Former ArthroCare CEO Indicted

The ongoing saga of DiscoCare has now landed its biggest fishes. Michael Baker and Michael Gluk, the former CEO and former CFO, respectively, of ArthroCare Corporation have been charged with defrauding the company’s shareholders in a $400 million scheme by falsely inflating company earnings by tens of millions of dollars.

Indictment

On July 17, 2013, the Department of Justice (DOJ) unsealed a 17-count indictment which was returned the previous day. Baker and Gluk are charged with securities and wire fraud. Both defendants surrendered to authorities on the 17th.

According to the indictment, between 2005 and 2008, Baker, Gluk and other senior executives and employees of ArthroCare allegedly falsely inflated company sales and revenue through a series of end-of-quarter transactions involving several of ArthroCare’s distributors. According to court documents, 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. The defendants then allegedly caused ArthroCare to “park” millions of dollars worth of the company’s devices at its distributors at the end of each relevant quarter. The company 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.

Inflating Revenue

The indictment alleges that the distributors agreed to accept shipment of millions of dollars of product in exchange for substantial, upfront cash commissions, extended payment terms and the ability to return product, as well as other special conditions, allowing ArthroCare to falsely inflate its revenue by tens of millions of dollars.

Baker, Gluk and others allegedly used DiscoCare as one of the distributors to cover shortfalls in ArthroCare’s revenue.  According to the indictment, at Baker and Gluk’s direction, ArthroCare shipped product to DiscoCare that far exceeded DiscoCare’s needs.

$400 Million Investor Hit

In addition, Baker, Gluk and others allegedly lied to investors and analysts about ArthroCare’s relationships with its distributors, including its largest distributor, DiscoCare. According to the indictment, Baker and Gluk caused ArthroCare to acquire DiscoCare specifically to conceal from the investing public the nature and financial significance of ArthroCare’s relationship with DiscoCare.

According to court documents, between December 2005 and December 2008, ArthroCare’s shareholders held more than 25 million shares of ArthroCare stock. On July 21, 2008, after ArthroCare announced publicly that it would be restating its previously reported financial results from the third quarter 2006 through the first quarter 2008 to reflect the results of an internal investigation, the price of ArthroCare shares dropped from $40.03 to $23.21 per share. The drop in ArthroCare’s share price caused an immediate loss in shareholder value of more than $400 million.

ArthroCare’s former senior vice president of strategic business units, John Raffle, recently pleaded not guilty to misleading investors to artificially inflating the company’s stock price.

On May 9, 2013, the DOJ announced that David Applegate, the company’s former senior vice president in charge of the company’s spine division pleaded guilty to two charges of conspiracy to commit securities, mail and wire fraud, and with a false statements violation.

According to his LinkedIn page, Baker was at ArthroCare for 12 years. Prior to that, he was a vice president and general manager at Medtronic, Inc. He is currently the president and CEO of a San Francisco Bay area company named Pulmonx.