Before Boston Scientific Corp. spent $26 billion on Guidant Corp. in 2006, its soon-to-be subsidiary discovered design flaws in one of its implantable cardiac defibrillators but didn’t disclosed that flaw and similar problems with another device until 2005.
Those failures turned out to be costly for Guidant’s new parent, which today settled a case with the U.S. Justice Dept., agreeing to pay penalties of $296 million and to Guidant pleading guilty to two misdemeanor counts of failing to supply certain information to U.S. regulators.
The settlement means a $294 million charge goes on the books for BSX’s 2009 third quarter, reversing $200 million in Q3 profits into a $94 million net loss. That prompted the company to lower its full-year earnings-per-share guidance buy 20 cents, from $.043-$.048 per share to $0.23-$0.28 per share.
The DOJ settlememt news follows a federal appeals court upholding the dismissal of a shareholders lawsuit against Guidant, accusing it and former management of malfeasance in failing to disclose the problems with the defibrillators.
In February 2002, Guidant discovered a design flaw in one of its implantable cardiac defibrillators, the Ventak Prizm 2 DR, after receiving reports of device failures. By April 2002, according to court documents, it fixed the flaws and begun producing a corrected version of the device — but didn’t recall the defective products.
“Instead, it continued selling its inventory of defective units without disclosing either to physicians or the public the design flaw or malfunctions that had led to device failures,” wrote Judge Diane Wood of the U.S. Court of Appeals for the Seventh Circuit, adding that Guidant never mentioned the defects in subsequent press releases and filings with the Securities and Exchange Commission.
In 2004, the company began talks with Johnson & Johnson for a possible merger. On Dec. 1 of that year Guidant put out a press release touting “highly positive news” about the potential for growth for its ICD and pacemaker businesses. Shares of Guidant rose nearly 8 percent in the week following the announcement, from about $65 per share to $70.
Two weeks later the J&J merger was revealed and Guidant’s stock again surged, eventually reaching $75 per share. But neither release mentioned the problems with the Ventak Prizm 2 DR; merger filings with the SEC were also silent about the defects.
Then, on March 13, 2005, 21-year-old Joshua Oukrop’s Ventak Prizm 2 DR short-circuited, killing him. Guidant told his doctor of the problems with the device, disclosed that it knew of 25 other such cases and told the physician that about 24,000 ICDs similar to Oukrop’s had been sold. When the doctor asked Guidant whether the other recipients would be told, the company said no, it did not want to “alarm” anyone.
The company kept its word in subsequent SEC filings and press releases, never mentioning the defect or Oukrop’s death. In fact, Guidant’s first public acknowledgment of the problem came in a letter to physicians issued about a month after its shareholders approved the JNJ deal, and then only because of an impending New York Times article that was to reveal the device’s flaws.
The FDA issued a national recall for the devices June 17, 2005; Guidant issued a physician communication and a press release on the same day, disclosing 15 reports of failure of the Contak Renewal and Contak Renewal 2 defibrillators, out of approximately 16,000 implanted worldwide, and two memory error incidents among its four models of AVT defibrillators, out of about 21,000 implanted worldwide.
Share prices plunged to $70.33 on the news — a $1.09 billion loss for Guidant investors — and when J&J said it was reconsidering the buyout in October shares fell to $64.10.