A former executive of medical device corporation, ArthroCare Corp., pleaded guilty to fraud charges brought against him by the U.S. Department of Justice. John Raffle, 45, former executive with ArthroCare Corp., was charged with conspiracy to commit securities fraud, mail and wire fraud, and two false statements violations, according to a U.S. DOJ press release.

The scam resulted in over $400 million in losses for ArthroCare’s shareholders holding over 25 million shares.

As vice president of Strategic Business Units, based out of Austin, Texas, Raffle oversaw sales and marketing at ArthroCare, putting him in a prime position to commit the type of fraud that he did. Raffle and others fraudulently inflated the sales and revenue of ArthroCare by way of “end-of-quarter transactions involving ArthroCare’s distributors.” The group also outright lied to the U.S. Securities and Exchange Commission (SEC) on both the company’s annual and quarterly reports about transactions including: sales, profits, revenue, and company overhead.

In order to pass off the reports as legitimate, the conspirators would find out the product and how much should be sent to distributors. They based this number on sales quotas rather than actual need of the distributors. This markup in unit sales created a residual amount of products that the accused would hold at the distributors and then would report the extra as sales in the quarterly and annual reports.

“Compensation is based on the profits or increased stock price of the corporation. The compensation structure promotes high-stakes risk because the executives and senior management are often not responsible for catastrophic losses but can cash in big if the stock prices rise,” said securities litigator, Peter Mougey, of Levin, Papantonio, Thomas, Mitchell, Rafferty & Proctor, P.A. “The amount of compensation at stake is a catalyst for manipulating financials to increase the stock price” says Mougey.  Of course, shareholders are left holding the bag when the fraud is revealed and the stock price drops like a rock.”    

The conspirators also struck a deal with ArthroCare’s largest distributor, DiscoCare Inc. DiscoCare accepted a product shipment worth about $37 million in exchange for cash commissions and freedom to return product, among other perks. To cover up the arrangement, Raffle had ArthroCare acquire DiscoCare in 2007.

The constant skewing of sales and revenue eventually affected ArthroCare’s market value. The company prompted an internal investigation in 2008 after market share prices plummeted almost by half, from $40.03 to $23.21.  

If convicted, Raffle could receive five years in prison for each of the four charges, as well as possible fines.

Josh is a writer and researcher with Ring of Fire. Follow him on Twitter @dnJdeli.