In the Courts

From 2005 to 2008, ArthroCare sold millions of dollars in products entirely on credit to one of its distributors, DiscoCare, with the agreement that the distributor would only have to pay once the products were sold. Id. at 1. However, these sales far exceeded DiscoCare's product needs and were done with the sole purpose of propping up ArthroCare's quarterly earnings. Id. The fraud was perpetrated by John Raffle and David Applegate, two ArthroCare executives. Id.

The scheme unraveled in 2008, when ArthroCare purchased DiscoCare for $25 million ' far above the company's true value ' triggering media reports of accounting improprieties. Id. at 2. To reassure investors, Gluk and Baker made several false statements during a series of conference calls with investors. Id. As reports continued to mount, ArthroCare's Board of Directors commissioned an independent investigation by the law firm Latham & Watkins to assess the company's conduct. Id' The investigation uncovered the fraud perpetrated by Raffle and Applegate, but ultimately concluded that Gluk and Baker had been misled and were not aware of the fraud at the time. In light of the investigation, ArthroCare's board restated the company's earnings, causing share prices to fall from $40.03 to $5.92 over the course of 2008, a loss of shareholder value of more than $750 million.

The SEC conducted its own investigation of the company and sued ArthroCare, Raffle and Applegate for securities fraud. In addition, the SEC filed a claw-back complaint against Gluk and Baker, which stated that the SEC “does not allege that Baker and Gluk participated in the wrongful conduct” and that the perpetrators of the fraud had “intentionally withheld” information from them. Id.

The government initially brought criminal charges against only Raffle and Applegate, who pled guilty and agreed to testify against Gluk and Baker. Id. At trial in the Western District of Texas, the district judge decided to exclude the Latham and SEC investigations, while allowing the government to introduce evidence of unrelated, uncharged medical fraud at DiscoCare. In June 2014, a jury convicted Baker and Gluk of wire fraud, securities fraud, and conspiracy; Baker was also convicted of making false statements. The court sentenced Baker to 20 years in prison, while Gluk received a 10-year sentence. In addition, they were required to forfeit over $22 million in proceeds from stock sales that took place during the period of the fraud.

On appeal, Baker and Gluk challenged the district court's decisions to: 1) exclude the SEC and Latham investigations, both of which determined that Raffle and Applegate hid the fraud from Gluk and Baker; and 2) admit evidence of uncharged fraud at DiscoCare. Id. The circuit court agreed that the district court “kept evidence out that should have been let in, and [] let in evidence that should have been kept out” and accordingly reversed the convictions. Id. at 3.

First, the court found that the district court abused its discretion by refusing to admit the Latham and SEC reports. Id' Rather than usurping the jury's fact-finding role, “the Latham and SEC reports are likely to have a proper and appropriate influence on a jury's deliberations” by providing “expert assistance regarding the plausibility of expert testimony.” As this evidence “could have held significant weight with the jury,” the court concluded that the exclusion of the reports was not harmless error and reversed and remanded on this error alone. Id.

The court also found that the district court's admission of evidence and testimony regarding fraud at DiscoCare was impermissible character evidence, stating that “[the district court] should have been careful to prevent the government from dwelling on the salacious details of DiscoCare's business practices that could not be charged to the defendants.” Id. The court stopped short of saying that this alone justified vacating the conviction, but stated that the district judge erred in “allowing this breadth of testimony.”

In the Courts and Business Crimes Hotline were written by Mayer Brown associate Micah Stein.