A Medical Device Daily

The Securities and Exchange Commission (SEC) reported Wednesday that it has charged Merge Healthcare (Milwaukee) and two former senior executives for their roles in an accounting fraud that ultimately caused the company's stock price to drop by two-thirds during a seven-month period.

Merge said that, in resolving the matter, the SEC decided not to charge the company with fraud nor assess any penalty against Merge for the actions of its former executives. The company was, however, charged with record-keeping violations.

Former CEO Richard Linden and former CFO Scott Veech also agreed to settle without admitting or denying the allegations against them. Linden will pay $590,000 and Veech will pay $280,000. Both men are also barred from serving as an officer and director of a public company for five years. Additionally, Veech consented to the entry of an administrative order that suspends him from appearing or practicing before the SEC as an accountant, with a right to reapply after three years. Merge is permanently enjoined from future violations of the internal controls, books and records, and reporting provisions of the federal securities laws.

The SEC alleges that Linden and Veech engineered a process where Merge improperly recognized revenue from sales that had not been fully completed with delivery of the software products, features or enhancements promised to customers. The agency further alleges that Linden, with Veech's knowledge, interfered with the audit confirmation process by instructing Merge sales personnel to tell some of Merge's customers not to disclose side agreements to Merge's outside auditor. Also, Linden signed at least 16 and Veech signed at least 14 false and misleading management representation letters to the company's outside auditor, the SEC said.

"Linden and Veech went to deliberate lengths to disguise the timing and truth behind the sales of their software products and enhancements," said Merri Jo Gillette, director of the SEC's Chicago Regional Office. "The company's weak and ineffective internal controls allowed these corporate executives to carry out the fraud."

According to the SEC's complaint, filed in federal court in Milwaukee, Merge prematurely recognized revenue from 124 transactions between 2002 and 2005, many of which involved Merge's promises to customers of "hanging protocols" that provide radiologists with the ability to rearrange the sequence and orientation of images. Under generally accepted accounting principles governing the recognition of revenue for sales of software, Merge was required to defer revenue recognition of transactions with these promises until the enhancements to hanging protocols were actually delivered in 2005 and 2006, the SEC noted.

The SEC alleges that these fraudulent accounting practices caused Merge to overstate its net revenue by about 26% and overstate its net income by nearly 230% in annual and quarterly reports from its first quarter of 2002 through its second quarter of 2005. The accounting fraud ultimately cost the company more than $500 million in market capitalization.

Merge noted that the SEC investigation ran concurrent with two shareholder lawsuits, which were resolved last year.

"Merge Healthcare is glad to see that the SEC considered the facts and circumstances, as well as Merge's cooperation, in reaching this resolution," said CEO Justin Dearborn. "This has been a long and difficult process for the company, even though these issues happened several years ago. Employees, customers and shareholders all welcome the closing of this chapter of Merge's history."

In other legal news:

• The class action lawsuits against Hansen Medical (Mountain View, California) continue to pile up with Coughlin Stoia Geller Rudman & Robbins (San Diego) reporting that another class action has been commenced in the U.S. District Court for the Northern District of California on behalf of purchasers of Hansen's common stock between May 1, 2008 and Oct. 18, 2009.

Last week two other law firms – Glancy Binkow & Goldberg (Los Angeles) and Howard G. Smith (Bensalem, Pennsylvania) reported filing similar class action suits, also on behalf of investors who bought securities of Hansen during the same period (Medical Device Daily, Oct. 27 & Oct. 28, 2009).

Like the previously reported suits, this latest complaint alleges that defendants issued materially false and misleading statements regarding the company's financial results and compliance with generally accepted accounting principles. Specifically, the complaint alleges, Hansen improperly recognized revenue associated with the sale of its Sensei systems. As a result of defendants' false and misleading statements, Hansen's stock traded at artificially inflated prices during the Class Period, reaching a high of $19.57 a share on May 13, 2008, according to the firm.

On Oct. 19, Hansen said it would be restating its financial results for 2008 and for the first and second quarters of 2009 due to its failure to properly account for its revenue as a result of an investigation by the company's audit committee. The audit committee's investigation was prompted by an anonymous "whistleblower" report Hansen received in August.

• The U.S. Court of Appeals for the Ninth Circuit has held that Medical Development International (MDI; Ponte Verda, Florida) had the right to bring its lawsuit against the California Department of Corrections and Rehabilitation (CDCR) and CDCR's court-appointed federal Receiver to recover payments for provider payments made to California Providers on behalf of CDCR and the receiver. MDI sued the CDCR and the Receiver in connection with the lack of reimbursement payments made by MDI and due under a contract performed by MDI in 2006-2007. The disputes over reimbursements made to California Providers caused MDI to file lawsuits both in federal courts and California state court to recover MDI funds expended on behalf of CDCR and Receiver.

At the trial court level, two federal district courts in northern California dismissed MDI's lawsuits ruling that MDI failed to gain approval from the Receiver's appointing court before bringing suit, and that judicial immunity also barred actions against the federal Receiver. MDI took a consolidated appeal of these decisions to the U.S. Court of Appeals for the Ninth Circuit.

In a unanimous published decision, the Ninth Circuit held that neither the Receiver nor CDCR were immune from MDI's suit, and remanded the case back to the U.S. District Court for the Eastern District of California for trial.