ArthroCare Execs Convicted in Fraud Case

Former ArthroCare CEO Michael Baker and CFO Michael Gluk have been convicted for their role in orchestrating a scheme that defrauded shareholders of more than $400 million in assets. A jury in the federal Western District of Texas found Baker to be guilty of conspiracy to commit wire and securities fraud, wire fraud, securities fraud, and making false statements; while Gluk was found to be guilty of conspiracy to commit wire and securities fraud, wire fraud, and securities fraud.

The U.S. Securities and Exchange Commission participated in the ArthroCare investigation.

Baker and Gluk have not yet been sentenced, but both potentially face decades of prison time. The maximum prison sentence for the conspiracy and securities fraud charges is 25 years. The maximum sentence is 20 years for each count of wire fraud.

Baker plans on appealing the verdict, according to one of his attorneys, Rusty Hardin.

The two men had previously asked to be acquitted, but that request was denied by U.S. District Judge Sam Sparks. Sparks gave no reason for denying the defendants' motions for acquittal. Baker and Gluk had argued that federal prosecutors had failed to present sufficient evidence at trial, and Baker additionally claimed the government had violated his Fifth Amendment rights.

Baker and Gluk each faced 11 counts of wire fraud and two of securities fraud, and Baker was also charged with three counts of making false statements. The charges stemmed from their alleged deception of investors and regulators by inflating sales and revenues through a series of end-of-quarter transactions with the Austin, TX-based company's distributors from at least December 2005 to December 2008.

According to the Justice Department, Baker, Gluk and others allegedly had millions of dollars worth of Arthrocare's medical device inventories shipped to the distributors at the end of each quarter. Arthrocare "would then report these shipments as sales in its quarterly and annual filings at the time of the shipment, enabling the company to meet or exceed internal and external earnings forecasts," the Justice Department said. In reality, it is alleged, these devices were merely being stored at the distributors' facilities.

In return, ArthroCare's distributors were given large cash commissions, extended payment terms, or the right to return products after the end of the quarter, prosecutors allege.

Prosecutors say that Baker, Gluk and others "determined the type and amount of product to be shipped to distributors based on Arthrocare's need to meet Wall Street analyst forecasts, rather than distributors' actual orders."

Former ArthroCare executives John Raffle and David Applegate have already pleaded guilty to conspiracy to commit securities and wire fraud in connection with the scheme.

ArthroCare Corp. itself has paid a $30 million fine to resolve charges of one count of conspiracy to commit securities fraud and wire fraud, and has entered into a two-year deferred prosecution agreement with the Justice Department. If Arthrocare meets requirements set by the Justice Department, it won't be subject to further charges related to the investigation, which was first made public in December 2008. The company also had to restate its earnings for the three-year period in question.

As we recently reported, ArthroCare was recently bought by Smith & Nephew plc (London) for about $1.5 billion.

Stephen Levy is a contributor to Qmed and MPMN.