Healthsouth & Fraud Risk Factors

Healthsouth, the largest provider of outpatient surgery and diagnostic and rehabilitation services in the US at the time, overstated its earnings by at least $1.4 billion from 1999 to 2003 to meet Wall Street analysts expectation of earnings. Ernst & Young was the auditor during this period. The following indications of fraud were present during the audits: In December 2001, Healthsouth was charged fraud in overbilling Medicare for physical therapy services it never performed and submitting falsified documents to justify the claims. Without admitting wrongdoing, HealthSouth in May 2001 agreed to pay $8.2 million to settle a separate Justice Department civil lawsuit that accused the company of fraudulently overbilling Medicare. Mr. Richard Scrushy, who co-founded HealthSouth in 1984, was well known inside and outside the company for his domineering management style. HealthSouth directors, including a member of the board's audit committee, had significant business dealings with the company. HealthSouth had substantial allowances, the size of which is open to wide management discretion, to reflect the difference between the amounts that HealthSouth would bill insurers for its services and the smaller amounts it actually expected to collect. HealthSouth grew rapidly through acquisitions. HealthSouth's 2000 pretax earnings more than doubled to $559 million, though its sales grew only 3%. Pretax earnings for 2001 were nearly twice 1999 levels, although sales rose just 8%.

Ernst & Young responded to the inquiry by the SEC stating, When individuals are determined to commit a crime, as was the case with certain executives of HealthSouth, a financial audit cannot be expected to detect that crime.

Using the information provided and the fraud risk factors, identify the incentives and pressures, opportunities, and attitudes and rationalizations that were present at HealthSouth. Given this information, do you feel that Ernst & Young should have uncovered the fraud at HealthSouth?