ArthroCare Poked by SEC Probe

Certainly, Arthrocare dropped the first bombshell without warning.

Before announcing its planned restatement, Arthrocare kept insisting that it faced no major problems other than unfair attacks by short-sellers looking to profit on declines in its share price. In fact, just three months ago, Arthrocare was touting the fact that the Nasdaq had investigated its purchase of DiscoCare -- a mysterious outfit suspected of inflating Arthrocare's spine sales -- and promptly closed the probe without any findings of wrongdoing.

"The company has no reason to believe that any other government action or regulatory inquiry, investigation or review relating to Arthrocare or DiscoCare is ongoing at this time," Arthrocare CEO Michael Baker proclaimed during the company's first-quarter conference call. In fact, "in our minds, this closes the matter."

At the time, Arthrocare was handily beating Wall Street estimates -- and forecasting phenomenal growth for the future -- despite a sharp slowdown in its lucrative spine business. While Arthrocare's stock rallied on that bullish update, short-sellers never believed the company.

By the time Arthrocare announced its looming restatement this week, bears had sold a full two-thirds of the company's stock short in anticipation of a big fall.

Early Clues

Gradient Analytics, a research house that specializes in dissecting corporate filings, has felt uneasy about Arthrocare for some time.

Gradient grew particularly alarmed after reviewing Arthrocare's annual 10-K filing this spring. At the time, Gradient had just noticed some new regulatory disclosures that might signal that Arthrocare was overstating its revenue and could face some major revisions down the line.