Tuesday, June 28, 2005

Scrushy Acquitted on All Counts

The jury returned not guilty verdicts on all counts in the prosecution of Richard Scrushy, dealing the government a significant blow, at least for now.  Among the charges was the first prosecution under the CEO/CFO certification provision adopted in the Sarbanes-Oxley Act (18 U.S.C. Sec. 1350), and the acquittal means that legal issues related to the provision, such as the requisite intent level for a violation, will have to await another case. 

We will not doubt hear from the jurors later, and I expect their comments on the verdict to focus on the government's failure to meet its burden of proof and the credibility (or lack thereof) of the government's many witnesses who participated in the fraud at HealthSouth.  One question for the government will be its decision to pursue the case in Birmingham, Alabama, which certainly gave Scrushy a "home court" advantage in a city in which he is well-known and was widely admired, at least by a segment of the population -- think about the prosecution of Bernie Ebbers in New York City, a venue that he challenged but did not win.  While U.S. Attorney Alice Martin and some members of the prosecution team are equally local, it is almost impossible for the federal government to play the home town card.

The question now is what's next for Scrushy and HealthSouth.  Just last week the company entered into a final settlement with the SEC on its civil securities fraud suit, agreeing to pay a $100 million penalty and to adopt corporate governance changes (Litigation Release here).  The SEC's civil fraud suit against Scrushy is pending (complaint here), and his first victory against the government came last year when he defeated the SEC's attempt to freeze his assets.  While Scrushy was dismissed as CEO in March 2003, when the fraud at HealthSouth first came to light, he remains a member of the board of directors, largely because the company has not been able to hold an annual meeting because of its inability to put out an audited financial statement until just last week.  Scrushy owns over 3 million shares of HealthSouth stock, and still has stock options for 700,000 shares (see HealthSouth 10-K here).  Given the "vindication" the verdict has delivered for his defense that he was misled by, among others, the Five Guilty CFOs, I think it is likely that Scrushy will seek to reclaim his position at the company he founded, or go down fighting any effort to remove him from the board.

The acquittal delivers even more bad news to the company because, under Delaware law (the jurisdiction in which HealthSouth is incorporated), Scrushy has been "successful on the merits or otherwise" in the criminal trial for conduct related to his actions on behalf of the corporation.  Therefore, under Delaware General Corporation Act Sec. 145(c), the company is legally required to pay all of his attorney's fees related to the criminal case.  There is litigation pending in the Delaware Chancery Court about the company's obligation to advance expenses in the criminal case (disclosed in the 10-K), but the acquittal means the decision is out of the hands of the board and the expenses must be paid.  Scrushy had a large, and no doubt expensive, legal team, a bill the company will have to foot -- and disclose at some point, which will give us an idea of just how much this defense cost.

Each week seems to bring a new view of the success and failure of the government in prosecuting cases of corporate fraud.  The convictions of Dennis Kozlowski and Mark Swartz for their conduct related to Tyco meant the government could not be stopped, while this verdict means the government has suffered a significant blow to its effort.  I suspect the lesson the government will learn is to try to stay away from smaller venues, but we'll see if there's more. 

These are just some first thoughts, and I'm sure Ellen will want to weigh in from across the pond in Scotland where she is at the moment, although it may take her a bit longer to supply a reaction. (ph)

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