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After the sharp downturn in Arthrocare (ARTC) last week, its analyst/cheerleader decided to keep their head in the sand and defend the company with the blanket logic on the theme of “management disagrees with a short seller”. The most interesting of all the defenses was that of Piper Jaffray who not only attempted to discredit Citron but also went on in saying that their internal research did not have the company using or suggesting any improper codes. Time to do more research.

It should be clear that the controversy surrounding Arthrocare is not limited to just their spine products, as now we see it has spilled over to sports medicine. Furthermore, as you will read below, it has become a problem in the industry. This does not bode well for a company who just used all of their available cash and more buying stock and buying Discocare – a shadowy entity at the heart of the controversial billing practices in question.

The 63056 Controversy – Does Discocare Coach Doctors in Coding?

Its great to see analysts on record opining that the “proper” coding this questionable scheme is 62287. In a note released Friday, main Arthrocare cheerleader Piper stated that through their “research” doctors were using the code 62287. Even though Arthrocare’s management vehemently denied coaching doctors on coding, we have proven otherwise, yet for some reason Piper Jaffray still has their head in the sand and lives in denial. Maybe these two documents will leave them with no choice but to tell the truth about the company advocating up-coding.

Arthrocare has a doctor qualifier form for PDD surgeries. On the form it asks for the code used for billing. Do we have to tell you what is suggested?

Doctor Qualifier Form [PDF]

And if that was not compelling enough, just look at the slide from Arthrocare’s 2007 sales meeting where they discuss physician profile for their spine procedures. Slide 3 says it all as they say look for a physicians open to 63056 and looking for an increase in profitability.

To show how important it became to Arthrocare to bill through Discocare we only need to read the FAQ on Discocare on Arthrocare sales material.

FAQ Discocare [PDF]

Q- What if the facility has a wand in stock and wants to use it on a wand approved case?

A- Try to convince them to use the wand on a case where the wand is not approved. If they use their wand we can’t create a bill-only form and Discocare can’t submit reimbursement claim.

Device Reimbursement Services [DRS]

There has been much recent debate over Atrhrocare’s DRS subsidiary. It is important to note that unlike any other subsidiary Arthrocare owns, they seem to go out of their way to hide this one. Yet, during one conference call, one day Mr. Baker made a brief mention of it — by acronym.

Arthrocare’s sales training documents state that DRS targets “high volume” surgical centers and processes rebates to the physician/owners quarterly as its standard business model. That practice is at the very least a black and white violation of the Standards of Professionalism as published by the American Academy of Orthopaedic Surgeons.

Citron published clear evidence that Arthrocare raised prices on a mature product line by 100% within a two month timespan less than a year ago, with no other justification than the above business scheme was put in place to manipulate the insurance system and provide a source for funds for “rebates”.

DRS Rebate [PDF]

The term kickback has a negative connotation. It is a lot friendlier to say rebate. It is very clear that “rebating” doctors for purchasing your equipment at a higher price to insurance companies might be a problem. In this page on the DRS overview it is clear that the business model is to bill insurance companies and to rebate doctors … this explains the #1 FAQ “is this legal” question.

Nowhere in any of Arthrocare’s filings do we see a reserve for rebates to physicians using the product. On an accounting basis this makes it difficult if not impossible for investors to get an accurate measure of the company’s gross margins – which is a key metric responsible for ARTC’s juiced valuation in recent quarters.

The Scheme to Defraud: Feds Hot on the Trail

A few weeks back a story hit that went unnoticed to Arthrocare shareholders. A federal investigation started in to Blackstone medical into illegally paying kickbacks to surgeons for using their spine products.. The attorney for John Thomas, the whistleblower in the case stated, "As alleged in our lawsuit, Dr. Chan is only one piece of a big scheme that has been going on across the United States."

Conclusion

If people believe that where there is smoke there is fire, than Arthrocare is a thick black cloud that does not allow you to see a foot in front of your face. Who would want to stick around for the fire… except their few analysts?

Source: Analysts Continue Defying Logic with Arthrocare Defense