Ethics and Fraud – From a Gray Area to Prison

I was recently honored to be a keynote speaker at the Institute of Management Accountant’s 91st Annual Conference in Baltimore, Maryland. Events like this provide me the opportunity to hear other speakers and to get a sense for hot topics and trends. My talk’s topic was on business analytics. But at this year’s conference there was an emphasis on ethics and fraud.

A riveting presentation was by Aaron Beam, co-founder and first CFO of the scandal-ridden HealthSouth. Beam served time in prison for “cooking the books” at HealthSouth. The audience was breathless listening to how an apparently honorable person could spiral into unethical behavior.

The HealthSouth Fraud
Beam was recruited in the 1980s by HealthSouth’s Richard Scrushy to create the company and be CFO. The business model of HealthSouth was to create outsourced rehabilitation centers, similar to fitness centers, that are located off-site from hospitals. This is less costly than a recovering patient occupying a hospital room. Beam early on suspected a problem with Scrushy, a charismatic and egotistic character, when Scrushy lied during their first meeting with a third party. Scrushy said he and Beam had spent hours …

I was recently honored to be a keynote speaker at the Institute of Management Accountant’s 91st Annual Conference in Baltimore, Maryland. Events like this provide me the opportunity to hear other speakers and to get a sense for hot topics and trends. My talk’s topic was on business analytics. But at this year’s conference there was an emphasis on ethics and fraud.

A riveting presentation was by Aaron Beam, co-founder and first CFO of the scandal-ridden HealthSouth. Beam served time in prison for “cooking the books” at HealthSouth. The audience was breathless listening to how an apparently honorable person could spiral into unethical behavior.

The HealthSouth Fraud
Beam was recruited in the 1980s by HealthSouth’s Richard Scrushy to create the company and be CFO. The business model of HealthSouth was to create outsourced rehabilitation centers, similar to fitness centers, that are located off-site from hospitals. This is less costly than a recovering patient occupying a hospital room. Beam early on suspected a problem with Scrushy, a charismatic and egotistic character, when Scrushy lied during their first meeting with a third party. Scrushy said he and Beam had spent hours the prior night preparing for the meeting. This had not happened. Beam reflected that he then realized that Scrushy was testing Beam’s reaction to his lie.

Prior to HealthSouth Beam had been an accountant with his estimate of financial savings of about $50,000. Within a few years Beam was a multi-millionaire. Scrushy’s net worth was $600 million, and he proclaimed his goal to be a billionaire. HealthSouth’s sales and profit growth rising and its stock price would accomplish this, but this required maintaining and increasing an already high price-earnings ratio. As with any growth company consistent double-digit percentage growth is difficult to maintain as the base grows large, its market gets penetrated, and aggressive competitors appear. These all happened.

Eventually a fiscal quarter arrived where HealthSouth’s financial results would not meet Wall Street’s expectations. Beam described how Scrushy’s powerful personality persuaded him to alter accounting entries that deferred recognition of expenses and accelerated revenues. Beam lost sleep that night. The nightmare continued. The stress on Beam led to his retirement with great wealth. Years passed. Then FBI agents appeared at his home. The nightmare was to become reality.

Meanwhile Scrushy demonstrated civic generosity with donations to local schools, hospitals and churches. He and his wife also began religious preaching on local radio and TV stations. Despite overwhelming evidence at the trial, the jury found Scrushy to be “not guilty” but Beam and three successor CFOs were given prison sentences. The IMA audience gasped.

After prison, the USA government took all of Beam’s net worth except for a subsistence amount that his wife and he could live on. He now cuts lawns as a one person company. He said he receives more satisfaction being paid by widows for cutting their grass than on any day when he was with HealthSouth.

Scrushy subsequently was convicted of bribery and is now serving seven years in prison. You can read Beam’s story in his book, HealthSouth: The Wagon to Disaster.

At the IMA conference Professor Marianne Jennings also presented on the topic of ethics. Her book is The Seven Signs of Ethical Collapse. Her talk helped explain reasons why conservative people like Beam, a CPA, slip past the “gray area” to be unethical. She described how small baby steps like accounting adjustments of asset and liability reserves lengthen past gray areas into fraud.

Additional unethical behavior?
I have an additional sense of unethical behavior. My feeling is when accountants report misleading and flawed internal product and costs or deny their managers of an expanded insight to channel and customer profitability reporting, they are doing a disservice to managers and employee teams. These people need insights to analyze to make better decisions. It is not breaking a law, but in my mind it is discourteous behavior.

Financial reporting for external reporting is formally audited by CPA firms. Internal reporting is not. I describe this in my article Increased Regulatory Governance – Why not also for Management Information? In my article I explain why I believe internal operating data and managerial accounting should eventually also be certified.