updated 2/4/2005 6:38:03 PM ET 2005-02-04T23:38:03

The massive fraud at HealthSouth Corp. began unraveling days after President Bush signed a new law with stiff penalties for false corporate reporting, according to testimony Friday by a former finance chief at the trial of fired CEO Richard Scrushy.

Bill Owens, who served in several top positions at the rehabilitation giant, said then-chief financial officer Weston Smith told him he was quitting on Aug. 5, 2002, rather than sign bogus financial statements under the Sarbanes-Oxley law, enacted less than a week earlier amid a wave of corporate scandals.

"He said he just couldn't sign the certifications and was quitting," said Owens.

Owens said he and Scrushy — the first chief executive tried under the law —tried to come up with a way to keep Smith "on the reservation" and get him to sign the financial reports, which Smith knew were fraudulent.

In a hastily arranged meeting, Owens said he and Scrushy decided to end the fraud and blame the subsequent earnings decline on new Medicare rules. Owens said they also decided to split HealthSouth in two as a "diversion" and to put Smith in the surgical division, where accounts were "clean."

Owens said he laid out the plan during a meeting in Smith's car as Smith drove him around on Interstate 459 for a couple of hours.

"I told (Smith) this gave us a fighting chance, that we could get things fixed and nobody would have to get hurt," said Owens.

The next day, after meeting with Scrushy, Smith agreed to sign the certification and become chief financial officer of the new surgical division, Owens said.

Seven months later, in March 2003, Smith became the first of 15 HealthSouth executives to plead guilty in what prosecutors describe as a scheme to overstate earnings by more than $2.6 billion. Among other things, Smith pleaded guilty to signing false statements under Sarbanes-Oxley on Aug. 14, 2002.

Smith is expected to testify against Scrushy.

'Firestorm'
Many pieces of the alleged plan to end the fraud went forward in August 2002: The company blamed a $175 million earnings reduction on Medicare rules, and it announced it was spinning off its surgical centers into a new company.

In the "firestorm" of investor suits, investigations and news reports that followed the earnings announcement, Owens said Scrushy offered to "take care of my family" if Owens would "take the fall" for the fraud.

Prosecutors contend Scrushy directed the fraud from 1996 until 2002 to drive up HealthSouth stock prices for personal profit.

The defense claims Owens, Smith and other subordinates lied to Scrushy for years, keeping him in the dark about the fraud.

In a fourth day on the witness stand, Owens said Scrushy knowingly spouted bogus numbers about the rehabilitation giant in a national TV appearance in 2002 just days before he sold $74 million in stock options.

In the interview on the CNBC financial channel, a recording of which jurors saw in court, Scrushy said HealthSouth stock — then trading around $15.50 a share — should be selling for more.

"I think the company should be going for $20 a share right now," Scrushy said on the tape.

Scrushy sold the options 12 days after the appearance, according to Owens, who added Scrushy knew that all the encouraging numbers he discussed on the show were based on a long-running fraud. The price Scrushy got for the shares was not brought out in the testimony.

Heading off evidence the defense was expected to bring out later, Owens confirmed under prosecution questioning that he failed to file tax returns from 1995 through 2002 and could be forced to pay some $400,000 in penalties and interest, although he still paid withholding taxes during the period.

Owens also said he had failed to repay a $1 million loan from HealthSouth. While Owens said he gave a co-worker a check made out to HealthSouth for $1.3 million to hold in exchange for the loan, the check was never cashed.

Scrushy is on trial on charges of conspiracy, fraud, money laundering, obstruction of justice, perjury and false corporate reporting in the first test against a CEO of the Sarbanes-Oxley Act.

Scrushy could receive what amounts to a life sentence if convicted, and prosecutors are seeking $278 million in personal property and accounts.

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