Healthcare Business News

ArthroCare resolves fraud allegations, but must cooperate in case against execs

By Joe Carlson
Posted: January 8, 2014 - 4:30 pm ET

A Texas surgical devicemaker resolved its internal legal problems, but it may have to dish on its former executives as part of the deal.

Publicly traded ArthroCare Corp. is paying $30 million and admitting to allegations that its executives used bogus inventory figures in financial reports to inflate the Austin company's stock price from 2005 to 2008. When the scheme was unmasked, the resulting drop in stock price vaporized $400 million in market value.

Late Tuesday, ArthroCare entered a deferred prosecution agreement (PDF) with federal prosecutors that resolves a criminal charge of conspiracy to commit wire fraud. The company faced maximum fines of $116 million, according to the agreement filed in U.S. district court in Austin.

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“We are very pleased with this result for our client,” said ArthroCare attorney Jeff Layne of Norton Rose Fulbright. “This agreement sends the right message to companies who are considering whether or not to self-audit, self-disclose and fully cooperate with the DOJ's investigations—should those investigations come along. The terms of the (agreement) and significant fine reduction make that clear.”

The agreement requires ArthroCare to pay about a quarter of what its total exposure could have been, but it requires the company to cooperate in the ongoing criminal case against its former CEO Michael Baker and former Chief Financial Officer Michael Gluk. Such cooperation includes making company records and witnesses available to the government.

Baker and Gluk have pleaded not guilty to a 17-count indictment in Austin federal court accusing them of conspiring and carrying out wire fraud and securities fraud. Baker also was charged with making false statements to investigators. After the indictments were announced last July, Baker posted $1 million deed-secured bond and Gluk posted 10% cash deposit on $100,000 bond. A trial is set for May.

ArthroCare sells a line of minimally invasive, electrified surgical tools for sports medicine and ear, nose and throat procedures. The company posted $46 million in income on $368 million in revenue in 2012.

ArthroCare's agreement with the U.S. Justice Department says it does not dispute prosecutors' charges that Baker, Gluk and other executives conspired to make the company appear more profitable than it actually was by using inflated sales numbers in company reports.

Specifically, executives arranged to have much more inventory shipped than distributors actually needed so ArthroCare would appear to have met Wall Street analysts' sales projections, the agreement says. The excesses amounted to millions' of dollars worth of products, which could secretly be returned to ArthroCare for refunds or discounted through “substantial” cash commissions to distributors.

ArthroCare even acquired its largest distributor, known as DiscoCare, so it could repossess the excess inventory and prevent DiscoCare from ultimately having to pay anything for the products, ArthroCare's agreement says.

The company said it self-disclosed the scheme to authorities in 2008.

Under the deferred-prosecution agreement, the criminal charge against the company will be dismissed by prosecutors after two years, as long as it complies with the terms of the agreement.

ArthroCare is not pleading guilty, but the agreement with prosecutors says “the company admits, accepts and acknowledges that it is responsible under United States law for the acts of its officers, directors, employees and agents … and that the allegations described in the (charges) … are true and accurate.”

Follow Joe Carlson on Twitter: @MHJCarlson

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