On January 18, 2017, Orthofix International announced a resolution with the Securities and Exchange Commission (SEC) resulting from investigations of bribery claims in Brazil and “certain historic accounting matters.” Orthofix, a global medical device company, was accused by the SEC of such activities between 2011 and 2013. According to Orthofix’s President and Chief Executive Officer Brad Mason, “We are very pleased to bring closure to these collective matters.” The company placed funds into an escrow account for the SEC in late 2016 after payments accrued in the second and third quarters of last year.
Orthofix specializes in reconstructive/regenerative orthopedic and spine products for healthcare providers around the world. Based in Lewisville, Texas, Orthofix’ four primary business units are Biologics, Extremity Fixation, BioStim and Spine Fixation. Like many large medical device companies, Orthofix has a vast distribution network encompassing subsidiaries, sales team members and distributors.
Having so many hands in the proverbial pot can make for a sticky mess.
A $14 Million “Fix”
Orthofix’s January 18 announcement highlighted the company’s voluntary efforts to clean up their alleged mess—with an emphasis on voluntary.
According to the SEC, Orthofix is being fined $14 million to settle claims that the company illegally recorded revenue and made erroneous payments to doctors at Brazilian government-owned hospitals. The SEC claims these practices were an attempt to boost sales. It’s also an alleged violation of the Foreign Corrupt Practices Act (FCPA). Orthofix also agreed to a one-year analysis by a third-party to ensure FCPA compliance.
The SEC reports that Orthofix “misstated certain financial statements from at least 2011 to the first quarter of 2013.” When the company discovered the problem, it worked with the SEC and agreed to an $8.25 million penalty for accounting violations. An additional $6 million was tacked on to settle FCPA claims.
According to government claims, Orthofix’s Brazilian subsidiary faked major discounts and invoices to garner unwarranted payments via third-parties in Brazil. The SEC claims that Orthofix also recorded revenue immediately after shipping a product, even though regulations require key events to happen before marking transactions as received and paid. Allegations that Orthofix recorded revenue immediately after giving customers who had “significant extensions of time to make payments” was a manipulation of their invoicing system.
The SEC’s Allegations
SEC Enforcement Division Associate Director Antonia Chion says, “Orthofix’s accounting failures were widespread and significant, causing Orthofix to make false statements to the public about its financial condition.” The company, according to the SEC, repeatedly exaggerated distributor revenue and operating income in a smattering of quarterly reports, annual reports and earning statements. Although most of the misconduct happened with the company’s spine segment (the largest from 2011 – 2013), there were also pepperings of misconduct in orthopedic.
However, it was with the spine distributors where Orthofix repeatedly agreed to contingent sales followed by an instant revenue recognition. These earnings were recorded before the product had a chance to be re-sold to hospitals. The SEC alleged that Orthofix intentionally delayed providing related products that were needed to make a sale complete. In the U.S., Orthofix is accused of accounting for transactions by tagging discounts as expenses and not “reduction to revenue.” Some transaction revenues where the buyer had the option to exchange or return products were not recorded as such, according to the SEC.
Within the orthopedics division of Orthofix, the company is accused of not properly recognizing revenue via extra-contractual agreements in the Brazil subsidiary. For at least two years, the SEC says Orthofix used lackluster internal accounting procedures for distributor revenue recognition. Plus, Orthofix seemed to have an environment rich with “aggressive internal sales targets.” It’s alleged that Orthofix sales members were highly pressured to meet unrealistic targets.
According to the SEC Enforcement Division Chief of the FCPA unit, Kara N. Brockmeyer, “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.”
Employees Named
Five (now former) Orthofix employees and executives agreed to settlements over the alleged accounting violations.
The deal? They wouldn’t have to admit or deny anything, but they DO have to pay money back.
Bob Vaters, the company’s former CEO, wasn’t charged with anything, in keeping with the agreement with the SEC, but did personally reimburse Orthofix $72,886 in stock awards and cash bonuses earned from “error-based accounting.” Vaters’ move kept the SEC from chasing him with a Sarbanes-Oxley Section 304(a) clawback move.
Also known as a SOX Clawback, this law allows the SEC to “claw back performance-based compensation paid to CEOs and CFOs of public companies in certain circumstances.” Harvard Law School’s forum on corporate governance and financial regulation notes that, “The SEC’s power to seek clawbacks arises when an issuer has been required to restate previously issued financial statements as a result of misconduct.”
Brian McCollum, the company’s former CFO, is paying $35,000 in penalties, and agreed to reimburse Orthofix for $40,885 in bonuses.
Jeff Hammel, the company’s former accounting executive, agreed to a $20,000 penalty. Hammel is also a CPA, and made an agreement to stop practicing in such a role. He is no longer allowed to be a part of audits or financial reporting for any public company. However, Hammel can be reinstated at Orthofix in two years.
Kenneth Mack and Bryan McMillan, former sales executives, paid penalities of $40,000 and $25,000, respectively.
A New Year’s Resolution (or Two)
One resolution closes alleged accounting errors in Orthofix’ restated financial statements in March 2014 and March 2015. Orthofix self-reported the issue to the SEC voluntarily, kicking off an independent audit. The SEC notes that Orthofix was fully compliant during the investigation. Orthofix headed up “extensive remediation” after the review, analyzing internal processes and controls within their financial reporting. Large-scale initiatives were also adopted, including a myriad of direct-response internal controls and process upgrades on a more intricate level. Finally, Orthofix embraced a more streamlined and centralized financial/operational reporting method. Such an approach is in keeping with a company of Orthofix’s size.
Mason told BusinessWeek, “We have instituted broad remedial measures designed to detect and prevent the issues that led to the matters being resolved, and these resolutions allow us to continue moving forward with the Company’s critical mission of serving patients, our physician customers and shareholders.”
Orthofix tackled the second resolution regarding bribery allegations in their Brazilian subsidiary with equal aplomb.
Again, the problem was self-reported. Orthofix alerted the Department of Justice (DOJ) and the SEC followed with a comprehensive internal review with the help of third-party counsel. Again, Orthofix cooperated with the SEC as well as the DOJ. Thorough remediation efforts were embraced. Ultimately, some employees were fired, relationships with outside distributors were ended and a full global review of the company’s entire corruption and anti-bribery measures were carefully combed.
Orthofix opted to implement routine audits of all third-party sales agents and distributors to prevent similar future issues. New worldwide accounting regulations were created, strengthening the company’s structure and communication with foreign subsidiaries. A new internal audit function was added, which grew the company’s compliance department. Mason reports Orthofix brought on more compliance employees while simultaneously increasing the quality of employees. Improved anti-corruption training sessions for everyone involved in Orthofix dealings, from employees to third-parties, were also part of the “Orthofix fix.”
The DOJ decided in January 2017 to cease actions against Orthofix following the company’ efforts.
Not Their First Rodeo
In 2012, the SEC charged Orthofix for violating the FCPA. In that case, the SEC alleged that Orthofix’s subsidiary group bribed Mexican officials with monetary compensation dubbed “chocolates” to get high-profit sales contracts at Mexican government hospitals.
“Chocolates” included cash, televisions, appliances and laptops. Instituto Mexicano del Seguro Social (IMSS) was the major hospital targeted. The Orthofix subsidiary group allegedly offered to deliver these “chocolates” directly to government officials or via “fronts” that the officials owned. Supposedly, this setup worked for many years and earned Orthofix $5 million in profits. The chocolate scandal was resolved with a $5.2 million settlement with the SEC.
Former Chief of the SEC Enforcement Divisions FCPA unit Brockmeyer said, “Once bribery has been likened to a box of chocolates, you know a corruptive culture has permeated your business.”
The U.S. District Court for the Eastern District of Texas estimates the “chocolate” bribes began in 2003 and lasted through 2010. Again, false invoices were utilized in an alleged attempt to hide the profits. Also once again, when Orthofix caught wind of the subsidiary bribes in Mexico, the company immediately self-reported to the DOJ. However, the SEC says that when the Mexican subsidiary reports were “significantly over budget,” little investigation happened.
A lot has changed at Orthofix since 2010. An entirely new management team is in place and, with this settlement, the past “chocolates” and other shenanigans are, hopefully, receding rapidly into a distant past.
