has to testify, that he would be on the right
side; is that not what you are saying? That is the implication.
Mr. Gordon. In my mind, I thought that was the implication
and I thought it might be flip. I did not really know if he was
making a flip or not.
Mr. Stearns. So Mr. Scrushy said he might be called to
testify. Now ``called'' does not mean by the Board.
Mr. Gordon. I think he might be required to testify.
Mr. Stearns. Must be required. So that would require the
law would ask him to testify. Would that be a safe
understanding in your estimation, somebody beyond the Board?
Because the required is not voluntary. So Mr. Scrushy at that
point was saying maybe in a indirect fashion that, hey, we had
better be nice to this fellow because he might be required to
testify under oath.
So my question to you is did that send up any flags?
Mr. Gordon. At that time things were coming to a conclusion
that they would eventually receive, and I think at that time,
you know, the comment was suspect, to say the least.
Mr. Stearns. Yes. Well, Mr. Watkins, I guess you are next
here. So the question is the obvious thing here is it looks
like a quid pro quo just from the outside. So did Mr. Scrushy
give--did you have any conversations now that this was sort of
a quid pro quo; we will give you a stock option, if you are
required to testify you will work with us?
Mr. Watkins. Never. In fact, I have never thought that
until this very minute that he said to the Board.
As part of my agreement when I resigned from the Board, I
simply requested that I be allowed to keep my stock options.
They were all under water. They were worthless, but my feeling
was it was a reward for 18 years of service. It was not unusual
business practice to let a Board member continue to have their
options. And I agreed to be a consultant and help in any way
with the company. But I never have heard that quote before. And
Richard Scrushy did not say that to me. He may have expected
that, but I certainly never would have done that.
Mr. Stearns. Mr. Scrushy never talked to you about this
idea that if you will resign, you will get your stock options?
He never mentioned anything like that to you?
Mr. Watkins. No. No. Actually, I brought it up. I asked if
I do go ahead and resign, is it okay if I go ahead and just
keep my stock options. I know they are under water, they are
worthless, but I would like to keep them because I have faith
in this company. And I will be glad to work for it.
Mr. Stearns. Okay. Had you ever heard what Mr. Gordon said
before? You said this is the first time you have ever heard
that Mr. Scrushy said he may be required to testify?
Mr. Watkins. Absolutely. I have never heard that before.
Mr. Stearns. Okay. Anybody else know anything? Okay.
Let me move to my last, Mr. Chairman, series of questions
here. And this is to Mr. May.
If you would be so kind to turn to Tab 25, it is one page.
It is a memorandum to George Strong from yourself. You are
acting chief executive officer. This is dated June 11, 2003.
Mr. May. Actually the date that is on the memorandum is
not--that is the date this memorandum was printed. The
timeframe in which the memo was originally created and sent to
George, was back in March 2003.
Mr. Stearns. The date on the memo from George Strong is
wrong?
Mr. May. Correct.
Mr. Stearns. And the date should be March 2003?
Mr. May. Correct.
Mr. Stearns. And is it just what? The computer puts it out,
when the set of computers some date, or tell me why the wrong
date here. I mean, how would you argue that it is the wrong
date when it says ``6/11/2003?''
Mr. May. I know when I created the document.
Mr. Stearns. Okay.
Mr. May. And when it was printed for the committee.
Mr. Stearns. Okay. Let me just review this. I will sort of
paraphrase because you know the thing.
The main point of this memo, and I will not laboriously go
down and read it, but the question was are there any Enron type
issues or exposure here. Ernst & Young focused heavily on those
type of items when evaluating our books. And what Mr. Strong
said ``What assurance can we have from Ernst & Young that next
year we do not have the same issues? Obviously, if we do the
consequences would be disastrous. I leave this question in your
hands to handle as you deem appropriate.''
So, I guess what about Mr. Lamphron's statements to the
Board prompted you to raise these issues with the Chairman of
the audit committee?
Mr. May. There were a couple of things. At that meeting we
were handed a set of minutes for approximately the last 12
months to approve. I asked that they must be given to me to
review before given to a whole Board to be approved. I took
those minutes with me and at that Board meeting, E&Y, this is
the year end, E&Y gave their year end report about the work
that they had done in the previous year and how the Board could
rely on E&Y's assurances that the books accurately reflected
the business, etcetera, etcetera.
So on the way home I was reading these minutes to review
them, and came upon the minutes from the previous year's
meeting, same time. And those minutes reflected in 1901 the
extensive work that E&Y did in taking a look at our books and
records in light of the fact that Enron and WorldCom and all of
those companies had made the news that year.
Mr. Stearns. Yes.
Mr. May. So at the Board meeting in Orlando that happened
in 2003 for a year end 2002, I heard similar assurances from
E&Y and at that same Board meeting there was--we had our fourth
quarter earnings report where we had significant write-offs.
Mr. Stearns. $600 million charge was inconsistent with--was
there not a $600 million dollar write-off?
Mr. May. Correct. So my question was with such a careful
examination, why are we having a $600 million charge off.
Mr. Stearns. Now, again, like we talked about these with
this Striplin, was this not presented at the eleventh hour? I
mean, it is sort of like just came out under the cracks, $600
million charge? And was this not sort of inconsistent with the
eleventh hour call, as you understand it?
Mr. May. I believe that we were--the Board was notified of
the charge off the day prior to the earnings release, I
believe. If that is your question.
Mr. Stearns. And what was your reaction to that? I mean,
did you have the same reaction as Mr. Striplin and say what the
hell is going on?
Mr. May. I certainly had a lot of questions as to why the
Board was not given more notice than the day prior to the
earnings release.
Mr. Stearns. When these things happen like this, do they--
when you go home at dinner at night, I mean do you say, hey we
got to do something here. Something is going on here. Tomorrow
morning I am getting up early and I am going in there and heads
are going to roll.
I mean, what did you do in terms of activity the next day
with this?
Mr. May. You certainly, you know, ask yourself those
questions; what is it that you can do to get at answers. And
then I think----
Mr. Stearns. But you just took the answer as credible and
moved on?
Mr. May. The answer to what, sir?
Mr. Stearns. That the $600 million popped up?
Mr. May. No, I would not say we took the answer as it was
laid out. We wanted to have answers as to why the charge offs
were, you know, were to the size that they were.
Mr. Stearns. Yes.
Mr. May. And then certainly simply a few weeks later is
when the revolution of the fraud occurred.
Mr. Stearns. Did you ask him why it came up so soon and so
unexpectedly? And what was his reply?
Mr. May. The question was--I believe was answered or asked
on the call that we had prior--the evening prior to earnings
release as to why, you know, we were given such notice. And the
answer was that there was a lot of complicated things that
needed to be done at the year end.
Mr. Stearns. Who gave you that answer, just for the record?
Who gave that answer that----
Mr. May. I cannot----
Mr. Stearns. [continuing] certain things just came up?
Mr. May. I cannot be certain exactly who gave me that
answer. But I believe it was Bill Owens.
Mr. Stearns. I assume it must have been the chief financial
officer?
Mr. May. Again, I am not certain, but I believe it was Bill
Owens.
Mr. Stearns. Okay. What was the response of Mr. Strong? Did
Mr. Strong respond to your suggestion, your memo?
Mr. May. Mr. Strong indicated verbally to me that, you
know, it was something that he would look into and make sure
that we got answers on.
Mr. Stearns. Did he actually get answers on this?
Mr. May. I am not certain. You would have to ask George.
But as I said, a couple of weeks later or just a few weeks
later, you know, the world fell apart with the fraud
disclosure.
Mr. Stearns. Let us move until today. You are sitting in
your desk operating now as the acting chief executive officer.
If this had occurred to you today, what would be your response?
Mr. May. If this type of write-off occurred at your end?
Mr. Stearns. If you were notified in such short notice like
you were, I mean if you had the same thing happen to you today,
I assume your behavior might be a little different?
Mr. May. I would say I would look----
Mr. Stearns. Would you accept the fact that somebody told
you these are just some write-offs, nothing to worry about?
Mr. May. No, I would throw them out the door.
Mr. Stearns. I think that is what you would do, yes.
Thank you, Mr. Chairman.
Mr. Greenwood. The Chair thanks the gentleman.
The Chair thanks the panel.
Ms. Givens, just one final request. If you would, either
you or would you have your attorneys send us a copy of the
report that they determined your independence with regard to
the audit committee, that would be helpful for our inquiry.
Ms. Givens. Be happy to.
Mr. Greenwood. We thank all of you for being here for these
many hours. We wish all of you and HealthSouth well as you try
to reconstruct this company into the future.
Thank you.
And we are going to recess now until 2:30. And we will take
the third panel at that time.
[Whereupon, at 1:58 p.m., the subcommittee recessed, to
reconvene at 2:37 pm. the same day.]
Mr. Greenwood. The committee will come to order. We welcome
the third panel, who have already found themselves to the
table.
Let me introduce you, Mr. Richard Dandurand. Am I
pronouncing that right?
Mr. Dandurand. Yes, Mr. Chairman.
Mr. Greenwood. All right. Is the former engagement partner
on HealthSouth account at Ernst & Young; Mr. Wayne Dunn is the
former senior manager on HealthSouth account at Ernst & Young,
and; Mr. James Lamphron is a former engagement partner on
HealthSouth account at Ernst & Young.
Gentlemen, as you may know, this committee takes its
testimony under oath, and so I need to ask if any of you object
to giving your testimony under oath this afternoon.
Mr. Dandurand. No, I don't.
Mr. Greenwood. Okay. I need to also advise you that
pursuant to the rules of the House and this committee, you are
entitled to be represented by counsel. Do you wish to be
represented by counsel this morning? Okay. And are you all
represented by the same counsel?
Mr. Dandurand. That's correct.
Mr. Greenwood. Okay. Mr. Lamphron, would you identify your
counsel by name and point to them, so we know who they are?
Mr. Lamphron. Sitting directly behind me is Steve Farina
and Matt Harrington of Williams & Connelly.
Mr. Greenwood. Okay. Very well.
In that case, I am going to ask if you would stand and
raise your right hands.
[Witnesses sworn.]
Mr. Greenwood. Okay. You are under oath. And it is my
understanding that Mr. Lamphron is going to give an opening
statement of approximately 7 minutes for all three of you.
Mr. Lamphron. That is correct.
Mr. Greenwood. That is fine. And the floor is yours, sir.
TESTIMONY OF JAMES P. LAMPHRON, FORMER ENGAGEMENT PARTNER ON
HEALTHSOUTH ACCOUNT AT ERNST & YOUNG; RICHARD DANDURAND,
ENGAGEMENT PARTNER, HEALTHSOUTH ACCOUNT AT ERNST & YOUNG; AND
WAYNE DUNN, FORMER SENIOR MANAGER ON HEALTHSOUTH ACCOUNT AT
ERNST & YOUNG
Mr. Lamphron. Thank you.
Good afternoon, Chairman and members of the subcommittee.
My name is Jim Lamphron and I am a partner in the firm of
Ernst & Young. Beginning with the audit for the year 2000 I
served as the engagement partner with responsibility for the
financial statement audits that we performed for HealthSouth.
I am here this morning with my colleague Wayne Dunn, who
for the last several years has been the senior manager on the
engagement, and my former partner who is now retired, Dick
Dandurand. Dick was the engagement partner on HealthSouth
before I took over.
I am 56 years old, married for 34 years, and have 3 adult
children. After completing my undergraduate degree and serving
as an officer in the Marine Corps, I became an auditor in 1975.
That was with the firm of Arthur Young & Company that later
merged in 1989 with Ernst & Whinney to form the firm of Ernst &
Young. Both firms were founded approximately 100 years ago, and
today Ernst & Young employs over 25,000 people in the United
States.
First let me say that, to a person, we at Ernst & Young
feel for and share the outrage of the many upright and decent
people at HealthSouth, and in the investing community who have
been harmed by this fraud. Investors, retirees and employees
have all been harmed. As a resident of Birmingham, I can attest
that the entire city has suffered and will continue to suffer
from the aftereffects of the fraud perpetrated at HealthSouth.
I don't know of another fraud that is quite like. According
to the Department of Justice and the SEC, a specific aim of the
criminal conspiracy was to undermine and sabotage Ernst &
Young's work as auditors. The fraud is also unprecedented in
terms of management involvement. Yesterday. the company's
founder and CEO, Richard Scrushy was indicted on 85 counts of
fraud and other charges. And as you know, 14 other HealthSouth
executives have already pled guilty, including every former
CFO. And the U.S. Attorney in Birmingham says that the
indictments will continue, and that her probe is extending
further into non-financial areas of the company. As you
observed at the first of these hearings, Chairman Greenwood,
HealthSouth presents the unique and uniquely troubling story of
a corrupt criminal enterprise.
At the outset, let me try and answer a few of the questions
that I think you may have.
People ask me how a fraud of this scale could go undetected
by the auditors. The U.S. Attorney has stated over and over
again that we were a target of the collusive fraud. We were
given fake documents, altered documents, and were lied to, over
and over again. Through the collusion among the senior
management of HealthSouth, our audit was impeded and
undermined. As Teresa Sanders, the former head of Internal
Audit at HealthSouth, testified before this subcommittee, and I
will say as Mr. Wallance testified before this subcommittee
this morning, when you have a collusive fraud involving
multiple members of management and where documents are
falsified, it is entirely possible to defeat a financial
statement audit.
People ask me if, in hindsight, there was one more thing
that I or my team would have done. I have asked myself that
question many times since March 19. I have looked back through
our work papers. I have tried to find that one string that, had
we yanked it, would have unraveled this fraud. I know we
planned and conducted solid audits. We asked the right
questions. We sought out the right documentation. Had we asked
for additional documentation there or asked another question
there, I think that it would have generated another false
document and another lie. With each guilty plea that is
announced, we see where the fraud was systematically expanded
to undermine our audit procedures.
Finally, people ask me what is the likelihood of this
happening again. The shorter answer is that there is no system,
no audit and no law that can be made invulnerable to a
collusive band of criminals. Character and ethics cannot be
legislated. That said, I believe our system has been
significantly strengthened of late, the requirements and
procedures legislated by Congress in the Sarbanes-Oxley Act
will, in my estimation, make another fraud of this type less
likely. It fact, it may be that the requirements for officer
certification and harsh criminal penalties is what brought down
the walls of silence around this fraud. The new rules being
adopted by the SEC and The New York Stock Exchange will also
promote corporate accountability and improve corporate
guidance.
I also believe the U.S. Attorney in Birmingham should be
praised for her vigorous prosecution of this case. And the
hearings being held by this subcommittee will undoubtedly be
constructive in publicizing the aftereffects of the fraud
further, so as to discourage others from following the same
path.
Finally, let me say, I have spent almost 3 decades building
my professional reputation. The criminals that ran HealthSouth
exploited many people, including me and my colleagues and
throughout the firm. In a very personal way I share the anger
and frustration of this subcommittee, the investing public and
the Birmingham community.
Mr. Chairman, we have worked to assist you and your staff
in every respect during the course of the subcommittee's
investigation. I am happy to answer the subcommittee's
questions, as are my colleagues.
[The prepared statement of James P. Lamphron follows:]
Prepared Statement of James P. Lamphron
Good Morning Mr. Chairman and members of the Committee. My name is
Jim Lamphron and I am a partner in the firm of Ernst & Young. Beginning
with the audit for the year 2000 I served as the engagement partner
with responsibility for the financial statement audits Ernst & Young
conducted for HealthSouth Corporation. I am here this morning with my
colleague Wayne Dunn, who for the last several years has served as
senior manager on the HealthSouth audit. My former partner Richard
Dandurand, now retired, also joins me. Dick was the engagement partner
on HealthSouth before I took over.
After completing my undergraduate degree and serving as an officer
in the United States Marine Corps, I became an auditor in 1975. That
was with Arthur Young & Co., which combined with Ernst & Whinney in
1989 to form Ernst & Young. Both of the predecessor firms were founded
approximately 100 years ago, and today Ernst & Young employs more than
20,000 people in the United States.
First let me say that, to a person, we at Ernst & Young feel for
the many outstanding and decent people at HealthSouth and in the
investing community who have been harmed by the HealthSouth fraud.
Investors, retirees and employees have all been harmed. Residing in
Birmingham, as I do, I can attest that the entire city has suffered and
will continue to suffer from the aftereffects of the fraud perpetrated
at HealthSouth.
I don't know of another fraud that is quite like HealthSouth.
According to the Department of Justice and the SEC, a specific aim of
the criminal conspiracy at HealthSouth was to undermine and sabotage
Ernst & Young's work as auditors. The fraud is also unprecedented in
terms of management involvement. So far, fifteen HealthSouth executives
have pled guilty to fraud, including every former Chief Financial
Officer. And the US Attorney in Birmingham advises that the indictments
will continue, and that her probe is extending further into non-
financial areas of the company. As you observed at the first of these
hearings, Chairman Greenwood, HealthSouth presents the unique and
uniquely troubling story of a corrupt criminal enterprise.
At the outset, let me try and answer a few of the questions that I
think you may have.
People naturally ask me how a fraud of this scale could go
undetected by the auditors. The US Attorney has stated over and over
again that we were a target of the collusive fraud. We, the auditors,
were given fake documents, altered documents, and were lied to, over
and over again. Through the collusion among the senior management of
HealthSouth, our audit was impeded and undermined. As Teresa Sanders,
the former head of Internal Audit at HealthSouth, testified before this
Subcommittee, when you have a collusive fraud involving multiple
members of management and where documents are falsified, it is entirely
possible to defeat a financial statement audit.
People ask me if, in hindsight, there was one more thing that I or
my team should have done. I have asked myself that question many times
since March 19th. I have looked back through our workpapers. I have
tried to find that one string which, had we yanked it, would have
unraveled the fraud. I know we planned and conducted solid audits. We
asked the right questions. We sought out the right documentation. Had
we asked an additional question here, or asked for an additional
document there, I am convinced that the fraud and deceit would have
expanded to generate another lie, another fake document. With each
guilty plea that is announced, we see where the fraud was
systematically expanded to undermine our audit procedures.
People also ask me about internal controls and if HealthSouth had
appropriate controls in place. A simple example of an internal control
that is probably familiar to all of us is the requirement of two
signatures on checks of a certain size. That is a classic internal
control, and is drawn from a basic insight about human nature: a one-
person crime is far more likely than a two-person crime. The internal
controls at a large corporation are an application of the same
principle, albeit often more complex. We look to see that multiple
layers of people and departments are involved in different
transactions. We look for sign-offs. We look for documentation. What
did my team do at HealthSouth? We did all those things and more.
HealthSouth had in place a formidable system of internal controls.
Could those controls be circumvented by a fraud that encompassed the
entire senior management of the company? The unfortunate answer is yes.
Finally, people ask me what is the likelihood of this happening
again. The short answer is that there is no system, no audit, and no
law that can be made completely invulnerable to a collusive band of
criminals. Character and ethics cannot be legislated. That said, our
capital market system has been significantly strengthened of late. The
requirements and procedures legislated by Congress in the Sarbanes-
Oxley Act will, in my estimation, make another fraud of this type less
likely. It may be, indeed, that it was the requirement of officer
certifications and the threat of harsh criminal punishment that finally
brought down the walls of silence surrounding the HealthSouth fraud.
New rules being adopted by the SEC and the exchanges will also promote
corporate accountability and improve corporate governance. The US
Attorney in Birmingham should be praised for her vigorous prosecution
of this case, which sends the right message. And the hearings being
held by this Subcommittee will undoubtedly be constructive in
publicizing the aftereffects of the fraud so as to discourage others
from following the same path.
Mr. Chairman, we have worked to assist you and your staff in every
respect during the course of the Subcommittee's investigation. I am
happy to answer the Committee's questions, as are my colleagues.
Mr. Greenwood. Thank you, Mr. Lamphron. I appreciate that.
And thank you for your cooperation thus far, thank you for your
corporation in the next hour or so.
Has Ernst & Young, as you have reviewed documents that
describe how this fraud was perpetrated, and as you have even
recently I am sure you have read the indictment where a lot of
this is set forth, has Ernst & Young changed any of its
procedures? Have you sat around the table and brainstormed how
you might change procedures so that this does not happen again?
Mr. Lamphron. Well first, Mr. Chairman, let me say that we
really have not been able to examine documents relating to the
fraud. We have, of course, gone back and reviewed our work
papers, our procedures, our processes.
The firm has addressed this and other situations. For
example, we early adopted many of the provisions of the new
auditing standard on fraud. We did that in 2002.
We have conducted extensive training of our people. As an
example in the past year or so I have been to 40 hours of
training dealing with Sarbanes-Oxley, SAS 99 fraud awareness.
Mr. Greenwood. But when you say have not been to see
documents, what I want to know is have you had the opportunity,
I mean HealthSouth still exists, it is under new management,
you have some new people on the Board and so forth, have you
been able to go in and look at documents within the company at
all?
Mr. Lamphron. We have not.
Mr. Greenwood. You have not? And why is that?
Mr. Lamphron. I am not sure. I--I----
Mr. Greenwood. Have you asked for the opportunity?
Mr. Lamphron. We have been--I have been led to believe that
we do not have access to the documents.
Mr. Greenwood. And who led you to believe that?
Mr. Lamphron. Well, in general conversations with my
attorney.
Mr. Greenwood. That you do not have access to--that Ernst &
Young cannot go back and look? In other words, I understand you
reviewed your work papers. But, obviously, there are--and I do
not know whether it may be the case that the Justice Department
has ceased all these documents, you do not have access to them
for that reason. Is that your understanding?
Mr. Lamphron. Well, that could be part of it. Another
reason might be because Pricewaterhouse is in the process of
conducting a forensic audit. They are not through with that. My
understanding is it will be some time before they release their
findings.
Mr. Greenwood. Okay. So is it fair to say that this company
through fraud, there is no dispute about that, and you guys
were lied to----
Mr. Lamphron. Correct.
Mr. Greenwood. And you were lied to to the tune of $2.4
billion dollars of the phony income that they got by you that
you were not able to know; you still do not know how they did
that?
Mr. Lamphron. Our knowledge of that is limited to the
things we have read in the press. Probably, maybe even less
than the extent that you know.
Mr. Greenwood. Yes. Okay. Have you had a chance to review
the indictment?
Mr. Lamphron. I have scanned the indictment and discussed
it with our attorneys.
Mr. Greenwood. Okay. Let me ask you to turn to Tab 78 in
the binder, please. And I am going to ask all of you to look at
that.
Mr. Lamphron and Mr. Dunn, this is the email from former
HealthSouth employee Michael Vine to Ernst & Young in which he
asserted that there were ``severe problems with the company's
accounting, particularly with respect to the capitalization of
expenses in certain accounts.''
When and how were you first made aware of the allegations
in this complaint?
Mr. Lamphron. I was made of that when, as you may see
there, the email was sent to one of our national websites and
on July 1 that email was routed to me.
Mr. Greenwood. Okay. And what did you do with that email?
Mr. Lamphron. Immediately I called our professional
practice director, that is the person in our consulting chain.
I informed him of the contents of the email. And together we
planned to discuss what we should do, our communications and
our investigation.
Mr. Greenwood. And did you inform HealthSouth about the
allegations?
Mr. Lamphron. I did. I made a call the very next day. This
was July 2. Near the July 4 holiday. The only person I could
reach at that time was Weston Smith, who was controller at the
time. I informed him of the allegations. I asked for a--to see
if we could put together a conference call with Richard
Scrushy, Bill Owens and himself.
Mr. Greenwood. Did you inform the audit committee at
HealthSouth about this?
Mr. Lamphron. Not right at that time, but later I did. I
had----
Mr. Greenwood. When was that?
Mr. Lamphron. That was after we had--the company had
conducted their investigation, after we had talked to them,
after we had conducted our independent investigation. And then
I talked to the Chairman of the audit committee and informed
him of our findings. And at that point he indicated he was
satisfied with what we had done.
Mr. Greenwood. So how did you proceed to looking into this?
What did you do to satisfy yourself with regard to this memo
internally as Ernst & Young?
Mr. Lamphron. Sure. The first thing we did was, of course,
notify the company and give them an opportunity to--a brief
period of time to perform their own investigation to see if
there were anything to these allegations.
We met with them a few days later. They discussed----
Mr. Greenwood. And let me stop you there. Is there such
thing as a standard operating procedure when an auditing firm
receives a tip from an outside party alleging misconduct on the
part of a client?
Mr. Lamphron. Absolutely.
Mr. Greenwood. At least in retrospect, my inclination would
be well, gee, if my client is cooking the books, I am not sure
that the first thing I want to do is to tip them off to the
allegation. I might want to look at it internally ourselves to
see if we are missing something. Because, as you said in your
opening statement, if they want to go back and give you another
false statement, it would not be hard to do.
Mr. Lamphron. Well, there is two pieces of auditing
literature, SAS 54, illegal acts, and SAS 99 on dealing with
the detection of fraud during an audit, both of which say if
something like this occurs, we are to communicate to management
at a level higher than where the issue or the fraud was
reported, which we did. And in fact, went all the way to the
audit committee level.
Mr. Greenwood. Did Mr. Owens ever suggest that Mr. Vines
might have had a motive behind his allegations?
Mr. Lamphron. He did. When we met with him after they had
conducted their investigation, they mentioned that Mr. Vines
had been fired during a few months previous to this.
Mr. Greenwood. Did they say why?
Mr. Lamphron. Yes. They said he had been--had several
instances of I think it was fraternizing with women in the
department or women he had been supervising. He had been warned
about it by human resources. Had been on several occasions. And
in a final case had been released.
Mr. Greenwood. Did you review Mr. Vines' personnel record
to verify that?
Mr. Lamphron. I did not.
Mr. Greenwood. Okay. Did you try to contact Mr. Vines
personally either by phone or email to gain fuller
understanding of his allegations before commencing the
investigation?
Mr. Lamphron. Well, I did but I would first say that his--
--
Mr. Greenwood. When did you do that?
Mr. Lamphron. I did that after discussing our findings with
the Chairman--I did try. Let me clarify that. No I did contact
him.
Mr. Greenwood. But still after you went to the company? In
other words, when the email came in, you looked at the email,
his email address is not--is right on there. You did not
attempt to engage him directly in a conversation?
Mr. Lamphron. I did not. If you--you know, reading the
email you can see that it was very, very specific and down to
the point of identifying the specific accounts that were
affected. We thought at that point we had enough knowledge to
conduct our investigation.
Mr. Greenwood. Okay. But you did not think it would have
been prudent if you had contacted him first?
Mr. Lamphron. No. Again, I felt like we had enough
direction in his email to begin the investigation.
Mr. Greenwood. Before commencing your review, did you make
any attempt to discover which division of HealthSouth Mr. Vines
worked in or which business units or regions of the company Mr.
Vines had responsibility for in order to better focus your
inquiry?
Mr. Lamphron. Well, we knew that he worked in fixed assets,
in which division, I do not think we knew at the time. But we--
--
Mr. Greenwood. You knew that because the company told you
that?
Mr. Lamphron. But we expanded our investigation to include
all divisions.
Mr. Greenwood. Okay. Did you know at the time that he
worked in the in-patient division, and did you know that this
business unit of nationwide responsibility was unit three?
Mr. Lamphron. Well, at the time I did not, but that is not
entirely correct. He handled in-patient facilities and also
handled 500 out-patient facilities. Between he and his two
cohorts, they handled all 1881 facilities.
Mr. Greenwood. But did you know that he had sole
responsibility for unit three?
Mr. Lamphron. No, I knew there were three people who
divided the work up. And, again, we tested records from all
three divisions.
Mr. Greenwood. Is it true that you only learned about Mr.
Vines' position in the in-patient division after he testified
in April 2003 at the Scrushy Asset Forfeiture hearing?
Mr. Lamphron. That is correct.
Mr. Greenwood. Okay. Is it not also true that you did not
learn which business units Mr. Vines had responsibility for
until after committee staff inquired about them to you doing a
recent interview?
Mr. Lamphron. I do not know.
Mr. Greenwood. Okay. Let us turn to the actual review you
did. I understand that Ernst & Young requested that HealthSouth
provide all reclassifications from the three accounts mentioned
by Mr. Vines in his email, is that right?
Mr. Lamphron. That is correct.
Mr. Greenwood. Okay. I also understand that in two of the
three schedules of reclassifications provided to you by
HealthSouth, there were no reclassifications from business unit
No. 3, the business unit for which Mr. Vines had principal
nationwide responsibility. Did you notice that at the time of
your review?
Mr. Lamphron. No, because that is not correct.
Mr. Greenwood. Okay. Help me out.
Mr. Lamphron. There were reclassifications from business
unit three, which we examined and found them to be appropriate.
Mr. Greenwood. But in only in one of the three accounts, is
that correct?
Mr. Lamphron. I do not know.
Mr. Greenwood. Okay. Mr. Dunn, do you know?
Mr. Dunn. I do not know the answer to that, no sir. I
believe a couple of the accounts did not have 03, but I do not
know if it was only one.
Mr. Greenwood. Okay. I do not know if you are able to check
your records, but the staff is telling me that you went over
with them when they interviewed you.
Mr. Dunn. We did--we did discuss that. And what I am saying
is I recall that it was not on a couple of the schedules we
had, but I do not recall that we had all the schedules that I
investigated at the time. If we remember our interview, we
talked about the fact that I only kept certain of the
documents. And so I did not know if there were items from 03
for the other ones I did not retain.
Mr. Greenwood. And when did you first learn that the data
runs provided by HealthSouth did not include any unit three
reclassifications in two of the three accounts? Is it not true
that the committee staff had to recently point this out to you
in an interview?
Mr. Dunn. Say that again, please.
Mr. Greenwood. When did you first learn that the data runs
provides by HealthSouth did not include any unit three
reclassifications in two of the three accounts?
Mr. Dunn. I do not know when I first learned that. I do not
know if I learned it at the time of the staff or if I had seen
it previously. But we did discuss that with the staff.
Mr. Greenwood. Okay. So given the fact I assume that you
did not audit any of the reclassifications from business unit
three and two of the three accounts noted by Mr. Vines in his
email, is that your understanding? You did not audit any
reclassifications from business unit three in two of the three
accounts noted by Mr. Vines in his email?
Mr. Dunn. In two of the three accounts related to the
information we had----
Mr. Greenwood. There were 7072 and 7995----
Mr. Dunn. I do not know the specific accounts, but I know
it was two of the accounts, and I do not know which period it
was. I do not know if it was the December period or the May
period.
Mr. Greenwood. Okay. So it is correct that you did not
audit two of these three accounts for business unit three?
Mr. Dunn. For two of the three accounts there were not
reclassifications associated with business unit three on some
of the periods. And so we would not have any samples from
business unit three.
Mr. Greenwood. And with respect to the third account for
which HealthSouth provided Ernst & Young reclassifications from
business unit three, you did not sample or review any unit
three reclassifications below $5,000, is that right?
Mr. Dunn. I do not know the answer to that. I am sure it is
in the information we provided, but I do not know the answer to
that.
Mr. Greenwood. Okay. Staff says that is correct.
So given that Mr. Vines' concerns dealt with unit three
reclassifications below $5,000, I take it that your conclusion
that his allegations were unfounded is it itself unfounded?
Mr. Dunn. Well, I would point out that the email he sent
did not alleged any specific amounts. It just said
reclassifications in those accounts. So, you know, based on
that there was not a reason we would specifically look for
items under $5,000.
Mr. Lamphron. Mr. Chairman, if I may?
Mr. Greenwood. Yes, please.
Mr. Lamphron. First, let me tell you we took this
allegation very seriously. Mr. Dunn and I decided on our audit
approach. Between the two of us we have got 40 plus years of
experience. And to the best of our ability, we designed an
approach to determine if his allegations were correct.
Now, I know that under oath in Federal court Mr. Vines
testified that his two co-workers, who between the three of
them, encompass every facility the company has, they were all
engaged in fraudulent activities. Our review encompassed all
the divisions for several months. And so at the time we thought
what we did was sufficient.
Mr. Greenwood. But when he sent the email, I mean the thing
that struck us and the staff, and it is puzzling, is this is
such a specific email. This says ``If you look under three
rocks, you will find three smoking guns.''
Mr. Lamphron. Yes.
Mr. Greenwood. And it tells you exactly what to find. And
what we are trying to understanding why it is that it seems
like in fact the thing to have done with someone who has got
that specific information, would have been to get in contact
with him immediately and say tell us exactly where to look.
Mr. Lamphron. Yes. Well, again Mr. Chairman, because the
email was so specific, we did not feel like we needed to do
that at this point.
Now, even today----
Mr. Greenwood. But Mr. Dunn was just saying, we did not
have specific enough--I mean, on one hand we are hearing you
say we did not have specific enough information to know where
to look. On the other hand, you are saying the information was
so specific we did not have to ask where to look. Which is it?
Mr. Lamphron. Well, it is that we--our review encompassed
every division for several months. And if what Mr. Vines says
is true, that his two cohorts were involved in that, and again
he said that in Federal court under oath, then our review
should have discovered it.
Now, I need to say that even at this date we do not know
that what Mr. Vines was talking--mentioned in his email has
anything to do with this fraud that we are here today to
discuss. In fact, through counsel, Mr. Owens, the----
Mr. Greenwood. You are not saying you know that it did not.
You are just saying that you do know that it did?
Mr. Lamphron. We do not know that it did. And we know that
Mr. Owens subsequent to pleading guilty to the fraud charges,
indicated that this was not how they did the fraud. And, of
course, us not having access to the corporate records at this
point, we have had no opportunity to go back and see if it was
part of this fraud or if it was not.
Mr. Greenwood. Okay. My time has long since expired.
The gentlelady from Colorado is recognized.
Ms. DeGette. Thank you very much, Mr. Chairman.
Following up on the Chairman's questions, now you were in
the independent--and by the way, I do not know which of you did
what, so rather than waste my time saying what do you know,
chime in--you know, speak up when I ask these questions if you
know the answers, okay?
Mr. Lamphron. Yes, ma'am.
Mr. Dunn. Yes, ma'am.
Ms. DeGette. Thank you.
Now, you all were engaged as the independent auditors for
HealthSouth, correct?
Mr. Lamphron. That is correct.
Ms. DeGette. Now you received this now infamous email from
Mr. Vines, June 2, 2002, the one you were just talking to the
Chairman about, correct.
Mr. Lamphron. Correct.
Ms. DeGette. Now in this email it said ``In December 2001
HealthSouth moved expenses to capital accounts.'' And then it
lists specifically three accounts as of December 31, 2001,
correct?
Mr. Lamphron. Correct.
Ms. DeGette. Now, what you have testified to, Mr. Lamphron,
is then what you did when you found this out in late June, you
contacted the Board, I believe. Or who did you contact?
Mr. Lamphron. I contacted----
Ms. DeGette. You contacted Mr. Owens?
Mr. Lamphron. Mr. Owens, Mr. Smith, Mr. Harris and George
Strong.
Ms. DeGette. And you gave them an opportunity to research
this internally, and that is standard operating procedures for
you?
Mr. Lamphron. That is correct.
Ms. DeGette. Correct?
Mr. Lamphron. Yes.
Ms. DeGette. How long did you give them again?
Mr. Lamphron. I first made them aware of this either on
July 2 or July 3 and we met with them on July 8. And they
reported their findings and we began our independent
investigation then.
Ms. DeGette. Now, when you began your independent
investigation since, as you have testified, you had three
specific account numbers that Mr. Vines gave you, what did you
do? Did you ask the company to provide you with information on
those accounts?
Mr. Lamphron. That is the only way that we get access
during the audit process. We ask----
Ms. DeGette. Did you ask them to provide all the
information on those accounts as of December 31, 2001?
Mr. Lamphron. We asked them--we selected 2 months during
the 2001 year.
Ms. DeGette. And what months were those?
Mr. Lamphron. Those were May and December and asked for all
the reclassifications from those three accounts, and actually
one more during those 2 months.
Ms. DeGette. Okay. And take a look at Exhibit 79 in your
notebook. These are listings of some of the 7200 accounts from
December 31, 2001. Mr. Dunn or Mr. Lamphron, whoever, does that
look like the information they gave you, the company gave you?
Mr. Lamphron. It does not look like the information he gave
me.
Ms. DeGette. Okay. Well, what I would like you to do, the
both or if you want to, all three of you, flip through this
exhibit. And I will tell you what it is. We got this exhibit
from Mr. Vines. And what it shows is that for a number of 7200
accounts it shows capital internet costs, page after page
after. Three pages of it. Attached to that are what look like
some ledger pages showing a variety of expenses being
reclassified as software capital internet costs. Can you see
that in flipping through Exhibit 79 there?
Mr. Lamphron. Yes.
Ms. DeGette. Now, what it looks like to me is there is
these accounts, like on the first page it says Florence Carpet
& Tile, Inc., $541.73. Further down the page DoobyDoo Grease
Exhaust System. On the next page Nasif's Texaco. And it goes on
and on like that. Hobart. Moody's Sprinkler Company. Ace Glass
Service. It is pretty clear in looking at these ledger sheets
that these are all expenses from all of the HealthSouth
facilities. Would that be fair to say?
Mr. Lamphron. Yes.
Ms. DeGette. But then when you look at it, he is
transferring it to capital accounts. Do you see that there, Mr.
Lamphron? If you look at, it says software capital internet
costs. On those pages where it says Florence Carpet & Tile and
all of those.
Mr. Lamphron. Yes.
Ms. DeGette. Okay. And then you will have to take my word
for this because we have gone back through and looked at it,
and gone through it with Mr. Vines. You can trace these numbers
here back to the numbers on the first page by looking at both
the facility number and the amount.
Now, I do not know about you, but you guys are trained
professionals. If you had this information, I would think Mr.
Dunn, Mr. Lamphron, you would say something is not right here.
Would that be accurate?
Mr. Lamphron. Very accurate.
Ms. DeGette. But you did not have this information, did
you?
Mr. Lamphron. We did not.
Ms. DeGette. What you had was simply maybe not this list,
but lists of information like this that the company gave you
that just showed capital internet costs, right?
Mr. Lamphron. Correct.
Ms. DeGette. So there is no way Ernst & Young would have
been able to figure out that this information had been
transferred to a capital--which is, by the way, pretty standard
basic accounting fraud, right?
Mr. Lamphron. Yes.
Ms. DeGette. Capitalizing expenses?
Mr. Lamphron. Yes.
Ms. DeGette. That is pretty basic.
Mr. Lamphron. Yes.
Ms. DeGette. I only had to take accounting 101 to know
that. So, I mean, but if you did not have this, you would not
know that this was fraudulent, right?
Mr. Lamphron. Right.
Ms. DeGette. And you would not have known that that was
fraudulent unless you talked to Mr. Vines, right? Just based on
what the company's giving you, you're never going to be able to
find out where this information came from, right?
Mr. Lamphron. That is as we have subsequently learned, that
is correct.
Ms. DeGette. Right. And see, the problem is when you have
widespread fraud going on, it is the fox guarding the hen
house. Because you are asking the company that you are supposed
to be independently auditing for the information that they are
not doing what Mr. Vines says they are doing specifically. He
said they are capitalizing expenses, right?
Mr. Lamphron. That is correct. But----
Ms. DeGette. Now, I think probably it would be fair to say
that if you had to redo this today, you would have called Mr.
Vines, right?
Mr. Lamphron. Do what?
Ms. DeGette. If you had to redo this independent
investigation?
Mr. Lamphron. Well, I tried to call Mr. Vines.
Ms. DeGette. Oh, you did?
Mr. Lamphron. I did.
Ms. DeGette. And what happened?
Mr. Lamphron. I placed three phone calls, got no answer. On
the third call I left--I identified myself, indicated I was
with Ernst & Young and asked him to call me.
Ms. DeGette. Did you try to try to email him?
Mr. Lamphron. I did not.
Ms. DeGette. Did you know that it was his phone? Did he--
was his voice on there identifying himself?
Mr. Lamphron. I am not sure how the message was at the
time. But it is the number that is identified in his email.
Ms. DeGette. And when did you try to contact him?
Mr. Lamphron. After we had our discussion with the Chairman
of the audit committee. And we thought it would be appropriate
to follow up with Mr. Vines.
Ms. DeGette. When was that?
Mr. Lamphron. Sometime later in July. I am not sure of the
exact date.
Ms. DeGette. Yes. By then, later in July, if you felt you
had done enough, you had been all the way through the audit
committee, why were you trying to call Mr. Vines then?
Mr. Lamphron. Mr. Strong, Chairman of the audit committee
felt it would be appropriate to sort of close the loop with Mr.
Vines, tell him our findings and to----
Ms. DeGette. Let me help you out. Because in your notes it
says: ``also decided to communicate with employee and let him
know we had followed up on his concerns,'' and found nothing of
any concern, right?
Mr. Lamphron. That is right.
Ms. DeGette. So that is why you were trying to call him?
You had done your investigational calling and said there is
nothing wrong, right?
Mr. Lamphron. To let him know the results.
Ms. DeGette. Yes.
Mr. Lamphron. That is right.
Ms. DeGette. Okay. Now, the indictment that came down
against Mr. Scrushy yesterday said that HealthSouth had
manufactured $370 million in cash accounts on its balance
sheet. My question is does not Ernst & Young as an auditor send
out confirmation letters to a client's bank to see if the cash
claimed on the balance sheets actually exist?
Mr. Lamphron. We do. We do not send them out to every
account. In the case of HealthSouth----
Ms. DeGette. How much of a company's cash accounts do you
attempt to verify?
Mr. Lamphron. Well, let me say that they had over 2600 cash
accounts.
Ms. DeGette. Right. So how many of those letters----
Mr. Lamphron. We selected a sample choosing the most--the
largest balances, the most active accounts and sent
confirmations to those.
Ms. DeGette. How many was that, do you know?
Mr. Lamphron. I think it was around 50.
Ms. DeGette. Fifty out of 2600?
Mr. Lamphron. That is right.
Ms. DeGette. Do you think that that's within industry
standards for an independent audit?
Mr. Lamphron. Absolutely.
Ms. DeGette. Did all those accounts have money in them or
were they zero balance accounts?
Mr. Lamphron. A number of them had money in them. Some were
zero balance.
Ms. DeGette. How many of the 50 had money in them?
Mr. Lamphron. The 50?
Ms. DeGette. Yes.
Mr. Lamphron. I do not know.
Ms. DeGette. Is it not true that most of your audit was on
this pristine audit? Most of your time was spent on this
pristine audit?
Mr. Lamphron. Absolutely not.
Ms. DeGette. Okay. You spent all of your time on the books?
Mr. Lamphron. I spent virtually zero time on the pristine
audits.
Ms. DeGette. Well, what about other members of Ernst &
Young?
Mr. Lamphron. No one has--who was part of the engagement
team except, as I understand, maybe in the very first year to
get the program off and going, was involved in the pristine
audits. We----
Ms. DeGette. But, in fact----
Mr. Lamphron. We had separate engagement teams.
Ms. DeGette. Okay. But overall, the money that Ernst &
Young was paid was paid more for doing pristine audits than for
doing financial audits.
Mr. Lamphron. Well, that is not correct either.
Ms. DeGette. That is not correct?
Mr. Lamphron. Not in any year did the fee for the pristine
audits exceed our fee for doing audit work for the company.
Ms. DeGette. Okay. Thank you for clearing that up. Because
that is not the information that we were given.
Mr. Lamphron. Okay.
Ms. DeGette. But we will follow up in a few minutes.
I yield back right now.
Mr. Greenwood. The gentleman from Oregon, Mr. Walden, 10
minutes.
Mr. Walden. Thank you, Mr. Chairman.
I wonder if any of you at the panel is familiar with a firm
known as CFRA? Does that ring a bell?
Mr. Lamphron. I have--the first time I heard of them was a
day ago.
Mr. Walden. Okay.
Mr. Dunn. Same thing.
Mr. Walden. Okay.
Mr. Dunn. Earlier this week.
Mr. Walden. Because, our staff has found a memo, perhaps
provided by you all. Well, it is from 1995 to Ernst & Young
from CFRA where they appear to have done a rather thorough look
at HealthSouth. And on the cover of this memo on Ernst & Young
letterhead, dated April 3, 1995, it is to G. Marcus Neas.
Mr. Lamphron. Neas.
Mr. Walden. Neas from James P. Conley. It says HealthSouth
Corp. Have you seen this? It is under Tab 69 in the book.
Mr. Lamphron. I have seen it, again, yesterday.
Mr. Walden. And you have read it?
Mr. Lamphron. Yes, sir.
Mr. Walden. Okay. Do you have any idea what the purpose of
this memo was, why it was done, why it was requested?
Mr. Lamphron. I would assume James Conley, Jim Conley was a
senior partner in our professional practice director group. A
consulting partner.
Mr. Walden. Why would he have this in his possession?
Mr. Lamphron. Well, I can only guess and assume that
somehow this report came to his attention. He read it, he
voiced his concerns through this memo to Mark Neas, the
engagement partner at the time. And I would suspect that Mr.
Neas responded back by April 19 as he was asked to do.
Mr. Walden. Except nobody can find the copy of that
response, is my understanding.
Mr. Lamphron. Well, that is my understanding also. But I
would like to add that, again, Jim Conley was our senior
consulting partner. Very experienced, very knowledgeable, very
well respected in the firm. And I have total confidence that he
would not have let this drop.
Mr. Walden. Okay.
Mr. Lamphron. Mark Neas got back to him, I am certain of.
Mr. Walden. Then why would he put on here please do not
copy or send the report to the client?
Mr. Lamphron. I do not know.
Mr. Walden. Would that be standard on these sorts of
reports; someone senior in your company would say don't share
this report with a client?
Mr. Lamphron. Well, I do not know. I would not say that is
standard. I do not know how he came to have this report. It,
you know, this report could be confidential, it could be for
subscribers to a newsletter or something. We just do not know.
Mr. Walden. Okay. But he had it, so it is in your firm? And
your firm is on retainer at this point to do the audits for
HealthSouth, right?
Mr. Lamphron. Right.
Mr. Walden. Okay. Because I would like to just--Mr.
Chairman, I am sure all this is in the record, but as I read it
today for the first time, it strikes me as really this company
CFRA appears to have detected the disease that was running
throughout HealthSouth back in 1995. And it says things like
``We would question the motive of any company that takes a
large write-off in the immediate aftermath of an acquisition by
writing off $49.7 million on the date of the acquisition,
however HealthSouth gives the appearance of `clearing the deck'
of expenses that would otherwise have to be charged in future
periods against operating income.'' Now, we know from testimony
from Mr. Gordon that he began to have some concerns about
rather large write-offs that took place every year. And I have
seen in other documents concerns like that as well.
They go on to talk about accounting for startup and related
costs and how some of these startup--how HealthSouth
capitalizes organization, partnership formations and startup
costs and subsequently amortizes such costs over 3 years. Go
on. And then they say ``We feel that such costs should be
expense as incurred since they appear to constitute ordinary
recurring operating expenses.'' And we know later on that while
maybe not specifically here, certainly in their payments they
tried to amortize or capitalize payment under 5,000 as a way to
hide from you all the opportunity to look at those accounts.
Mr. Lamphron. Yes, sir.
Mr. Walden. They go on to talk about a weak control
environment. It says ``In general, we feel the outside members
of a public company's Board of Directors should lack any
significant affiliation with either the company, its executive
officers or other Board members outside their services as
directors and their ownership stake in the company. We also
advocate the Board should be comprised of individuals with a
diverse set of experiences and perspectives. Furthermore, we
feel a public company should avoid engaging in any significant
related parties transactions with either its directors officers
or any relatives of such directors or officers. As outlined
below, HealthSouth's Board appears lacking with regard to such
criteria.''
Then they go through the various relationships among Board
members citing specifically Strong, Givens and I think
Chamberlain, it would indicate here, perhaps, and how they are
interrelated with Scrushy.
Then they go on talking about CEO compensation. ``On a more
sober note, we would argue the willingness of a company to
engage in the wholesale repricing of options granted to its CEO
and other executive officers, in effect all such offers to
``have their cake and eat it, too.'' We consider such an
approach a clear transfer of wealth to executive option holders
from other company shareholders. If they do this, they ought to
be explicitly reported in the annual proxy statement.''
And when apparently they tried to do a more generous stock
option, it was voted down in 1994. And they say ``We are
nevertheless troubled by HealthSouth's attempt to implement a
plan that institutional investors who reported led the charge
against the stock option plan would consider out of bounds.'' I
raise this because these all appear to be things that came up
again and again, now as you go back and look. And you all,
somewhere the very upper echelons of your company had this in
your possession. And you say somebody, obviously, responded to
it because you know these people.
Are these issues, as you audited the company, you
discovered on your own as well? Were they ever identified?
Mr. Lamphron. Well, these issues, as best I can tell, every
one of them that is mentioned was available in public filings.
These are things we were aware of.
For instance, the $49 million write-off.
Mr. Walden. Right.
Mr. Lamphron. We were aware of that. We audited it. It was
totally proper. And, in fact, was required by accounting
standards. What he suggests that it be made a part of the
purchase price allocation is not good accounting. It is not the
rules.
Mr. Walden. All right. Did you or your auditors feel that
management was dominated by one or a few individuals without
effective oversight by the Board of Directors or the audit
committee?
Mr. Lamphron. We were--I assume you are----
Mr. Walden. I am referring to Tab 78, I believe it is.
``Wherein your internal documents under management's control
consciousness and operating style.'' Apparently year after year
this box was checked on your internal documents. That and
management's excessive interest in maintaining or increasing
the client stock price or trend earnings. Those were both
checked yes?
Mr. Lamphron. Yes.
Mr. Walden. These were issues you were concerned about then
and how Mr. Scrushy ran the company?
Mr. Lamphron. Well, let me say the point of this document
is to help us assess internal controls at the entity level.
Mr. Walden. Okay.
Mr. Lamphron. Not over cash receipts, cash disbursements,
but over HealthSouth.
Mr. Walden. Okay.
Mr. Lamphron. We were aware that Mr. Scrushy had a strong
personality.
Mr. Walden. Understatement.
Mr. Lamphron. And that he was involved in the day-to-day
operations of the company. And that is what that response
means.
Mr. Walden. Okay.
Mr. Lamphron. Now, having a strong personality does not
mean you are engaged in fraud. There are a lot of very
successful companies that have leaders like that.
Mr. Walden. Sure. In fact, most have that.
Mr. Lamphron. What it tells us is it is an element. It is a
risk element and we assess that in the context of the entire
internal control environment.
Mr. Walden. Mr. Lamphron. Let me give you an example.
Mr. Walden. Okay. Go ahead, give me an example.
Mr. Lamphron. Well, let me give you an example. On
something like that with a dominant personality as the CEO, we
would look to see for things like was he personally presenting
accounting issues to us. Did we feel like he was pushing the
envelop on accounting issues. Did we feel like he was pushing
his CFO and controller. And that is not the thing we found. In
fact----
Mr. Walden. Okay. Let me go to a point then. Because also
in your monitoring checklist it is checked yes that internal
audit is not adequately staffed or trained, does not have
appropriate specialized skills given the environment. Internal
audit is not independent, authority and reporting relationships
and does not have adequate access to the audit committee or
equivalent. The scope of internal audit's activities is not
appropriate. Balance between financial and operational audits,
coverage and rotation, decentralized operations. And internal
audit has limited authority to examine all aspects of the
client's operation or fails to exercise its authority.
All four of those are also checked.
Mr. Lamphron. Yes, sir. That was our acknowledgement that
we were not in our audit process going to place much reliance
on the work that internal audit did. I mean, let me say that
prior to today, and there was no requirement. Until yesterday,
as a matter of fact, that a company has to have an internal
audit department.
Mr. Walden. Right.
Mr. Lamphron. Second, if they choose to have one, there is
no direction that says here is what they have got to do.
Mr. Walden. All right.
Mr. Lamphron. And companies can choose to employ them
several ways. They can direct them toward operational auditing
or exclusively in operational areas, which we knew that is what
they did. And what that meant to us is we are not going to
place much reliance on their work. In fact, we replaced the
hours that another internal audit department, let us say, that
did financial auditing; we essentially replaced all those
hours. So we put in thousands of hours doing the kind of work
that internal audit might do.
Mr. Walden. Then why the next year in comments and
additional information would you--whoever wrote this say
``Overall, we believe that management has designed an
environment for success. As a result of this environment,
management has designed sufficient controls and oversight
functions in order to prevent instance of material misstatement
of the financial statements. We believe the management is
ethical, competent and fully aware of all potential business
developments.''
If you had some of these other concerns over the years
about the internal audit committee not really being properly
trained, having appropriate access to books and things, was it
your view then that you all had all that access and so the
internal audit was not that----
Mr. Lamphron. Well, with respect to internal audit, it just
meant that we had to do the work, which we did. And those are
just several of the factors in many, many factors in assessing
the internal control environment.
Mr. Walden. Did you ever share those concerns that you say
you had about the internal control environment, concerns that
led you to replace the hours that otherwise would be done; did
you ever share any of that with the audit committee, the Board
or management?
Mr. Lamphron. No.
Mr. Walden. Why?
Mr. Lamphron. Because they were well aware of it. We were
at meetings when internal audit--at Board meetings when
internal audit reported the scope of activities. We knew the
Board and the audit committee were well aware of the charge
that internal audit had. And that was operationally based. I
mean, that is a management decision as to--and a Board decision
and an audit committee decision as to how you are going to
employ those resources.
Mr. Walden. Did you ever recommend changes? Did you ever
see--I guess what I struggle with is, for example, there is a
boxed checked here. It says ``Management's excessive interest
in maintaining or increasing the client's stock price earnings
trend'' is checked yes.
Mr. Lamphron. It is checked yes, but let me say I would
be----
Mr. Walden. That would be a red flag, I would----
Mr. Lamphron. Well, we did not take it as red flag. It is
just our acknowledgement that this is a public company and
their focus is earnings, like probably most if not all public
companies focus on earnings. So it is--I would not at all call
it a red flag. It was another factor for us to consider in
designing our audit.
Mr. Walden. I am just trying to put myself in the place of
one of those Board members relying on you who have far more
experience than they do at this sort of look. And I guess, and
maybe I am just misreading all this, I look at it and say there
was something that caused whoever filled out this forms year
after year to say management is probably a little more
aggressive than most, and he would not have checked yes. I
mean, is that not accurate? There are internal auditing control
issues that need to be watched. And yet none of that gets
conveyed to the Board. So they do not think you are seeing
anything wrong. In fact, you are telling them they got
controls, right?
Mr. Lamphron. Yes, sir. Let me say that how they employed
internal audit, how management and the Board----
Mr. Walden. Right.
Mr. Lamphron. [continuing] decide to use them----
Mr. Walden. It is totally their decision?
Mr. Lamphron. It is their decision. So we do not mark it up
as hey, that is a weakness. That is how they choose to do it.
Mr. Walden. So that was not in your responsibility----
Mr. Lamphron. Right.
Mr. Walden. [continuing] when you analyzed the company for
outsiders to look at?
What if internal audit said you have access, the internal
auditors do the corporate books, too? I mean, they did not,
but----
Lamphron. I am not sure what you are asking. I am sorry.
Mr. Walden. Well, my point is what if management had said,
okay, we are going to have our internal auditor to do 33 other
things, and you say, you know, looking at it from the inside I
do not think they are doing it right, but that is not my view.
That is not our responsibility. So to heck with that. We will
go do our thing, ignore that. We do not have a responsibility
to tell the Board anything about what we spot as concerns.
Mr. Lamphron. Sure
Mr. Walden. Concerns enough that we put them year after
year on our internal documents.
Mr. Lamphron. Yes.
Mr. Walden. Meanwhile we put that it is great controls,
everything is in place.
Mr. Lamphron. Right.
Mr. Walden. There is no way you can have a misstatement of
financial.
Mr. Lamphron. Well, if their internal audit department was
charged with doing financial audits, and----
Mr. Walden. Which they did.
Mr. Lamphron. And in our assessment we found them to be
incompetent or not well trained, or not well supervised, we
would bring--we would talk to the audit committee. Because by
having internal audit focus that way, they would be expecting
that in the design of our audit we would place reliance on the
work internal audit does. That was not an issue.
Again, they choose to use them over here. All it meant was
we had to use more of our people and take more time in doing
the audit.
With respect--you indicated that we viewed management as
being aggressive.
Mr. Walden. Yes.
Mr. Lamphron. I need to sort of clarify that. I think we
viewed the Chairman as being a dominant personality, aggressive
person. We did not view management way.
I can tell you that from 2000 forward when I was engagement
partner and had meetings with the CFO, with the controller to
discuss accounting issues, every time that I can think of they
said what do you think, how should this be accounted for. We
told them, and they said okay, that is what we will do. We want
to do the right thing.
Now, certainly there is some irony there after all we have
come to learn.
Mr. Walden. Sure.
Mr. Lamphron. But that was their persona. That was the
picture they put up in front of us. They were not aggressive.
They were not--they were not pushing the accounting envelop.
Mr. Walden. They were not cavalier?
Mr. Lamphron. Again and again they said we want to do the
right thing. You tell us what that is and----
Mr. Walden. All right. But in your 1999, I guess,
proceeding, you are in charge of this, both yes and no are
checked when it says ``Management displays a cavalier attitude
toward an inadequate monitoring of significant business
risks.'' ``Management's excess interest to maintain or
increasing client stock price earnings trend'' is checked yes.
``Management dominated by one or a few individuals without
effective oversight by the Board of Directors or audit
committee.''
Those are not flags that should--that you share with an
audit committee? None of those rise to the level? They rose to
somebody's level to check them here.
Mr. Lamphron. Well, again, having a focus on earnings for a
public company is normal. We did not----
Mr. Walden. But that is not what you say. I mean, it is
management's excessive interest.
Mr. Lamphron. Well, that is the way the checklist is worded
and, you know, we do not have the ability to modify it. But I
can tell you the intent in the years I was responsible for it
when we checked that, it is a reminder. That is what this whole
checklist is, it is a reminder. And we say, sure, they are a
public company. These guys are focused on earnings. Let us keep
that in mind as we do our audit, as we plan our audit, as we
conduct our procedures. And that is what we did.
Mr. Walden. Looking back, and I realize that it is a lot
easier to see looking back, when I read this checklist and see
a pretty clear picture that a company is driven by a very
strong executive who lacks oversight by the Board and audit
committee who is consumed with earnings numbers in an area
where there is cavalier attitude toward business risks--I mean
I look at what you all did and say that it was like you were
pointing but you did not know when to pull the trigger. Because
you were seeing all the indicators, but somehow it got passed
you.
Mr. Greenwood. The time of the gentleman has expired.
Mr. Lamphron. Congressman Walden, I would concede that
looking back you can certainly take a different view of these
things. But at the time onsite----
Mr. Walden. You did not see it?
Mr. Lamphron. [continuing] they were not red flags. They
were not red flags at us. Sorry.
Mr. Walden. Thank you, Mr. Chairman.
Mr. Greenwood. The gentleman from Florida, Mr. Stearns
recognized for 10 minutes.
Mr. Stearns. Thank you, Mr. Chairman.
We all up here have the benefit of hindsight, you know. So
we are able to ask these questions that, you know, in the
overall operations day-to-day for us seem significant, but
perhaps for you it was not. And one I want to talk about is the
Tab 72, which is the letter from a ``fleeced shareholders'' to
Ernst & Young and HealthSouth. You probably heard us talk about
this when we were talking to the Board of Directors.
Mr. Lamphron. Yes, sir.
Mr. Stearns. They could say that this letter, anonymous
letter that came from a ``fleeced shareholder'' in November 12,
1998, so that was 5 years ago, talked all in detail about some
of the problems with HealthSouth. So the letter, evidently,
went to you folks and I guess it is to Mr. Dandurand.
Mr. Dandurand. Yes.
Mr. Stearns. Were you involved with the account, the
HealthSouth account when the ``fleeced shareholder'' facts came
in to your company?
Mr. Dandurand. Yes, Congressman.
Mr. Stearns. Okay. Now, you saw a copy of the letter
yourself?
Mr. Dandurand. Oh, yes.
Mr. Stearns. Okay. Okay. And would you not agree with me,
somebody who wrote this letter had to have a pretty good idea
of what was the problems? I mean, they talked about the impact
of Tefra reimbursements. They talked about the balanced budget
amendment, and the cutbacks and the Medicare. They talked about
how the Ernst & Young auditors in Alabama missed things. I
mean, it seemed if I got this memo, it would sort of put some
antenna up.
Now, I know you folks are busy. So my question is did you
folks address the allegations that are in this letter from 5
years ago, and what did you do?
Mr. Dandurand. Yes, Congressman.
Mr. Stearns. Sure.
Mr. Dandurand. We took this very, very seriously. We do not
get these kinds of letters very often.
Mr. Stearns. Especially with this kind of detail.
Mr. Dandurand. And, unfortunately, it was anonymous. And it
is in detail.
We took two actions related to the receipt of this letter.
And, as you can see, this letter came to the Chairman of our
firm. It went to the SEC. It went to HCFA.
Mr. Stearns. It went to the SEC?
Mr. Dandurand. Yes. HCFA, the American Institute of
Certified Public Accountants.
Mr. Stearns. Did the SEC respond to this?
Mr. Dandurand. I am not aware they ever did.
Mr. Stearns. They never called you and said, look what is
the story on this letter? You better get hopping on it or
anything.
Mr. Dandurand. I know they did not do that.
Mr. Stearns. They did not? Okay.
Mr. Dandurand. That is correct.
But what we did, we took two actions really as a result of
this letter.
Mr. Stearns. Yes.
Mr. Dandurand. We took a similar action that was described
earlier, in that we notified the company that we had received
this letter----
Mr. Stearns. When you notified the company, was Mr. Scrushy
aware of these allegations? Did he get told?
Mr. Dandurand. I believe he did. In fact, I have been told
and I am positive, I feel very comfortable that he was aware of
these allegations. Yes.
Mr. Stearns. When I look at the memo it has, you know as
you mentioned, Morgan Stanley. It was cc'd to a lot of people.
We do not know, in fact, whether they got it at all. But at
least the memo said it was sent to them, so we just have to
speculate. We assume they got it, but we have never confirmed
it. But you have never got anything back from any of these
people on the cc saying we got this memo, what is the story?
Mr. Dandurand. That is correct, Congressman.
Mr. Stearns. Okay.
Mr. Dandurand. We know we got ours.
Mr. Stearns. All right. Yes. Okay. So you think you have a
pretty sure, what? Ninety percent sure that Mr. Scrushy was
aware of the allegations?
Mr. Dandurand. Yes, I am.
Mr. Stearns. A 100 percent?
Mr. Dandurand. It is 5 years ago.
Mr. Stearns. Yes, you do not know. I know.
Mr. Dandurand. And I am under oath. I just, you know----
Mr. Stearns. Okay.
Mr. Dandurand. [continuing] feel uncomfortable saying 100
percent.
Mr. Stearns. All right. So the question is----
Mr. Dandurand. I will say 95, 90, whatever.
Mr. Stearns. Right. And so Mr. Scrushy knows about it. You
folks know about it. And do you think the Board of Directors
knew about it?
Mr. Dandurand. No, I do not.
Mr. Stearns. You do not think so? And did you ever tell the
Board of Directors?
Mr. Dandurand. No, and I would like to explain that, if I
could.
Mr. Stearns. Yes. Yes.
Mr. Dandurand. Because I think it is important to
understand the actions that we did take.
We took two actions, as I mentioned earlier. The first was
to notify the company in accordance with our professional
standards to let them know that we had received this letter.
And in that context, I called Michael Martin, who was the chief
financial officer at the time, and told him that I wanted to
come share this letter with him, which I did that same
afternoon.
I met with----
Mr. Stearns. I think that is very good.
Mr. Dandurand. I met with Mr. Martin and Mr. Owens at the
time, who was the controller of the company. I shared the
letter with them. And then the discussion started as to how the
letter should be responded to.
My initial recommendation was the company ought to consider
hiring an independent counsel to investigate this and report
back. Mr. Martin and Mr. Owens felt that maybe at this time it
was premature, which certainly was their prerogative, and in
that context I suggested then that it needs to be--should be
audited or reviewed by someone independent of the financial
folks. And suggested Mr. Horton, who is the general counsel,
might be the appropriate person or certainly someone might
consider that.
Mr. Stearns. Do you know if Mr. Horton got the memo and did
anything?
Mr. Dandurand. Oh, I he got the memo because----
Mr. Stearns. So you are 100 percent sure he got the memo,
but you are not sure what he did?
Mr. Dandurand. Well, I will try and explain----
Mr. Stearns. Okay.
Mr. Dandurand. [continuing] exactly what I remember of the
whole situation.
So at that point Mr. Horton was called and invited to Mr.
Martin's office.
Mr. Stearns. Yes.
Mr. Dandurand. And certainly the letter was shared with
him. There was some discussion about how the review ought to
proceed. My recommendation, again, was to again keep it
independent. I suggested that Teresa Sanders, who was the----
Mr. Stearns. When you say ``independent,'' you mean outside
the company?
Mr. Dandurand. Outside of the area where the allegations
were being directed.
Mr. Stearns. Which should be the right way to do it, sure.
Mr. Dandurand. I would think so.
Mr. Stearns. Yes.
Mr. Dandurand. At least thought so at the time.
Mr. Stearns. Right.
Mr. Dandurand. And that--and then I offered Ernst & Young's
help in that capacity.
Mr. Stearns. Was any report resulting from this
independent--was an independent counsel selected?
Mr. Dandurand. No, it was not. General counsel----
Mr. Stearns. Nothing was done then? General counsel did it?
Mr. Dandurand. No, general counsel did.
Mr. Stearns. Did you see the report from the general
counsel?
Mr. Dandurand. Well, I had several conversations with him
and followed up verbally.
But the point I would like to make in addition to that
action, is that Ernst & Young took our own independent action
related to those charges. The----
Mr. Stearns. So you invested the ``fleece'' memo yourself?
Mr. Dandurand. Well, not only did I do it, but the firm
sent two of our associates from the PPD office over to
independently look at our work.
Mr. Stearns. You actually met with the audit committee at
HealthSouth and gave it to them, and told them about it?
Mr. Dandurand. No, we did not.
Mr. Stearns. No? Okay.
Mr. Dandurand. We did an independent review. And if you
read the letter----
Mr. Stearns. Because, Mr. Horton you gave it him, you
suggested outside counsel?
Mr. Dandurand. Yes.
Mr. Stearns. He did not go ahead with it. So at this point
you left it in his responsibility and then you acted
independently on your own?
Mr. Dandurand. That is correct. But I would like to go back
to that, because there is I think one more important element
that you reminded me of; is that I did suggest that the company
inform Dr. Watkins, who at that time was Chairman of the audit
committee. And they told me that they would about receiving the
letter.
Mr. Stearns. So under that scenario, the Board of Directors
was told about it?
Mr. Dandurand. Well----
Mr. Stearns. Hearsay? From your----
Mr. Dandurand. I had a lot of confidence in Mr. Horton and
assumed that that took place. I do not know what----
Mr. Stearns. So your inner feelings was I have done the
right thing. I have given it to the counsel. I have made a
recommendation. But Ernst & Young never went back and took each
allegation and investigated it down into detail?
Mr. Dandurand. No, that is not correct. And I would like to
make myself clear on that.
Mr. Stearns. I got another whole area I want to explore. So
I am sorry, I do not mean to do this.
Mr. Dandurand. We certainly did. The firm sent 2
representatives over to look at our work papers, to talk to our
engagement team, to go down each and every charge in that
letter. And to----
Mr. Stearns. And were they all considered false or correct?
Mr. Dandurand. Well, I----
Mr. Stearns. I mean, for example, did the Ernst & Young
auditors in Alabama miss things that the ``fleece'' letter
says? Just yes or no.
Mr. Dandurand. I say no.
Mr. Stearns. Okay. What about the idea that, this is an
accounting question, how can the company carry tens of millions
of dollars in accounts receivable that are well over 360 days?
Is that normal.
Mr. Dandurand. Well, in a company of this size----
Mr. Stearns. It is, yes.
Mr. Dandurand. [continuing] and I remind you it is over a
billion dollars a healthcare company, yes.
Mr. Stearns. So when they say the accounting slick, the
cost reports are not accurate, so your opinion is this memo is
false and this memo is incorrect and you corroborated through
your investigation that this has no validity; that is your
statement today?
Mr. Dandurand. My statement is we concluded that----
Mr. Stearns. Had no validity?
Mr. Dandurand. [continuing] it had no impact on the
financial statements.
Mr. Stearns. Okay. So I would say we can pretty much say
from Ernst & Young's standpoint this memo had no validity?
Mr. Dandurand. We did not believe the charges----
Mr. Stearns. Did you go back to Mr. Horton and tell him
look, we have looked at this and this doesn't mean anything?
Mr. Dandurand. I do not remember having that conversation.
Mr. Stearns. Okay.
Mr. Dandurand. I also would like to point out that we did
provide the staff with a detailed description of our procedures
in case I forgot something here.
Mr. Stearns. Yes. Okay. Let me just turn quickly to the
pristine audits. And you probably heard my conversation with
the Board of Directors on this. You know ``The Wall Street
Journal'' did an article on this, and if you like you can
probably to Tab 89. It talked about, you know, this pristine
audits that you performed. You had junior level executives go
into HealthSouth and armed with a 50 point checklist to
reevaluate things; whether toilets were free of stains, trash
receptacles had liners. And so did Ernst & Young in fact advise
HealthSouth to classify pristine audits as audit related
services? Because I have here this audit fees for proxy
disclosure, and you have the audit fees and then you have audit
fees related. And that, evidently, is what you put the pristine
audits.
So the question I have you, did you classify these pristine
audits when you were actually looking at whether toilets were
free of stains and trash receptacles had liners, was that a
separate audit related fee on the accounting statement?
Mr. Dandurand. Congressman, I believe those standards for
the description of audit related----
Mr. Stearns. Are normal?
Mr. Dandurand. Came into being after I retired. So I am not
comfortable knowing what those figures are.
Mr. Stearns. But you folks did this?
Mr. Lamphron. That classification was done for the 2001/
2000.
Mr. Stearns. Yes. And I guess the question----
Mr. Lamphron. When I was the engagement partner.
Mr. Stearns. Yes. I am sorry. Mr. Lamphron, you were the
one I probably should address this question. I am sorry.
Okay. This was done, and it was done this way. Now in a
``Wall Street'' article it was brought out that this was done,
and low and beyond, I guess the SEC sent you folks a letter on
July 8, 2003 about it. Do you remember this letter?
Mr. Lamphron. I think I have seen a copy of it.
Mr. Stearns. It sort of said that what you did in
classifying these pristine audits of checking the toilets and
things would not be correct today. Let me just read from the
letter, and if you do not have it, I can give it to you.
``The Commission current rule states that registrants are
to disclose under the caption audit related fees, the aggregate
fees billed in each of the last 2 fiscal years for assurance
and related service by the principal accountant that are
reasonably related to the performance of the audit review or
the registrant's financial statement.''
So they are saying that you were wrong to put it into the
audit related fees and that classification is incorrect.
Mr. Lamphron. I do not think they were saying we were wrong
at the time. I think that the letter says that under the new
rules they would not be classified as audit related, and we
agree completely.
Mr. Stearns. The article quotes the SEC former chief
accountant Lynn Turner as saying ``Ernst & Young arguing that
checking the cleanliness of a facility is audit related goes
well beyond the pale of sanity and common sense.''
On a common sense level does it make sense for you to
classify this as audit related?
Mr. Lamphron. Under the----
Mr. Stearns. I mean in retrospect. I am sorry.
Mr. Lamphron. Under the existing rules there wee three
classifications. Audit, which deals with just the corporate
audit and the quarterly reviews; information technology work
and other. We classified it in other.
We went further and put a subcategory that was not required
or defined at the time of audit related because they were
operational audits.
Mr. Stearns. Today would you classify it the same way?
Mr. Lamphron. No. There is guidance that makes it very
clear we would not put it in that category.
Mr. Stearns. I think you would not be off base to say you
did it wrong. I mean, you seem to be hedging a bit, but it
seems to me that you are saying you would not do it this way
today.
Mr. Lamphron. I am not hedging. I am saying that at the
time with no guidance on what would go in audit related, that
we considered these operational audits and as such, we put them
in audit related.
Mr. Stearns. Okay. But the SEC former chief account Lynn
Turner disagrees with you.
Mr. Greenwood. The time of the gentleman has expired.
Mr. Stearns. Yes. Thanks.
Mr. Greenwood. The gentleman from New Jersey, Mr. Ferguson
is recognized for 10 minutes.
Mr. Ferguson. Thank you, Mr. Chairman.
Mr. Lamphron, I am over here.
You have been going for a while. Do you want to take a sip
of water or something.
Mr. Lamphron. I am okay. Thank you.
Mr. Ferguson. I do not know if you saw the last hearing,
our first hearing on this.
Mr. Lamphron. I did.
Mr. Ferguson. The last hearing we heard a lot about
internal controls at HealthSouth. Can you tell some of the
nonaccountants here a little bit about internal controls. What
do we mean when we say internal control?
Mr. Lamphron. Let me give you an example. A very classic
example would be where a business has a policy where checks
above a certain amount have to be signed by two people instead
of just one. That's--the basis of that is just human nature,
knowing that it is easier for a crime to be committed by one
person than it is by two people who to do that have to engage
in collusive activities.
Mr. Ferguson. So having a check signed by two people or
limiting people who can authorize certain transactions, those
are examples of internal controls?
Mr. Lamphron. Sure.
Mr. Ferguson. What are some examples of internal controls
that were in place at HealthSouth?
Mr. Lamphron. Well, one that comes to mind deals with their
cash They had a treasury group that monitored cash balances on
all 2600 accounts on a daily basis. Now, all the activity that
affected the financial statements recording cash disbursements,
cash receipts was done in the general accounting department. So
the control was you had this group in treasury separate and
distinct that overlooked that and made comparisons and that
sort of thing.
Mr. Ferguson. Are publicly traded companies required by law
to have internal control?
Mr. Lamphron. Yes, absolutely. The Fair Practices Act
requires that.
Mr. Ferguson. And who is responsible for maintaining this
system of internal controls at a publicly traded company?
Mr. Lamphron. Well, I think it extends to senior management
all the way through the CEO, but from a practical standpoint it
is typically the CFO who has that--who deals with those sorts
of things.
Mr. Ferguson. What about the auditors? Do the auditors have
a role in maintaining the internal controls at a company, the
outside auditors?
Mr. Lamphron. Well, we review internal controls as part of
every audit. If we saw weaknesses, we would communicate those
to management, to the audit committee.
Mr. Ferguson. How is Sarbanes-Oxley effecting that?
Mr. Lamphron. Well, significantly, I think. One provision I
am thinking of is 404 of Sarbanes-Oxley which requires
management to attest--to evaluate and to test to those internal
controls. And then for us to audit management's attestation.
Mr. Ferguson. If management is in intent on circumventing
internal controls to commit fraud, is there something that the
auditors can do about that?
Mr. Lamphron. No. I think we heard from numerous people, it
is very clear in our professional literature that collusive
fraud may be impossible to detect.
HealthSouth had a--on paper HealthSouth had a formidable
system of internal controls. They were doing all the right
things. We heard from Mr. Wallance this morning about best
practices and corporate governance. And we were sitting in
there thinking they did all those things. They had policies,
procedures in place.
Now, obviously, what we did not know was there was a large
group of criminals sort of behind the scene that were
overriding those controls. And there is no system that is going
to prevent that.
Mr. Ferguson. So is that your opinion of what happened
here? That they could have had the best system of internal
controls in the world, but if you had management intent on
doing an end run around those internal controls, it undermine
the effectiveness of those internal controls?
Mr. Lamphron. That is correct.
Mr. Ferguson. Is that your opinion?
Mr. Lamphron. Yes, sir.
Mr. Ferguson. Okay. Let me return to a line of questioning
that I had pursued in the first hearing. You said you had seen,
you had watched the first hearing.
Specifically in some questions I asked Ms. Henze because
when she was--and I asked her some questions about what she did
when she realized or found out that there was fraud being
committed or when she suspected there was fraud going on. And
when she confronted Mr. Owens and he did not deny the fraud, do
you recall that from her testimony?
Mr. Lamphron. Yes, sir.
Mr. Ferguson. Ms. Henze was known to your audit team?
Mr. Lamphron. She was known very well to us. In fact, for
several years she was the primary audit coordinator.
Mr. Ferguson. How often did Ernst & Young talk with her?
Mr. Lamphron. Daily, every other day.
Mr. Ferguson. Regularly?
Mr. Lamphron. During the course of the audit, yes.
Mr. Ferguson. Did she ever tell anybody on the audit team
about the fraud that she had uncovered or suspected?
Mr. Lamphron. Never once.
Mr. Ferguson. Okay. That is what she said as well.
Did she report her concerns--she did report her concerns of
fraud internally, though. She talked with some folks at the
compliance department, Kelly Cullison in particular. Is that
correct?
Mr. Lamphron. That is correct.
Mr. Ferguson. And Ms. Cullison testified that she confirmed
that these fraudulent adjustments had been described to her by
Ms. Henze and that they in fact had been made. She then
referred the entire matter to her boss, Mr. Tanner. Correct?
Mr. Lamphron. That is correct.
Mr. Ferguson. Who was one of the founders of the company.
He was serving as the head of compliance.
Mr. Lamphron. Right.
Mr. Ferguson. That is right?
Mr. Lamphron. Yes.
Mr. Ferguson. Was Ms. Cullison known to your audit team?
Mr. Lamphron. Yes. As a matter of fact, a routine part of
each audit we would ask her in her role as--in the compliance
department about the nature of the complaints and issues. In
fact, I got to tell you, I listened to the testimony a couple
of weeks ago and I cannot tell you how frustrated I was. And
let me tell you why.
Subsequent to Henze going to Cullison and Cullison going to
Tanner, we sat down and met with them face-to-face. There were
two Ernst & Young partners and another person there. We asked
them, tell us about activities in the compliance department.
Tell us about anything that has come to your attention, whether
resolved or whatever the status. Tell us anything that might
have any effect on the financial statements. And they looked us
in the eye and lied to us.
Mr. Ferguson. You made an actual inquiry of Ms. Cullison?
Mr. Lamphron. That is correct.
Mr. Ferguson. A direct inquiry?
Mr. Lamphron. That is correct.
Mr. Ferguson. Okay.
Mr. Dandurand. Can I respond, because I was the one that
made that inquiry?
Mr. Ferguson. Sure.
Mr. Dandurand. And it is very important to me that everyone
understand that 6 feet away from me was the answer to
everything that was going on. And we asked the right question,
and we still did not get the right answer.
Mr. Ferguson. So Mr. Tanner, he was not able to recall much
about his final years at HealthSouth. But you are saying that
your audit team at Ernst & Young, you made an actual inquiry,
affirmative inquiry of Ms. Cullison and Mr. Tanner?
Mr. Lamphron. Yes, and I would add Mr. Hale was at the
meeting. But he was due to take over the department. So our
questions were to Tanner and Cullison.
Mr. Ferguson. And you asked them if any allegations of
fraud had been made or brought up?
Mr. Lamphron. We asked them exactly that.
Mr. Ferguson. And did you ask the compliance officials what
complaints they had perhaps received or substantiated?
Mr. Lamphron. We asked them to describe the nature of
those. And I believe as we have it documented, the description
is that fairly routine personnel type issues that they were
able to push off to people in human resources.
Mr. Ferguson. So Ms. Henze brought her concerns to Ms.
Cullison. Ms. Cullison brought her concerns to Mr. Tanner. You
and your team directly asked Mr. Tanner and Ms. Cullison about
any allegations or suspicion of fraud. And they told you there
was none?
Mr. Lamphron. Yes.
Mr. Ferguson. And this is all in connection with the 1999
audit?
Mr. Lamphron. That is correct. In fact, the meeting was on
December 3, 1999.
Mr. Ferguson. Okay. And at that meeting did Ms. Cullison
say anything about what Ms. Henze had come to her about?
Mr. Lamphron. Absolutely not.
Mr. Ferguson. Okay.
Mr. Lamphron. No hint, no wink, no reference, nothing.
Mr. Ferguson. Okay. So, I just want to get this straight.
You asked them a straight question, they were mum with regard
to the 1999 audit?
Is it your opinion that--I mean, it just seems to me a lot
of this could have been avoided if they had spoken up at that
time.
Mr. Lamphron. Absolutely. And even outside of that meeting
with respect to Henze, I mean, we probably met with her 50 or
100 times during the audit process for several years. She just
had multiple opportunities to just say one thing to us. She did
not take that opportunity.
Mr. Ferguson. This meeting that you are talking about, is
it documented?
Mr. Lamphron. Yes, sir.
Mr. Ferguson. Where?
Mr. Lamphron. In our work papers, and I think we have
provided that to your staff. I am not certain, but we can
certainly get it for you.
Mr. Ferguson. That is all I have, Mr. Chairman. Thank you.
I yield back.
Mr. Greenwood. The Chair thanks the gentleman.
The Chair recognizes himself for 5 minutes.
A cynic connecting the dots after the fact might think
something like this: According to the indictment the fraudulent
activity began around 1996. In 1995 there is a report from the
Center For Financial Research and Analysis that says--there is
a lot of red flag, or at least pink flags or some things to
worry about with this company.
In 1996 right after Mr. Scrushy allegedly started cooking
the books, he decides out of the clear blue sky to make--
basically double the amount of money he is paying to his
auditors. Makes up kind of this cockamamie pristine audit
business. You get the ``fleeced stockholder'' piece in 1998.
You get the email in 2002. Connecting the dots from where we
sit today, it makes us fairly suspicious.
Mr. Dandurand, you said that in response to the issue about
the ``fleeced shareholder'' letter that you do not get letters
like that very often.
Is it common for an auditing firm to have a client with
this sort of number of things happening where you get these
allegations coming in, is that routine or is this extraordinary
to have allegations of this specificity and this seriousness
come in with regard to a client? Anyway?
Mr. Dandurand. Go ahead.
Mr. Lamphron. Well, you know, first I would remind you that
with respect to the ``fleeced shareholder'' letter and the
Vines' email, that is 5 years between those. So it is not like
we sat there and these things were tumbling down on us. But we
were aware of those.
Mr. Greenwood. Yes.
Mr. Lamphron. But, you know, we took----
Mr. Greenwood. You have already very well explained.
Mr. Lamphron. [continuing] those and investigated them.
Mr. Greenwood. Yes. And you have already explained it. I am
not questioning.
Mr. Lamphron. Yes.
Mr. Greenwood. I am just trying to get to a specific point,
which is is this unusual? Do you have other clients where you
have had two, even 5 years apart, two hand grenades hurled over
the transom like this?
Mr. Lamphron. Not that I can recall right now, Mr.
Chairman.
Mr. Greenwood. Okay. Ms. Givens said in her 13 years on the
Board, Ernst & Young never brought a single problem to their
attention. Is that true? The Board's attention, never brought a
single concern?
Mr. Lamphron. I cannot speak to the entire 13 years, but I
can say that, you know, I know we talked to her about proposed
audit adjustments where we felt balances should be different
than what we recorded. You might call that an issue.
You know, beyond or before 2000, I just do not know.
Mr. Greenwood. Okay. What about this policy that, Mr.
Lamphron, you said that the standard operating procedures is if
something comes in, a compliant like this comes in from the
outside, that you go over to a person in superior position to
that person to bring it to their attention? It seems to me that
it is not the little guys that have a whole lot at stake in
managing earnings and falsifying books. It is the big dogs at
the top that have the stock options and a whole lot to gain in
bonuses and all of the rest if earnings are fraudulently
managed. And I am not attributing that to you. You are
following the standard operating procedures. But help us out
here. Does that make sense?
It seems to me that in each of these cases that we have
seen over the last several years, it is the guys at the top
that are gaming the system. It is the guys at the bottom that
frequently have the best insight into what is going wrong with
the company.
Mr. Lamphron. Well, again, I followed all of our internal--
--
Mr. Greenwood. No, I know you did. And I am not faulting
you. You think it is a good idea? Do you understand the concern
that I might have?
Mr. Lamphron. I do. And I would respond by saying we went
to the Chairman of the audit committee. Now, it does not go
much higher.
Mr. Greenwood. Okay. Mr. Dandurand, you had told us earlier
that you made an inquiry of Mr. Tanner and Cullison about
whether any allegation of fraud were made. Did you review the
compliance, the log complaints for fraud?
Mr. Dandurand. I did not, Mr. Chairman.
Mr. Greenwood. Okay. Was that ever part of your audit
procedure to do that?
Mr. Dandurand. We did not, to my knowledge.
Mr. Greenwood. You can do a sampling of the complaints that
came in on the log?
Mr. Dandurand. No, we do not. I have a lot of confidence in
both Mr. Tanner and Ms. Cullison, and the entire corporate
compliance program that was put into place.
Mr. Greenwood. You took their word for it that----
Mr. Dandurand. Unfortunately, I did.
Mr. Greenwood. Okay. You would not do that again if you had
it to do over again?
Mr. Dandurand. Well, I do not know what I would do----
Mr. Greenwood. Final question. When was the pristine audit
program started?
Mr. Dandurand. I believe in 1996.
Mr. Greenwood. Okay. And in retrospect, and I am not
casting the tiniest dispersion on Ernst & Young when I say
this, in retrospect when you see an indictment that says that
the fraud began in 1996 do you wonder whether Mr. Scrushy said
to himself I am about to start cooking some serious books here
and I have an auditing company that might find out about this,
let me invent a lovely sweetener of the pot? Has that thought
occurred to you?
Mr. Dandurand. It never has. And, Mr. Chairman, HealthSouth
is not a significant client to Ernst & Young. Never has been.
Mr. Greenwood. Okay. Fair enough.
What percentage of your income was HealthSouth?
Mr. Dandurand. Oh, that is difficult.
Mr. Greenwood. In the Birmingham office?
Mr. Dandurand. I have been retired. Well, we do not measure
particularly Birmingham office, per se.
Mr. Greenwood. Anybody else know what percentage it is in
Birmingham?
Mr. Dandurand. You may have the information related to
that. I have seen percentages calculated, and I do not agree
with the way they were calculated.
Mr. Greenwood. Anybody else?
Mr. Lamphron. We manage our practice on an area basis. And
it was no more than one to one and half percent in any year.
Mr. Greenwood. Okay. We seem to have some documents that
says it was 15 percent.
Mr. Dandurand. I have seen those documents. And I disagree
with how that was calculated. That basically adds up the
pristine audit revenues and puts them in the Birmingham office,
whereas all that work was done throughout the entire firm and
was not done in the Birmingham office. So although----
Mr. Greenwood. Did Ernst & Young make more profit on the
financial audits or on the pristine audits?
Mr. Dandurand. Oh, I do not remember.
Mr. Lamphron. I do not know. But this questioning raises
the issue of can we be--is were we influenced by that.
Mr. Greenwood. And I am not raising that question. I am
trying to find out whether Mr. Scrushy, that might have been
his intention.
Mr. Lamphron. Well, just to put in perspective. Again, 1 to
1.5 percent on an area basis, firm wide less than I think .1 of
1 percent. But I would just repeat what we hear almost every
week, and certainly our new people that start, they hear it
probably the first day. There is no client too important to
cause us to jeopardize their professional reputation.
Mr. Greenwood. Glad to hear that.
Mr. Lamphron. It did not influence me, and it did not
influence this team.
Mr. Greenwood. I believe you.
The gentlelady from Colorado is recognized for 5 minutes.
Ms. DeGette. Thank you, Mr. Chairman.
I wanted to follow up on my question to you, Mr. Lamphron,
about whether you made more fees on the pristine audits or on
the audit fees. And you unequivocally said no.
Mr. Lamphron. Right.
Ms. DeGette. So I went back to where I was confused,
because I had been reading the proxy disclosure for 2000 year
end, and if you want to look at Tab 85, you know what I am
talking about?
Mr. Lamphron. Yes.
Ms. DeGette. Because what it says in the proxy disclosure
which was filed with the SEC, it says audit fees, total audit
fees for 2000, $1,026,649. And for that same year then, at
least on this proxy disclosure, it says pristine audits
$1,250,000 which is more, correct?
Mr. Lamphron. Let me explain my statement. Is that what you
would like me to do?
Ms. DeGette. And then for 2001 same thing it is $1,165,750
for total audit fees and then $1,332,261 for pristine audits.
You would not disagree that is what this proxy disclosure says,
correct?
Mr. Lamphron. That is what the proxy disclosure says.
Ms. DeGette. Okay. So why do you not tell me what you
meant?
Mr. Lamphron. Well, at the time--the proxy rules have
changed. But at the time in 2000/2001 the definition of audit
fees was very narrow. It was the audit of the consolidated
financial statements and the quarterly reviews. In addition to
that, each and every year we did a number of other audits.
Ms. DeGette. Right. Which are in also in the proxy.
Mr. Lamphron. Thirteen, 14, sometimes 15 or more audits.
Ms. DeGette. Right.
Mr. Lamphron. The question was did our audit fees, were our
audit fees less. Our audit fees were not. You add all the audit
fees together and exceeded what we received on the pristine
audit.
Ms. DeGette. Right. But my question to you was based on
what was filed at the SEC, which says the total audit fees were
less than the pristine audit. I just wanted to clear the record
up. You know, I think we are talking about apples and oranges.
One last question, which is the same question I asked to
the last panel. Like the Chairman, I would never impugn your
integrity or your motives. But I must say, I do have a concern
when you have a firm that has been engaged to perform an
independent audit, when you have a CEO who was indicted
yesterday on 85 counts of fraud. And as we discussed earlier, a
pretty basic textbook kind of fraud, for the most part. Fifteen
senior executives including 5 CFOs have plead guilty to
criminal offenses. And you folks were the external auditors.
I have heard today you had conversations with people, you
talked to folks, you asked the company for some records which
they supplied you when allegations were made.
Hindsight is 20/20, but in conducting an independent audit
today, is there more you could do to stop this kind of
widespread fraud, which of course hurts all the employees of
HealthSouth plus the stockholders? Any of you.
Mr. Lamphron. Well, again, if there--regardless of how well
the system of internal controls is developed, if there is
widespread collusive fraud, it may not be detected. But----
Ms. DeGette. So your answer is no? You do not think there
is anything else that could be done to avoid this?
Mr. Lamphron. Well, I was going to go on and say that there
are a number of things that have happened since then that
have--we have got a new auditing standard, for instance, which
basically increases our attention we pay to the potential for
fraud. We heightened the awareness on the engagement team. We
spent 300,000 hours in Ernst & Young educating our people on
fraud awareness.
I mean, there is a lot of things we have done. And we would
hope we would detect fraud, but again if we are examining a
transaction and we ask senior management, financial management
and then we go and ask the people in general accounting, and if
we ask legal counsel, and if we ask treasury, and we if we ask
tax and they all give us the same answer----
Ms. DeGette. Yes.
Mr. Lamphron. [continuing] and the same documents, you will
never uncover it.
Ms. DeGette. You know what it depends on, and you know this
and I know this, we all know this. It does not depend on what
those people say. It depends on what the records show, right?
And I think the thing to do is next time go in and get the
supporting documentation. If that had happened, for example,
with the allegations that were made in this case, you would
have caught it right away. Do you not think so?
Mr. Lamphron. Possibly, but the implication that we do not
check documentation is, you know--we--to the extent there is
documentation, we look for it. We do not audit by conversation.
Ms. DeGette. Thank you.
Mr. Lamphron. What we know at this point is that they
falsified documents.
Ms. DeGette. Well, okay. Thank you very much.
Mr. Greenwood. The gentleman from Florida for 5 minutes.
Mr. Stearns. Mr. Chairman, thank you.
Just sort of a summary comment here. I have here the
indictment of the United States of America versus Richard
Scrushy, the defendant. And I am reading on page 11 about the
overall acts. And it is staggering how much money that we are
talking about. It said from 1996 to the year 2003 Richard
Scrushy and others reviewed internal financial statements
setting forth the actual financial condition. And from that
same period of time, with coconspirators, senior officers they
falsified record.
Then it says coconspirators including members of the
corporate accounting staff made and caused to be made entries
in the books and records of HealthSouth which causes the
following approximate amount of fictitious income to be
included in the annual report to stockholders and SEC filings
for the year 1996 through 2001 and intended to be included in
the annual report to stockholders and SEC filings for the year
2002.
Let me just read the amounts, and I know you know them. And
this is all alleged now. But, I mean, this is staggering.
Amount of fictitious income in 1996 was $70 million. 1997
$700 million. 1998 550 million. 1999 $390 million. 2000 $350
million. 2001 $450 million. And 2002 $230 million. For a total,
grand total of $2.740 billion dollars, fictitious fraudulent
income.
That does not include what the coconspirators of the
corporate accounting staff added to that. And they have $370
million in cash. Approximately $27 million in the stock of a
publicly traded company.
And so, I mean, when you look at the amount of money that
was fictitious and fraudulently--it does not happen in 1 year.
It happens in 1, 2, 3, 4, 5, 6, 7 years. And that must be, in
all honestly just between you and I, staggering to you as the
accounting firm of record for this kind of fictitious income
under your watch. And I have to point that out, that it is hard
to believe that that all amount could--I mean, this is not $10
or $100, this is billions of dollars.
So, you know, I will certainly give you an opportunity to
comment on that. That is just my closing comment. It is
probably very difficult for you to do, because this is alleged
by the Department of Justice.
Mr. Lamphron. There is no doubt it is staggering, shocking.
Again, we share your outrage with this whole thing. You know,
we had what we thought was a very prosperous, very fast growing
organization, the pride of Birmingham. And if you look at those
numbers, which last night was the first time I had a chance to
look at them, what you see is they were basically not making
any money and often had losses.
Mr. Stearns. And, you know, sometimes of the tip of the
iceberg is nine-tenths below the water. So this is what the
Justice Department finds, $2.74 billion. It could be much more.
So, let us hope not for the stockholders and shareholders. But
that is my only comment.
Mr. Chairman, I return the balance of my time.
Mr. Greenwood. The Chair thanks the gentleman.
The Chair thanks the members of the panel, the witnesses.
Thank you for your testimony. We appreciate it. And you are now
excused.
Mr. Lamphron. Thank you.
Mr. Greenwood. And the Chair would call forward our fourth
and final panel consisting of: Mr. Howard Capek, former
Managing Director of UBS Warburg Equity Research and Healthcare
Group; Mr. Benjamin Lorello, head of Global Healthcare Finance
Group at UBS Warburg; Mr. William McGahan, former co-head of
Global Healthcare Finance Group at UBS Warburg; Mr. Lanny
Davis, formerly of Patton Boggs, former counsel to HealthSouth
and Richard Scrushy, and; Mr. Hal Hirsch, formerly of Fulbright
& Jaworski, former counsel to HealthSouth.
Gentlemen, we welcome you. We thank you for your patience.
As you may have heard me say to the other panels, the other
witnesses, that it is the practice of the Oversight and
Investigation subcommittee to take testimony under oath. And I
need to ask if any of you object to giving your testimony under
oath. I see no such objection.
I also, pursuant to the rules of the House and this
committee, need to advise you that you are entitled to be
represented by counsel. And so, I would ask if any of you are,
in fact, represented by counsel today.
Mr. Hirsch? Make sure your microphone is turned on and
pointed pretty much at your face. And identify your attorney
for us, please.
Mr. Hirsch. Yes, sir. Edwin Chessler of Corvas Sven &
Moore. And Mr. Chessler is sitting behind me.
Mr. Greenwood. Very well.
Mr. Capek?
Mr. Capek. Yes, sir. Thomas Fitzpatrick and Patricia Braur
sitting right behind me.
Mr. Greenwood. Very well.
Mr. Lorello?
Mr. Lorello. Yes, sir. Robert Lorello.
Mr. Greenwood. Very well.
Mr. McGahan?
Mr. Greenwood. Very well.
And Mr. Davis?
Mr. Davis. Mr. Lustin.
Mr. Greenwood. Mr. Lustin, very well.
Welcome to all of the counsel.
At this point I would ask you as soon as you pour the water
there, to stand and raise your right hands, please.
[Witnesses sworn.]
Mr. Greenwood. Okay, in so saying you are under oath.
And I will begin with you, Mr. Hirsch, and ask if you have
an opening statement?
TESTIMONY OF HAL HIRSCH, FORMERLY OF FULBRIGHT & JAWORSKI,
FORMER COUNSEL TO HEALTHSOUTH; HOWARD CAPEK, FORMER MANAGING
DIRECTOR, UBS WARBURG EQUITY RESEARCH AND HEALTHCARE GROUP;
BENJAMIN LORELLO, HEAD OF GLOBAL HEALTHCARE FINANCE GROUP, UBS
WARBURG; WILLIAM MCGAHAN, FORMER CO-HEAD OF GLOBAL HEALTHCARE
FINANCE GROUP, UBS WARBURG; AND LANNY J. DAVIS, FORMERLY OF
PATTON BOGGS, FORMER COUNSEL TO HEALTHSOUTH AND RICHARD SCRUSHY
Mr. Hirsch. I do not, sir. I am solely here to answer the
questions of the committee, to the best of my ability.
Mr. Greenwood. Very well. I appreciate your being here.
Mr. Capek, do you have an opening statement, sir.
TESTIMONY OF HOWARD CAPEK
Mr. Capek. I have an opening written statement which I have
submitted, and I am prepared to answer all of your questions.
[The prepared statement of Howard Capek follows:]
Prepared Statement of Howard Capek, Former Managing Director, UBS AG
Mr. Chairman, members of the House Committee on Energy and
Commerce, my name is Howard Capek. Until July of this year, I served as
a Managing Director in UBS AG's Equity Research department.
I began my equity research career after earning a master's of
business administration from the Johnson Graduate School of Management
at Cornell University in 1993. Upon graduation, I joined Merrill Lynch
as a healthcare research associate and was soon promoted to assistant
vice president, working under one of that firm's senior analysts. I
later joined Credit Suisse First Boston as a senior associate, after
following the senior analyst with whom I had worked at Merrill Lynch. I
was promoted to vice president in December of 1996, and in March of
1998, upon the departure of my superior, was named senior analyst
following healthcare providers.
I joined UBS in May of 1999 as an executive director, providing
research coverage to institutional investors on long-term care and
alternate site healthcare providers. I was promoted to Managing
Director in December of 2001. Over the past three years, I've expanded
my research coverage to 35 companies across five health care sectors,
including drug wholesalers and specialty distributors, prescription
drug benefit managers, contract research organizations, alternate site
providers and healthcare real estate investment trusts. When UBS
completed its acquisition of Paine Webber in November 2001, I also
began providing my research to retail shareholders.
During my time at UBS, I was consistently ranked in the top
quartile among the approximately 75 analysts in the research department
by the UBS institutional sales, trading and retail departments and
research management. I was also ranked top 10 in categories of stock-
picking, responsiveness to clients, and sector knowledge. In addition,
I was ranked top-5 in stock picking by The Wall Street Journal 2002
all-star survey, a poll compiled solely on objective criteria. Over the
last two and one-half year period, as well as the individual analyzed
periods (calendar 2001, 2002, and the first six months of 2003), my
buy-rated stocks have outperformed the major market and healthcare
indices.
Of course, none of this meant that my stock picking was right all
the time. However, I do believe it meant that the quantitative approach
I took to analyzing stocks was beneficial to UBS clients. These clients
felt comfortable using my research reports and earnings models to help
them anticipate how a company might perform in the future, thereby
contributing to their investment decision making process.
As with all equity stock market investing, no return can be
guaranteed. Any of a thousand uncertainties can change anticipated
return outcomes and the validity or success of any business model or
bundle of assets. One of the greatest uncertainties involves the human
element, the management of a company. Senior managers make decisions
that can affect the value and profitability of a company and they also
control a great deal of what the outside world gets to see. As with any
member of the investing public, analysts must rely on the honesty,
accuracy and completeness of audited and unaudited information that a
firm's senior management team regularly makes available to the public.
My exposure to Healthsouth began while working at Merrill Lynch
under Lucy Olwell, a top ranked analyst in the healthcare sector. Lucy
decided to pick up coverage of the company in the mid 1990's, because
it was a significant factor in several healthcare services sectors and
because its large market capitalization made it one of the biggest such
firms. We continued coverage of Healthsouth when the two of us moved to
CSFB from Merrill, and I took over Ms. Olwell's portfolio of coverage,
including Healthsouth, following her departure from CSFB in 1998.
Throughout much of the period I covered Healthsouth, I rated the
stock a buy or strong buy. Throughout my entire career my ratings on
every stock that I had covered were based on potential appreciation to
a price target that I would expect the stock to eventually reach,
typically one-year into the future. My price targets were derived from
my projections of a firm's future cash flows and relative sector
returns and cost of capital. My projections and modeling were
ultimately based on audited financial information that was publicly
available and whatever information Healthsouth management and their
investor relations department routinely conveyed to me and the
investment community.
One challenge that any analyst faces is supporting an investment
thesis or recommendation over the long-term, despite short-term
fluctuations in a stock, which can make those recommendations seem
counterintuitive, particularly in retrospect. If an analyst were to
change recommendations with trading momentum, he would inevitably be
perceived as reactive rather than proactive, and would quickly become
less valuable to his clients. Although there were times where the stock
price performance of Healthsouth ran counter to my recommendations, I
maintained that in the long term, the company's value would be better
recognized. Indeed, from February 2000 through mid 2002, Healthsouth
stock price performance supported this view.
With the benefit of hindsight, we now know that a significant
portion of Healthsouth's financial history was predicated on fraud. Had
I known this at any time, not only would I have never assigned it a
positive rating, I would have dropped coverage of the company. For the
many analysts in the sector that had positive ratings on Healthsouth,
including myself, I do not believe that any of the operating changes
and volatility that occurred from time to time in any way foretold the
nature or magnitude of fraud that took place.
Another concern the Committee has raised in its investigation of
the Healthsouth matter is the potential for conflict between investment
banks and their stock research departments. Prior to the recent Wall
Street settlements, a research analyst job description included, if not
required, regular interaction and discussion with investment bankers.
At times, such discussions gave bankers the opportunity to suggest
coverage of certain stocks and required research analysts be available
to lend their opinions on potential corporate transactions that
involved banking services. That said, my record shows that the final
word on coverage and ratings always fell first and foremost to my
analysis and sector coverage considerations, and that my
recommendations, based on quantifiable expected price targets, were
always appropriate, unconflicted and fair.
At any point while a company I covered was on a ``restricted
list,'' that is to say where I was not permitted to publish research
coverage due to investment banking, my interaction with clients
complied with what I understood to be Firm policies at the time. The
two widely publicized emails, which were taken grossly out of context
by the media, were consistent with my understanding of UBS policy at
that time.
Members of the Committee, what I have tried to demonstrate in these
remarks is that, despite short term trends sometimes defying my
recommendations; despite the challenges in maintaining continuity in
research when dealing with restrictions imposed by investment banking;
and despite the many uncertainties associated with stock picking, my
efforts as an analyst have led to what I believe was an unbiased,
modeled approach to research that benefited my clients in making their
investment decisions. Throughout my entire career as an analyst, my
intentions have been honest, my opinions have been independent and my
actions have been proper.
Mr. Greenwood. Very well.
Mr. Lorello?
Mr. Lorello. Yes. I would like to give an opening
statement.
Mr. Greenwood. In that case, you are recognized for 5
minutes.
Did you submit a copy of your statement to the committee?
Mr. Lorello. I believe the statement has been or will be
submitted.
Mr. Greenwood. Will be. We would have liked to have had it
before now, but you are entitled to present it. And so you are
recognized for 5 minutes.
TESTIMONY OF BENJAMIN LORELLO
Mr. Lorello. Chairman Greenwood, and members of the
subcommittee, my name is Ben Lorello. Currently I am Managing
Director of UBS and head of the Global Healthcare Investment
Banking Group.
I am here today at the subcommittee's invitation to answer
questions concerning the work UBS has done for HealthSouth. I
will assist the committee in anyway I can, and would be glad to
share some thoughts on potential ways to lessen the opportunity
for this type of fraud that HealthSouth has brought to light.
I have worked in the investment banking industry for 25
years and have spent the last 20 or so managing healthcare
groups. First at Salomon Smith Barney, and then at UBS.
I am proud to be an employee of UBS and proud of what the
healthcare teams I have managed have accomplished during the
last 2 decades in helping clients achieve their strategic goals
and also in their capital formation.
HealthSouth was a client of UBS from 1999 until March 2003.
UBS views HealthSouth as an important healthcare company,
providing valuable services to millions of patients in modern
facilities across the country. Indeed, due to the qualify of
the company's operations and many thousands of honest,
dedicated employees, it appears that HealthSouth will be able
to withstand the accounting fraud perpetrated by its former
executives.
Throughout its relationship with HealthSouth, experience
UBS deal teams conducted extensive due diligence on
HealthSouth. Under UBS' systems of checks and balances, the
firm's commitment committees evaluated the deal teams' due
diligence and made an independent assessment of whether to
proceed with each transaction.
UBS' due diligence started with and relied upon
HealthSouth's audited financial statements. Until the
announcements of criminal prosecutions against the HealthSouth
officers in the spring of this year, I was not aware of or did
not suspect that anyone at HealthSouth was engaged in any
improprieties.
Further, I want to emphasize a point made by members of
this subcommittee and underscored in the indictment filed
yesterday, which is that HealthSouth management engaged in an
elaborate conspiracy to cover up, conceal and keep secret the
fraud from its auditors, its underwriters and lenders such as
UBS, and from numerous other outsiders. As a result,
HealthSouth's investors, dozens of underwriters and lenders and
many companies who sold themself to HealthSouth in return for
stock, all of whom necessarily and appropriately relied on the
integrity of the financial statements were by design misled and
defrauded.
I believe the work of the subcommittee and others in
Congress have done to expose to examine corporate fraud will
limit these types of abuses in the future. The reforms
implemented under the Sarbanes-Oxley Act will make corporate
boards and audit committees for vigilant and corporate
executives more accountable.
I can assure you that UBS for its part will continue its
commitment to conducting its business with the highest ethical
standards.
Thank you.
Mr. Greenwood. Thank you, Mr. Lorello.
Mr. McGahan, do you have an opening statement, sir?
You need to turn on your microphone, please.
TESTIMONY OF WILLIAM MCGAHAN
Mr. McGahan. Mr. Chairman, my name is William McGahan, and
I am a former employee of UBS. I have no opening statement,
other than to say that I have tried as best as I can to assist
the committee staff with its inquiry, and I am here today to
answer any questions that you may have.
Mr. Greenwood. Thank you. And we appreciate it both of
those things.
Mr. Davis, do you have an opening statement, sir?
TESTIMONY OF LANNY J. DAVIS
Mr. Davis. Yes, I do, Mr. Chairman.
Mr. Chairman, thank you for giving me this opportunity to
respond to questions and to explain the role that I played in
this matter.
First, I had no role regarding the accounting fraud issues
that were the subject of the indictment. I was asked to provide
legal media and crises management advice about the singular
question about insider knowledge: What did Mr. Scrushy know and
when did he know it.
I set three conditions to my representation when Mr.
Scrushy and the Board asked me to undertake it.
First, full cooperation and transparency with the SEC.
Second, an honest and complete investigation of the insider
information charges against Mr. Scrushy by a distinguished law
firm.
And third, full waiver of attorney/client privilege so that
the SEC would have immediate and complete access to all of the
fruits of the investigation, not just the report itself, but
all underlying materials so that they could continue the
investigation wherever the evidence led.
In the absence of agreement on those three conditions, full
transparency, an outside investigation and waiver of attorney/
client privilege, I would not have undertaken this
representation.
On the issue of transparency, I sent to the Chairman, to
the Director of the Enforcement Division of the Securities and
Exchange Commission on a Sunday evening after I received those
commitments from Mr. Scrushy, the following email that you can
find at Tab A of my testimony.
``I understand that it is also possible that that the Board
of Directors will appoint another law firm to conduct its own
review. The management of HealthSouth has given me full
authority to communicate with your office and to commit to
respond fully and cooperatively with any questions or concerns
your office might have, to disclose the results of any
inquires, to reveal promptly any improper conduct that may be
ascertained, and, if appropriate, to assist the company in
remedial efforts when and if it is determined that such are
necessary.
Before an investigation had begun, before Fulbright &
Jaworski had been retained, I had committed in writing to the
Chairman of the Director of the Enforcement Division to waive
all privilege and to send over the results of the investigation
including underlying documents. And I did so with the knowledge
and permission of the Board and Mr. Scrushy.
At one point Mr. Scrushy began to resist on my commitment
of transparency. And there is another email that I would
appreciate your looking at, which is at Tab B where I basically
reminded Mr. Scrushy that I was not going to renege on that
commitment, and I said in part in arguing against the full
release of this report to the SEC, which Mr. Scrushy was now
raising some weeks later, ``Not releasing the full report will
look like a pullback on our prior commitment to transparency
with little credible explanation.''
Second, Mr. Chairman, I was committed to a complete and
accurate Fulbright & Jaworski report with no attempt--no
attempt to influence the conclusions. I did ask Mr. Hirsch who
headed up this investigation for the opportunity to hear the
report read to me ahead of time. He objected, because he
thought it would appear as if I was attempting to compromise
the independence of his work. And, of course, I was not.
I had two reasons for asking him to do that, Mr. Chairman.
The first is that I needed to prepare our media team for a
public release of the conclusions of the report because I had
committed to sending this over to the SEC and to releasing it
publicly.
I assured Mr. Hirsch that my intention was not to influence
in anyway the conclusions. In fact, my intention was to bolster
the credibility and independence of his work, precisely because
credibility was the issue in the media as well as at the SEC.
So at Tab C in answer to Mr. Hirsch's legitimate concerns
about reading me the conclusions ahead of time, I sent him an
email. And I said to him the report is in ``final form, and
that would be the understanding BEFORE you read. Advance
reading has no impact on Fulbright's credibility.''
The second reason that I wanted it read ahead of time is
that I was concerned that there may be open issues that would
create uncertainties in which the media and the SEC would ask
why did you not address those open issues. And it turns out
after he read the report to the Board there were two open
issues. One was the shredding issue, which we heard about for
the first time on October 22. The other was what happened at a
staff meeting where Mr. Scrushy might have been told about the
possibility of the impact of this rule change.
So we asked Mr. Hirsch and his team to go back and
reinvestigate and elaborate on this shredding issue, which I
saw as explosive, legally as well as after Arthur Anderson and
Enron in the media.
And second, I asked him to reinterview to the best he could
everybody at this July meeting to close those two issues that
were left open in the first report.
On October 29 he delivered two reports. One was the
reinterview of the July meeting on the insider trading issue.
The second was a much more extensive report on the shredding
issue which led to the conclusion we cannot answer this
definitively, let us turn both over the SEC.
So on October 29 and several days thereafter, despite some
resistance from Mr. Scrushy, we kept our word and we sent all
the reports, the preliminary report done in early February, the
October 21 report with the two open issues and the October 29
report on shredding and report on insider information to the
SEC with all of the underlying documents.
Now, there was one issue that arose between me and Mr.
Horton. I learned from somebody at HealthSouth that despite my
commitment to the SEC, that Mr. Horton had attempted to
convince a Fulbright lawyer not to send over certain emails
that showed some awareness by Mr. Horton and Mr. Owens of the
impact of the rule change prior to Mr. Scrushy exercising his
stock options. I felt that by reneging on our commitment at
that point, especially if Mr. Horton was the influence behind
that reneging, that it would look like a conflict of interest
by Mr. Horton, since I was worried that he was withholding the
very same emails which evidenced that he had some
foreknowledge. So I sent an email to Mr. Scrushy. And that
email, unfortunately, has been put out in fragmentary fashion
by a member of your staff. I urge you to read the entire email.
Because the opening of the email expresses my concern that the
Fulbright attorney was being influenced by Mr. Horton to renege
on our commitment to send everything to the SEC. So I said we
must cutoff Fulbright this morning, not this afternoon, but
immediately before more harm is done. That is the only fragment
released, or at least printed, by some of the members of your
staff 2 weeks ago. But the rest of the email explains my
concern about keeping the commitment the company had made to
the SEC.
And so I then went on to say we must supervise--before more
harm is done, other than the Fulbright attorney, and only if he
is willing to be supervised by me and my law partner and not by
Horton, who is the focus of the Board's investigation and
Fulbright & Jaworski's, and likely the SEC's. At the very
least, Horton's effort to convince the Fulbright attorney to
assert a privilege and withhold documents from the SEC without
consultation with me, constitutes a potential conflict of
interest of him and the company.
So in conclusion, I had the greatest of respect for the job
that Fulbright did and for the job that Mr. Hirsch did. It was
never even slightly my intention to influence the credibility
or perceived independence of that inquiry. And at the end of
the day, after we handled the inside information allegation and
released everything to the SEC, my job was over by
approximately by December 2002 to early 2003.
Thank you.
[The prepared statement of Lanny J. Davis follows:]
Prepared Statement of Lanny J. Davis
Good afternoon, Mr. Chairman.
Thank you for giving me this opportunity to report on my
representation of HealthSouth Corporation and its former Chairman,
Richard Scrushy.
In September 2002 I was asked by Mr. Scrushy and the HealthSouth
Board of Directors to offer legal, media, and crisis management advice
concerning published reports in late August that Mr. Scrushy may have
improperly used inside information prior to his sale of substantial
amounts of HealthSouth stock in May and late July 2002. The alleged
inside information was that the federal Medicare agency, the Center for
Medicare and Medicaid Services (``CMS''), had changed its rules on
physical rehabilitation reimbursements, changes that would allegedly
have had a substantial negative impact on HealthSouth's earnings.
The classic question raised in the media in late August 2002 when
the story first broke on these insider trading issues was: What did Mr.
Scrushy know about this Medicare rule change, and when did he know it?
I am proud of my work for HealthSouth in this matter, because,
throughout my representation, I was faithful to three commitments I
made to the SEC on HealthSouth's behalf when I began the engagement:
--First, full cooperation and transparency with the SEC;
--Second, an honest and complete investigation of the insider
information charges against Mr. Scrushy by a distinguished
outside law firm;
--And third, full waiver of attorney client and work product privileges
so that the SEC would have immediate and complete access to all
of the fruits of that investigation--not just the report
itself, but all underlying materials--and could continue the
investigation wherever the evidence led.
1. Commitment to Transparency and Cooperation With SEC
From my very first conversations with Mr. Scrushy in early
September 2002, I conditioned my willingness to represent him
personally and the HealthSouth on his and the Board of Directors'
express acceptance of these three commitments. They agreed.
I memorialized those commitments in an email I sent to Stephen M.
Cutler, Director of the SEC's Enforcement Division, on Sunday evening,
September 15, 2002, which you can find attached to my testimony as Tab
A. This email was sent three days before the SEC decided to initiate
its own investigation of Mr. Scrushy and HealthSouth. The key last two
sentences of this email read:
``I understand that it is also possible that the Board of
Directors will appoint another law firm to conduct its own
review. The management of HealthSouth has given me full
responsibility to communicate with your office and to commit to
respond fully and cooperatively with any questions or concerns
your office might have, to disclose the results of any
inquiries, to reveal promptly any improper conduct that may be
ascertained, and, ifappropriate, to assist the company in
remedial efforts when and if it is determined that such are
necessary.''
I always counseled HealthSouth and Mr. Scrushy to honor that
commitment, even though they received conflicting advice at times from
others. For example on October 21, 2002, shortly before Fulbright and
Jaworski delivered its first report, Mr. Scrushy and others in senior
management questioned whether the entire report should be released. I
direct your attention, at Tab B, to an email I transmitted to the
entire public relations and legal teams, dated October 21, 2002, at
12:00 AM that morning. Despite concerns raised by Mr. Scrushy and other
company officials as to whether it was wise to transmit the entire
Fulbright report to the SEC and release it publicly, I argued in favor
of the company maintaining its commitment to give the SEC the full
report. I stated, in relevant part:
``Not releasing it [the full Report] will look like a pullback
on our prior commitment to transparency--with little credible
explanation.''
I am pleased to report that HealthSouth honored its commitment and
shared with the SEC not only the report that Fulbright & Jaworski
prepared, but all of the background materials that Fulbright relied
upon, including documents, analyses, and reports of interviews. Many
people and companies under investigation talk about full cooperation;
very few, if any, deliver. Mr. Scrushy and HealthSouth deserve credit,
not blame, for fulfilling the commitment I made to the SEC.
2. Commitment To Complete and Accurate Fulbright Report--With No
Attempt to Influence Conclusions
HealthSouth's hiring of Fulbright & Jaworski fulfilled its second
commitment to the SEC--the retention of a nationally renown law firm to
complete an outside investigation into the insider trading issues. This
Committee should understand that I counseled Mr. Scrushy and the
Company to maximize, not undermine, the integrity of Fulbright's
investigation. The Company's goal of weathering this crisis could only
be achieved if the regulators, the media, and the market credited
Fulbright's conclusions. I counseled--and HealthSouth and Mr. Scrushy
understood and agreed--that only an honest, independent, and aggressive
investigation would suffice.
With this in mind, I counseled Mr. Scrushy and the Company that a
committee of independent Board members, and not the Company, should
retain Fulbright so that their investigation would be truly independent
in fact and would be recognized as independent by the courts, by the
regulators, and by the public. The Company decided otherwise and
directly retained Fulbright to conduct the investigation and to
represent it before the SEC.
Our commitment to release the Fulbright report promptly inevitably
complicated my efforts to advise Mr. Scrushy and the Company on the
most effective means to communicate Fulbright's findings. In the
typical situation, where reports such as these are closely guarded and
selectively released, there is always plenty of time, after the report
is prepared, to review its findings and to consider how to communicate
them. But in a setting where we had committed to prompt release of the
report, we did not have the luxury of time. To help formulate this
advice, I asked Fulbright to show, or at least read to me, portions of
its October 21, 2002 report before the date on which Fulbright
delivered the report to the Board.
I had two reasons for asking Fulbright to show or read me the
conclusions--neither of them had anything to do with attempting to
influence the conclusions.
The first reason was to prepare the media team for public release
of the conclusions of the report.
I assured Fulbright partner Hal Hirsch in an October 21 email, as I
was trying to persuade him to read the report to me ahead of time, that
I had no interest in changing a single word of the Report, which I
understood to be ready for transmittal to HealthSouth's Board of
Directors. In asking Mr. Hirsch for the opportunity to review the
Report shortly before its presentation to the Board, I emphasized: the
Report ``is in final form--and that would be the understanding BEFORE
you read--advance reading has no impact on Fulbright credibility to the
S.E.[C] [sic] or anyone else if factually neither he nor anyone else is
ableto make any changes.'' [Tab C].
The second reason I wanted to hear the final conclusions ahead of
time was to permit me to advise Mr. Hirsch whether there were open
issues left unresolved in the Report that might lead to additional
questions in the media and, thus, continuing uncertainties in the
public markets. I understood that for the Report to be credible, it had
to be not just independent, but complete, leaving literally no stone
unturned.
As things turned out, I was correct in this concern.
The October 21 Fulbright Report presented to the Board left open
two important questions that needed further investigation.: (1) the
circumstances surrounding the shredding of documents during the time of
the Fulbright review; and (2) whether Mr. Scrushy had heard about the
Medicare rule change at a large staff meeting in early July 2002,
several weeksbefore he exercised stock options and repaid Company
loans.
At my and the Board's request, the Fulbright team undertook a
supplemental investigation of both of these matters. On October 29,
Fulbright presented two final Reports that more extensively addressed
both those issues.
The October 29 Report concerning Mr. Scrushy's alleged insider
knowledge confirmed the conclusions in Fulbright's October 21, 2002
Report: namely, there was no evidence uncovered by Fulbright to date
that showed that Mr. Scrushy had inside knowledge of a material adverse
effect of the CMS rule change.
A separate Report, also dated October 29, addressed the
circumstances of the shredding more extensively. Fulbright could not
reach any definitive conclusions about the shredding issue and
determined that the SEC was in a better position to continue and
complete that investigation.
But I want to emphasize two crucial and undisputed facts: First, I
only asked to review the October 21 and 29 reports ahead of time and
not to change any of Fulbright's conclusions in these reports; and,
second, the purpose and result of my review of the first October 21
report was to urge Fulbright to conduct further investigation, not to
soften any of its findings.
Both of these final October 29 reports, as well as the October 21
incomplete report and a preliminary two-page report dated October 2,
were transmitted to the SEC as promised, and, as far as I knew at the
time, the underlying emails and documents that were the basis of
Fulbright's conclusions on the insider knowledge issue.
3. Completion of Fulbright's Services--SEC To Continue Investigation
With Benefit of All Fulbright Reports and Underlying Documents
After Fulbright completed its final reports and sent them to the
SEC, I recommended (with Mr. Scrushy's concurrence) that Fulbright no
longer needed to continue billing time to HealthSouth. I did so for
three reasons.
First, I believed it was more appropriate for the SEC, as the chief
enforcement agency, to continue the investigation on this and other
matters--without HealthSouth having to continue to be burdened by
substantial additional legal expenses.
Thus, as you will note from the email to Mr. Hirsch dated November
6, and found at Attachment D, I stated to Mr. Hirsch:
``I have advised Richard [Scrushy] that with the investigation
regarding himself completed, we will continue to fully
cooperate with the S.E.C. and therefore do not need Fulbright's
services any more.'' [Emphasis added].
Second, as I expressed in an email and in several telephone
conversations in early November 2002--after the final reports had been
delivered to the SEC--I was told that HealthSouth's general counsel
might be attempting to persuade Fulbright to withhold certain documents
from the SEC on grounds of attorney-client privilege, which would have
been a breach of HealthSouth's commitment to the SEC, as I had stated
in my email of September 15 to the Director of the Enforcement Division
of the SEC.
The Company's general counsel, Mr. William Horton, had told me
directly on several occasions that as a general matter he did not favor
turning over all documents to the SEC and waiving attorney-client and
work product privilege. I did not question his sincerity in taking this
position. I did question his judgment, however, in light of the
position I had previously taken with the SEC.
Further, among the documents underlying the October 21 and 29
Fulbright Reports were certain emails authored by Mr. Horton that
suggested that he had some knowledge and concerns, before Mr. Scrushy's
stock transactions, that the CMS rule change might have a significant
negative impact on the Company's earnings. I was concerned that some of
the documents Mr. Horton reportedly wanted to refrain from delivering
to the SEC might be these same emails creating at least the appearance
of a potential conflict of interest.
On or about November 3, I was told by a HealthSouth official that
Mr. Horton might be trying to convince an attorney from Fulbright not
to send all the underlying documents and emails to the SEC. Therefore,
on November 4, I sent Mr. Scrushy an email (found at Attachment E)
stating that Fulbright should be terminated immediately because
``Horton's effort to convince [the Fulbright attorney] to assert a
privilege and withhold documents from the SEC without consultation with
me constitutes a potential conflict of interest for him and the
Company.''
To this day I am not sure whether Mr. Horton, in fact, was taking
this position with respect to these specific documents. I certainly am
not suggesting that he was doing anything improper. But I was concerned
enough to write this email at the time.
The third reason I believed that Fulbright did not need to continue
any investigation was that Special Litigation Committee of the Board
had retained its own outside and independent counsel to investigate the
same transactions at issue in the Fulbright investigation. The
Committee had done so to help it defend a civil stockholder derivative
lawsuit. The Company did not believe that it should pay two separate
law firms to continue investigating the same transactions, and I
agreed.
To repeat: Clearly my overriding concern was maintaining the
Company's commitment to the SEC concerning transparency and waiver of
privilege--and preventing the harm that might be done to the Company
and its shareholders if that commitment were reneged upon.
To this day I have nothing but the greatest respect for the
integrity and professional skills exhibited by Mr. Hirsch and his
colleagues at Fulbright & Jaworski for the job they did in these very
difficult circumstances. Nothing I have seen or heard since then casts
any doubt upon the integrity of their conclusions or the independence
of their efforts.
Conclusion
I appreciate the chance to clear up any questions about my role in
the HealthSouth matter. We tried to learn and apply the lessons of
Enron and the high standards of Sarbanes-Oxley. My role in HealthSouth
was to counsel for and to insist upon transparency and cooperation.
That was sound legal advice, good corporate governance, and the only
truly effective way for HealthSouth and Mr. Scrushy to address the
questions that had been raised.
[GRAPHIC] [TIFF OMITTED] 91232.001
Mr. Greenwood. Thank you, Mr. Davis.
And just for the record, our staff releases only entire
emails, not fragments thereof. And so what is printed is beyond
our control as well.
Mr. Davis. I understand.
Mr. Greenwood. Thank you.
The Chair recognizes himself for 10 minutes for
questioning.
And I want to start with Mr. Capek.
The reason that this committee holds hearings, holding this
hearing on this matter and the reason that we have held other
hearings is ultimately to find out whether the laws and the
processes that are in place to protect the investor are
working. And in the case of HealthSouth, we found out that
barricade after barricade that was supposed to be erected to
protect the investor were breached. The employees who had the
responsibility to give the investors honest information, failed
to do that. The Board of Directors, for right or wrong as we
learned this morning, were unable to protect the investors from
this fraud. The accountants were unable to protect the
investors from this fraud. And that is not to say we are
guessing blame there, it is just the fact the matter is that
they testified that they could not do that.
One of the barricades that is erected in our economic
system is the stock analyst. And, of course, as you well know,
Mr. Capek, you have a very important responsibility in trying
to make sure that investors have good honest information with
which they can base their judgments and make a whole economic
system work.
I am going to ask you, Mr. Capek, to turn to Tab 1 in the
binder there. This is a report you published on HealthSouth in
May 1999, and in big bold letters on the first page is the word
or the words ``strong buy.'' Do you have that document, sir?
Mr. Capek. It starts on the first pages, a fax to L. Murphy
from myself?
Mr. Greenwood. Yes. The second page of that document.
Mr. Capek. The second page, the draft, dated June 4. Yes,
sir.
Mr. Greenwood. Right. Okay. Would you identify the
document, please?
Mr. Capek. This is a research report, a draft, dated June
4, 1999 written by me with my current rating at the time on
HealthSouth, which was a strong buy.
Mr. Greenwood. Okay.
Mr. Capek. The title of the report is ``Reiterating the
Strong Buy, Dispelling Some Near Term Market Concerns.''
Mr. Greenwood. Very well.
What does ``strong buy'' mean to an investor. What are you
trying to signal to the investment community when you say
strong buy?
Mr. Capek. That my price target, which according to the
report here, was $20 and the stock was trading at $14.44 at the
time; is greater than a 20 percent upside to my price target or
what I would theorize as my fair value of the company roughly
12 months out from now.
Mr. Greenwood. So would a strong buy imply as well that you
do not see any immediate downside to the company, is that
right?
Mr. Capek. No. It is a rating that I have applied for the
last year and half. It is not even a category a strong buy
rating that the firm, UBS, has. But, no, there can be
volatility with the stock up or down.
Mr. Greenwood. Right. But it does mean that the stock is at
a price where it should be bought. You're recommending people
buy it and continue to do well in the foreseeable future?
Mr. Capek. Yes, sir.
Mr. Greenwood. Okay. Would you please turn now to Tabs 3
and 4 in your binder? And identify the document in Tab 3. I
will identify it. There are two separate emails written to
Susan Zeeb by you in response to her questions about HRC, which
refers to HealthSouth. Is that correct?
Mr. Capek. Yes, sir.
Mr. Greenwood. Have I correctly identified the document.
Mr. Capek. Yes, sir.
Mr. Greenwood. Okay. Let us look at the first email on Tab
3. This is written a few months after you have indicated that
HealthSouth was a strong buy, which is as we just discussed.
And you state ``I would love to publish on this pig, then I
would not be spending so much time in Birmingham in July/
August, at least there is no humidity. Okay. On HRC, what is
your fax number, I will send you a few charts and graphs which
should glaringly highlight the company's inability to collect
and convert sales into cash and also their inability to
reinvest cash at good rates of return.''
Would you agree that this is not a positive statement about
HealthSouth's stock?
Mr. Capek. It is a reactionary statement to Ms. Zeeb's
original email, which I believe the reply separator is dated
below, where she seems to be responding to ``it's acting like
such a pig again,'' the stock price. So in hindsight being the
perfect looking glass that it is, I would have in my response
put the word ``pig'' in quotes because responding to what she
was saying or asking----
Mr. Greenwood. Was that the kind of language you would use
to recommend that she buy that stock?
Mr. Capek. No, sir.
Mr. Greenwood. Okay.
Mr. Capek. I was not--I did not have a strong buy
recommendation on the stock at this point in time.
Mr. Greenwood. What recommendation did you have at this
point in time?
Mr. Capek. I did not have a rating. I was restricted on the
stock. Shortly after the last research report that you
referenced in Tab 1, sometime in mid-June I was restricted on
HealthSouth stock.
Mr. Greenwood. Okay.
Mr. Capek. So I did not have a rating.
Mr. Greenwood. Yes. Were you aware when you wrote the
strong buy recommendation that--and did you have in your
possession charts and graphs which would glaringly highlight
the company's inability to collect and convert sales into cash
and their inability to reinvest cash at good rates of return?
Mr. Capek. Yes, sir. Actually, the draft report, dated June
4 that you referenced in Tab 1, was a summation of high points
from my larger report dated May 18. And actually, as I was
going to continue, the charts and graphs that I was sending Ms.
Zeeb were my analysis of historical return on invested capital,
margin analysis, spending trends, all based on historical data
and all of it that was published in the May 18 report on
HealthSouth.
Mr. Greenwood. When you used the term ``pig'' what did you
mean?
Mr. Capek. I was----
Mr. Greenwood. I know you were echoing her, but you----
Mr. Capek. I was just taking the word that she said and
putting it into my response. She was referring the stock as
acting like a pig again, assuming she meant volatility on
August 18/19 when these were written. And I was just putting it
back in there to her. It didn't mean anything beyond that.
As I said, if I had put it in quotes or if I had not put it
in at all----
Mr. Greenwood. Well, how can you explain what appears to us
to be two polar statements about this company? Strong buy,
which is your official statement that you send out to investors
and in a private email saying nothing but negative things about
this company, particularly as I have said and read a couple of
times here, the company's inability to collect and convert
sales into cash and their inability to reinvest cash at good
rates of return? Those qualities do not seem like the qualities
of a company that one would normally expect to receive a strong
buy recommendation, do they?
Mr. Capek. They can be. And in my May 18 report was the
theory was the trend would reverse in the near term. There is a
cycle to cash collection. There is a cycle capital spending.
And you want to own the stock when the cycle is at the
inflection point. And when I wrote the report in May, my strong
buy rating in June when the follow reiteration, my thoughts
were the next quarters based on the managed care or commercial
pricing cycle and how they pay their bills, and how HealthSouth
had been spending money, that that cycle would turn. And you
would be in what I would call a cash hog mode or the company
would be.
So my strong buy rating is on the stock and I regret using
the word ``pig'' in response to when my institutional client
used it, it was poor judgment. But beyond that, I was not
changing my investment----
Mr. Greenwood. Well, did you think that your email to her
would be the kind of email that would prompt her to invest in
this company?
Mr. Capek. I was not trying to elicit her to buy or sell
the stock. I was responding to her. I thought maybe she had not
seen or did not have a copy of my large report from May. Here
are these historic charts and graphs, take a look. I was trying
to help her explain the trading activity that she referred to
that the stock was acting like a pig.
Mr. Greenwood. You said that you were restricted. Why were
you restricted?
Mr. Capek. In mid-June I was asked to participate in a
piece of presentation to the Board at HealthSouth to discuss
the split out of the company into two pieces. The in-patient
business and the out-patient business. And at the time I was
still involved in working on that.It was publicly disclosed by
the company that they hired UBS Warburg to advise them on that,
and that is what I was doing. So I was not publishing on
HealthSouth.
Mr. Greenwood. So you were not allowed to publish reports
and you also were not allowed to discuss material issues about
the company with outside investors, is that right?
Mr. Capek. Correct.
Mr. Greenwood. Okay. Let us look at the next email at Tab
4. This is dated September 10, 1999, also to Ms. Zeeb. And in
this email, again, referencing HealthRC, HealthSouth, you state
``I would not own a share.'' Is this statement consistent with
your strong buy rating of HealthSouth?
Mr. Capek. Again, I did not have a strong buy rating at the
time. I was still restricted. But to put this email in context,
on Friday, September 10, on Thursday September 9 HealthSouth
announced that they were not going to go forward with the split
up of the company and that they were taking charges, they were
reducing earnings guidance, changing some management spots and
a whole bunch of stuff along those lines.
So, again, I do not know why we do not have the rest of,
but I was responding again to Ms. Zeeb, and I was commenting
knee-jerk to that press release of less than a day before
saying what a mess. I just would not own a share right now.
Mr. Greenwood. And would you have owned a share when you
made your strong buy recommendation?
Mr. Capek. Yes, sir.
Mr. Greenwood. Okay. And the vents that you just listed
occurred prior to your strong buy recommendation--after your
strong buy recommendation but prior to your declaration that
you would not own a share?
Mr. Capek. Yes, sir.
Mr. Greenwood. Okay. Were you aware at the time that you
wrote these emails that you were on a restricted list regarding
HealthSouth?
Mr. Capek. Yes, sir.
Mr. Greenwood. Okay. Had UBS informed you that you were no
longer on the restricted list during the time you wrote these
emails?
Mr. Capek. No, sir.
Mr. Greenwood. Okay. When you re-initiated coverage of
HealthSouth----
Mr. Capek. Yes, sir.
Mr. Greenwood. [continuing] how did you rate it then?
Mr. Capek. In February 2000, I re-initiated coverage on
HealthSouth with a strong buy.
Mr. Greenwood. Okay.
Mr. Capek. At the time I initiated coverage again, February
2000, keeping in mind again my rating is commiserate to the
upside potential and what I think the stock is fairly valued
at. The stock was $5. My price target was $11, I believe.
Contrast that to my May rating where the stock was $14, my
price target was $20. So valuation parameter had changed based
on while I was restricted the company reported two quarters of
earnings, expectations had come down, the stock gone down to 5.
And on a clean slate, I thought the $5 stock was worth 11,
based on the projections, forecasts I had then in February.
In fact, actually the stock went up over the next 18 months
going to high teens. But be that as it may, yes, I re-initiated
coverage in February 2000 with a strong buy.
Mr. Greenwood. So the only time that you would not buy a
share was the time during which you were restricted, is that
right?
Mr. Capek. Coincidentally with timing of announcements and
what it says in the emails, yes.
Mr. Greenwood. Okay. So your testimony is that in June when
you wrote--when did you write your strong buy recommendation?
Was that in June?
Mr. Capek. My initiation of coverage was in the end of May
1999. Excuse me. The June 4 graph that you referred to was a
reiteration of that report.
Mr. Greenwood. Okay. So between June 4 and February, which
were your two strong buy recommendations----
Mr. Capek. Yes, sir.
Mr. Greenwood. [continuing] you went from strong buy to pig
can't earn money, I would not own a share of it back to strong
buy?
Mr. Capek. I was restricted on the stock in mid-June, and
when I re-initiate coverage, that time line of events the way
the company disappointed two expectations reported results--
yes, sir. Given the way the stock price traded, yes.
Mr. Greenwood. My time has expired.
The gentlelady from Colorado is recognized for 10 minutes.
Ms. DeGette. Mr. Capek, there is another email that is not
in the book. If we can have staff give you a copy of it. This
is an email from Susan Lee to you, dated Tuesday, September 24,
2002. And what Ms. Lee says in this email is that several of
your institutional clients were concerned about HealthSouth's
high capital expenditure figures quarter after quarter and were
worried that HealthSouth was capitalizing expenses. And she
even says similar to what WorldCom was doing. And in her email
she says that when talking to your client, she tried to
``concentrate on strong cash, but that it did not sound like he
was buying it.'' She continued by saying that she was aware
that HealthSouth ``is expanding their facilities and that there
are some maintenance costs.'' And then she asks ``Are we
looking at anything else here?'' Do you recall getting that
email from her?
Mr. Capek. I have seen it in the process of gathering and
reviewing documents for the last--since March, but I do not
recall it.
Ms. DeGette. You do not remember specifically?
Mr. Capek. No, ma'am.
Ms. DeGette. But do you remember some discussions during
that time period of September 2002 wondering about the
capitalizing of expenses of HealthSouth?
Mr. Capek. In September 24--on September 24--well, Susan
Lee was my associate.
Ms. DeGette. Yes, I know.
Mr. Capek. Okay. Yes, and that----
Ms. DeGette. I mean, these are pretty serious allegations
in here, would you not say so?
Mr. Capek. I would not call them allegations. But, yes,
they are serious and they are points that I have scrutinized
with the company over time, and investors had been aware of.
Ms. DeGette. You had scrutinized the issue of whether there
were high capital expenditure figures?
Mr. Capek. Yes.
Ms. DeGette. And what was your conclusion?
Mr. Capek. The company was investing, they were opening new
facilities or hospitals. And at some point it would slow. I
mean, cap X did fluctuate year to year. In 2002, we are to the
point September 24 that the earnings----
Ms. DeGette. Let me ask you something, how long have you
been in the business?
Mr. Capek. Ten years, roughly.
Ms. DeGette. Ten years. And I think you said at least in
your written testimony you have kind of a complex method by
which you decide whether you recommend buy or not, right?
Mr. Capek. Yes.
Ms. DeGette. So do you concentrate on healthcare
enterprises?
Mr. Capek. I cover only healthcare services.
Ms. DeGette. Now, during this period in 2002, or you know
1999 to 2003, were the capital expenditure figures for
HealthSouth different from other similar healthcare entities?
Did you look at that?
Mr. Capek. Yes, I did look at it on the per bid basis or as
a percentage of total cash-flow. And it is not out of line.
Ms. DeGette. It did not seem that different to you?
Mr. Capek. No.
Ms. DeGette. Okay.
Mr. Capek. When you look at----
Ms. DeGette. Now----
Mr. Capek. If I can?
Ms. DeGette. I'm sorry.
Mr. Capek. At September 24, you are less than 1 month after
the August 27 announcement from the $175 million reduction, a
number of things going on. The company points to slowdown in
surgery volume trends. So the stock had traded down. When you
look at complex valuation methodologies, one of the things at
this point and well before September 24 as one of the
investment risks in my research, I pointed out management's
credibility with hitting cap X targets and other things. So I
do not think there is anything new being discussed here.
Ms. DeGette. I am having difficulty understanding you. I am
sorry, if you could just speak into the mike.
Mr. Capek. Okay.
Ms. DeGette. Thank you.
Mr. Capek. I said September 24, the date of this one email,
it is less than 1 month----
Ms. DeGette. No, I heard that part.
Mr. Capek. Okay.
Ms. DeGette. But my question is then if there was a lot
going on, do you recall calling this investor and talking to
him about all of these issues, management credibility and all
these things?
Mr. Capek. I do not recall, and I do not know these
institutional investors, for what firms they work at, who they
are. If Susan asked me to call them back, I am sure I did
either from the road or----
Ms. DeGette. But you do not recall that conversation?
Mr. Capek. No. And on average----
Ms. DeGette. Were you aware that after 2000 that
HealthSouth did not make any more facilities acquisitions. And,
in fact, they were closing facilities?
Mr. Capek. Yes, ma'am.
Ms. DeGette. So what were they spending their capital
expenditure money on if they were actually closing facilities?
Mr. Capek. They were consolidating----
Ms. DeGette. Did you wonder about that?
Mr. Capek. They were consolidating out-patient facilities.
So if you were closing an MRI facility or a diagnostic center,
the actual magnet or whatnot was being moved to another
location that was already there. And, actually, at this point--
--
Ms. DeGette. So what you are saying they were not really
closing facilities, they were just shifting them?
Mr. Capek. They were closing some of those out-patient and
satellite facilities.
Ms. DeGette. Right.
Mr. Capek. They were also opening nine new hospitals. And
hospitals----
Ms. DeGette. So you thought that was where the capital
expenditures had----
Mr. Capek. Roughly a $100 to $120 million a hospital, yes.
Ms. DeGette. Okay. Now, were you concerned about what Susan
Lee was saying in this email?
Mr. Capek. I was concerned, as I said, and I wrote about my
concerns and risk factors in my written document--my written--
--
Ms. DeGette. Do we have those? Does the committee have
those?
Mr. Capek. In my interview, yes, we went through my packet
of research. But----
Ms. DeGette. No, wait. I am sorry. Is that answer yes we
have those documents?
Mr. Capek. Yes.
Ms. DeGette. Okay.
Mr. Capek. And if you do not, I will be happy to get them
to you.
Ms. DeGette. Okay. Now, I have another question. I would
like to get them. I do not know. Do we have those? Staff does
not know. If you can provide us with another copy, that would
be very helpful.
Now, as recently as March 2003 the company was, obviously,
unraveling. There was a Department of Justice probe. There was
Transmittal 1753. There were all these news articles. Mr. Davis
can tell us all about what was going on in that period. Yet you
were still making a buy rating. Can you please tell me your
rationale for that?
Mr. Capek. Yes. And, again, my methodology of rating stocks
is based on what I expect the stock to trade at in fair value.
There was still roughly $3 plus of tangible book value on the
company and the stock was trading between 5 and 6. When I
looked at----
Ms. DeGette. Well, were you concerned about the effect that
all of these other issues like the Department of Justice probe
and Transmittal 1753, etcetera, would have on the business. I
mean, you had actually been expressing these concerns way back
to 1999 in various ways, right?
Mr. Capek. Yes. And to answer your question, yes, I did
have those concerns. But I also felt or estimated that at $5 a
share, the way the stock was trading and based on what--based
on audit financial for many years at tangible book value per
share with $300 plus million in cash, the coverage ratios--I
mean your concerns, when you are asking my concerns about
capital spending, you tie those into my projections for cash-
flow and coverage ratios. Can this company service its debt. I
cover the healthcare rates, which many of my competitors do
not. The real estate companies that own the facilities. In the
case of the rates that had business or had rents outstanding to
HealthSouth, HealthSouth was current within 1 month of all of
their rents. And they remain that way through today, by the
way.
So, yes, I was concerned, cognizant----
Ms. DeGette. Even though their stock has plummeted? I mean,
if someone had actually bought the stock in March 2003, they
would have lost a lot of money, right?
Mr. Capek. I have not followed the stock since.
Ms. DeGette. Okay.
Mr. Capek. But probably. At some point the stock was .08
cents, and I think today it is----
Ms. DeGette. Well, let me just ask you--I am sorry, they
only give us limited time.
Mr. Capek. It is okay.
Ms. DeGette. Yes. Wrap up.
Mr. Capek. Yes, I was concerned. But relative to where the
stock was trading, the tangible book value and what I expected
based on historic results what their true cash-flow was, the
company was okay.
Ms. DeGette. Now, before 2002 when Attorney General Spitzer
entered into the settlement with all the investment banking
companies, a number of firms were both performing banking and
research analyst functions. And I am wondering if your firm was
doing that with HealthSouth?
Mr. Capek. I was never called on to perform banking
functions.
Ms. DeGette. No, no. I am talking about your firm. Were
people doing banking and research analyst functions at your
firm?
Mr. Capek. No. Not--in healthcare and to what I was exposed
to, no. Healthcare research analyst reported to research and--
--
Ms. DeGette. Mr. Lorello, do you know the answer to that
question? Was your firm performing banking functions and also
research analysis functions?
Mr. Lorello. On the same companies?
Ms. DeGette. On HealthSouth?
Mr. Lorello. Yes.
Ms. DeGette. Tell me, if you know, what percentage of the
income your firm received from HealthSouth was received from
banking and what was received from research analysis?
Mr. Lorello. I cannot give you the statistic on the
research, but I can give it to you on the banking.
Ms. DeGette. How much was from banking?
Mr. Lorello. Approximately 2 percent of our group's
revenues of the healthcare group's revenues came from
HealthSouth.
Ms. DeGette. And what was the rough amount of that revenue?
I do not know what your group's revenues were, so I do not know
what 2 percent is.
Mr. Lorello. I think in any given year, about $5 to $6
million.
Ms. DeGette. Okay. And what about the research analysis.
You do not know how much of your firm's income came from that?
Mr. Lorello. Well, yes. That question would be the sales
and trading commissions that we generate from research and on
the equity side, I just do not know the answer to that.
Ms. DeGette. Mr. Chairman, I would ask if either this
witness or someone else from the company can supplement in
writing the answers to give me that information.
Do you know, Mr. Lorello, is your firm now performing both
of these functions for HealthSouth? Both banking and the
research?
Mr. Lorello. Well, we no longer have a relationship with
HealthSouth.
Ms. DeGette. Okay. So the answer is no.
Mr. Lorello. Yes.
Ms. DeGette. Are you doing it for anybody?
Mr. Lorello. Well, with the Spitzer legislation that has
resulted in the settlement, is a complete and total separation
now between banking and research.
Ms. DeGette. There is a firewall, right?
Mr. Lorello. It is even thicker than that.
Ms. DeGette. Okay. Thank you.
Thank you, Mr. Chairman.
Mr. Greenwood. The Chair thanks the gentlelady.
The gentleman from Florida is recognized for 10 minutes.
Mr. Stearns. Mr. Chairman, thank you.
And, Mr. Hirsch, I would just like to chat with you briefly
here.
You were hired at the request of Mr. Davis, is that----
Mr. Hirsch. I was hired by Fulbright & Jaworski.
Mr. Stearns. Yes.
Mr. Hirsch. Who was hired by HealthSouth. I believe at the
recommendation of----
Mr. Stearns. Of Mr. Davis.
Mr. Hirsch. Yes, sir.
Mr. Stearns. Yes. Okay. And you came in and you did a
report on October 1, 2002. You did another report on October
21, 2002. Then you had two more reports on October 29. Is that
true?
Mr. Hirsch. Yes, sir. And one on March 14, 2003.
Mr. Stearns. Okay. Right.
As a result of these reports, did you think at that time
that your investigation cleared Mr. Scrushy of any culpability
dealing with the sale, inside trading?
Mr. Hirsch. I am not certain from your question as to what
that time was. But if I can----
Mr. Stearns. I mean, as a result of these four reports and
the additional reports that came, did you in your own mind feel
my reports pretty much show consistently that Mr. Scrushy did
not know, and when you--he did not know about the $175 million
shortfall. And then when he sold the stock, that it was not
insider trading. Do you feel comfortable at saying at that
point your report said that?
Mr. Hirsch. No, sir. My report never said that.
Mr. Stearns. Right.
Mr. Hirsch. And in fact, prior to the issuance of any of
the reports and at the time of the engagement, I advised Mr.
Scrushy, the Board and all other related counsel that we would
never be able to say that.
Mr. Stearns. No.
Mr. Hirsch. I advised that we would not be able to prove a
negative. That we would most likely, at best if there was in
fact a complete inability to establish that Mr. Scrushy had
done it----
Mr. Stearns. Okay.
Mr. Hirsch. [continuing] the negative.
Mr. Stearns. Okay. Then on October 30, 2000, there was a
press release issued by HealthSouth. Did you receive a copy of
this press release?
Mr. Hirsch. I received a copy of that press release, sir.
Mr. Stearns. And the press release said HealthSouth
Chairman Richard Scrushy cleared by outside investigation of
advanced knowledge of Medicare rule change prior to stock
transaction. Did you know about the press release?
Mr. Hirsch. I saw the press release on the morning of the
29th, I believe.
Mr. Stearns. And I guess the basic question is what was
your reaction when you saw that press release?
Mr. Hirsch. I was very dismayed by the contents of the
press release, and immediately contacted general counsel who
had sent it to me, Mr. Horton. Advised him of all of my
concerns. I was also accompanied by----
Mr. Stearns. And the reason you were concerned was because
it had the word ``cleared'' when your investigation did not say
that?
Mr. Hirsch. That was one of our concerns, sir.
Mr. Stearns. Okay. And did you have conversation with Mr.
Scrushy, Mr. Horton or Mr. Davis later that afternoon about
that press release?
Mr. Hirsch. No, sir.
Mr. Stearns. You got no calls from any of them?
Mr. Hirsch. Yes, sir. That afternoon on October 29, that is
correct.
Mr. Stearns. I think our staff said when they talked to
you, you said you got a call from three of them at 4 p.m. on
October 29 asking if there is anything in the--from using that
press release as it was already written and passed out?
Mr. Hirsch. Yes, sir. I was confused as to whether it was
that or the following.
Mr. Stearns. And did you communicate really clearly to them
your position that you were upset?
Mr. Hirsch. Yes, sir.
Mr. Stearns. Did they go back and change the press release?
Mr. Hirsch. No. That was not exactly the connotation or the
purpose of their call to me. But, in fact, no there were no
changes to the press release.
Mr. Stearns. Okay. Was there reaction from the law firm of
Fulbright & Jaworski to this press release?
Mr. Hirsch. Is the question what was the reaction?
Mr. Stearns. Yes. What was F&J's reaction to the press
release?
Mr. Hirsch. We advised Mr. Horton, and I advised others,
that the press release was unacceptable. We had no control over
the issuance of the press release. When, in fact----
Mr. Stearns. Did you----
Mr. Hirsch. Excuse me, sir.
Mr. Stearns. That is good.
Do you know a Mr. Felice Gallant?
Mr. Hirsch. I do know a woman who is an attorney at
Fulbright & Jaworski named Felice Gallant, yes.
Mr. Stearns. This is Tab 77 from Neil Gold to Hirsch with a
cc copy to Felice. This is what he said to you:
``Hal, this is hilarious. Is it a''--and he is talking
about the press release. ``Is it a parity or is it for real? A
few thoughts and questions. One, I did not know we had the
power to clear Richard. In fact, our letter says quite the
contrary. What is the legal definition of inkling? Is it more
like scintilla? Do these idiots realize that 2 months after May
14 is July 14?'' And it goes on.
Do you remember that memo?
Mr. Hirsch. Very much so, yes.
Mr. Stearns. Okay. Do you agree with that memo?
Mr. Hirsch. I do not agree with the colorful connotation of
that memo.
Mr. Stearns. No. But I mean content, in terms of the just
saying what are we clearing Richard for, because our evidence
shows he was not cleared.
Mr. Hirsch. In fact, sir, we never cleared Mr. Scrushy. I
am certain that the staff has seen, and I believe you have seen
that our report reflects totally different statements.
What in fact we did do is, I had spoken to Mr. Horton. We
advised Mr. Horton of the errors. We had no control over the
press. We advised what was wrong with the press release. I
believe it is a subsequent email to either Mr.--I know to Mr.
Horton, as well possibly copying others and Mr. Gold evidencing
in fact that I had contemporaneous conversation with Mr. Horton
evidencing or explaining all of those issues.
Mr. Stearns. Did you threaten to say listen, if you do not
change that press, we are going to resign as counsel if a
corrective press release were not issued?
Mr. Hirsch. Yes, sir, we did.
Mr. Stearns. Okay. And what was Mr. Davis' reaction to the
decision concerning the press release?
Mr. Hirsch. Subsequently after the press release was
issued, and it became public, we advised that the press release
needed to be revised to reflect the actual state of what our
report had said. And that report, in fact, did not say what the
first press release was. The results was that there was a
dialog and there was a change by the company, a revised press
release was negotiated on the 1st of November and it was issued
before the business--the opening of business on November 4.
Mr. Stearns. Did you ever communicate to Mr. Davis that you
felt that this whole press release was being finessed based
upon your conclusions and was really a PR?
Mr. Hirsch. I do not think I ever connoted it in that way,
sir. I think what I had----
Mr. Stearns. But you did tell him?
Mr. Hirsch. I did tell him bluntly that it was wrong.
Mr. Stearns. You said, listen, we are all in the same team
here. You are trying to finessed this. This is not right. I did
not say this. We are going to do a retraction or I am off?
Mr. Hirsch. I do not think I said in that----
Mr. Stearns. In those terms, but----
Mr. Hirsch. But I do not think I said--I know I would have
said we are all on the same team. I know that the press release
had to be revised. The company was under a Securities Exchange
review. We needed to be certain that the public information
that was being disseminated was consistent with what we believe
was correct. And because that press release seemed to be
somewhat inconsistent with our report at the minimum, that we
required a revised press release. And the company acceded.
Mr. Stearns. Okay. Let me just move to document shredding.
Mr. Hirsch. Yes, sir.
Mr. Stearns. Did you discover during your investigations
that potentially relevant documents to the investigation were
shredded in a file room on the fifth floor of the executive
office tower?
Mr. Hirsch. We founded shredded documentation. My staff
did. The relevance of the documents were not determined until a
time thereafter. But, yes, sir.
Mr. Stearns. And was the incident reported to the Board?
Mr. Hirsch. The incident was reported to the Board, sir,
yes.
Mr. Stearns. Okay. And Mr. Scrushy?
Mr. Hirsch. And to Mr. Scrushy.
Mr. Stearns. Okay. And what about Mr. Horton, what was his
reaction when he was told about it?
Mr. Hirsch. I had advised 2 days after the day after my--I
believe it was 2 days after my engagement, of Fulbright's
engagement, I had spoken to Mr. Horton on the telephone and
asked him what the document retention policy was at
HealthSouth. I was advised, in fact, that there was not one
that was consistent with what I needed. So I directed Mr.
Horton, or instructed me, to issue a notification to the 50
some thousand employees that every single document needed to be
retained in everything except the daily newspapers.
Mr. Stearns. Well, that sounds like you acted very
honorably. I mean, you just sensed something was happened. You
immediately said, hey, listen we got to stop this. And so that
was good.
And you do not have to answer this, but did you know why
this shredding was not mentioned in the October 1, 2002 Board
meeting minutes?
Mr. Hirsch. I have no understanding as to how the minutes
were kept, who kept them or anything.
Mr. Stearns. Okay. Let us go to the shredded documents.
Evidently, you were able to get a copy of these shredded
documents?
Mr. Hirsch. We found two bags, sir.
Mr. Stearns. Yes. Two bags. So we have here in subtab 88
copies of these shredded documents.
Do the shredded documents, even though they are shredded,
there appears in looking at them myself that some of the
shredded documents contain notations dealing with 1753 and $175
million. And, in fact, when I looked at this I have got from
Richard Scrushy on one of the shredded documents. And I have
got $175 million. In fact, I have got $175 million, 1, 2, 3,
4--3 times. You know about these.
Mr. Hirsch. Pretty much so, yes. We found them, sir.
Mr. Stearns. So if we have shredded documents that indicate
that we are talking about 1753, we are talking $175 million and
they have the word Scrushy in it, from Scrushy, I do not know
what that means. I guess probably you do not either. And
probably it would be difficult to conjecture. But it appears
that these shredded documents were about the $175 million and
1753, and somebody was trying to destroy documents dealing with
relevant pertinent information that could apply to this whole
investigation you were doing. Could I say that?
Mr. Hirsch. You can say that, sir. We were--my and our
concerns were greatly heightened.
When we found the shredded materials, we told Mr. Horton he
had a problem, he needed to send out another memo. There was
another document retention memo sent out to the firm, to the
employees, the 50 some odd thousand. We then subsequently
advised the company that every shredder needed to be
sequestered or removed from the premises.
We ultimately, as you have seen I am sure in our report,
made tasking recommendations to the Board which specifically
included retaining an outfit who could seek to reconstruct
these shreds for the purpose of trying to ascertain what was
going on.
What you see here, sir, this October 31 memo, was one to
the Board subsequent to the Board meeting that I believe was
had on the 29th where the Board members were being provided
copies of what we had found and asking them for their authority
under the tasking instructions or suggestions we had found as
to whether they were going to authorize us to retain an outfit
to try and reconstruct.
Mr. Stearns. I will just conclude, Mr. Chairman, and ask
this final question to Mr. Hirsch.
Did you feel at this point that the scope of your
investigation was being reduced significantly?
Mr. Hirsch. On October 31, sir? There was certainly an
attempt, and the emails I think reflect that the staff has
shown me and refreshed me, that there was an effort to indicate
that our services had been completed. That as a result of the
first four reports that you have referenced, that our work had
been finished. We had a disagreement and believed there was
more work to be done.
Mr. Stearns. Did the Board ever instruct you or anybody to
reconstruct these shredded documents? I mean, from what I see
here, I mean it does not seem like it is impossible to
reconstruct these shredded documents?
Mr. Hirsch. I am sorry. That it is or is not impossible,
sir.
Mr. Stearns. I think it looks possible to reconstruct these
shredded documents. Did the Board ever instruct you and say,
look, we see all these very pertinent terms there. Why do you
not go ahead and reconstruct the shredded documents?
Mr. Hirsch. We were persistent and the Board was agreeable.
We did retain an outfit named Corefax. They made significant
efforts and we have provided, I believe to staff, copies of
what Corefax was able to do. In fact, they had large room,
little pieces of data. We have photographs of what they were
able to reconstruct.
Mr. Stearns. So the Board never directed you to reconstruct
the shredded documents?
Mr. Hirsch. They authorized us to do it, though, sir.
Mr. Stearns. Do it.
Mr. Hirsch. But in fact----
Mr. Stearns. It was difficult to do?
Mr. Hirsch. We were told by Corefax they could not do it.
As I--with my very limited understanding of shredding----
Mr. Stearns. Mine, too.
Mr. Hirsch. Well, I am grateful to know----
Mr. Stearns. Because we shred documents, and I do not know
how you do it.
Mr. Hirsch. We do not shred documents, sir.
Mr. Stearns. Yes.
Mr. Hirsch. But notwithstanding that, apparently if they
are shredded once----
Mr. Stearns. Yes.
Mr. Hirsch. Life is easier.
Mr. Stearns. Yes.
Mr. Hirsch. If they are shredded and crosshatched, it is
near impossible----
Mr. Stearns. The permutations?
Mr. Hirsch. Right. And apparently the very advanced
shredding machines which seem to be located with each
photocopier machines, maybe 50 or 60 of them, in the facility
that you are speaking of there, crosshatched each of them. And
these were, in fact, were a part of those.
Mr. Stearns. Thank you, Mr. Hirsch.
And thank you, Mr. Chairman.
Mr. Greenwood. The Chair thanks the gentleman.
Recognizes himself for another 10 minutes.
Mr. Davis. Mr. Chairman.
Mr. Greenwood. Yes, Mr. Davis.
Mr. Davis. Excuse me for interrupting you. At some point
either in your questioning or somebody else's I would like an
opportunity to respond to Congressman Stearns' and his
references to me, and the exchange that just occurred with Mr.
Hirsch.
Mr. Greenwood. We will try to do that. We will try to do
that. And I suspect that after I ask Mr. Hirsch questions, we
will have some more things that you want to say.
Mr. Davis. Thank you. And I hope Congressman Stearns will
be here to hear me out, and we can set the record straight.
Mr. Greenwood. Mr. Hirsch?
Mr. Hirsch. Sir?
Mr. Greenwood. When was the report reviewed with the Board?
Mr. Hirsch. I beg your pardon, sir, which report? The
shredding report?
Mr. Greenwood. No, no. The October 21 report?
Mr. Hirsch. I believe that was on October 22, sir. But I am
not certain. But I believe it was the following day.
Mr. Greenwood. Okay. Was anyone provided a copy of the
report prior to the October 22, 2002 Board meeting?
Mr. Hirsch. No, sir. I handed it out to the members myself.
Mr. Greenwood. Okay. And did Mr. Davis ever ask you to
provide him a copy of the report in advance of that Board
meeting?
Mr. Hirsch. Yes, sir.
Mr. Greenwood. Okay. Would you look at Tab 57 and if you
will begin with Tab 57. And could you identify that?
Mr. Hirsch. Well, the upper left hand corner of the email
of the document evidences that it's an email that would have
come from my machine, as my name is on it. It appears to be an
email from Lanny Davis to me on October, 17, 2002.
Mr. Greenwood. Okay. And he asks you in that email ``Can I
get a rough draft tomorrow, please?'' This is on October 17, 5
days before it was presented to the Board meeting. ``You
promised I would not have to wait any longer than that. Need
more than 1 day to register concerns. Let us talk early in A.M.
Hope all is well, etcetera.''
How did you respond to that email?
Mr. Hirsch. I do not recall exactly how I responded. I can
tell you the transposition of events if you like, sir.
Mr. Greenwood. Go ahead, please.
Mr. Hirsch. All right. What had occurred is that there was
a dialog had where Mr. Davis had requested a copy or the
opportunity to see the document in advance. I was very reticent
to do so for fear that the integrity of the report might be
compromised. Mr. Davis, as I best understood, was responsible
for a number of things with regard to the engagement,
particularly and including the media issues. I was very
sensitized to the media issues and did not want any of my
reports, Fulbright's reports, to be disseminated to anybody
prior to them going to my client through the Board of
Directors.
The result is that I attempted to--advised Mr. Davis that I
did not want to give him a copy. Notwithstanding that, a dialog
was had by Mr. Davis with myself and myself with my colleagues
at Fulbright & Jaworski. And Mr. Davis advised of one thing,
one point he made, it reigned true; and that is that Mr. Davis
was co-counsel and he may have facts, information or knowledge
which might impair or impact upon our report. Mr. Davis had
people on the ground doing investigation even before Fulbright
began. And Mr. Davis wanted to be certain that there were not
facts that would be in error.
In discussing those issues with Fulbright and myself, I
certainly personally concluded that the very last thing I
wanted to do is have a report that would go in error.
Ultimately, I agreed to Mr. Davis' request, such that I
would read the document to him, which I did. And your staff has
refreshed me, as I did not recall, it seems that it was the
morning of the 20th, that Sunday. And I had read Mr. Davis and
Mr. Goldberg, his associate, the entire report that morning.
I did not thereafter--and it was the final report. There
were no changes ever made to the report. The report was
finished at that point and in that condition was provided and
read to the Board on the 22nd.
Mr. Greenwood. Okay. Would you refer to Tab 63.
Mr. Hirsch. Sixty-three, sir?
Mr. Greenwood. Yes, please.
Mr. Hirsch. Yes, sir.
Mr. Greenwood. Okay. Did you get permission from Bill
Horton to read the report to Mr. Davis?
Mr. Hirsch. Yes, sir. That was very important to me. I
wanted the company's authority to be able to do what I was
doing before I had done it. And my contact with the company was
general counsel, Bill Horton. And he gave me that authority.
Mr. Greenwood. Now, are these words yours? ``We have just
finished with an ultimate draft of the report due to the Board
on Tuesday. I expect a copy near midnight. Lanny Davis has
requested to see and comment on the report in advance.
Fulbright will not allow me to transmit a draft, but with your
authority as general counsel, I can allow him to read it''--it
should say at, I assume, ``or in our office tomorrow morning or
read it to him. I therefore request your authority to do so.''
Mr. Hirsch. Yes, sir. Typos and all.
Mr. Greenwood. And did you in fact read him the report?
Mr. Hirsch. I read it to him. He was--I do not recall if he
was unable or unwilling, or whatever it may have been. I think
he was unable to come to the Fulbright offices in DC, so it was
agreed that I would read it to him.
Mr. Greenwood. Okay. At the top of that email it says--
there is an email from you to Bill Horton, dated Sunday,
October 20, 2002 at 10:53 a.m. It says ``In the process right
now and he is happy so far.'' To whom are you referring there?
Mr. Hirsch. I am referring to Lanny Davis that Mr. Davis
was happy that I was reading it to him. He had wanted me to
read it, and he was happy that I was reading it to him.
Mr. Greenwood. And did you read the entire report to him?
Mr. Hirsch. Yes, sir.
Mr. Greenwood. Word-for-word?
Mr. Hirsch. Yes, sir.
Mr. Greenwood. Okay. Did he have any comments on the
report? Did he identify any factual errors or did he express
any concerns or want any corrections made?
Mr. Hirsch. Your staff asked me that. And the best that I
can, you know, reach into the recesses of my mind from that
time is that I do not recall Mr. Davis referencing anything,
having concerns other than indicating that he wanted to--I
basically recall him saying he wanted to think about it and he
would get back to me. But I do not think he had any substantive
comments or nonsubstantive comments, for that matter.
Mr. Greenwood. When you read in the conclusion of the
report that Mr. Scrushy was present during a Monday morning
meeting on July 8, 2002, during which the existence of
Transmittal 1753 was referenced, do you recall Mr. Davis
registering any response to that?
Mr. Hirsch. I--as you say that now, I recall Mr. Davis
having a reaction, but I cannot replicate the reaction. It was
something along the lines of surprise, as best I can describe
it.
Mr. Greenwood. Surprise? Okay.
And if you would look at 67?
Mr. Hirsch. Yes, sir.
Mr. Greenwood. And at the page, the third page of that, the
bottom there is an email from you to Mr. Davis at Patton Boggs,
dated October 21, 2002 at 7:25 a.m. So this would be the next
day after you read Mr. Davis----
Mr. Hirsch. I am sorry, sir.
Mr. Greenwood. Okay.
Mr. Hirsch. You said page 3, do you mean page----
Mr. Greenwood. Tab 67. I am sorry. Page 2 on Tab 67.
Mr. Hirsch. Thank you, sir.
Mr. Greenwood. Do you see the----
Mr. Hirsch. I do, sir, yes.
Mr. Greenwood. Okay. So this was the morning after you had
read Mr. Davis the report. Would you characterize that email
for us?
Mr. Hirsch. I think--I do not know what you mean by
characterize. Do you want me to explain it?
Mr. Greenwood. Yes.
Mr. Hirsch. There had been a request that I read the email
again or--beg your pardon, the report again or provide it again
to other people. And I thought that that was something that
might compromise both the integrity of what we had done at
Fulbright and possibly, more likely, get the document into the
hands of the media or other people than my client before I
delivered it. Once I delivered it, they could do as they like.
Mr. Greenwood. And did Mr. Davis want Mr. Scrushy to have
access to the report?
Mr. Hirsch. In accordance with this email that appears, yes
sir. But I do not have a specific recollection other than what
the email says.
Mr. Greenwood. And did you know at the time that Mr. Davis
represented Mr. Scrushy and the Board?
Mr. Hirsch. I have subsequently found that I did not know
that. When I met with staff, I did not recall when I was
apprised of that. As you might expect, I became quite curious
because staff was curious. And I found that I was apprised of
that on November 8, 2002.
Mr. Greenwood. Well, the email says ``Despite the issues of
propriety when the SEC demands advice as to who had
preknowledge of the report before its release, as it always
does, do you really think that it is wise to say that RMS''
referring to Richard Scrushy, ``was given the opportunity to
influence the report. This would undermine all F&G has done.''
What made you have concern about the fact that Mr. Scrushy
might have opportunity to influence the report?
Mr. Hirsch. I do not recall why I used the word influence.
But my concern is always when anyone sees a report or any
document prior to when it is ready to be presented, that there
will be a question as to whether or not that person did or had
the opportunity to influence the report. My concern is very
heightened with regard to integrity. I did not want anyone in
hindsight to be able to say that there was an opportunity for
someone to influence whether they did or they did not.
Mr. Greenwood. Now, did you know at the time that the
arrangement that Mr. Davis had was that he would represent the
Board and the Mr. Scrushy, and if they became in conflict, that
he would then, his allegiance would go to Mr. Scrushy, not to
the Board.
Mr. Hirsch. That is what I spoke to before. Let me be more
clear.
Apparently there was an email that went from Mr. Davis to
Mr. Scrushy. It was a 4 or 5 page email that was dated
September 22, 2002. When we imagined Mr. Scrushy's personal
computer in his office, apparently we came to a copy of that
document. And that document reflected what you are saying, sir.
I did not see, and I believe that my staff did not see that
document until November 8. And on November 8 a copy of that
email was sent to me by one of the attorneys in the Fulbright
office who had been down in Birmingham and provided it to me.
That was the first time that I had seen it.
Mr. Greenwood. Okay. For the information of all, we have 7
or 8 votes coming. I did not want to keep this panel here for
that length of time. I want to be fair to the gentlelady from
Colorado, I want to be fair to Mr. Davis.
So I am going to ask that in the next 10 to 12 minutes, Ms.
DeGette, that you do your best to answer--ask questions and if
you can, give Mr. Davis an opportunity to say something.
Ms. DeGette. You know, it would be a first if I had to
answer questions. So I appreciate you letting me ask the
questions, Mr. Chairman.
Mr. Hirsch, your firm was originally hired to be
independent counsel for HealthSouth special litigation
committee, correct?
Mr. Hirsch. I was told when I entered the middle of a
Board, yes.
Ms. DeGette. And then when you got down to Birmingham, Mr.
Scrushy convened a telephonic Board meeting to hire Fulbright &
Jaworski as the defense counsel, right?
Mr. Hirsch. When I arrived in Birmingham, litigation
attorneys for a company apprised me that there was an SEC
investigation of he company and they wanted us to handle that.
I apprised them that we could not do that if we were----
Ms. DeGette. Right.
Mr. Hirsch. [continuing] in fact to do the SLC
Ms. DeGette. Because it would be conflict.
Mr. Hirsch. Then we could not.
Ms. DeGette. Right.
Mr. Hirsch. In fact could not. And there was a dialog had
between litigation counsel who arrived at the facility and Mr.
Scrushy that they wanted us to take on the other engagement,
which I said that we would do----
Ms. DeGette. But, so the answer is----
Mr. Hirsch. Yes. But I said----
Ms. DeGette. Yes.
Mr. Hirsch. [continuing] we would do that in the event that
the Board authorized it.
Ms. DeGette. Right. And that is what you did, right?
Mr. Hirsch. That is correct.
Ms. DeGette. So do you know did the special litigation
committee ever hire anybody to do the job you were originally
contacted to do?
Mr. Hirsch. I do know they did that.
Ms. DeGette. I am sorry?
Mr. Hirsch. I do know that they did that.
Ms. DeGette. Did they?
Mr. Hirsch. They did, yes.
Ms. DeGette. Who did they hire?
Mr. Hirsch. I believe the name of the first, I do not know
the gentleman's name, I do not recall, but it was Balch &
Bingham. They were retained. They were, I believe, an Alabama
firm. And they were retained to represent the committee. And
they did do that.
Ms. DeGette. Right. And did they do anything, do you know?
Mr. Hirsch. I do not know what they did.
Ms. DeGette. Did they ever come up with a report?
Mr. Hirsch. I met--I met telephonically with the gentleman
from Balch & Bingham on three occasions, I believe they told
staff, and I met with his special litigation committee in
person with him by telephone for an extended period at a
particular time. I gave him the information----
Ms. DeGette. But you do not know if they ever did anything?
Mr. Hirsch. I do not.
Ms. DeGette. Thank you.
Mr. Hirsch. I know that we provided----
Ms. DeGette. I am sorry.
Mr. Hirsch. I am sorry.
Ms. DeGette. We have to go vote.
Mr. Hirsch. Certainly.
Ms. DeGette. Hang on 1 second.
Mr. Davis. Just to be perfectly fair, if you are going to
vote and there is has been 10 or 12 minutes of conversations
about me, I should have an opportunity to respond.
Mr. Greenwood. We are in discussion about that.
Ms. DeGette. Mr. Davis, you are so right.
Mr. Greenwood. We are going to do that. And----
Mr. Davis. This is very unfair that I have no opportunity
to respond to 10 or 15 minutes of references to me that are not
entirely accurate.
Mr. Greenwood. Actually, if I may, Mr. Davis?
Mr. Davis. All right.
Mr. Greenwood. Okay. We are in discussion right now about
trying to be fair to you. And it is our conclusion that if you
would like additional opportunity, the only way to manage that
will be to come back in about an hour and you will have plenty
of time to----
Mr. Davis. Well, how about giving me 5 minutes right now
before you leave to vote? Because there are members of the
media here who have----
Ms. DeGette. Go ahead. Because I cannot come back. Just go
ahead. Go.
Mr. Davis. Well, Madam Congresswoman----
Ms. DeGette. Go.
Mr. Davis. It is only fair----
Ms. DeGette. Mr. Davis, 5 minutes. It is yours.
Mr. Davis. Mr. Chairman, may I?
Mr. Greenwood. Yes, sir.
Mr. Davis. I will try to be brief, and I apologize----
Ms. DeGette. Go.
Mr. Davis. My first comment is that I take responsibility
for the word ``cleared,'' because I believed that that was a
reasonable inference in the Fulbright report. It is not correct
that that word ``cleared'' was not circulated as a draft press
release throughout the day, including circulated to Fulbright &
Jaworski.
Second, I included in that press release the entire last
paragraph that included all of the Fulbright's caveats that you
cannot prove are negative.
Also, never having heard any objection to the word
``cleared'' in exchanges of emails throughout the entire day, I
would never have sent a press release without the approval of
all of the counsel involved, and that is the position that I am
taking.
Second, regarding the reason that I asked for the report to
be read ahead of time, I simply ask you again to look at Tab C.
I only wanted ahead of time advance notice so that I could
prepare for the media and address whether there were any open
issues.
And third, most importantly, the shredding issue and the
July issue was not addressed in the first draft and, in fact, I
did not hear the sentence about shredding read to me over the
phone until it was read to the full Board. Because it was read,
we then asked Fulbright go back ahead of time. There was
absolutely no intention to influence the results of that
report.
Thank you, and I am sorry for interrupting, Madam
Congresswoman.
Ms. DeGette. Mr. Chairman, I would also--what I had
originally intended to do was ask unanimous consent that Mr.
Davis could supplement his answer in writing for the committee.
Because I also believe that it is very important that he be
given an opportunity to respond to the allegations. And so I
would ask that.
Mr. Greenwood. This is what I would propose----
Ms. DeGette. If that is all right with him.
Mr. Davis. Thank you.
Mr. Greenwood. I would propose we have 8 minutes and 42
seconds to the vote. We will need about 3 of those minutes to
get to the floor.
Ms. DeGette, you have 5 minutes additional if you would
like. And then I am going to propose that we will reconvene in
approximately 1 hour.
I would ask if there is anyone on the panel who cannot be
back here in an hour?
Ms. DeGette. I cannot be here. I will send someone back
over.
Mr. Greenwood. Okay. In that case, Mr. DeGette, do you wish
to take time now?
Ms. DeGette. Mr. Chairman, I have no further questions.
We have been here. It has been a long day. I want to thank
the panel for coming. And once again, I would say, you know,
there is 5 minutes. If Mr. Davis wants to talk now, if he wants
to supplement his answer in writing, I really--I think we have
got the gist of it. And I am, frankly, done.
Mr. Davis. Well, if the Madam Congresswoman will allow me,
in a few more minutes I only have a couple of more points that
I would like to make, but I did not want to crowd her time.
Mr. Greenwood. Here is what we are going to do. We are
going to be fair to you, Mr. Davis. We are going to be fair to
the process, which means that we are not going to just give you
the last word and then walk away from that either.
So, regretfully, because everyone's schedule is impacted by
this, we will recess and we will return in approximately 1 hour
at the conclusion of the next six votes.
The committee is in recess.
[Brief recess.]
Mr. Greenwood. The subcommittee will reconvene with
apologies to all of you for the interruption.
The Chair will recognize himself for 10 minutes.
And, Mr. Davis, I am going to give you an opportunity to
make things as clear as you can, but I am going to do it by
asking you some questions rather than just the microphone over
to you.
Mr. Davis. I thought you were talking to me.
Mr. Greenwood. Welcome, Mr. Davis.
Prior to the break, Mr. Hirsch testified that he read you
the entire Fulbright report over the phone. And I am going to
ask you to turn to Tab 63. You will find there an email from
Mr. Hirsch to Bill Horton. And this email, October 20, Mr.
Hirsch responds to Mr. Horton's statement to make arrangements
to review the draft with you. Mr. Hirsch replies: ``In the
process right now, and he is happy so far.''
Mr. Hirsch contends that this was written contemporaneous
with reading you the report. During our staff interview with
you, staff specifically asked you whether Mr. Hirsch had read
the report to you. You told staff that Mr. Hirsch had
paraphrased the last two sentences of the report for you. In
your statements to the committee today you have suggested that
you heard more than a paraphrased last two sentences.
So, will you please state for the record what Mr. Hirsch
read to you on the phone?
Mr. Davis. Yes, am I am happy to clarify that.
First of all, I appreciate the fact that Mr. Hirsch and I
agree that I did not attempt to alter any conclusions and he
had too much integrity and independence to alter any
conclusions, and that is the central issue for me that I never
attempted to influence the truth coming out here. I did
everything I could to get the truth out.
On the issue of what happened on that Sunday morning,
reasonable memories can differ. Adam Goldberg, my young
colleague and I, were trying to convince Mr. Hirsch to read us
the entire report so that we could prepare for a press plan,
not to influence the outcome.
It is my best recollection that he read the last paragraph,
not the last two sentences, of the report and paraphrased was
in fact a report that was about the process of the
investigation; how many witnesses were interviewed, how many
documents were reviewed. But that only the last paragraph was
what I remember him paraphrasing or reading which led to the
last two sentences comment that I made----
Mr. Greenwood. Let me interrupt you there.
Mr. Davis. Yes.
Mr. Greenwood. If you turn to Tab 63 and 64, you will see
memos from Mr. Hirsch. The first, on Sunday October 20 at 10:53
a.m. went to Bill Horton. ``In the process right now, and he is
happy so far'' that was in response to Mr. Horton's email which
said ``Please make arrangements with Lanny to review the
draft.''
On Tab 64 we have another email from Mr. Hirsch, this is to
Tom Dowdel on the same day at 12 p.m., and he says I am on with
Lanny, all is well. I need 15 minutes.
The separation there is an hour and 7 minutes and he still
seemed to need 15 minutes. If he was on the phone with you all
of that time, one would assume that he would be able to read
more than the last couple of sentences?
Mr. Davis. We were talking about a lot of things during
that telephone. It was a Sunday morning. We were talking about
the press implications, the Board meeting and he was trying to
paraphrase the earlier sections of the report. So the entire
conversation, and Adam Goldberg and I tried to remember this
before my staff meeting, took about an hour. But that hour was
not filled--that hour was not filled----
Mr. Greenwood. You said in answer to my previous question
that your recollection is that Mr. Hirsch read you the last
couple of sentences?
Mr. Davis. He paraphrased almost verbatim by reading, but
said he was paraphrasing the entire last paragraph called on
the conclusion. And then----
Mr. Greenwood. He paraphrased other sections of the----
Mr. Davis. Paraphrased the parts of the report before the
conclusion that were essentially process about how many people
were interviewed and how many documents were reviewed.
Mr. Greenwood. Now let me return to you, Mr. Hirsch,
because I believe you responded earlier to a question that, I
think it was I who posed, which was I thought you response was
that you read the entire report to Mr. Davis, word-by-word. Is
that correct?
Mr. Hirsch. That is my recollection, sir, yes.
Mr. Greenwood. Okay. And it's an extraordinary different
set of recollections. Because reading a report word-for-word is
a time consuming and lengthy process. And is it your
recollection, Mr. Hirsch, that you began to read that report
and were you interrupted by Mr. Davis during the reading of
that report, or did he allow you to read the entire report
word-for-word and then discussion commenced after that?
Mr. Hirsch. My recollection is that I read the report from
beginning to end, sir.
Mr. Greenwood. Mr. Davis, how do you reconcile that?
Mr. Davis. I had a different recollection. I do not
reconcile it. And I can only say that the sentence----
Mr. Greenwood. It strikes me as impossible for two people
to recollect that differently. In other words----
Mr. Davis. One of us is right.
Mr. Greenwood. In other words, one of you is right, and I
dare say, telling the truth. The fact of the matter is reading
a report word-for-word is a laborious thing to do and it hard
for me to imagine someone doing that--not doing that, instead
just paraphrasing some sections and recollecting a word-by-word
verbatim reading of the document. And it is also very difficult
for me to imagine having someone having a report read to him
word-for-word and not being able to recollect that process.
Mr. Davis. Well, Mr. Chairman, you are addressing that
comment to me.
Mr. Greenwood. Yes.
Mr. Davis. I would assume you would address the same
comment to Mr. Hirsch. We have different recollections. It
could be an honest failure of memory, as much as anything else.
I have a clear recollection that Mr. Hirsch read me the
conclusion, but said I am going to paraphrase it and then read
me the whole last paragraph and then summarized the earlier
parts of the report. That is my clear recollection.
Mr. Greenwood. Hal Hirsch, would you turn to item 61,
please? And this is a memo that apparently you sent to Hal
Hirsch on the Saturday night before, at 7:14 p.m. I am sorry.
It was from Hal Hirsch to you. And he says ``Call in the
morning when you wake up and we can go over it line-by-line on
the phone.'' That is the HealthSouth report. Do you remember
receiving that?
Mr. Davis. Yes, I do.
Mr. Greenwood. Okay. And so we have got him saying to you
call me tomorrow morning, I will read the whole thing line-by-
line. We have got him sitting here saying and I did in fact
read it to him line-by-line, word-by-word. And you are saying
that all you recollect was a paraphrasing of a small portion of
the report?
Mr. Davis. I actually said I have a clear recollection that
he did not read it line-by-line, but he did the last paragraph
virtually as I saw when I got to Alabama, and he actually read
the entire report to the Board that the final paragraph was
virtually the same.
But there was a sentence that I did not know about until he
read it to the Board on October 22. And that sentence was the
sentence pertaining to shredding. That is the first time that I
knew that there was a sentence about shredding in the report. I
did not even know that on Sunday when we discussed the contents
of the report.
Mr. Greenwood. Mr. Hirsch, do you recall reading that
statement, that sentence to Mr. Davis?
Mr. Hirsch. That sentence, not specifically, sir. I recall
reading the report. That is all I recall, sir. I do not recall
any other great moment of reading the report, of that
conversation.
Mr. Greenwood. Is it unusual that you would have read this
report line-by-line to an attorney representing a client?
Mr. Hirsch. I had read all of the prior read--I read the
prior report to the Board line-by-line. When I met with the
Board on October 22, I read this report line-by-line, even
though I gave them a copy. The same thing with the report on
October 29.
So, it was not unusual or out of the ordinary in this
circumstance. This is the best that I can recall, sir.
Mr. Davis. Mr. Chairman, it may help for me to add that I
would have liked to have the whole report read to me from
beginning to end that Sunday morning, because I wanted to
prepare for a press plan. And since both--since both Mr. Hirsch
and I agree on the most important point, which my email Tab C
states, I had no intention of effecting Mr. Hirsch's
conclusion.
Mr. Greenwood. Then turn to Tab 57.
Mr. Davis. And I believe that he agrees with me on that.
Mr. Greenwood. Tab 57 is an email from you to Mr. Hirsch on
October 17. So this is 3 days prior. And in that email you say
``Can I get a rough draft tomorrow, please. You promised I
would not have to wait any longer than that. Need more than 1
day to register concerns. Let's talk early on in A.M.,
etcetera.''
So you just a moment ago said I had no intention of
altering a report.
Mr. Davis. To influence the conclusions of the report. And
I said in my opening statement, Mr. Chairman, what my concerns
were, which turned out to be correct.
My concerns were that there would be open issues
unresolved, that would raise more questions in the media and in
the public markets. And it turned out after Mr. Hirsch read the
report to the full Board, including the sentence that I had not
heard before about shredding, my reaction was before we release
this report, we need a further investigation of the shredding
and a further investigation of the July meeting. That is what I
mean by the word ``concerns,'' and only that, sir. Not
substantive, and not about effecting conclusion, which Mr.
Hirsch and I both agree I did not do.
And I do hope that you will reread, Mr. Chairman, Tab C,
which is my email of October 21. Mr. Stearns suggested by
pointing to the word ``influence'' in the email that he read,
that Mr. Hirsch used the word I was possibly trying to
influence. This email came 30 minutes after the email that
Congressman Stearns read. And I was responding to Mr. Hirsch's
legitimate concerns on the appearances. And so I said this was
me and Mr. Deaver and Mr. Powell wanting to hear the report
read ahead of time without influencing or altering the report.
And here is what I said at Tab C. ``If it is in final
form--and that would be the understanding BEFORE you read--
final form, advance reading has no impact on Fulbright
credibility to the SEC or anyone else.'' That's for me, the
most important email to persuade Mr. Hirsch it was okay to read
me something ahead of time if I did not try to influence the
outcome, other than completing open issues that might be raised
because they had not been finally resolved.
Mr. Greenwood. Mr. Hirsch, would you turn to Tab 93,
please.
Mr. Hirsch. Yes, sir.
Mr. Greenwood. Could you identify that document?
Mr. Hirsch. No, sir. I mean, I can tell you that it appears
to be some Jason Hervey's email system from Richard Scrushy,
dated Friday, November 8 at 9:15:02 to Jason Hervey, subject:
Re thank you. I have not seen it before, sir, so I cannot
otherwise identify it.
Mr. Greenwood. Well, the one below it.
Mr. Hirsch. Oh, I see. The one below it. Yes. Thank you.
Thank you. Yes.
Okay. That is an email from me to Richard Scrushy, sir.
Mr. Greenwood. Okay. Now that says in your email, and that
was written on Friday, November 8, 2002, it says, I will read a
section of it, it says ``That is because Lanny Davis filters
everything that you hear. Ever wonder why he badmouths all your
people, including officers, lawyers and new directors? The
billing issues arose because Davis advised that he would
determine how much and if we got paid. From the start, Davis
has tried to use the reviews as media props, not as you had
described, to find out the truth. If they were used as
corporate America uses them and the SEC views them, then your
release and media statements would have said something like
Scrushy unaware of 1753 when he sold the stock. That is what we
said.''
Now, can you explain what you meant when you wrote that?
Mr. Hirsch. This email was sent to Richard Scrushy because
I was somewhat frustrated at the--from the events of the first
press release, the need for the second press release and at
this same time about the issues that related to the engagement,
whether or not we were finished, we were not finished. Our
primary engagement was the CMS work, the Transmittal 1753.
These securities were secondary. Richard Scrushy's stock
transfers were tertiary.
It was important that we working for the company were
allowed to finish the CMS work. It was important that our work
not be filtered by anybody, and I was very concerned with
regard to the media's potential influence in what we were doing
and the word getting out differently than what we had
undertaken. So I wrote this email.
Mr. Davis. May I comment, Mr. Chairman?
Mr. Greenwood. Yes. Please do, Mr. Davis.
Mr. Davis. Thank you.
I think Hal Hirsch did an outstanding job for this company.
And I think he did it under very, very difficult circumstances.
Mr. Greenwood. Please bear with us.
I am sorry, go ahead.
Mr. Davis. I think Hal Hirsch did an outstanding job for
HealthSouth and wrote a report not under anybody's influence
with a high amount of integrity.
We had a very difficult time with hurt feelings on both
sides about the press release that was issued, which led to a
revised press release. After that very difficult time, and I
believe this email was written during that time period, I felt
that our assignment was over and that it was up to the SEC to
continue the investigation.
On November 6, 2 days before this email, at Tab D to my
statement I wrote an email to Mr. Hirsch in which I said
``Richard Scrushy has instructed me to inform you that, other
than Peter Unger, who is the SEC attorney, that you will do no
further work for HealthSouth.'' ``I have advised Richard that
with the investigation regarding himself completed,'' remember
we had sent everything over to the SEC and waived attorney/
client privilege including all the documents, ``that we will
continue to fully cooperate with the SEC, and therefore'' it is
the SEC that should continue, ``we do not need Fulbright
services any longer.'' Now, some months after this unfortunate
hurt feelings period of time for both of us, Mr. Hirsch and I
broke bread, he invited me to his son's bar mitzvah. I have the
greatest respect for him. And these hurt feelings and these
harsh statements have to be viewed in the context of both of us
being under a lot of stress at the time.
Mr. Greenwood. Anything you have, Mr. Hirsch?
Mr. Hirsch. I think the answer is that this was not the
result of hurt feelings, sir. This had nothing to do with hurt
feelings. This was a result of my frustration over the fact
that I was trying to represent a client. I was trying to get a
report and all the fact, maintain the integrity of what we were
doing, get the information out to the world and the world would
be first to our client, the Board and second to whomever the
Board wanted to give it to.
I was trying to go, as the email said, to go directly to
the company, to speak directly to Mr. Scrushy. We have a
voluminous number of emails which led up to this, as you have
seen. And I was seeking only to get the information done and
the report completed.
Mr. Greenwood. All right. We are going to pursue one line
of inquiry with Mr. McGahan, so you do not feel that you have
come here for no good reason.
And I want you to turn to Tab 15, please, sir. Do you have
that document? Okay. This is an email from a Roderick O'Neill
to you from March 15, 2002. Could you tell us what the meaning
of this email is?
Mr. McGahan. Yes, sir. He is indicating to me that certain
officers of HealthSouth have intentions or desires to buy into
a healthcare we called First Cambridge.
Mr. Greenwood. Define the REIT. It's Real Estate Investment
Trust?
Mr. McGahan. Yes, sir.
Mr. Greenwood. Okay. All right. And what else is this
telling you about who would be the investors in this?
Mr. McGahan. Richard Scrushy's daughter, Bill Owens, Bill
Horton, Tadd McVay, Weston Smith, Richard Davis and Jason
Brown, all of whom are officers of HealthSouth or their
designees.
Mr. Greenwood. Okay. Would you turn to Tab 13 then? Okay.
And would you identify that document, please?
Mr. McGahan. This is a document from Ray Garson, who is a
fixed income analyst to two people who work in the healthcare
investment banking group, regarding this original loan.
Mr. Greenwood. Okay. And if you look at the third, I guess,
paragraph there it says ``Need to add transaction rational. Why
is HRC selling assets below market or alternatively why is HCI
setting rents so low.'' Okay. And do you know what the answer
to those questions are?
Mr. McGahan. No, I do not.
Mr. Greenwood. It says we need--further down, three more
paragraphs down it says ``Does HRC management or related
parties own part of Cambridge or HCI.'' Do you see that?
Mr. McGahan. I do see that.
Mr. Greenwood. Do you know why he would want to know that?
Mr. McGahan. I think he would want to know that because
that would be a normal due diligence question when making a
loan to a company.
Mr. Greenwood. Why do you not explain to us what you know
about what was going on here in terms of the loan, what the
purpose of the loan was and what this real estate investment
trust was all about.
Mr. McGahan. Okay. My understanding of First Cambridge was
that it was a group of real estate executives that were forming
a company to form a healthcare REIT. And I----
Mr. Greenwood. Real estate executives, are you including
Scrushy's daughter and so forth?
Mr. McGahan. No, sir.
Mr. Greenwood. Okay. Go ahead.
Mr. McGahan. These executives I met, I believe in the
summer or fall of 2001. And the next I heard of this
transaction was in December when Mr. O'Neill informed me that
they were interested in buying some healthcare properties from
HealthSouth to start this healthcare REIT, to start this
company.
I gave him the go ahead. I thought this was a group of
experienced executives and that they were going to be
successful, I hoped. They had said that we would have future
investment banking business.
Mr. Greenwood. And why would HealthSouth guarantee their
loan?
Mr. McGahan. Well, this was--they would guarantee the loan
because--in order to the healthcare REIT started. Because we
would be extending credit to the healthcare REIT and they would
do a sale lease back----
Mr. Greenwood. Did HealthSouth have a financial interest in
the REIT?
Mr. McGahan. Our understanding, and again this is what
people told me at the time, was that they did not. And we were
told in December 2001 when this transaction was funded, that
they did not have an interest.
Mr. Greenwood. Did it strike you as appropriate for a
publicly held company to guarantee a loan which would go on
their books, and yet have no potential to benefit from the
profits of the REIT?
Mr. McGahan. Well, I thought that they would have a benefit
of the REIT, not the profits of the REIT. Healthcare REIT
business, there is about 10 or 11 companies out there who are
healthcare REITs, all of which were started originally--almost
all of which were started by healthcare providers.
So Universal Health has a healthcare REIT, which they do
not own the substantial portion of it. National Medical
Enterprises started a REIT, and on and on. And the benefit to
those provider companies is that they have a financing company
that knows them and works closely with them, and knows their
properties, etcetera. So it is an established practice,
essentially, that healthcare providers have started healthcare
REITs. And those have been very successful companies over the
years.
Mr. Greenwood. Okay. On Tab 15, going back to this email,
it says ``I want to make sure we are doing nothing wrong on the
HealthSouth REIT. This is the current owner of REIT. No one has
put any money in and they want to designate ownership to a
significant other, i.e. a wife, daughter, etcetera. Do you
think there will be a problem with this when and if they go
public?'' And then the designation of percentage of ownership
would be Richard Scrushy's daughter 20 percent, Bill Owens 10
percent, Horton 5 percent, Tadd 5 percent, Weston 5 percent,
Richard Davies 3 percent, Jason Brown 1 percent, etcetera.
Why would you think that Mr. O'Neill would have a concern
about the propriety of this?
Mr. McGahan. Well, I thought it was also a very bad idea.
Mr. Greenwood. You thought it was a bad idea?
Mr. McGahan. Yes.
Mr. Greenwood. And why was it a bad idea?
Mr. McGahan. At this time in March 2002 there were two
other companies, MedCenterDirect and Source Medical, of which
the senior management of HealthSouth had some equity ownership
interest. They were under--shareholders had concerns about
these sorts of arrangements, and I thought that it would be a
very bad idea to startup or have these executives invest in
this company, and I expressed----
Mr. Greenwood. But why was it a bad idea?
Mr. McGahan. Because the senior executives were under
pressure from their shareholders due to the fact of the
perception of conflict of interest of owning shares in a
company that was doing business with HealthSouth. And so I
thought that would--to add to that would be not a very smart
thing.
Mr. Greenwood. Yes. Now, they had done something similar to
this for the company called Capstone, had they not?
Mr. McGahan. Back in the 1990's.
Mr. Greenwood. And were you involved with that?
Mr. McGahan. Not originally, no. But later on----
Mr. Greenwood. Eventually?
Mr. McGahan. Yes.
Mr. Greenwood. And who profited from that enterprise?
Mr. McGahan. Well, that company, from what I recollect,
went public and in the low teens, had dividends of around 10
percent per year for 4 or 5 years and was sold in the high
teens. There was also executives from the HealthSouth, to your
point, that had an equity ownership in that company as well. So
all the shareholders profited.
Mr. Greenwood. And made millions of dollars, as a matter of
fact, is that not right?
Mr. McGahan. I believe so, yes.
Mr. Greenwood. Mr. Scrushy made millions of dollars as
well?
Mr. McGahan. I believe so, yes.
Mr. Greenwood. Okay. And did you think that was a bad idea
as well?
Mr. McGahan. I thought that times had changed.
Mr. Greenwood. Because of the different expectations that
the stockholders might have?
Mr. McGahan. I think that the stockholders in the equity
markets and what they expected out of HealthSouth in March 2002
was much different than it was in the----
Mr. Greenwood. Did you share your view with others that you
thought it was a bad idea?
Mr. McGahan. I did.
Mr. Greenwood. To whom did you express that?
Mr. McGahan. I expressed it to Mr. O'Neill and to Mr. Leder
internally. And then I called HealthSouth and spoke with Mr.
McVay, and then Mr. Owens, and then Mr. Scrushy.
Mr. Greenwood. Was the REIT ultimately formed by those
individuals on the memo, on the email?
Mr. McGahan. I am not sure. I expressed my concerns to Mr.
McVay. And then I further expressed, because he was principally
working on this transaction, he said he had heard me. But then
I went over his head and talked to Mr. Owens and Mr. Scrushy.
And they ultimately told me that they agreed with me.
Mr. Greenwood. Did you think that using significant others
was a way to hide the ownership of the HealthSouth executives?
Mr. McGahan. I did not think that they were trying to hide
that. I thought that the entire thing was a bad idea, that
included.
Mr. Greenwood. Okay. So was the REIT ultimately
established?
Mr. McGahan. What ultimately happened with this company was
it was originally funded in December 2001. This memo or this
came to our attention in March 2002. We expressed that it was
not a very good idea. We do know also that in--the loan was
ultimately paid off and this transaction was unwounded, and the
properties went back to be owned by HealthSouth.
Mr. Greenwood. Were you aware of the fact that the
company's auditors did not disclose the guarantee in the
company's audited financial statements?
Mr. McGahan. I was not personally aware of that at all
until later.
Mr. Greenwood. When did you become aware of it?
Mr. McGahan. In preparation for this. Since I left UBS.
Mr. Greenwood. Preparation for this hearing?
Mr. McGahan. Yes.
Mr. Greenwood. Did you know that the loan guarantee was
extended for 4 days by UBS with the condition that CRC agreed
with the 4 day extension and expressed concerns with the fact
that the loan guarantee had not been reported and the
associated potential reputational risk to UBSW?
Mr. McGahan. I did know a part of that, the extension. The
other part of it I am not sure that I did.
Mr. Greenwood. Did you know that they required that it be
disclosed in the 10k?
Mr. McGahan. My understanding that there was--from what I
remember, was that there were conversations between people at
UBS and the company about the disclosure and to make sure that
it was an appropriate disclosure that HealthSouth was making.
Mr. Greenwood. Why do you think UBS agreed to this being
done as a side deal and kept off the books?
Mr. McGahan. I think that just in terms of the structure of
the transaction, the original intent of the transaction was to
form a healthcare real estate investment trust that would then
go out and get other properties. The idea was that they would
get $150 or $200 million of other properties in addition to
these $80 million from HealthSouth and would go on and become a
successful real estate investment trust, just like the others.
It became apparent--and the only way to construct a company
like that is to do it the way that it was done. It became
apparent some time in 2002 that they were not going to get
these properties. It was going to be very difficult for them to
do so. That--and that this company really was not getting off
the ground.
Mr. Greenwood. Well, why would they want it off the books?
Mr. McGahan. Why would they want--I am sorry, sir?
Mr. Greenwood. The loan guarantee off HealthSouth's books?
Mr. McGahan. My understanding was that this was a normal
healthcare sale lease back transaction. I was not aware at the
time of the loan what was going on. My understanding was that
there was discussion between people at UBS, not myself, and the
company about accounting for the loan. And it was represented
to the UBS people that this was an immaterial amount, it was an
$80 million loan in a context of a $3.4, $3.5 billion debt
balance sheet. And it was an immaterial amount.
Mr. Greenwood. So the justification for not putting it on
the books was that it was immaterial?
Mr. McGahan. No, that this was a sale lease back
transaction. It was being guaranteed by HealthSouth. There was
some discussion between the UBS professionals and the company
about how it was going to be accounted for. And it was
represented, I am told, to the UBS people that the HealthSouth
folks had had discussions with their auditors and that this was
going--that they were comfortable in the way that this was
going to be accounted for.
Mr. Greenwood. Well, and theoretically then if you had a
company of $3 or $4 billion size, if you take money off the
books in $80 million increments it is de minimis, and therefore
you do not have to report it. Would that be your reasoning?
Mr. McGahan. Again, you know, I think that obviously I
think your point is that if you take $80 million that they add
up. But this was one transaction and that it was ultimately
unwound and the properties went back to HealthSouth and the
loan was repaid.
Mr. Greenwood. Okay.
Mr. Capek. Sir? Sir? If I may?
Mr. Greenwood. Mr. Capek?
Mr. Capek. When you look at the sale lease back
transaction, you know for the $80 million to be going away or
coming off of the books, when analysts calculate covered ratios
and whatnot, you do look in the footnotes for the REIT.
Remember they are still REITing. So we do capitalize the REIT
expense and consider that debt and add it back.
So even though the $80 million was going away in this
example, there would be REIT that we are capitalizing and
adding back to the total debt----
Mr. Greenwood. But the shareholders would not have been
aware of that, would they?
Mr. Capek. Well, disclosed in the footnotes of the annual
report, you do have the future REIT obligations, so they would
be aware of that obligation. Not the loan--the loan going away,
but the obligation of the REIT.
Mr. Greenwood. Okay. I think 9 hours should do it.
I want to thank all of our witnesses. I thank you for
indulging us with this extra time we need for the break.
Oh, Mr. Walden, I am sorry. Nine hours is not enough.
The Chair recognizes the gentleman from Oregon for--I
apologize for not noticing you were here.
The gentleman from Oregon is recognized for 10 minutes.
Mr. Walden. Thank you, Mr. Chairman.
Mr. McGahan, you were in charge of this account, is that
correct?
Mr. McGahan. I was the coverage officer.
Mr. Walden. You are a coverage officer? Mr. Lorello, what
role did you play in this account?
Mr. Lorello. I run the healthcare group, and this was one
of our clients.
Mr. Walden. Okay. After Bill McGahan joined Salomon and
Smith Barney and became the HealthSouth coverage officer, to
what extent though were you involved with HealthSouth and its
transactions?
Mr. Lorello. Starting in the mid-1990's, I would be invited
to annual Board meetings. And what attend those meetings along
with Mr. McGahan. And perhaps once a year would attend a
meeting down in Birmingham.
Mr. Walden. Mr. McGahan, how often did you report to Mr.
Lorello on HealthSouth issues?
Mr. McGahan. Periodically when I would see him in the
office and when there was something to talk about.
Mr. Walden. When there was something to talk about, does
that mean like every time there was something to talk about you
fed back to Mr. Lorello?
Mr. McGahan. Mr. Lorello would keep track of the pipeline
of transactions and I would keep him updated on things that
were being contemplated or other transactions that were coming
down the pike. If there was also any significant items that
would come up, I would keep him informed. But it was
periodically. I covered about a 100 healthcare companies and so
I would keep him informed----
Mr. Walden. I see.
Mr. McGahan. [continuing] on those as things were going on.
Mr. Walden. Okay. Could you turn to Tab 34, please? This is
an email chain from March 6 and 7 regarding an email from Mr.
Scrushy having the subject line ``To hell with you guys.'' Do
you recognize this message?
Mr. McGahan. Tab 34?
Mr. Walden. Thirty-four, sir, yes.
Mr. McGahan. Yes, sir.
Mr. Walden. Can you please read for the record Mr.
Scrushy's message and then explain to us what Mr. Scrushy is so
angry about?
Mr. McGahan. The original message?
Mr. Walden. Yes, please.
Mr. McGahan. This is from Mr. Scrushy to me. ``I will put
up the money myself. Please call Ben and tell him that I will
put up the $24 million personally. Cannot believe you guys are
doing this. I guess you guys are breaking up the 20 year
relationship, Ben will understand us moving it all somewhere
else. We will come back strong and kick butt again. Thanks for
the help over the years. We had some good times. Richard.''
Mr. Walden. Okay. And then what was your response to that?
Mr. McGahan. To Richard, ``I will get it done. I promise.
Do not wash us away yet. I have talked to Bill and Tadd and
tried to call you, and I am all over it. I will call you in the
morning with it being done.''
Mr. Walden. Okay. And that was your response to Mr.
Scrushy, right?
Mr. McGahan. Yes.
Mr. Walden. And then you forwarded that on to----
Mr. McGahan. This was Mr. Ryan.
Mr. Walden. That is right. And then----
Mr. McGahan. I think I also informed Mr. Lorello that
through an email forward.
Mr. Walden. And I was going to refer to that one, too,
which is Tab 31. Could you read your comment?
Mr. McGahan. I think that is to Mr. Leder.
Mr. Walden. Yes. I am sorry. To Mr. Leder.
Mr. McGahan. ``Just to fill you in what I got. Please get
this done ASAP.''
Mr. Walden. Okay. And Mr. Lorello is copied on that as
well?
Mr. McGahan. I believe, yes.
Mr. Walden. Yes. Along with Roderick O'Neill.
And that was at what time, again, you sent that?
Mr. McGahan. Around 5:14 p.m.
Mr. Walden. 5:14. Four minutes later on under Tab 32 you
sent a direct email to Mr. Lorello.
Mr. McGahan. I guess.
Mr. Walden. You want to read that one, sir?
Mr. McGahan. Yes, sir. ``I hate my job. I resign. Go jump
off a bridge.''
Mr. Walden. We have all had those days.
The only question I have is was the reference to you
jumping off a bridge or suggesting someone else should go jump
off a bridge?
Mr. McGahan. I am not sure.
Mr. Walden. You are not?
Mr. McGahan. I think it was Mr. Lorello.
Mr. Walden. Should go jump off a bridge?
Mr. McGahan. Yes.
Mr. Walden. Why?
Mr. McGahan. I was just--I just had a bad day. When we had
a client that was requesting a loan and I was struggling with
it, and it is a very pressure filled environment. So, I was
expressing my frustration with my work.
Mr. Walden. And I want to get to what the source of that
frustration might have been. If you could turn to Tab 26,
please. This is a Commitment Committee meeting concerning the
proposed loan to Source Medical Solutions, Inc.
Mr. McGahan. Yes.
Mr. Walden. Which on page 48 a Mr. Baudin says ``Yes. I am
sure what I am looking here at is--I am concerned about dealing
with these entities. I do not think we have got a full
transparency on the--on Source Medical. I do not like the fact
that we have got management who have been owning shares in this
and now donating them to charities and so forth. I would not
trust Scrushy, Rod, further than we can throw him. I do not
think this company management has been that transparent with us
in the past.''
And then a Chris Ryan responds ``But that is true with both
entities.''
And Baudin replies ``Yes.''
Chris Ryan replies ``Right. So what I mean, I am just--why
would you rather in 2007 4 years than an 2003 1 year.''
Something from Baudin, ``I would rather something be in
2003.''
Ryan says ``2004 1 year I guess. For 1 year at HealthSouth.
Then 2007.''
They go on.
``I do not want to be lending to Source Medical Solution.''
And then somebody says ``So you know.'' And then somebody says
``Please, please explain. I am confused. I don't understood.
You doubt the validity of the guarantee. Is there a problem
with it?''
And Baudin says ``I am not doubting the validity of the
guarantee. I'm--what I do not like is the reputation that
issues that (something inaudible) we are running with this
entity. I do not like the fact that we keep getting asked to
deal with these partially owned companies and a lot of it
revolves around just the noise that is going on with the
company. I mean, you know, the fact is there is an SEC
investigation and the FBI is in there. It just smells bad'' and
then Chris Ryan says. ``Okay. The--the--I think the firm--well,
we ought to check if the firm wants to have a relationship with
the company. But--and that's that. Then I think that is a
fundamental issue. But at the firm let us just say we got a
matter of resolving that which not--not me or this committee
and I think it can. I agree with you. We should vet this before
we lend anywhere money in, and that this transaction--make sure
that this client that we want to continue to--to promote within
the firm. But the firm decides to, whoever, I am not sure who
that body is, but we will collect it. You know it is probably--
maybe it is management committee, let us say at Warburg. Let us
say they decided they want to push on the HealthSouth and
therefore they want to try to accommodate the client where we
can we like--do our other client.''
And then Baudin says ``Chris, we are being asking to
accommodate of client in a fashion that we typically do not,
have not. We do not get asked to accommodate other clients.''
Chris Ryan ``I disagree with that, David.''
Baudin comes back ``Asked to provide clients, we--we view
as--as key clients of the firm and I am'' Baudin says
something. ``But we should only be doing it for companies with
decent reputations and this company's tarnished its reputation
in just about every which way over the last year.''
Ryan says ``That is a fair--well, I think that is a fair
comment, at least as near--as near as I can tell. And I do not
think it is certainly--it is not my call to.''
And Baudin says ``That clearing the way.''
Ryan says ``Turn this on that basis? Yes. Shares are
traded,'' etcetera, etcetera.
Who is David Baudin?
Mr. McGahan. I believe--I do not work at UBS anymore, but I
believe he is the head of the credit area.
Mr. Walden. Mr. Lorello, is he head of the credit area?
Mr. Lorello. Yes. Yes. He runs the----
Mr. Walden. Pardon me?
Mr. Lorello. He runs the credit risk department.
Mr. Walden. He runs the credit risk department?
Mr. Lorello. For the U.S.
Mr. Walden. For the United States at UBS? Are you familiar
with him? Do you and he communicate?
Mr. Lorello. No, we do not.
Mr. Walden. So you had no idea about the concern of the
head of the credit department within UBS Warburg?
Mr. Lorello. I became aware of this transcript in
connection with recent preparation.
Mr. Walden. Okay. Then help me understand how this works in
your company. You have these kind of people looking at these
sorts of loans and all at the credit department. And what is
your role? Your role, Mr. Lorello?
Mr. Lorello. I run the healthcare group, investment banking
group.
Mr. Walden. Okay. And so you have worked with Scrushy for a
number of years?
Mr. Lorello. Yes. Well, I have known him since 1987.
Mr. Walden. 1987. Okay. But HealthSouth, according to Mr.
Scrushy's emails has had a 20 years relationship with UBS?
Mr. Lorello. It has actually been since 1999 at UBS when we
joined. But with myself, it has been since 1987.
Mr. Walden. Since 1987? What as your relationship back in
1987? What were you doing?
Mr. Lorello. I was at Salomon Smith Barney.
Mr. Walden. Okay. But you have been working with Mr.
Scrushy and his company for some time helping them get
financing, right?
Mr. Lorello. That is correct.
Mr. Walden. So you would go out then and recommend to
various individuals who might want to buy bonds, the credit
worthiness of this company and that bond, or bonds, is that
right? What do you do?
Mr. Lorello. Well, can I----
Mr. Walden. Yes.
Mr. Lorello. Perhaps put some of the pieces together here.
The interchange here is between the Chairman of the
Commitment Committee, which is Chris Ryan, and one of the
members of the Commitment Committee, which is David Baudin. He
also was the chief credit person at UBS in the Americas.
The way the process works is that when a transaction
mandate occurs, for instance, a loan, the deal team that is
responsible for that client and responsible for that project
puts a memorandum together, does the due diligence and then
presents that to the Commitment Committee. The Commitment
Committee is charged with approving or disapproving the loan.
In this case, they actually turn the loan down. And they are an
independent body within UBS that has the final authority over
any transaction that the bankers are proposing. So that is the
interplay here.
It is between two members of the Commitment Committee who
are reviewing a loan for Source Medical. And who are making an
assessment as to whether or not they want to proceed with that
loan.
Mr. Walden. And they decide not to?
Mr. Lorello. And they decide not to.
Mr. Walden. They raise some very disturbing questions, say,
in back a year ago. I mean, there has been problems with
transparency, there is problems with different board members on
different committees and all.
Mr. McGahan, were you familiar with any of this information
or the concerns that were raised?
Mr. McGahan. I was familiar at the time, yes. Mr. Leder and
Mr. O'Neill had informed me that the credit committee was
struggling with getting this loan approved. And the specific
issues that they were struggling with was they wanted to get
the audited financial information before they would approve the
loan. And they also were struggling with the information flow.
They did not think they were getting----
Mr. Walden. Well, they could not get a balance sheet, could
they?
Mr. McGahan. Over the short of time, that happened in
February. In March, they could not get a balance sheet. They
were trying to get financial information from HealthSouth and
they would not approve the loan until they got that
information.
I thought that this was an example of the process that was
working. There was checks and balances in the system. The
credit people were doing their jobs. And the bankers were
proposing and advocating a loan for a client. And the process
worked, which was that they did not approve the loan until they
got an audited financial statement.
Mr. Walden. And you did not share any of this information
with Mr. Lorello, was he aware of it at the time?
Mr. McGahan. I was not aware of the specifics of Mr.
Baudin's comments. I knew through Mr. O'Neill and Mr. Leder
that the credit committee was struggling. And--but I thought we
were in the middle of a credit process. I thought that what was
happening was the credit folks were struggling to get to the
goal line. I certainly forwarded on Mr. Scrushy's email to let
Mr. Lorello know with my tag line that there was an issue. But
I thought we were in a process. And once the audited financial
information came in, that perhaps we could get to the goal. But
that never came in.
Mr. Walden. Okay. Mr. Lorello, did you follow up on that
email that he sent you?
Mr. Lorello. I do not specifically recall following up.
Mr. Walden. Did you follow up with Mr. Scrushy at all since
he personally referenced you?
Mr. Lorello. No. I did not speak to Mr. Scrushy or anyone
else at HealthSouth.
Mr. Walden. Okay. What was your reaction? What did you do
after you got--I mean, this is a pretty big client, is it not?
Was this one of your bigger clients?
Mr. Lorello. HealthSouth was an important client of our
group. Earlier I think someone had asked, the accounts were
about 2 percent of our revenues.
Mr. Walden. How about in your division, though?
Mr. Lorello. In my group.
Mr. Walden. In your group, 2 percent of your revenues?
Mr. Lorello. Yes. Yes.
Mr. Walden. Okay. All right.
Did you believe that HealthSouth's reputation was
tarnished?
Mr. Lorello. At this moment in time, March 2003?
Mr. Walden. Yes.
Mr. Lorello. I looked at it as a company that was having
some financial difficulties. And clearly a number of issues
that were out there in the public market that were being vetted
by our Commitment Committee and by others.
Being in the healthcare industry, it is not uncommon to
have companies who are experiencing reimbursement issues. Many
of our clients go through Medicare cuts. It is not unusual in
healthcare generally because it is a volatile industry to see
companies go into favor and out of favor.
So, these were clearly issues. But we were continuing to
work with the company to try to help them.
Mr. Walden. Mr. McGahan, could we go to Tab 29? This was
sent to Roderick O'Neill and Michael Leder.
Mr. McGahan. Yes.
Mr. Walden. You can both read that and explain it to me?
Mr. McGahan. Sure. Would you like me to read it out load?
Mr. Walden. I am afraid so.
Mr. McGahan. ``I just got my ass wiped by Scrushy and
Owens. The key is the amendment. So focus only on that for now.
They need it by Tuesday. We must get it done. It must not leak
into the market that we are struggling. If it does, we are all
dead. Start with a detailed time line of how information has
slowed over the past 2 weeks. We must all agree on specifics of
this by tomorrow morning. We need the information from the
company. Get Tadd and Richard Davis working on everything that
you need. We must get this done. Our relationship is over.''
Mr. Walden. What was your concern about something leaking
into the market?
Mr. McGahan. I am talking about the bank market. And first
of all, I am reminding Mr. O'Neill and Mr. Leder about dealing
with the confidential information of the client. And what we
are working with here is trying to get, I believe, a bank
amendment approved. And our credit folks were struggling to get
that done, as indicated by the--what we were just talking
about.
I wanted to reenforce to Rod O'Neill and Mike Leder that
they should tell the bank syndication folks to make sure that
they treated the information confidentially until we either got
the loan approved or we did not. And that is what I meant by
that.
Mr. Walden. Okay. Back on the email from Christopher Ryan
to you on March 7.
Mr. McGahan. Which time again?
Mr. Walden. Well, you know, this is the whole back of the
Scrushy email. Tab 34. And it really is the second page of Tab
34. And it is--I think you have written to Mr. Ryan saying
``Chris, see the email string below from CEO. Obviously, he is
pissed. I have Leder putting the time line together and I will
send you any other information from the company. The CEO is
solely focused on the amendment, not the 22 loan. What else can
I do internally not to permanently blow up this relationship by
not getting there as soon as possible on the amendment? Bill.''
Mr. McGahan. Right.
Mr. Walden. And then his--could you read his response to
you then?
Mr. McGahan. Yes. He said--yes. ``Internally not much.
Externally it depends. If the time line exonerates HealthSouth,
you know better than me. If the time line demonstrates
duplicity, I would counsel Scrushy as a friend and an advisor
to change the company's attitude toward the debt markets. He
will need them.''
Mr. Walden. Okay. What does he mean by if the time line
demonstrates duplicity?
Mr. McGahan. At this time, the credit folks and the credit
process was being frustrated by their ability or lack of
ability to get financial information from the company. They
believed that they did not have a good understanding of what
the year end earnings announcement was going to be. They
thought it was going to be one thing, and I think it turned out
to be another.
They also, I think there was a downgrade of the company's
earnings by a major rating agency, and they felt they did not
know about that.
So there was not good information flow. They could not get
at least a draft to the audited financial information. And so
they felt that they were not being treated well.
And so what we are attempting to do here is get the
information, get specific on what information we had, what we
needed. And get specific on the time line of that information
flow. And--but what Chris is saying to me in terms but if it
turns out that they have not been treating the bank market,
they have not been treating us well in terms of not giving us
the information on time, not telling us about the rating agency
downgrade, you should tell him he needs to change his attitude
toward the debt market. And I agree with that.
Mr. Walden. Okay. So and the effect was UBS still pushing
the billion dollar bond deal and a $22 million loan at a time
when this company basically is----
Mr. McGahan. Well, the bond deal happened in May 2002. So
that as done. So we are now in March 2003.
Mr. Walden. But was it not going to be registered in
August?
Mr. McGahan. It was in fact registered. Again, this is,
unless I might have my dates confused, but this is Friday,
March 7, 2003.
Mr. Walden. Right.
Mr. McGahan. That happened--the bond deal happened, I
believe, in May 2002 and was registered in August 2002. So--and
I think I have that right.
Mr. Walden. Okay.
Mr. McGahan. But what was happening here was this was 10
days before or so that the fraud was disclosed. We were not
getting good information from HealthSouth. We're are struggling
through a credit process, which I believe was working because
we were waiting on audited financial information. So I think
there was a process which was working, which was that there was
an advocate for the corporate finance client, the credit folks
which wanted the audited financial information. And it turned
out that we were not going to do anything as an institution
until we got that information.
Mr. Greenwood. The Chair thanks the gentleman.
One more quick series of questions for you, Mr. McGahan,
and then we will wrap this up.
It was a billion dollar bond deal, a bond offering in May
2002. Are you familiar with that?
Mr. McGahan. Yes, sir.
Mr. Greenwood. Okay. Now it is my understanding that
HealthSouth initially filed with the SEC to register the bonds
on June 28 and amended that filing on August 22. I have also
been informed that in order for a registration to become
effective, HealthSouth would have had to make some affirmative
notification either by phone or writing within 48 hours of the
effective date.
The question is what if between the time the bond offering
was filed for registration and the time the SEC permits
registration to take effect, for its registration to take
effect, if HealthSouth were to learn about a material negative
impact on its finances; what should happen to the pending bond
registration?
Mr. McGahan. My understanding, although I am not an
attorney, my understanding is that it should updated.
Mr. Greenwood. Updated or----
Mr. McGahan. In terms of the disclosure. If they have
learned new information, my understanding is----
Mr. Greenwood. So then they need to go, give that
information to the--and put it into the SEC?
Mr. McGahan. Into the SEC, that is my understanding.
Although we were not advising HealthSouth on that. It is for
their counsel and internal counsel.
Mr. Greenwood. So that is not UBS' responsibility?
Mr. McGahan. Absolutely. We have nothing to do with that.
Mr. Greenwood. It is the company's responsibility?
Mr. McGahan. Yes, sir.
Mr. Greenwood. And would the SEC likely postpone the
permit?
Mr. McGahan. I do not know.
Mr. Greenwood. The registration, I should say.
Mr. McGahan. It is just an area that we work with them.
Mr. Greenwood. Now are you aware that yesterday's
indictment of Mr. Scrushy includes ``false statements, accounts
directed to, among other things, the June and the August SEC
registration filings for the bond issue?''
Mr. McGahan. I was not aware of that. But that----
Mr. Greenwood. Okay. If you look at Tabs 20 and 21 in your
book. They indicate that in August 2002 by looks at the Tab 20
email, at least as early as August 13, HealthSouth was
preparing to issue a press regarding the impact of Transmittal
1753. The Tab 21 email and its attachment indicate that on
August 23 the UBS team saw a copy of the press release that
contained the disclosure of the Transmittal 1753 and its $175
million impact on earnings. Is that what they indicate?
Mr. McGahan. Yes, sir.
Mr. Greenwood. Okay. HealthSouth disclosed its financial
hit to UBS on August 23 and issued the press release on August
27. And in between those dates on August 26 the registration
became effective.
So I see it, UBS and HealthSouth had the opportunity to
notify the SEC to postpone registration of the these bonds, is
that not right?
Mr. McGahan. No, sir. I was--we were--I personally was
completely unaware of the registration process going on. And
that is not anything that we have anything to do with at all.
So--they work with outside counsel and attorneys on their
public filings, but not with the investment bankers.
Mr. Greenwood. Did UBS inform their inside counsel that
this was going on?
Mr. McGahan. UBS did inform the--the proper folks in--in
terms of inside counsel what we were working on, but we had no
knowledge of the SEC filings or we were not reviewing them.
Whatever HealthSouth was doing in terms of the bonding venture,
we just did not have anything to do with.
Mr. Greenwood. On August 23 UBS knew that there was going
to be $175 million impact on the company, right?
Mr. McGahan. Yes.
Mr. Greenwood. Both HealthSouth and UBS knew that?
Mr. McGahan. I believe so, yes.
Mr. Greenwood. And you felt no obligation to disclose that
information to the SEC?
Mr. McGahan. Well, my understanding of this was that
HealthSouth was in a mode to publicly disclose this as soon as
they had their arms around it. They were telling all the people
that they working with, including their internal--all the
lawyers they were working with, exactly what they were going to
do.
But in terms of the public disclosures, we are not advising
the company on what disclosures they make. But I was under the
impression at the time that they were going down the road to a
rapid disclosure of this information.
Mr. Greenwood. Well, why would they have sent those emails
to you if you were not advising them on their disclosures?
Mr. McGahan. What I was referring to was on their legal
disclosures, their public filings with the SEC. This was a
draft of a press release that they sent around which they
announced, I believe, within one or two business days of this
circulation.
Mr. Greenwood. And UBS has no role whatsoever in the
registration process for these bonds?
Mr. McGahan. We do not.
Mr. Greenwood. And as far as you know, HealthSouth never
informed the SEC on August 23 of this impact?
Mr. McGahan. I just do not know. I have no idea.
Mr. Greenwood. Okay. Thank you.
And this time I mean. Thank you to all of you.
The hearing--without objection, we need to have all of the
documents and the binders be entered into the record.
Without objection they will be entered.
And the hearing is adjourned.
[Whereupon, at 7:45 p.m., the subcommittee was adjourned.]
[Additional material submitted for the record follows:]
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