Accounting & Tax

CFO Quits over Accounting Boo-boos

Revenue-recognition errors and faulty internal controls send the finance chief and two other executives packing.
Stephen TaubDecember 19, 2008

Medical-device maker ArthroCare Corp. says its CFO and two other officers have quit after its audit committee identified accounting errors and other possible irregularities.

The errors are categorized into four areas: revenue recognition, expense reclassification, purchase-price allocation or intangible-asset impairments in connection with the company’s acquisition of DiscoCare, and foreign-exchange translation.

ArthroCare added that it will expand the periods covered by a previously announced restatement of its financial statements. In addition, the company said that it and its DiscoCare subsidiary have each received grand jury subpoenas from the U.S. Attorney for the Southern District of Florida requesting documents related to DiscoCare’s operations before and after the acquisition.

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ArthroCare’s stock plunged by nearly two-thirds in Friday morning trading.

The departed CFO is Michael Gluk, who had joined the company in December 2004 as vice president of finance and administration. He previously served in a number of controllership, treasury, and business-development positions at General Motors.

The company said it is currently looking for an interim CFO.

The other two officers who resigned were John Raffle, senior vice president of strategic business units, and David Applegate, senior vice president and general manager of the company’s Spine business unit.

Most of the accounting errors and possible irregularities relate to the way ArthroCare recognized sales revenue from fiscal 2005 through fiscal 2008. These transactions involved distributors, customers, and programs in the company’s Spine; Sports Medicine; and Ear, Nose, and Throat business units, it noted. They were primarily quarter-end transactions and were frequently structured in an effort to meet revenue forecasts, according to a company press release.

The company said actions by senior sales managers, including Raffle and Applegate, were the primary cause of the accounting errors. Those actions included withholding key information and practices bearing on revenue recognition and other accounting issues from the company’s accounting staff and outside accounting firm.

ArthroCare also said weak internal controls over financial reporting were a likely contributor to the improper accounting. The company acknowledged that it is overly driven by sales generation and that some senior executives lack a proper appreciation for internal controls and generally accepted accounting principles.

Other internal-controls deficiencies included inadequate or revenue-recognition training for sales and sales support personnel; insufficient technical expertise in GAAP; inadequate controls or processes for contract and purchase-order review, or for checking exceptions to revenue-recognition policies; and an inadequate reporting structure, particularly with respect to the customer-service and order-entry functions.

“While management is in the process of remediating some of these deficiencies, some of the material weaknesses may not be remediated before the restatement is completed,” the company warned.

In addition to the audit committee review, management is conducting its own analysis as part of the restatement process. This analysis has identified additional items that will require adjustments to the company’s historical financial statements. The restatement now will include the years ended 2000 through 2005, in addition to the previously announced restatement for 2006 and 2007.