Corruption: CEO, CFO charged with orchestrating $400 million securities fraud scheme

U.S. Department of Justice 
Office of Public Affairs

WASHINGTON—The former chief executive officer and former chief financial officer of ArthroCare Corp., a publicly traded medical device company based in Austin, Texas, were charged for their alleged leading roles in a $400 million scheme to defraud the company’s shareholders and members of the investing public by falsely inflating ArthroCare’s earnings by tens of millions of dollars, announced Acting Assistant Attorney Mythili Raman of the Department of Justice’s Criminal Division and U.S. Attorney Robert Pitman of the Western District of Texas.

A 17-count indictment was unsealed today in the U.S. District Court for the Western District of Texas against Michael Baker, the former chief executive officer and director of ArthroCare, and Michael Gluk, the former chief financial officer of ArthroCare. Both defendants surrendered to authorities this morning.

The indictment, which was returned on July 16, 2013, charges Baker and Gluk with one count of conspiracy to commit wire and securities fraud, 11 counts of wire fraud, and two counts of securities fraud; it charges Baker alone with three counts of false statements. The indictment also seeks forfeiture of assets held by Baker and Gluk.

“Truthful corporate earnings reports are critical to the soundness of our financial system,” said Acting Assistant Attorney General Raman. “Today’s indictment alleges that those at the top of ArthroCare deceived investors and regulators by manipulating the company’s reports to inflate its stock, ultimately causing hundreds of millions in losses in shareholder value. The Criminal Division will continue to aggressively pursue corporate executives who undermine our financial markets for personal gain.”

According to the indictment, from at least December 2005 through December 2008, Baker, Gluk, and other senior executives and employees of ArthroCare allegedly falsely inflated ArthroCare’s sales and revenue through a series of end-of-quarter transactions involving several of ArthroCare’s distributors. According to court documents, Baker, Gluk, and other ArthroCare employees 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. Baker, Gluk, and others then allegedly caused ArthroCare to “park” millions of dollars worth of ArthroCare’s medical devices at its distributors at the end of each relevant 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 indictment alleges that ArthroCare’s 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, a privately owned Delaware corporation, 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.

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.

The indictment further alleges that when Baker was deposed by the U.S. Securities and Exchange Commission about the DiscoCare relationship in November 2009, he lied again on multiple occasions.

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.

If convicted, Baker and Gluk would face a maximum prison sentence of 25 years for the conspiracy charge, 20 years for each count of wire fraud, and 25 years for each securities fraud count. Baker faces five years for each count of false statements.

An indictment is merely a charge, and the defendants are presumed innocent until proven guilty.

This case was investigated by the FBI’s Austin Resident Agency. The case is being prosecuted by Deputy Chief Benjamin D. Singer and Trial Attorneys Henry P. Van Dyck and William Chang of the Criminal Division’s Fraud Section. The Department recognizes the substantial assistance of the U.S. Securities and Exchange Commission.