The House Committee on Energy and Commerce

W.J. "Billy" Tauzin, Chairman

 

Subcommittee on Oversight and Investigations
November 5, 2003, 10:00 AM
2123 Rayburn House Office Building


Prepared Witness Testimony

The Financial Collapse of HealthSouth


Mr. James Lamphron, Ernst & Young

Former Engagement Partner on HealthSouth Account


Good Morning Mr. Chairman and members of the Committee. My name is Jim Lamphron and I am a partner in the firm of Ernst & Young. Beginning with the audit for the year 2000 I served as the engagement partner with responsibility for the financial statement audits Ernst & Young conducted for HealthSouth Corporation. I am here this morning with my colleague Wayne Dunn, who for the last several years has served as senior manager on the HealthSouth audit. My former partner Richard Dandurand, now retired, also joins me. Dick was the engagement partner on HealthSouth before I took over.

After completing my undergraduate degree and serving as an officer in the United States Marine Corps, I became an auditor in 1975. That was with Arthur Young & Co., which combined with Ernst & Whinney in 1989 to form Ernst & Young. Both of the predecessor firms were founded approximately 100 years ago, and today Ernst & Young employs more than 20,000 people in the United States.

First let me say that, to a person, we at Ernst & Young feel for the many outstanding and decent people at HealthSouth and in the investing community who have been harmed by the HealthSouth fraud. Investors, retirees and employees have all been harmed. Residing in Birmingham, as I do, I can attest that the entire city has suffered and will continue to suffer from the aftereffects of the fraud perpetrated at HealthSouth.

I don’t know of another fraud that is quite like HealthSouth. According to the Department of Justice and the SEC, a specific aim of the criminal conspiracy at HealthSouth was to undermine and sabotage Ernst & Young’s work as auditors. The fraud is also unprecedented in terms of management involvement. So far, fifteen HealthSouth executives have pled guilty to fraud, including every former Chief Financial Officer. And the US Attorney in Birmingham advises that the indictments will continue, and that her probe is extending further into non-financial areas of the company. As you observed at the first of these hearings, Chairman Greenwood, HealthSouth presents the unique and uniquely troubling story of a corrupt criminal enterprise.

At the outset, let me try and answer a few of the questions that I think you may have.

People naturally ask me how a fraud of this scale could go undetected by the auditors. The US Attorney has stated over and over again that we were a target of the collusive fraud. We, the auditors, were given fake documents, altered documents, and were lied to, over and over again. Through the collusion among the senior management of HealthSouth, our audit was impeded and undermined. As Teresa Sanders, the former head of Internal Audit at HealthSouth, testified before this Subcommittee, when you have a collusive fraud involving multiple members of management and where documents are falsified, it is entirely possible to defeat a financial statement audit.

People ask me if, in hindsight, there was one more thing that I or my team should have done. I have asked myself that question many times since March 19th. I have looked back through our workpapers. I have tried to find that one string which, had we yanked it, would have unraveled the fraud. I know we planned and conducted solid audits. We asked the right questions. We sought out the right documentation. Had we asked an additional question here, or asked for an additional document there, I am convinced that the fraud and deceit would have expanded to generate another lie, another fake document. With each guilty plea that is announced, we see where the fraud was systematically expanded to undermine our audit procedures.

People also ask me about internal controls and if HealthSouth had appropriate controls in place. A simple example of an internal control that is probably familiar to all of us is the requirement of two signatures on checks of a certain size. That is a classic internal control, and is drawn from a basic insight about human nature: a one-person crime is far more likely than a two-person crime. The internal controls at a large corporation are an application of the same principle, albeit often more complex. We look to see that multiple layers of people and departments are involved in different transactions. We look for sign-offs. We look for documentation. What did my team do at HealthSouth? We did all those things and more. HealthSouth had in place a formidable system of internal controls. Could those controls be circumvented by a fraud that encompassed the entire senior management of the company? The unfortunate answer is yes.

Finally, people ask me what is the likelihood of this happening again. The short answer is that there is no system, no audit, and no law that can be made completely invulnerable to a collusive band of criminals. Character and ethics cannot be legislated. That said, our capital market system has been significantly strengthened of late. The requirements and procedures legislated by Congress in the Sarbanes-Oxley Act will, in my estimation, make another fraud of this type less likely. It may be, indeed, that it was the requirement of officer certifications and the threat of harsh criminal punishment that finally brought down the walls of silence surrounding the HealthSouth fraud. New rules being adopted by the SEC and the exchanges will also promote corporate accountability and improve corporate governance. The US Attorney in Birmingham should be praised for her vigorous prosecution of this case, which sends the right message. And the hearings being held by this Subcommittee will undoubtedly be constructive in publicizing the aftereffects of the fraud so as to discourage others from following the same path.

Mr. Chairman, we have worked to assist you and your staff in every respect during the course of the Subcommittee’s investigation. I am happy to answer the Committee’s questions, as are my colleagues.


The Committee on Energy and Commerce
2125 Rayburn House Office Building
Washington, DC 20515
(202) 225-2927