Accounting and Auditing Enforcement - Case Study Example

Accounting and Auditing Enforcement of the of the Table of Contents Table of Contents 2 Introduction 3 SOX Regulations in Public Healthcare Organizations 4 SOX Regulations in For-Profit and Not-For-Profit Healthcare Organizations 4 SEC Investigation 6 The Role of HealthSouth Corporation’s Auditors 8 SOX Regulations 8 Recommendations 9 References 10 Introduction The public healthcare company that have been chosen in this study is HealthSouth Corporation. The company is located in Birmingham, Alabama in United States. It is the largest owner as well as operator of the inpatient rehabilitative hospitals. The company operates in more than 28 states throughout the country and serves the patients through its channel of the outpatient rehabilitative hospitals, inpatient rehabilitation hospitals and various health agencies. It provides high level of care to the patients for recovery from conditions like stroke, orthopaedic and neurological disorders, brain injury, spinal cord injury, cardiac and pulmonary conditions. HealthSouth Corporation was found to be involved in corporate accounting scandal. The Founder, who was also the Chairman and CEO of the company, was accused of influencing the employees to manipulate the figures in the financial statement and exaggerate the earnings for meeting the expectations of the stockholders. He was the first executive to be caught in the Sarbanes Oxley Act for manipulating the financial returns of the company (Will, Handelman, & Brotherton, 2012). Richard M. Scrushy was accused of conspiracy, money laundering charges, securities fraud and charges of overstating the company’s earnings by approximately $ 3 billion (Forbes, 2013). The federal investigators stated that the company intentionally overstated the earnings in the financial statement for meeting the estimates of the analysts. At the same time the company had to make efforts to hide the accounting fraud attempt from auditors. Now, the question that was raised was whether the auditors failed in finding the fraud activity or they overlooked the company’s fraud. SOX Regulations in Public Healthcare Organizations There are strict regulations imposed by the SOX Act on the public companies (Greene, 2009). It includes: Creation of Public Company Accounting Oversight Board for overseeing the entire process of accounting of the organizations. Limitation in the types of services that will be provided by the accounting firms to the public companies (clients). Increase in the disclosure requirements for the public companies. Requirement of top executives in the public companies who will take the responsibility of all the contents in the financial statements. Requirement of excellent analysts for disclosing the probable conflicts of interest. Added rigorous punishments for various misdeeds and frauds. These provisions have been imposed to public companies for controlling the regulations of corporate governance and business ethics. This will prohibit them from violating the GAAP rules and manipulating the financial statements of the companies for their own benefit. SOX Regulations in For-Profit and Not-For-Profit Healthcare Organizations There has been increase in the scrutiny for both for-profit as well as not-for-profit organizations by the regulators, donors, bondholders and the rest of the external stakeholders. It is because there have been an increased suspicion among the investors and other external stakeholders about the proper maintenance of corporate governance and business ethics in the healthcare organizations. It has been found that for Not-For-Profit companies including the hospitals as well as other different healthcare organizations, there have not been very strict disclosure requirements as mandated in case of the public For-Profit organizations. This is a problem faced by the bondholders, investors and other stakeholders who want to judge the quality of corporate governance and management in these Not-For-Profit organizations. Governance is very challenging task for the not-for-profit organization because of no such strict disclosure regulation to manage and control it. In some cases, not-for-profit health care organizations face more challenges in managing corporate governance as compared to the for-profit healthcare organizations. Moreover hospitals are highly complex organizations because of the rapid changes taking place in the technology, high market competition, changing government policy, tough labour relations, high liability exposure etc. When the SOX Act took place in the year 2002, the primary focus was given mainly to the public organizations. There were very few rules applicable for the not-for-profit organizations. As a result it became very difficult for the bondholders and investors to assess the corporate governance performance of the not-for-profit organizations. However, presently even the not-for-profit organizations can feel the impact of the SOX regulations in their business operations (Rezaee, 2007). The SOX Act has imposed two provisions for all the organizations (whether it is for-profit or not-for-profit organization): Sarbanes Oxley Act declared it an illegal activity to alter or destroy any document for prohibiting its use into any legal action. Sarbanes Oxley Act has declared it to be illegal for the companies to get revenge against their employees who report about any suspected illegal action performed by their employers. There were some additional recommendations made. The additional recommendations included: Review of the tax exempt status in every five years by the IRS. Improvement of the quality and scope of the financial statements and Form 990. Availability of all the important financial records that is required for maintaining the transparency. These rules and provisions were provided to both for-profit and not-for-profit healthcare organizations for reducing the scope of their unethical activities Mandating specific rules for the not-for-profit organizations will help in reducing the fraud and increasing the corporate governance within these organizations. SEC Investigation In the year 2003, the SEC accused HealthSouth Corporation of violating civil law (Turner, & The Staff of Vault, 2005). According to the Securities and Exchange Commission, the company’s Chairman and CEO, Richard M. Scrushy inflated the company’s earnings by almost $ 1.4 billion by the year 1999.According to SEC, this was done in order to meet the Wall Street’s earnings expectation. The company committed this fraudulent activity for satisfying the stakeholders by hiding the actual performance and altering the earnings in the financial statement. In this fraud case, Scrushy was accused for money laundering, racketeering, bribery and other illegal activities along with Don Siegleman, the former Alabama Governor. 15 more people who were the former executives of HealthSouth Corporation appealed their guilt of participating in the criminal activity of showing fake corporate profits in the financial statement for increasing the company’s reputation. Among these executives, there were five Chief financial officers, vice president of the Investment Department, Senior Vice President of the Tax Department and Vice President of Finance Department. There were regular meetings held between the chairman and these senior officials for finding the ‘dirt’ for filling up the earnings hole in order to hide the actual financial condition of the firm from the external stakeholders and meet their expectations. Some executives admitted that this fraudulent activity was directed by Scrushy. These executives agreed that they will be cooperating with the US Government and in exchange they pleaded for leniency in their imprisonment period. The SEC reported after detailed analysis that the actual earnings of the company fell short of the expectation of the Wall Street’s analysts. The solution found out by Scrushy was to ‘fix’ the difference amount by overstating the earnings. The seniors attended meetings and took a decision of lowering down the expenses in the income statement and decrease one contra revenue account and consequently increase the value of the assets and reduce the values of the liabilities. Finally, for balancing the company’s books of accounts it was important to increase the earnings along with the increased value of the company’s assets. The adjustment accounts were based on the difference in the amount of money that the company billed to the patients and the amount reimbursed to HealthSouth by the insurance companies. According to Frieswick (2003), there were very limited paper activities which could trace this fraudulent activity. Thus it was tough for the auditors of HealthSouth Corporation to trace and verify every individual entry. The Role of HealthSouth Corporation’s Auditors Ernst and Young, the auditor of HealthSouth Corporation, was unable to discover the systematic overstatement of almost $2.5 million of the company’s earnings. The auditors permitted HealthSouth Corporation to keep overstated amount of $500 million of account receivables, payable by the financially disturbed heath care technology companies, in its books. However, the auditors were not responsible for the company’s establishment of adequate reserves because of these receivables. Ernst and Young was also found to have other non-audit dealings with HealthSouth Corporation. In the time period of 2000 to 2001, E&Y conducted cleanliness, janitorial and physical appearance assessment of the HealthSouth facilities. The accounting company has used the Fifty point checklist in this inspection process, which was designed by Scrushy. The audit scores obtained after this inspection was used by the HealthSouth Corporation in the market campaigning programs. E&Y, on the other hand, received an amount of $ 2.6 million as the ‘audit associated fee’ for conducting this inspection. This raised the suspicion related to the independent and impartial behaviour of the auditors. SOX Regulations The Security and Exchange Commission alleges on the fact that HealthSouth Corporation’s and Richard M. Scrushy’s actions have violated or aided violations of antifraud, books and records, reporting and the internal control provisions mentioned in federal securities laws. The SEC has charged the company for violating the rules of Section 17 (a) in Securities Act and also Section 13 (a), 10 (b), 13 (b) (2) (A), 13 (b) (2) (B) in the Exchange Act. The company was charged for also violating the rules of (Exchange Act Rules) 12 b-20, 10b-5, 13 a-1, 13 a-13. The SEC is looking for a permanent order against the company and Scrushy for penalizing them (Securities and Exchange Commission, 2003). Recommendations The CEO of every organization should be separate from the Chairman of the company for limiting their power or authority. The senior executives of the organizations should be given the responsibility to maintain accuracy in the company’s financial statement. The auditors of the for-profit and not-for-profit organizations should be impartial and independent while auditing the financial reports of the organizations. The auditors should be replaced at periodic intervals. References Forbes. (2013). Former HealthSouth CEO, Richard Scrushy, Gets Prison Sentenced Reduced. Retrieved from http://www.forbes.com/sites/walterpavlo/2012/01/26/former-healthsouth-ceo-richard-scrushy-gets-prison-sentenced-reduced/ Frieswick, K. (2003). How Audits Must Change. Retrieved from http://www.cfo.com/article.cfm/3009752/c_3036076 Greene, E. F. (2009). U.S. Regulation of the International Securities and Derivatives Markets. Amsterdam: Aspen Publishers. Rezaee, Z. (2007). Corporate Governance Post-Sarbanes-Oxley: Regulations, Requirements, and Integrated Processes. New Jersey: John Wiley & Sons. Securities and Exchange Commission. (2003). SEC Charges HealthSouth Corp., CEO Richard Scrushy With $1.4 Billion Accounting Fraud. Retrieved from http://www.sec.gov/litigation/litreleases/lr18044.htm Turner, T. N., & The Staff of Vault. (2005). Vault Guide to the Top Health Care Employers. New York: Vault Inc. Will, S., Handelman, S., & Brotherton, D. C. (2012). How They Got Away With It: White Collar Criminals and the Financial Meltdown. New York: Columbia University Press. Read More