A chief mechanic of the huge fraud at HealthSouth choked back tears yesterday at the trial of fired Chief Executive Officer Richard Scrushy...

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BIRMINGHAM, Ala. — A chief mechanic of the huge fraud at HealthSouth choked back tears yesterday at the trial of fired Chief Executive Officer Richard Scrushy as he testified that an exciting, visionary company resorted to bogus numbers when it couldn’t meet earnings forecasts.

Former assistant controller Ken Livesay said he and other members of a group called “the family” ditched “aggressive accounting” practices and began inserting outright fraud into HealthSouth’s books when Wall Street expectations outstripped the ability of the rehabilitation giant to make money.

“At some point in 1996, we crossed the line. We could no longer use those aggressive methods,” he said. “We crossed the line from gray to black.”

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Livesay said he would download the company’s true earnings into his computer, figure out how much fraud was needed to meet analysts’ earnings expectations and pass along the figures to two superiors in finance, Bill Owens and Mike Martin. “They’d instruct me that ‘We need to fill in that gap,’ basically. So I’d figure out ways to make that happen,” said Livesay, who pleaded guilty and has cooperated with prosecutors.

Owens and Martin — who also have pleaded guilty in the scheme — repeatedly said Scrushy was aware of the fraud, Livesay said.

“It was a recurring question I had,” said Livesay, who fought back tears as he described making his plea deal once the fraud became public in March 2003.

Prosecutors said Scrushy was behind a long-running scheme to inflate HealthSouth earnings by some $2.7 billion and made millions from the conspiracy through stock sales, bonuses and salary. In all, 15 former HealthSouth executives have pleaded guilty and are cooperating with prosecutors.

Named in a 58-count indictment, Scrushy is accused of conspiracy, fraud, money laundering, obstruction of justice and perjury. He also is charged with false corporate reporting in the first test of the 2002 Sarbanes-Oxley Act against a chief executive.

If convicted, he could receive what amounts to a life sentence and be ordered to forfeit as much as $278 million in assets.

The defense argues that Scrushy’s aides committed the fraud on their own and lied to him for years to keep it hidden.

Livesay said he had some $1.1 million in mutual funds and a $300,000 home by 1998 or ’99 after receiving salary, bonuses and stock options.

“I made a lot of money as a result of my actions,” Livesay said.

Livesay paid $760,000 in criminal forfeitures and fines in his plea deal, and he served six months under house arrest besides getting five years on probation.

Livesay, who plays the guitar, joined HealthSouth in 1989 after joining a “garage” rock band fronted by Scrushy. He described HealthSouth as an “exciting place to work” that had a good plan for providing high-quality, low-cost health care nationwide. “I believed in our senior management’s ability to achieve that plan,” Livesay said.

Owens promised the fraud would end as HealthSouth continued with a string of acquisitions, Livesay testified, but instead the overstatements reached $600 million by 1998, up from about $70 million two years earlier.

Before Livesay took the stand, testimony showed internal auditors working under Scrushy were assigned to check bathrooms and parking lots for trash but lacked access to corporate books where the fraud occurred.

Former chief auditor Teresa Rubio Sanders, who reported directly to Scrushy, said she and her eight employees were assigned to perform financial audits of individual HealthSouth facilities and do “white-glove” tests, called pristine audits, ordered by Scrushy.

“Mr. Scrushy wanted to make sure that anyone who walked into a facility got a certain level of service and each one looked a certain way,” said Sanders, explaining a 50-point checklist that included things like looking around each facility for garbage.

But Sanders, who was hired by Scrushy in 1990 and quit in late 1999, said her office wasn’t allowed to see the general ledger, where previous testimony showed that a $2.7 billion earnings overstatement occurred from 1996 through 2002. “We didn’t have access to the corporate information,” said Sanders, who didn’t elaborate. An outside firm, Ernst & Young, audited the corporate accounts and helped with the pristine audits, she said.

Under questioning from defense lawyer Jim Parkman, Sanders said she never complained to HealthSouth directors about the lack of access to corporate records. Parkman also countered earlier prosecution suggestions the pristine audits were at least partly meant to divert auditors’ attention from the fraud.

“At the time it was put in, did you see the importance, No. 1, of having a clean facility?” Parkman asked.

“I agree,” answered Sanders, who said she rarely met with directors or the board’s audit committee.

Sanders said internal auditors conducted the white-glove checks at about 100 of HealthSouth’s approximately 1,800 hospitals and outpatient centers. Ernst & Young made up to $1.2 million annually performing additional cleanliness reviews, an arrangement Sanders said she opposed.