In 2003, the Securities and Exchange Commission (SEC) accused U.S. healthcare giant HealthSouth Corporation and its CEO Richard Scrushy of inflating the company’s earnings to the tune of $1.4 billion since 1999 to meet analysts’ earnings while hiding the accounting fraud from auditors (Moynilian, 2003).
Although questions were raised as to whether auditors Ernst and Young (E&Y) failed to find or simply overlooked the financial scandal at HealthSouth, industry analysts and mainstream commentators are in agreement that the fraud went down as one of the closely guarded corporate malpractices in U.S. history (Hassink et al., 2010). Deriving from this case study, the present paper aims to evaluate the effects of fraud on individuals, businesses, and society, and also outline recommendations for early detection of fraud.
It is evident from extant accounting literature that fraud affects every level of society and has clear negative ramifications on individuals, business entities, and communities (Alleyne & Howard, 2005). At the individual level, 15 former executives of Health South lost their jobs, earnings, and reputation upon pleading guilty to participating in a scheme aimed at inflating corporate earnings to meet Wall Street expectations (Pathak & Wells, 2008).
At the company level, it is clear that HealthSouth Corporation must have suffered substantial image and reputation destruction, as well as a reduction in shareholder’s equity and diminished credit rating due to the indictment of its executives by SEC for fraud-related charges (Pathak & Wells, 2008). The firm’s earnings must also have been significantly reduced following the news of the corporate fraud. At the societal level, it is clear that community members and shareholders of HealthSouth suffered psychological anguish from uncertainties related to their shareholding, and from increased taxes to cover for the fraudulent activities. Fraud also affects the economic landscape of a community as it negatively influences the disposable income of involved parties and employees (Pathak & Wells, 2008).
Moving on, it is evident from the literature that HealthSouth’s Corporation’s fraud raised deep-seated suspicion about the impartiality and independence of auditors E&Y, particularly due to the reason that they were conceivably unable to detect the malpractice for four consecutive years (Moynilian, 2003). The next section deals with recommendations for the early detection of corporate fraud.
HealthSouth’s fraud was difficult to detect since it was collusive and was committed by top executives who could conceal it (Alleyne & Howard, 2005). In such circumstances, it is important to encourage whistle-blowing as one of the critical ways to discover fraud. Whistle-blowing is defined as the “…disclosure of illegal, immoral, or illegitimate practices to persons or organizations that may be able to effect action” (Read & Rama, 2003 p. 354). Since the CEO and other top executives of HealthSouth were part of the fraud, the whistle-blower should have targeted an external party such as SEC.
The auditors should desist from having any non-auditing business dealings with the company to maintain their independence and report fraud at the earliest convenience. In the case scenario, auditors E&Y were suspected of connivance in the fraud as they kept non-auditing business dealings with HealthSouth’s CEO Richard Scrushy (Moynilian, 2003).
Additionally, auditors should be given the leeway to conduct frequent and unplanned audits on the company’s accounts to ensure everything is up to the required standard. As acknowledged by Alleyne & Howard (2005), “…the auditor has the responsibility to plan and perform the audit to obtain reasonable assurance about whether financial statements are free of material misstatement, whether caused by error or fraud” (p. 288). Lastly, companies need to provide the capacity for auditors and accountants to build skills and expertise in the critical domain of fraud detection (Hassink et al., 2010).
References
Alleyne, P., & Howard, M. (2005). An exploratory study of auditors’ responsibility for fraud detection in Barbados. Managerial Auditing Journal, 20(3), 284-303.
Hassink, H., Meuwissen, R., & Bollen, L. (2010). Fraud detection, redress, and reporting by auditors. Managerial Auditing Journal, 25(9), 861-881.
Moynilian, R. (2003). Another US health giant is hit by scandal. British Medical Journal, 327(7424), 1128-1128.
Pathak, J., & Wells, A. (2008). Financial fraud: Causes, consequences and accounting profession’s role – A Canadian perspective. ICFAI Journal of Audit Practice, 5(1), 24-35.
Read, W.J., & Rama, D.V. (2003). Whistle-blowing to internal auditors. Managerial Auditing Journal, 18(5), 354-362.