These days, with the industry under widespread government scrutiny, orthopedic-device makers are replacing a lot more than worn-out joints. This week Smith & Nephew ( SNN) hired a new CEO. The device maker joins rivals Zimmer ( ZMH), Biomet ( BMET) and Johnson & Johnson ( JNJ - Get Report) in announcing major leadership changes since the beginning of last year. All three companies have been named as targets of an ongoing Justice Department investigation into aggressive marketing practices. They have promised to cooperate with authorities while defending their conduct. Stryker ( SYK - Get Report), another DOJ target, replaced its own CEO before the government investigation began. Stryker's former chief, John Brown, has nevertheless fielded questions about the company's past stock option grants. Biomet, for its part, has confessed to issuing backdated stock options. Smith & Nephew offered no clear reason Thursday for the looming departure of veteran CEO Sir Christopher O'Donnell. O'Donnell said "the time is now right for me to hand this excellent business to a new team." But industry investors seemed rattled even before the new management shakeup. One of them, seeking answers from Zimmer CEO Ray Elliott during an analyst conference in February, wondered aloud what was going on. The orthopedics industry "has been a revolving door," the investor noted. "Do you see anything over the next five years that makes it ... a less healthy" business?
Elliott offered only reassurance at the time. "I think, in this case, the pattern is meaningless
and has nothing to do with the industry." So far, Wall Street seems to agree. Shares in the group are trading near their all-time highs, even with Smith & Nephew's 2% decline Thursday.
Still, despite that bullish outlook, Johnson reminds investors of the DOJ threat and the pain that it could bring to the industry's largest player. "The potential ... that the DOJ could impose penalties (financially or through other regulatory mandates) is a risk that could continue to weigh on investor sentiment," he acknowledged. Furthermore, "risk specific to ZMH from this issue could exist if the DOJ were to impose larger penalties on ZMH than other manufacturers." Biomet, at least, has spared public shareholders from any looming regulatory pain. The company will soon go private through a $10.9 billion leveraged buyout deal. Biomet continues to clean out its management suite in the meantime. This March, the company announced the departure of its former senior counsel -- who temporarily filled in as CEO -- as well as its finance chief. Both executives resigned after the company held them accountable for backdated stock options that require financial restatements. Meanwhile, Brown had already left the top post at Stryker before the company's past stock option grants stirred up questions last summer. Stryker has been accused of issuing options at especially opportune times -- particularly after the 9/11 terrorist attacks -- rather than backdating the options outright. Company leaders would "pick what we think would be the low point of the year" for the stock, Brown told The Grand Rapids Press back in July. "That's what we're gunning for."
However, Brown added, Stryker has since changed its practices and now issues stock options "during a relatively narrow period" each spring.