Medical Device Manufacturer Admits to Wrongdoing, Faces $14 Million Penalty

. By Gordon Gibb

An unnamed stock analyst who fancies himself as a student of numbers and trends, didn’t think a medical device manufacturer’s unbridled success added up. Today he and a whistleblower colleague enjoy a payday in the millions.

It was a little over a year ago that the US Securities and Exchange Commission (SEC) issued an official press release announcing that a Texas-based medical device company, Orthofix International (Orthofix), had agreed to pay $14 million to settle charges brought by the regulator with the help of two SEC fraud whistleblowers. Orthofix, which has faced a SEC whistleblower lawsuit in the past, also agreed to admit to wrongdoing.

It was a major SEC fraud story that dates back to 2012 but has for the most part flown under the radar.

Following the official announcement by the SEC on January 18 of last year, Reuters (04/25/17) provided an in-depth follow-up concerning the underpinnings of the now-admitted wrongdoing, and how it led to an SEC whistleblower fraud investigation.

It all began when a stock analyst thought things just didn’t look right

According to Reuters, the wrongdoing came to light thanks to the efforts of two unidentified stock analysts, one of whom is a student of numbers and trends that may appear to hint at either emerging success, or pending disaster.

Or, as it turns out, stock skullduggery amidst misleading numbers.

It was back in 2012, according to Reuters that the analyst noted that Orthofix had been consistently achieving what were described as ambitious earnings targets, with numerous analysts issuing ‘buy’ recommendations for Orthofix stock.

At the same time, however earnings reports issued by the medical device enterprise appeared to show that payment from wholesalers was taking longer than usual. Unpaid invoices were piling up. Executives with the firm cited logistical problems at Orthofix’s foreign offices as a partial explanation – however the analyst found those arguments to be unconvincing.

He shared his concern with a colleague, and the two continued to dig. What they found resulted in their participation as whistleblowers in the SEC whistleblower investigation against Orthofix that eventually resulted in the $14 million settlement. At the time, in April of last year Reuters estimated the two men stood to earn a $2.5 million payday each – or more – for their respective roles in the investigation.

Accounting practices were found to be misleading

According to Reuters, Orthofix was alleged to have engaged in a practice known in the industry as ‘channel stuffing,’ in which revenue is recognized prematurely. Orthofix was seen to have sent various implants from its spine division to distributors in Brazil lacking either regulatory approval, or the medical instruments that were a prerequisite to the implants being used. The implants – even though they couldn’t be effectively utilized – were recorded in the company books as revenue. Some price discounts were also, it was alleged, reflected as expenses rather than a revenue reduction, in the accounting logs.

The practice of flooding distributors with more product than they can use or realistically pay for, according to Reuters, remains illegal if not disclosed to investors.

The SEC was approached by an attorney acting on behalf of the two concerned analysts, and the resulting investigation led to the announcement of a settlement.

“Orthofix’s accounting failures were widespread and significant, causing Orthofix to make false statements to the public about its financial condition,” said Antonia Chion, Associate Director in the SEC’s Enforcement Division, in statements made in January of last year.

Orthofix admitted to wrongdoing, but the CEO was in the clear

Orthofix was also found to have violated the Foreign Corrupt Practices Act (FCPA). “Orthofix did not have adequate internal controls across all its subsidiaries and failed to detect and prevent the improper payments in Brazil that were intended to boost sales,” said Kara N. Brockmeyer, Chief of the SEC Enforcement Division’s FCPA Unit, in the statement released January 18, 2017 in Washington.

It should be noted that Robert Vaters, who was the Chief Executive Officer of Orthofix at the time, was not charged with wrongdoing. Vaters nonetheless is reported to have returned $72,886 in cash bonuses and certain stock awards he received during the time over which Orthofix was found to have committed accounting violations, according to the SEC statement.

The SEC indicated Orthofix agreed to pay an $8.25 million penalty to resolve the accounting violations, as well as more than $6 million in disgorgement and penalties to settle the FCPA charges. Four individuals who were serving as executives of Orthofix at the time – not including Vaters, who was found not to be involved – were also required to pay various penalties.

Orthofix faced a previous whistleblower lawsuit in 2010, filed by a former employee who brought claims under the False Claims Act (FCA). That lawsuit was The United States v. Orthofix International, Civil Action Nos. 05-10557-EFH, 08-11336-JLT in the US District Court for the District of Massachusetts.

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