It turns out

HealthSouth

(HRC) - Get Report

is even sicker than most people thought.

According to the

Securities and Exchange Commission

-- which charged the company with numerous securities violations on Wednesday -- HealthSouth and its top executive intentionally overstated earnings by at least $1.4 billion in the past four years alone. The agency is seeking unspecified penalties from HealthSouth and its founding leader, Richard M. Scrushy, saying that since its birth as a public company more than 16 years ago, HealthSouth has set out to mislead investors about its true financial condition.

The SEC's action comes eight months after CEO Scrushy sold $25 million worth of HealthSouth stock -- or half his stake in the company -- just ahead of an earnings warning that sent the shares plunging. The SEC now maintains that HealthSouth contrived the sudden earnings shortfall to bring Wall Street's expectations down to the company's real earnings potential, sparing uncomfortable officers from certifying false financial statements in the future.

Getting Scrushed

But the earnings-manipulation scheme, allegedly hatched when HealthSouth first went public, did not end before Scrushy and the company's CFO-certified 2001 financial statements that overstated income (before income taxes and minority interests) by 4,700%, according to the SEC. The Justice Department announced Wednesday that the company's former CFO, Weston Smith, has already agreed to plead guilty to fraud charges and assist the federal government with its ongoing investigation.

In the meantime, the SEC has halted all trading in HealthSouth's securities for at least two business days because the company's current financial information is not reliable. The agency's action follows a

raid Tuesday by the FBI, which is subpoenaing HealthSouth employees for information related to the company's earnings.

In a prepared statement issued Wednesday, the SEC blasted the company's actions.

"HealthSouth's fraud represents an appalling betrayal of investors," said Stephen M. Cutler, the SEC's director of enforcement. "HealthSouth's standard operating procedure was to manipulate the company's earnings to create the false impression that the company was meeting Wall Street's expectations."

HealthSouth's stock, which last closed at $3.91 on Tuesday, is down 75% from its prescandal high. On Wednesday analysts were still attempting to digest the SEC's findings.

"The world was already aware of the SEC investigation, the

Justice Department investigation and the shareholder lawsuits," said Jefferies analyst Frank Morgan, who rated HealthSouth a hold ahead of Wednesday's news. "Now, the fun begins with all the gory details. ... There's a lot more information to be disseminated."

Friends and Family

Already, the SEC's charges are clearly severe. According to the agency, Scrushy has long instructed the company's senior officers and accounting personnel to materially inflate earnings so the company could hit Wall Street targets.

By 1997, the agency says, the company's accountants routinely convened so-called "family meetings" to fix HealthSouth's earnings. The SEC says HealthSouth's accountants would generally follow through by increasing a revenue account and/or decreasing expenses to hike earnings. They would then cover their tracks, the agency says, by correspondingly increasing assets or decreasing liabilities under the established matching rules of accounting.

As time went on, the SEC says, the fraudulent behavior only escalated. HealthSouth allegedly began to falsify journal entries and invent invoices to hide overstatements from its independent auditors. Between 1999 and 2002, the SEC says, HealthSouth's practices resulted in a $1.4 billion overstatement in earnings and an $800 million overstatement in total assets.

But even before that period, the SEC says, company accountants had grown worried about the earnings game and asked Scrushy to end it.

"In the fall of 1997, when HRC's accounting personnel advised Scrushy to abandon the earnings manipulation scheme, Scrushy refused, stating in substance, 'Not until I sell my stock,'" the SEC complaint says.

The complaint goes on to charge Scrushy with profiting handsomely from the company's inflated earnings. Scrushy has sold nearly 7.8 million shares of the stock since 1999, and in 2001 -- the year with certified financials -- the CEO collected a $6.5 million incentive bonus and a $9.2 million salary that was largely based on hitting financial targets.

The SEC is seeking to force HealthSouth and its CEO to disgorge any ill-gotten gains. It also hopes to permanently bar Scrushy from ever serving as an officer or director of a public company again.