Former ArthroCare (NSDQ:ARTC) senior executives John Raffle and David Applegate were arrested yesterday morning for alleged roles in a securities fraud scheme that cost shareholders more than $400 million.
The U.S. Justice Dept. this week unsealed a 16-count indictment against Raffle, former senior vice president of ArthroCare’s strategies business units, and Applegate, former SVP in charge of ArthoCare’s spine division.
The federal agency accused the pair of inflating the company’s earnings by 10s of millions of dollars, charging them with 1 count of conspiracy to commit fraud, 4 counts of wire fraud, 8 counts of mail fraud and 3 counts of securities fraud, according to a DOJ notice.
Raffle and Applegate face a maximum prison penalty of 5 years for each conspiracy charge and 20 years for each count of mail and wire fraud. The securities fraud holds a maximum sentence of 25 years for each count, according to the press release.
The indictment states that Raffle, Applegate and other ArthroCare executives and employees falsely inflated the company’s sales and revenues through sham transactions with distributors from around December 2005 to December 2008 .
Raffle and Applegate allegedly sent excessively large shipments of products to distributors, determining the quantity and type of products needed in order to meet Wall Street forecasts rather than on a distributor’s actual needs.
One distributor in particular, a Delaware corporation named DiscoCare, purportedly made cash payments of less than $50,000 to ArthroCare from Q4 2005 to Q4 2007, a period for which ArthroCare reported more than $37 million in sales to DiscoCare. The DOJ claims that Raffle and Applegate pushed ArthroCare to acquire DiscoCare on Dec. 31, 2007, in order to conceal the "substantial amount of money in unused inventory."
Participating distributors agreed to accept the excess shipments in exchange for "substantial, upfront cash commissions, extended payment terms and the ability to return product, as well as other special conditions," according to the DOJ’s accusations.
ArthroCare launched an internal investigation in July of 2008 and announced that it would restate previously reported financial earnings for the period from Q3 2006 to Q1 2008. The day the announcement was made ARTC shares dropped from $40.03 to $23.21 per share, a loss of more than 40%.
Earlier this year ArthroCare lost a $74 million settlement to shareholders in a lawsuit accusing the company, former president & CEO Michael Baker and former senior VP and CFO Michael Gluk of making "public statements that were materially false and misleading" in order to inflate share prices.