On July 16, 2013, the U.S. Department of Justice  (DOJ) indicted Michael Baker and Michael Gluk, the former CEO and CFO, respectively, of ArthroCare Corp. – a Texas-based publicly traded surgical device company.   Baker and Gluk allegedly orchestrated a $400 million scheme to defraud investors by falsely inflating ArthroCare’s earnings through sham end-of-quarter shipments to distributors.  The charges against the former company executives include wire fraud, securities fraud, and conspiracy to commit wire fraud and securities fraud.  The DOJ also charged Baker with making false statements to the U.S. Securities and Exchange Commission (SEC) during a sworn deposition.  These recent charges supplement the indictment of two former ArthroCare senior vice presidents and alleged co-conspirators, John Raffle and David Applegate, last August.  Applegate agreed to a plea deal in May 2013, and the DOJ filed a superseding indictment against Raffle that same month.

According to the indictment against Baker and Gluk, between 2005 and 2008, they, along with other senior co-conspirators within ArthroCare, allegedly:

• Arranged sham transactions to “park” enough medical device products with distributors to meet ArthroCare’s end-of-quarter sales expectations;

• Offered, as incentive for the distributors’ agreement to the sham transactions:

  • Substantial upfront cash commissions; 

  • Extended payment terms for the devices; and

  • Expanded ability to return the product after the end of the quarter; and

• Took extensive measures to hide the forgoing actions, including purchasing one distributor (DiscoCare Inc.) that ultimately became ArthroCare’s largest source of revenue during the scheme because it purportedly accepted shipments that far exceeded its legitimate needs.

The sham transactions appeared as ordinary sales on ArthroCare’s financial reports, but the DOJ alleges that they artificially inflated ArthroCare’s revenue by tens of millions of dollars – potentially inducing investors to engage in trades or to hold company shares based on the falsely generated sales data. 

Baker, Gluk, and ArthroCare have also been subject to various collateral actions, including an SEC clawback lawsuit against the former executives as well as several direct and derivative shareholder lawsuits.  Moreover, ArthroCare stated in its financial results that it is the subject of a DOJ investigation into potential corporate liability based upon the same underlying allegations.

This case serves as a powerful reminder that the health care industry remains squarely in the U.S. government’s spotlight.  Health care fraud, securities fraud, and the U.S. Foreign Corrupt Practices Act are all top enforcement priorities for the DOJ and SEC, and health care companies of all sizes should periodically reevaluate their risk profiles and strengthen their compliance programs to account for enforcement trends.