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Prepared Witness Testimony The House Committee on Energy and Commerce
The Financial Collapse of HealthSouth
Subcommittee on Oversight and Investigations
Dr. Phillip Watkins
Mr. Chairman, Ranking Member, and members of the Subcommittee, good morning. My name is Dr. Phillip Watkins, and I am a former member of the HealthSouth Board of Directors. I resigned from the Board in February 2003 and am proud of my long service on behalf of HealthSouth and its stockholders. I welcome the opportunity to share with the Subcommittee my insight into the Board's functions at HealthSouth. First, let me describe my background. I am a cardiologist in private practice in Birmingham where I grew up. I attended the University of Alabama, the Medical College of Alabama, trained at the Mayo Clinic in Internal Medicine and specialized in Cardiovascular Disease. I am currently the Medical Director of The Autonomic Disorders and Mitral Valve Prolapse Center located in Birmingham, Alabama. I became involved with HealthSouth, a brand new company then known as Amcare, in 1983, after I first met Mr. Scrushy. Mr. Scrushy proposed a merger of my practice's cardiac rehabilitation facility with Amcare to form what is known as a "CORF" - Comprehensive Outpatient Rehabilitation Facility. The unique concept of a CORF was to combine outpatient surgery and rehabilitation facilities into one stand-alone medical complex in order to ease patient burden and expense, and ultimately provide for more successful patient recoveries. In 1984, I was asked by Mr. Scrushy to join the Company's Board of Directors, two years before HealthSouth became a publicly traded company in 1986. As a physician and director, it was determined that I could add valuable insight by talking to physicians and helping to meet their needs in working with our facilities. Our ability to provide high quality, efficient, low cost patient care was the core of the Company's business. Early on, I was appointed Chairman of the Board's Audit & Compensation Committee. At that time the Company was a startup with such a small board that these two functions were combined to form one committee. At that time, many companies followed this practice. Later, the committees were separated into two distinct committees. As Chairman of the Audit & Compensation Committee, I worked with and relied upon the outside experts hired by our Board. For example, we hired Mercer Human Resource Consulting to assist the Committee as our compensation consultants. Mercer retains a reputation as one of the largest and most relied upon compensation consulting firms in the country. Mercer analyzed the compensation trends of similar firms in the healthcare industry and, along with other experts, advised the Compensation Committee. It was based upon this information and advice that we determined the compensation packages of HealthSouth's management team. By all accounts, HealthSouth was growing at an exciting pace, and was singled out by numerous industry publications, including Forbes and Fortune, as an up and coming star in the field of outpatient surgery and rehabilitation. Since I joined the HealthSouth Board in 1984, I have seen HealthSouth grow from a company with two rehabilitation facilities - one in Little Rock and one in Birmingham - to become the largest outpatient surgery company, rehabilitation company and diagnostic services company in the world with over 48,000 employees throughout the country. The compensation for HealthSouth senior executives, including Mr. Scrushy, was based upon this apparent outstanding performance, and the Committee was always assured by the independent analyses of experts such as Mercer that the Board's compensation philosophy was entirely in keeping with the best practices at the time. Specifically, we implemented a performance based incentive-compensation program, which included annual bonuses and stock option grants under a stockholder - approved option plan. We now know the numbers we relied on and were certified by our outside accountants to calculate senior management compensation were fraudulent. If the Compensation Committee had known of the fraud, Mr. Scrushy and others would have been terminated immediately and would never have received these salaries, bonuses, and stock options. I was as shocked and angry as the rest of the public when I learned that senior members of HealthSouth's management team had been perpetrating a fraud on HealthSouth's stockholders. The Board of Directors was similarly deceived. These criminal conspirators were able to fraudulently conceal or otherwise alter information and documents such that all of the experts including the accounting firm of Ernst & Young did not detect the fraud. As a corporate director, I relied on the accuracy of information provided to me by management and by outside experts such as Ernst & Young. It is now evident that because the truth had been so thoroughly concealed by certain former members of management, the probing questions and activism of this Board could not have discovered the existence of this accounting fraud. In addition to questioning former management and outside experts, the Company had in place internal control systems designed, in part, to catch fraud. But every system of checks and balances is only as good as the people who are there and use them. Ms. Henze testified that she did use the compliance system we had set up to receive and act upon such information. That's how the compliance system was supposed to work. It is incomprehensible to me how designated compliance personnel could have received such apparently clear information and could not have told Ernst & Young, the Audit Committee or the Board. Just to be clear, the fraud occurred at a corporate level. Ernst & Young conducted the corporate-wide audit. In contrast, internal audit conducted facility level audits. The Subcommittee heard testimony two weeks ago from Ms. Teresa Sanders and Mr. Greg Smith of HealthSouth's internal audit department. The Audit Committee did meet on a regular basis with Ms. Sanders and Mr. Smith and received their reports and questioned both of them. In fact, I had more internal auditors added to the internal audit staff after talking to Ms. Sanders. They never told us they had any suspicion of impropriety. Let me conclude by saying that I am proud of my service to the HealthSouth Board. HealthSouth enabled me to combine my obligation as a medical doctor to patients with that as a director of the Company to the stockholders. Had I known of the hidden fraud being perpetrated on us all, I would have acted quickly and decisively, just as the current Board has in removing those responsible. HealthSouth is one of the great healthcare companies in America and I am confident that it will continue to be under the guidance of the new management team. I look forward to answering any questions you or any other members of the Subcommittee may have.
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