Scrushy v. Tucker

• Decision Date: 04 February 2011
• Docket Number: 1081424
• Parties: Richard Scrushy v. Wade C. Tucker and the Wendell J. Cook, Sr., Testamentary Trust, John P. Cook, trustee, derivatively, for and on behalf of HealthSouth Corporation
• Court: Alabama Supreme Court

Richard Scrushy

v.Wade C. Tucker and the Wendell J. Cook, Sr., TestamentaryTrust, John P. Cook, trustee, derivatively, for and onbehalf of HealthSouth Corporation

1081424

SUPREME COURT OF ALABAMA

Date: February 4, 2011

Appeal from Jefferson Circuit Court

(CV-02-5212)

WOODALL, Justice.

In this shareholder-derivative action, Richard Scrushy, a former director and former chief executive officer ("CEO") of HealthSouth Corporation ("HealthSouth"), a Delawarecorporation, appeals from a judgment against him for $2,876, 103, 000.This action was commenced on August 28, 2002, on behalf of nominal defendant HealthSouth by Wade C. Tucker, a shareholder of HealthSouth since August 18, 1998.We affirm.

I.Facts and Procedural Background

Certain aspects of this case have already come before us during this long and intricate litigation.SeeScrushy v. Tucker, 955 So. 2d 988(Ala.2006)("Scrushy," sometimes referred to herein as "the bonus case");andErnst & Young, LLP v. Tucker, 940 So. 2d 269(Ala.2006)("Tucker").It was the first of a number of derivative actions to be commenced by various HealthSouth shareholders against Scrushy and other former HealthSouth officials and related parties in various forums including (1) the Jefferson Circuit Court, (2) the United States District Court for the Northern District of Alabama("the Federal derivative actions"), and (3) the New Castle Chancery Court in Delaware, Biondi v. Scrushy, 820 A.2d 1148(Del. Ch.2003), restyled and resolved, In re HealthSouth Shareholders Litig., 845 A.2d 1096(Del. Ch.2003), aff'd, 847 A.2d 1121(Del.2004)(table)("the Delaware derivative actions").

The derivative actions appear to have been sparked by the "'public scrutiny of HealthSouth's financial integrity, '" which "'first became intense in the summer of 2002.'"Tucker, 940 So. 2d at 273(quotingTeachers' Retirement Sys. of Louisiana v. Scrushy, Civ. A. 20529, March 2, 2004(Del. Ch. 2004)(not published in A.2d)).

"'At that time, HealthSouth announced that a new policy regarding reimbursement issued by the federal Centers for Medicare and Medicaid Services (the "CMS Policy") would have a large, detrimental effect on the company's revenues.Put simply, many stockholders... were deeply suspicious about HealthSouth's announcement, given that the CMS Policy had, according to them, been expected for some time.In particular, they suspected that HealthSouth insiders--many of whom had engaged in large transactions involving sales of HealthSouth stock earlier that year--had concealed the effect of the CMS Policy in order to keep HealthSouth's stock price artificially high.'"

Id.

In March 2003, federal authorities learned that, beginning at least as early as 1994, HealthSouth corporate officers had engaged in a fraudulent accounting scheme of "massive" proportion.United States v. Martin, 455 F.3d 1227, 1230(11th Cir.2006).The fraud involved a conspiracy by HealthSouth officers

"to artificially inflate HealthSouth's reported earnings and earnings per share, and to falsify reports about HealthSouth's overall financial condition.The HealthSouth officers made, and directed accounting personnel to make, false and fraudulent entries in HealthSouth's books and records for the purpose of falsely reporting HealthSouth's assets, revenues, and earnings per share and in order to defraud investors, banks, and lenders.As a result, HealthSouth's public financial records overstated its financial position cumulatively by billions of dollars from 1994 to 2002, and public investors purchased overvalued shares of HealthSouth's stock, which plummeted... to $.11 per share when the massive fraud was revealed."

Id.Throughout the litigation of this case, the accounting scheme has been referred to as "the fraud," which practice will generally be followed throughout this opinion.

Criminal charges were filed against various alleged conspiratorial HealthSouth officers as early as April 2003 in the United States District Court for the Northern District of Alabama.Eventually, at least 15 "'senior HealthSouth executives...[pleaded] guilty to sundry and various criminal acts, including criminal fraud, specifically regarding the accuracy, reliability, falsification and fabrication of the financial information and documentation that HealthSouth waslegally required to file during the years 1996 through 2002.'"Scrushy, 955 So. 2d at 993(quoting trial court's judgment).

Meanwhile, complaints in the pending derivative actions were amended to assert claims reflecting the latest revelations of fraud and mismanagement.In that connection, on August 8, 2003, Tucker filed a third amended complaint and a fourth amended complaint, asserting claims alleging, among other things, (1) improper "interested transactions," waste and "misappropriation of corporate assets"; (2) unjust enrichment; (3) breach of contract; (4) conspiracy; (5)"intentional, reckless, and innocent misrepresentation and suppression"; (6) breach of fiduciary duty of loyalty, related to fraud, false accounting, and "insider trading"; and (7) seeking to impose a constructive trust.

The pertinent allegations of the complaint included the following:

"36.Scrushy [and other defendants]... created false journal entries to HealthSouth's income statement and balance sheet accounts....

"37.It was part of the wrongdoing and conspiracy that Scrushy [and other defendants] engaged in an unlawful scheme to inflate artificially HealthSouth's publicly reported earnings and earnings per share and to falsify reports of HealthSouth's financial condition so thatthey could reward themselves with bonuses, stock options, and other corporate perks.Scrushy personally benefitted from the scheme to artificially inflate earnings, having sold at least 7, 782, 130 shares of stock since 1999 at prices grossly inflated by the materially misstated financial statements.Scrushy [and other defendants]'earned' tens of millions of dollars in bonuses, stock options, and excessive salary and perks based on the inflated earnings.

"....

"77.On or about July 31, 2002, Scrushy, with knowledge of material nonpublic information regarding HealthSouth's financial condition and prospects, sold back to HealthSouth 2, 506, 770 shares of HealthSouth stock at a price of $10.06 per share, or $25,218, 106 (the 'Buyback').The Buyback was made at the direction of Scrushy, the Board of Directors and its Compensation Committee....¹

"118.During each year from 1 992 through his departure in March 2003, Scrushy received tens of millions of dollars in compensation from HealthSouth, including, but not limited to, salary, stock options, benefits, bonuses, incentive compensation, and other income from the corporation in the form of loans, benefits, and/or the use of equipment and facilities of HealthSouth.

"119.The amounts paid by HealthSouth to Scrushy were grossly excessive, particularly when one considers the value of stock and dividends.

"120.What is more, incentive compensation to Scrushy [and other defendants] in executivemanagement, is based on HealthSouth's reported financial results.As those results are and were false, Scrushy [and other defendants] in executive management benefitted improperly and were unjustly enriched to the extent they received incentive compensation based on exaggerated revenues and profits.

".....

"140.At the very least, Scrushy knew that HealthSouth's financial health was materially overstated in its financial statements and public disclosures, whether because of material overstatements of revenues, profits, and assets, or because of past, present or future Medicare reimbursement problems, or both.Such material misstatements or omissions caused HealthSouth stock to be materially inflated at all times between 1999 and August 2002, and Scrushy knew it.

"141.[Scrushy sold] on May 14, 2002,... 5, 275, 360 shares of HealthSouth stock on the open market... at the grossly inflated price of $14.05 per share.Scrushy received $74,118, 800 for his shares.On March 26, 2003, the first trading day after public disclosure of the massive false accounting, HealthSouth stock closed at $0.11 per share.This values the 5, 275, 360 shares Scrushy

sold at $580,289.60.

"142.Based on the applicable state law doctrines of...Brophy [v. Cities Service Co., 70 A.2d 5(Del. Ch.1949)], based on theories of breach of fiduciary duty, constructive trust, and unjust enrichment, Scrushy is liable to pay HealthSouth the proceeds of these illicit insider trades....

"....

"177.Payment of excessive salaries and benefits amounts to waste of corporate assets."

For all the alleged wrongful conduct, the complaint sought "money damages."Additionally, the complaint specifically requested "[d]isgorgement of amounts received as the result of breaches of fiduciary duty, waste of corporate assets, conflicted and prohibited transactions, misappropriation of corporate opportunities and assets, [and] unjust enrichment," as well as "[d]isgorgement of all compensation including but not limited to salary... as the result of the wrongful acts and breaches of fiduciary duty, breaches of contract, and breaches of duty of good faith."(Emphasis added.)It also sought "all such other relief at law and equity to which the corporation may be entitled."

Additionally, the third amended complaint averred that no pre-suit demand had been made "on the Board of Directors to take action to press the claims asserted [there]in because such a demand would have been futile."Approximately 10 pages of that complaint were devoted to an explication of the assertions of the futility of such a demand.

All HealthSouth derivative actions pending in the Jefferson Circuit Court were consolidated with Tucker'scase no. CV-02-5212 or abated in its favor.Coordination orderswere entered in the various derivative actions pending elsewhere:

"'In orders entered [in case no. CV-02-5212], [in the Federal derivative actions], and [in the Delaware derivative actions], the following

...