[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
---------------------------------------------------------------------------
    \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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