HealthSouth Settles on Board

More than half of its directors will depart within nine months under a deal with a state pension fund.
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HealthSouth's

(HLSH)

boardroom is losing that cozy feel.

Facing the prospect of a courtroom loss that could have cleared the way for a full-blown proxy fight, HealthSouth agreed early Tuesday to begin replacing most of its board members on its own. Over the next nine months, the company will hand out pink slips to five incumbent directors accused of collecting secret perks while failing to do their jobs.

All five have deep ties to ousted CEO Richard Scrushy, who faces criminal charges for allegedly orchestrating a multibillion-dollar accounting scam that went unchecked by the board for many years.

"These were the five directors who were on the board when Scrushy did his dirty work," said Stuart Grant, a partner at Grant & Eisenhower, the law firm that scored Tuesday's settlement on behalf of the Teachers Retirement System of Louisiana. "We got exactly what we were after."

In confirming the settlement on Tuesday, HealthSouth said that it had decided to adopt a "transition plan which had previously been under consideration." But before the actual agreement, HealthSouth had warned that boardroom upheaval could disrupt its recovery, and even push it into bankruptcy.

"I don't think anybody bought that," Grant said. "There's nothing like a trial you know you're going to lose that will bring you to the table."

In the end, HealthSouth agreed to replace five incumbent directors in an orderly fashion. The first two will leave in less than two weeks. Two more will follow by next April, and a fifth will depart by next August. Interim Chairman Joel Gordon, along with three newcomers to the board, will remain "in order to help ensure the continuity and stability of HealthSouth's current turnaround efforts."

Grant said the settlement offered "the best of both worlds" by eliminating questionable directors with minimal disruption to the company. Board members tapped for removal include John Chamberlin, Sage Givens, Charles Newhall, Larry Striplin and George Strong. All but Striplin have spent a decade or more on the board.

According to Grant's complaint, all five also participated in a "web of financial entanglements" that benefited board members -- particularly Scrushy -- at the expense of common shareholders. It accuses HealthSouth directors of "rubber-stamping" a number of related-party deals that were never properly disclosed to the public.

"Scrushy directed where all the company's business would go," the complaint states, "and that business in large part ended up in the laps of Scrushy and his fellow directors."

In the past, HealthSouth's regulatory filings have simply glossed over such transactions as fair to the company. But Grant's complaint raises questions about the deals that run on for pages. Moreover, it claims that the board did not -- and probably could not -- produce evidence to justify the transactions.

"The paucity of documents produced in response to the court order -- all that exist by defendants' tacit admission -- shows that the board never took seriously its fiduciary responsibility," the complaint states.

The complaint then singles out HealthSouth directors individually. Chamberlin is tagged for his ownership stake in

MedCenterDirect.com

and

Source Medical

, two companies that have relied heavily on HealthSouth for both financing and business.

Givens is attacked for her ties to MedCenter as well. Her venture capital fund,

Acacia

, owns stock in MedCenter. Moreover, her fund has attracted millions of dollars in investments from HealthSouth -- and snared at least one valuable business from the company -- during her long tenure on the board. Indeed, the complaint states, Givens' entire career was "jump-started" by her dealings with HealthSouth.

Newhall is accused of similar conflicts. His own investment firm,

New Enterprise Associates

, also invested in MedCenter and -- together with Given's fund -- bought a HealthSouth subsidiary that has quickly evolved into "one of the nation's largest providers of healthcare recruiting and staffing services."

Striplin is also attacked for his ties to MedCenter and

Capstone

, another business "spawned by Scrushy and his close associates." The latter, a real estate investment trust, reportedly purchased HealthSouth properties below their appraisal value and then leased some of them back to the company at above-market rates.

Striplin has served on the boards of both MedCenter and Capstone but denies that he currently has a personal investment in either one. He also works full time as the CEO of

Nelson-Brantly Glass Contractors

, a company that snagged a HealthSouth contract worth $5.9 million -- nearly a year of annual sales -- just weeks before he joined an internal HealthSouth committee that defended Scrushy's insider stock sales even before it began investigating the transactions.

Finally, Strong -- like Chamberlin -- is criticized for his ownership stake in both MedCenter and Source Medical. Although HealthSouth can choose which directors to boot first, Grant has speculated that Chamberlin and Striplin may top that list.

In the end, however, he said that all five incumbents must go.

"Regime change was desperately needed at HealthSouth," he said. "Accomplishing a regime change through this settlement -- without a court-ordered annual meeting and a full-scale proxy fight -- will allow HealthSouth to stay focused on its turnaround, thereby providing shareholders and other constituents with the best situation of all: a new board and a focused management."

HealthSouth shares -- which traded for mere pennies after the accounting scandal first broke -- jumped 2.7% to $4.56 on Tuesday's news.