Richard M. Scrushy made the lion's share of his fortune at

HealthSouth

, the collapsed health care company where he had one of the industry's most liberal pay packages.

But his riches, which reportedly included several mansions, 20 boats, 40 cars, planes and other valuable objects, didn't come only from HealthSouth. The founder and chief executive of HealthSouth also netted millions of dollars from other publicly traded and private companies. Among them was Capstone Capital, a real estate investment trust he founded that was acquired by

Healthcare Realty Trust

(HR) - Get Report

.

According to filings with the

Securities and Exchange Commission

, Scrushy's total windfall from Capstone was about $17.5 million at the time its merger with Healthcare Realty was announced. Those proceeds, which came from founder's shares, options, dividends, director's fees and consulting arrangements during the short life of Capstone, were higher than the proceeds of executives who actually ran the company, according to company documents.

Meanwhile, HealthSouth's stock now trades for pennies, and Scrushy and several former HealthSouth executives are under investigation for a litany of allegedly fraudulent practices.

A spokeswoman at Healthcare Realty Trust, whose stock was punished last month due to its exposure to HealthSouth assets, said that apart from the real estate it inherited when it acquired Capstone, it has no relationship with Scrushy or HealthSouth. "Scrushy was not an insider or director, nor were any other Capstone directors or founders, with Healthcare Realty after the merger with Capstone," Bethany Mancini said. Scrushy sold much of his Healthcare Realty stock as it was allocated to him as part of the consulting and noncompete arrangement.

Capstone's Origins

In 1994, HealthSouth was acquiring rehabilitation practices at a frantic pace, and needed to maintain its liquidity to keep buying and building out its business. At that time, HealthSouth was sitting on several ancillary hospital facilities and wanted to sell them for cash and lease them back from the buyer.

But Scrushy didn't want to sell out to one of the 13 publicly traded REITs dealing exclusively in health care properties. Most health care REITs invested in long-term care facilities or acute-care hospitals -- Scrushy needed a REIT to buy HealthSouth's ancillary hospital facilities, according to a 1994 article in

Modern Healthcare

. In the article, Scrushy complained that most REITs take "a big cut of facilities' revenues, which was unacceptable," a claim questioned by an attorney from the National Association of Real Estate Investment Trusts.

Scrushy came up with a solution: He started a REIT with other directors from HealthSouth. The REIT's primary clients: HealthSouth and MedPartners -- now

Caremark

(CMX)

-- two companies once under Scrushy's control.

The partnership was called Crescent Capital Partners and was launched by Scrushy along with John W. McRoberts and Michael D. Martin. The partnership became known as Capstone Capital when it was offered to the public in June 1994; at that time, HealthSouth was added to the list of founders.

McRoberts became Capstone's president and CEO. He was Scrushy's banker at HealthSouth and was in charge of health care lending at AmSouth Bank. Martin, director, treasurer and senior vice president of HealthSouth at the time, became a director of Capstone. Martin was also a director of MedPartners, now Caremark, a company started by Scrushy in 1993. He is now well-known as the former HealthSouth chief financial officer who has agreed to plead guilty to fraud at HealthSouth.

According to Capstone's offering documents, the REIT was to use the proceeds of the stock offering to purchase properties from HealthSouth and lease them back.

During the offering period, investors and bankers questioned the inherent conflicts of interest detailed in the offering documents, according to the

Modern Healthcare

article. Besides HealthSouth, Capstone was to buy properties from MedPartners, a company Scrushy founded; and Integrated Health Services, a company now operating under bankruptcy reorganization that included Scrushy among its board of directors. Robert N. Elkins, Integrated Health's chairman, CEO and founder, was placed on the board of Capstone. Also on Integrated Health's board was Caremark Chairman Edwin M. Mac Crawford.

Other Capstone board members included Larry D. Striplin Jr., who was on the board of MedPartners and HealthSouth; William B. Luttrell, president and CEO of Surgical Health Corp, which sold out to HealthSouth in 1995; and Larry House, president of HealthSouth from 1992 to 1993 and president of MedParnters at the time.

According to Scrushy in the

Modern Healthcare

article, the REIT has "enough outside directors to make good, solid business decisions

when there's a potential conflict."

The Wisdom of Salomon

Many analysts recommended buying the shares of the REIT as it prepared to go public. Then Smith Barney analysts Geoffrey E. Harris and Vivek Khanna were particularly enthusiastic. Smith Barney, now part of

Citigroup

(C) - Get Report

, was HealthSouth's biggest investment bank at the time. Smith Barney handled the Capstone offering, as well as subsequent equity offerings.

The public offering was completed at the low end of the expected range and raised $104 million before expenses and underwriting fees. Capstone promptly paid $1.675 million to the original Crescent partnership of Scrushy, Martin, and McRoberts for organization expenses and salaries, according to company filings with the

Securities and Exchange Commission

. The original partners also purchased founder's shares in Capstone. Founders shares are generally sold for a fraction of a penny a share to those who start the company.

Scrushy, Martin, McRoberts, and HealthSouth purchased an aggregate of 180,000 shares for $.001 per share, or $180 in total cost, valued at about $3.25 million immediately after the offering, according to company filings with the SEC. Scrushy's cut was 82,656 of the founder's shares, more than any other founder, including his company, HealthSouth.

HealthSouth promptly sold more than $50 million in properties to the REIT, and slated the capital for new operations. Scrushy, Martin, and McRoberts purchased Midway Medical Plaza on April 19, 1994, through a company they created to purchase the property called Midway Acquisition Co., only to sell Midway Medical Plaza to Capstone a month later for $20.4 million, an acquisition that represented 17.7% of the Capstone portfolio at the time. Documents show Midway Acquisition Co. paid the same price for the property when purchased from OrNda HealthCorp in April.

Over the next few years, Capstone grew in size, purchasing more real estate with debt and equity. In 1998, the company had a capitalization of close to $1 billion.

Enter Healthcare Realty

Around this time, Capstone officials indicated to shareholders that the best way for the company to grow was through a merger, according to proxy statements. Healthcare Realty Trust emerged as the main suitor. Under the guidance of NationsBank, the company agreed to the terms put forth by Capstone and its banker, Salomon Smith Barney. Both banks did significant business with HealthSouth and MedPartners.

Healthcare Realty announced it agreed to acquire Capstone in June 1998, and the acquisition was completed in October 1998. Salomon Smith Barney acquired 1.2 million shares of Capstone, or 7% of its shares outstanding, in February 1998. The bank advised Capstone on the deal.

One unusual term of the deal: Healthcare Realty was asked to sign a consulting and noncompete contract with Scrushy, Martin, and McRoberts. Scrushy's team wanted $17 million to $19 million in cash, according to Healthcare Realty documents filed with the SEC. The three executives got more than they asked for in the noncompete deal, but they received a mixture of cash and stock: Scrushy received $2.04 million in cash and 360,000 restricted shares, worth about $10.3 million at the time the deal was announced. Martin received $1.02 million in cash and 180,000 restricted shares, worth $5.15 million at the time. Roberts received $340,000 and 60,000 restricted shares, worth $1.72 million. The total in cash and stock: $20.57 million. Neither side's investment bank raised concerns about the noncompete deal in the due diligence process, according to SEC filings.

An independent committee from Capstone was created in part to oversee the requirements by Scrushy, Martin, and McRoberts of the special side deal. This committee included Larry Striplin, a director at HealthSouth, Medparters, and Capstone.

Scrushy held 107,300 restricted shares from the inception of the company, and received a cash payment of about $2.6 million from Capstone for them as the company purchased all restricted shares from directors and founders. Scrushy held 158,000 in options on Capstone that he acquired over the companies' four-year history, and received a cash payment of about $1.1 million for those from Capstone. Scrushy also received consulting fees and payments for being a director. Scrushy also made more money from demanding a consulting agreement with the merged entity over the next six years as a prerequisite to any deal going through.

Big Money in Real Estate

According to a spokesman from Healthcare Realty, Scrushy likely sold most or all of his restricted shares as they came off restriction in ensuing years. Healthcare Realty Trust still owns properties leased to HealthSouth, Caremark (formerly MedPartners) and Integrated Health Services. The HealthSouth-leased properties are worth $276 million and generate 13% of the yearly revenues of the REIT, according to a Healthcare Realty release on March 20. The news sent the stock off 13% to $25.45. The stock currently trades at $25.50.

According to Healthcare Realty, all tenants are current on lease obligations, including the bankrupt Integrated Health Services.

It is unknown if the REIT bought property at prices different from market rates, or leased them back at above or below market rates.

The SEC has not contacted Healthcare Realty regarding the Capstone merger or HealthSouth, according to Mancini. Healthcare Realty has disposed of about $216 million of Capstone propertiesacquired from the merger because they were noncore assets. Any losses onthe properties from values placed on them by Healthcare Realtyduring the merger were negligible.