A former HealthSouth finance chief testified yesterday that then-Chief Executive Richard Scrushy decided not to pursue a merger after being...

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BIRMINGHAM, Ala. — A former HealthSouth finance chief testified yesterday that then-Chief Executive Richard Scrushy decided not to pursue a merger after being warned it could reveal earnings overstatements at the rehabilitation chain.

Mike Martin, the third former HealthSouth CFO to testify against Scrushy at his corporate-fraud trial, also said an investment banker who helped dissuade Scrushy from pursuing the deal was aware of the scheme to inflate earnings.

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The merger didn’t go through, Martin said, after he warned Scrushy “the fraud would be exposed” if it did.

Martin said he hadn’t previously used the word “fraud” with his boss.

The government claims Scrushy was behind a conspiracy to overstate HealthSouth earnings by $2.7 billion for seven years beginning in 1996, when it began missing Wall Street estimates. Scrushy made millions off the scheme through salary, stock sales and bonuses, prosecutors claim.

The defense contends Martin and other former Scrushy aides who were in a group called “the family” came up with the conspiracy on their own and hid it from the chief executive so they could get promotions and raises.

Martin said he told Scrushy he would resign in 1998 as internal projections showed HealthSouth earnings for the next year at a maximum of 78 cents a share, well short of the $1 ordered by Scrushy in a bid to keep stock prices at about $15 a share.

“He said, ‘Martin, you can’t quit. You’ll be the fall guy,’ ” Martin testified in his third day on the stand.

Martin said he was “petrified” by Scrushy’s remark.

“I felt like I was stuck. I felt like I couldn’t get out of it,” he said.

Martin previously testified that Scrushy resisted lowering earnings estimates because he feared shareholder lawsuits after selling more than $100 million in stock. Evidence has shown the medical-rehabilitation company inflated earnings through mid-2002.

With members of the conspiracy fighting stress and frazzled nerves as they tried to conceal some $600 million in fraud for the 1998 year-end audit, Martin said he was called to give the family a “pep talk.”

Martin described his speech as a failure: The meeting ended with assistant controller Ken Livesay yelling and saying, “We’re digging a hole deeper and deeper.”

Livesay, one of the former HealthSouth executives who pleaded guilty, previously took the stand against Scrushy.

Martin also corroborated testimony by former HealthSouth Treasurer Leif Murphy, who earlier said Scrushy yelled at him after Murphy confronted Scrushy with a report indicating the company had fabricated earnings. Murphy, who said he wasn’t involved in the conspiracy but figured it out, was not charged.

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, Scrushy could get what amounts to a life sentence and be ordered to forfeit up to $278 million in cars, boats, homes and other assets.