With a Name Like “DiscoCare,” How Can You Go Wrong? Two ArthroCare Executives Indicted for Securities Fraud

July 19, 2013

By: Sara Kropf

A few years ago, massive securities fraud cases were all the rage. Over the last few years, health care fraud has been on the hit parade. Now, DOJ has managed to combine the two into one case.

The former CEO and former CFO of publicly-traded medical device company ArthroCare Corp. were indicted this week on charges of wire fraud, securities fraud and conspiracy. The former CEO, Michael Baker, is also charged with making false statements based on statements he supposedly made to the SEC, while it was investigating the case. Here is the ArthroCare indictment.

The alleged scheme was not very complicated. Between 2005 and 2008, the indictment alleges, Baker and Michael Gluk (former CFO) as well as other executives and employees inflated the earnings of ArthroCare. At the end of financial quarters, the company would purportedly send products to its distributors based not on how much the distributors had ordered but on how much the company would need to ship in order to meet analysts’ expectations. These “sham transactions,” as the indictment calls them, would be included as sales in the quarterly financial statements.

The indictment charges that these transactions resulted in tens of millions of dollars in fake sales and led to inflated public earnings.  Mr. Baker and Mr. Gluk did not disclose this scheme to the public. Hence: securities fraud.

It almost goes without saying that Mr. Baker and Mr. Gluk received bonuses and other incentives based on the company’s performance.

Now, when a company sends me stuff that I didn’t order, I tend to pick up the phone and give them a call. Maybe send back the stuff that is not mine. So, how did ArthroCare make sure that did not happen?

The indictment alleges that ArthroCare would

(a) provide the distributors extended payment terms; (b) pay the distributors substantial, upfront cash commissions; (c) allow the distributors to return the product; and (d) in some cases, acquire the distributor and the excess inventory so that the distributor would not have to ultimately pay ArthroCare for the products at all.

The distributors are not named, except for “DiscoCare.” You may be imagining, like I am, John Travolta in a white suit, but apparently this “disco” is more on the lumbar side of things. DiscoCare gets a little extra love in the indictment because ArthroCare acquired it but allegedly did not inform the public of this relationship or the fact that much of ArthroCare’s growth was due to DiscoCare’s receipt of shipments.

It’s hard to know whether the distributors are targets as well or if DOJ has decided instead to use them as cooperators. Either way, for now, they are not being charged. Two other executives of ArthroCare were indicted in August 2012. They may be cooperating but it is not clear from the Baker-Gluk indictment. The shipments may be explainable or not (this is when a great forensic accountant is helpful), but either way, these two executives are facing a long road ahead.

Update July 23, 2013:  One of the other executives of ArthroCare, John Raffle, pleaded guilty today participating in this securities fraud scheme. He pleaded guilty to conspiracy, mail and wire fraud and false statements. A sentencing date has not been scheduled.

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