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Prepared Witness Testimony The House Committee on Energy and Commerce
The Financial Collapse of HealthSouth
Subcommittee on Oversight and Investigations
Mr. Lanny Davis
Good afternoon, Mr. Chairman. Thank you for giving me this opportunity to report on my representation of HealthSouth Corporation and its former Chairman, Richard Scrushy. In September 2002 I was asked by Mr. Scrushy and the HealthSouth Board of Directors to offer legal, media, and crisis management advice concerning published reports in late August that Mr. Scrushy may have improperly used inside information prior to his sale of substantial amounts of HealthSouth stock in May and late July 2002. The alleged inside information was that the federal Medicare agency, the Center for Medicare and Medicaid Services ("CMS"), had changed its rules on physical rehabilitation reimbursements, changes that would allegedly have had a substantial negative impact on HealthSouth's earnings. The classic question raised in the media in late August 2002 when the story first broke on these insider trading issues was: What did Mr. Scrushy know about this Medicare rule change, and when did he know it? I am proud of my work for HealthSouth in this matter, because, throughout my representation, I was faithful to three commitments I made to the SEC on HealthSouth's behalf when I began the engagement: --First, full cooperation and transparency with the SEC; --Second, an honest and complete investigation of the insider information charges against Mr. Scrushy by a distinguished outside law firm; --And third, full waiver of attorney client and work product privileges so that the SEC would have immediate and complete access to all of the fruits of that investigation - not just the report itself, but all underlying materials - and could continue the investigation wherever the evidence led. 1. Commitment to Transparency and Cooperation With SEC From my very first conversations with Mr. Scrushy in early September 2002, I conditioned my willingness to represent him personally and the HealthSouth on his and the Board of Directors' express acceptance of these three commitments. They agreed. I memorialized those commitments in an email I sent to Stephen M. Cutler, Director of the SEC's Enforcement Division, on Sunday evening, September 15, 2002, which you can find attached to my testimony as Tab A. This email was sent three days before the SEC decided to initiate its own investigation of Mr. Scrushy and HealthSouth. The key last two sentences of this email read: "I understand that it is also possible that the Board of Directors will appoint another law firm to conduct its own review. The management of HealthSouth has given me full responsibility to communicate with your office and to commit to respond fully and cooperatively with any questions or concerns your office might have, to disclose the results of any inquiries, to reveal promptly any improper conduct that may be ascertained, and, if appropriate, to assist the company in remedial efforts when and if it is determined that such are necessary." I always counseled HealthSouth and Mr. Scrushy to honor that commitment, even though they received conflicting advice at times from others. For example on October 21, 2002, shortly before Fulbright and Jaworski delivered its first report, Mr. Scrushy and others in senior management questioned whether the entire report should be released. I direct your attention, at Tab B, to an email I transmitted to the entire public relations and legal teams, dated October 21, 2002, at 12:00 AM that morning. Despite concerns raised by Mr. Scrushy and other company officials as to whether it was wise to transmit the entire Fulbright report to the SEC and release it publicly, I argued in favor of the company maintaining its commitment to give the SEC the full report. I stated, in relevant part: "Not releasing it [the full Report] will look like a pullback on our prior commitment to transparency - with little credible explanation." I am pleased to report that HealthSouth honored its commitment and shared with the SEC not only the report that Fulbright & Jaworski prepared, but all of the background materials that Fulbright relied upon, including documents, analyses, and reports of interviews. Many people and companies under investigation talk about full cooperation; very few, if any, deliver. Mr. Scrushy and HealthSouth deserve credit, not blame, for fulfilling the commitment I made to the SEC. 2. Commitment To Complete and Accurate Fulbright Report - With No Attempt to Influence Conclusions HealthSouth's hiring of Fulbright & Jaworski fulfilled its second commitment to the SEC - the retention of a nationally renown law firm to complete an outside investigation into the insider trading issues. This Committee should understand that I counseled Mr. Scrushy and the Company to maximize, not undermine, the integrity of Fulbright's investigation. The Company's goal of weathering this crisis could only be achieved if the regulators, the media, and the market credited Fulbright's conclusions. I counseled - and HealthSouth and Mr. Scrushy understood and agreed - that only an honest, independent, and aggressive investigation would suffice. With this in mind, I counseled Mr. Scrushy and the Company that a committee of independent Board members, and not the Company, should retain Fulbright so that their investigation would be truly independent in fact and would be recognized as independent by the courts, by the regulators, and by the public. The Company decided otherwise and directly retained Fulbright to conduct the investigation and to represent it before the SEC. Our commitment to release the Fulbright report promptly inevitably complicated my efforts to advise Mr. Scrushy and the Company on the most effective means to communicate Fulbright's findings. In the typical situation, where reports such as these are closely guarded and selectively released, there is always plenty of time, after the report is prepared, to review its findings and to consider how to communicate them. But in a setting where we had committed to prompt release of the report, we did not have the luxury of time. To help formulate this advice, I asked Fulbright to show, or at least read to me, portions of its October 21, 2002 report before the date on which Fulbright delivered the report to the Board. I had two reasons for asking Fulbright to show or read me the conclusions - neither of them had anything to do with attempting to influence the conclusions. The first reason was to prepare the media team for public release of the conclusions of the report. I assured Fulbright partner Hal Hirsch in an October 21 email, as I was trying to persuade him to read the report to me ahead of time, that I had no interest in changing a single word of the Report, which I understood to be ready for transmittal to HealthSouth's Board of Directors. In asking Mr. Hirsch for the opportunity to review the Report shortly before its presentation to the Board, I emphasized: the Report "is in final form - and that would be the understanding BEFORE you read - advance reading has no impact on Fulbright credibility to the S.E.[C] [sic] or anyone else if factually neither he nor anyone else is able to make any changes." [Tab C]. The second reason I wanted to hear the final conclusions ahead of time was to permit me to advise Mr. Hirsch whether there were open issues left unresolved in the Report that might lead to additional questions in the media and, thus, continuing uncertainties in the public markets. I understood that for the Report to be credible, it had to be not just independent, but complete, leaving literally no stone unturned. As things turned out, I was correct in this concern. The October 21 Fulbright Report presented to the Board left open two important questions that needed further investigation.: (1) the circumstances surrounding the shredding of documents during the time of the Fulbright review; and (2) whether Mr. Scrushy had heard about the Medicare rule change at a large staff meeting in early July 2002, several weeks before he exercised stock options and repaid Company loans. At my and the Board's request, the Fulbright team undertook a supplemental investigation of both of these matters. On October 29, Fulbright presented two final Reports that more extensively addressed both those issues. The October 29 Report concerning Mr. Scrushy's alleged insider knowledge confirmed the conclusions in Fulbright's October 21, 2002 Report: namely, there was no evidence uncovered by Fulbright to date that showed that Mr. Scrushy had inside knowledge of a material adverse effect of the CMS rule change. A separate Report, also dated October 29, addressed the circumstances of the shredding more extensively. Fulbright could not reach any definitive conclusions about the shredding issue and determined that the SEC was in a better position to continue and complete that investigation. But I want to emphasize two crucial and undisputed facts: First, I only asked to review the October 21 and 29 reports ahead of time and not to change any of Fulbright's conclusions in these reports; and, second, the purpose and result of my review of the first October 21 report was to urge Fulbright to conduct further investigation, not to soften any of its findings. Both of these final October 29 reports, as well as the October 21 incomplete report and a preliminary two-page report dated October 2, were transmitted to the SEC as promised, and, as far as I knew at the time, the underlying emails and documents that were the basis of Fulbright's conclusions on the insider knowledge issue. 3. Completion of Fulbright's Services - SEC To Continue Investigation With Benefit of All Fulbright Reports and Underlying Documents After Fulbright completed its final reports and sent them to the SEC, I recommended (with Mr. Scrushy's concurrence) that Fulbright no longer needed to continue billing time to HealthSouth. I did so for three reasons. First, I believed it was more appropriate for the SEC, as the chief enforcement agency, to continue the investigation on this and other matters - without HealthSouth having to continue to be burdened by substantial additional legal expenses. Thus, as you will note from the email to Mr. Hirsch dated November 6, and found at Attachment D, I stated to Mr. Hirsch: "I have advised Richard [Scrushy] that with the investigation regarding himself completed, we will continue to fully cooperate with the S.E.C. and therefore do not need Fulbright's services any more." [Emphasis added]. Second, as I expressed in an email and in several telephone conversations in early November 2002 - after the final reports had been delivered to the SEC - I was told that HealthSouth's general counsel might be attempting to persuade Fulbright to withhold certain documents from the SEC on grounds of attorney-client privilege, which would have been a breach of HealthSouth's commitment to the SEC, as I had stated in my email of September 15 to the Director of the Enforcement Division of the SEC. The Company's general counsel, Mr. William Horton, had told me directly on several occasions that as a general matter he did not favor turning over all documents to the SEC and waiving attorney-client and work product privilege. I did not question his sincerity in taking this position. I did question his judgment, however, in light of the position I had previously taken with the SEC. Further, among the documents underlying the October 21 and 29 Fulbright Reports were certain emails authored by Mr. Horton that suggested that he had some knowledge and concerns, before Mr. Scrushy's stock transactions, that the CMS rule change might have a significant negative impact on the Company's earnings. I was concerned that some of the documents Mr. Horton reportedly wanted to refrain from delivering to the SEC might be these same emails creating at least the appearance of a potential conflict of interest. On or about November 3, I was told by a HealthSouth official that Mr. Horton might be trying to convince an attorney from Fulbright not to send all the underlying documents and emails to the SEC. Therefore, on November 4, I sent Mr. Scrushy an email (found at Attachment E) stating that Fulbright should be terminated immediately because "Horton's effort to convince [the Fulbright attorney] to assert a privilege and withhold documents from the SEC without consultation with me constitutes a potential conflict of interest for him and the Company." To this day I am not sure whether Mr. Horton, in fact, was taking this position with respect to these specific documents. I certainly am not suggesting that he was doing anything improper. But I was concerned enough to write this email at the time. The third reason I believed that Fulbright did not need to continue any investigation was that Special Litigation Committee of the Board had retained its own outside and independent counsel to investigate the same transactions at issue in the Fulbright investigation. The Committee had done so to help it defend a civil stockholder derivative lawsuit. The Company did not believe that it should pay two separate law firms to continue investigating the same transactions, and I agreed. To repeat: Clearly my overriding concern was maintaining the Company's commitment to the SEC concerning transparency and waiver of privilege - and preventing the harm that might be done to the Company and its shareholders if that commitment were reneged upon. To this day I have nothing but the greatest respect for the integrity and professional skills exhibited by Mr. Hirsch and his colleagues at Fulbright & Jaworski for the job they did in these very difficult circumstances. Nothing I have seen or heard since then casts any doubt upon the integrity of their conclusions or the independence of their efforts. Conclusion I appreciate the chance to clear up any questions about my role in the HealthSouth matter. We tried to learn and apply the lessons of Enron and the high standards of Sarbanes-Oxley. My role in HealthSouth was to counsel for and to insist upon transparency and cooperation. That was sound legal advice, good corporate governance, and the only truly effective way for HealthSouth and Mr. Scrushy to address the questions that had been raised.
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